From Adam Smith to Maynard Keynes: The Heritage of Political Economy 9781442632080

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FROM ADA M SMIT H T O M A Y N A R D KEYNE S THE HERITAG E O F POLITICA L ECONOM Y

In thi s surve y o f th e grea t exponent s o f th e classica l tradition , Vincen t Bladen examine s th e though t an d work s o f Adam Smith , T.R . Malthus , Henry Thornton , Davi d Ricardo, J.S. Mill , Kar l Marx, W.S. Jevons, Alfre d Marshall, an d Joh n Maynar d Keynes , an d relate s thei r view s t o moder n situations. Thi s i s a persona l introductio n b y on e o f Canada' s senio r economists t o som e o f the grea t books in the Englis h literature o f political economy. Vincen t Blade n wrot e i t t o induc e a n interes t i n an d a n understanding o f the economi c classics , in th e belie f tha t contemplatio n of thos e work s wil l increas e ou r understandin g o f curren t economi c writing and curren t economi c problems . For th e purpos e o f discussing th e developmen t o f 'wealth' - th e majo r concern o f economists - Blade n define s fou r period s withi n th e classica l tradition, an d demonstrate s tha t i n eac h ther e appeare d a characteristi c preoccupation wit h a particula r are a o f economics. From Ada m Smit h t o John Stuar t Mil l th e principa l concer n wa s productivit y an d growth ; th e neoclassical economist s represente d b y Jevons an d Marshal l emphasize d the problem s o f allocatio n o f give n productive resources ; depression s i n the twentie s an d thirtie s an d th e impac t o f Keynesia n theor y le d t o a preoccupation wit h 'employment, ' an d afte r Worl d Wa r I I attentio n shifted t o 'growth. ' Blade n i s critica l o f previou s historie s o f economi c thought: 'b y isolatin g th e treatmen t o f on e elemen t i n a comple x an d integrated syste m o f thought the y frequentl y misrepresen t eac h author' s treatment o f th e particula r element. ' I n thi s wor k h e attempt s t o sho w each aspect o f the wor k of the economist s h e has selecte d in the contex t of an integrate d whole . wa s formerly Professo r o f Economics, Directo r o f th e Institute o f Industria l Relations , Directo r o f th e Institut e o f Busines s Administration, an d Dea n o f th e Facult y o f Art s an d Scienc e a t th e University o f Toronto . I n 1960-6 1 h e serve d a s a one-ma n Roya l Commission t o inquir e int o th e automobil e industr y i n Canada . A t present h e i s a n honorar y lecture r a t Scarboroug h College , Universit y of Toronto. VINCENT BLADE N

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VINCENT BLADE N

From Adam Smith to Maynard Keynes: the heritage of political economy

UNIVERSITY O F TORONT O PRESS

© Universit y of Toronto Press 1974 Toronto and Buffal o Printed in Canada ISBN 0-8020-2136-0 (cloth) ISBN 0-8020-6239-3 (paper) LC 73-91568

To the memory of Charles Ryle Fay

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Contents

FOREWORD / Xi

INTRODUCTION / XV

Book One

THE WEALTH OF NATIONS

i. The role of labour / 3 2 Som e problems of terminology / 7

Real price; Value; Labour command or purchasing power; Labour command of particular goods

3 Th e Wealth o f Nations: the theory of production /13 Division of labour; Mone y 4 Ada m Smith on value /19 Utility; Real price; Natural price

5 O n distribution / 34

Wages; Profits; On wage differences

6 Th e neglected and exciting Chapter xi: on the rent of land / 47 Precious metals; Changing real price of cattle; The three orders of man

7 Mone y / 58 8 Productiv e and unproductive labou r / 62

9 Saving s and investment / 69 10 Tow n and country / 75 11 Internationa l trade / 79

The benefits; Free trade; Obiter dicta; Colonial trade

12 Laisse z faire / 91 13 Th e education of Youth/96 14 Th e canons of taxation /101 Digression i: Consumer sovereignty /104 Digression 2: The pursuit of wealth /114 Gross National Product; Rea l cost; Net produc t Digression 3: On competition /123 Book Two

THE CLASSICAL ERA: MALTHUS AND RICARDO TO MILL AND MARX

Introductory statement/12 9 1 Malthu s and population /130 i Facts and fears /130 ii The Malthusian population thesis /135 2

2 Malthus : the economist /144 i The poor laws /144 ii Effective demand : the Ess ay an d th e Investigation I 148 in The over-saving thesis: the Essay and the Principles 1149 3 Th e paper pound: Thornton, Ricardo, and Malthus /154 i The climate of opinion /154 ii The historical context /158 in The Paper Credit of Great Britain 1160 iv The High Price of Bullion 1167 v Ricardo and the Ricardian theory of the mechanism of adjustment /173 vi Postscript, us, 193 0 /175 4 Th e Ricardian theory of value and distribution /176 i The Corn Law controversy /176 ii Malthus: Observations on the Corn Laws I '178

in Ricardo: Influence of a Low Price of Corn on the Profits o f Stock, 1815/182 iv Ricardo's Principles (1817) /188 Profit continued; On value; On rent; On wages; On profit; On machinery; O n foreign trade; Conclusion

5 Joh n Stuart Mill, general characteristics / 206 i The Autobiography I 207 ii Mill on method / 213 The antagonizing principle s

in Means and ends / 220 iv Mill and social change / 224

6 MSTs Principles 122& i The degre e of productiveness of productive agents / 228 ii Investment in human capital / 233 in Capital and development / 235 iv Population and production / 241 v Distribution: institutions/ 244 vi Distribution: analysis / 247 vii Value / 252 vni The theory of money / 257 ix International trade / 261 x The dynamics of Book iv / 263 xi Of the functions of government / 268 7 Kar l Marx / 272 i The Communist Manifesto I 272 ii The preface s to Capital I 282 in The labour theory of value / 284 iv Exchange / 290 v The theory of exploitation / 293 vi The workin g day / 297 vn Absolute and relative surplus value / 301 vni 'Net revenue' and 'surplus value' / 306 ix Accumulation / 308

The general law of capitalist accumulation; Primitive accumulation; The climax

xTwo notes/ 313

Value and price; The business cycle

Book Three

AFTER MILL

Introductory statement/ 319

1 Willia m Stanley Jevons/322 i Papers read at the British Association in 1862 / 322 ii The pamphlet on gold (1863) / 328 in The Coal Question (1865) / 332 iv The Theory o f Political Economy (1871 ) / 337 v Utility and exchange / 339 vi Labour, land , and capital / 343 vii Jevons andCliffe Leslie / 348 vm Some other writings / 350 2 Alfre d Marshall / 358 i Introduction / 358

Marshall and Jevons; The role of mathematics; Marshall and the Historical School

ii The Principles, general characteristics / 367

Preface t o the first edition; Book i: preliminary survey; Book ii: some fundamental notions

in On wants and their satisfaction (Book in) / 373 iv The agents of production (Book iv) / 376 v General relations of demand, supply and value (Book v) / 381 vi Distribution of the national income (Book vi) / 392 vn Marshall on money / 402 vm Marshal l on the classics / 403 3 Joh n Maynard Keynes / 405 i Introduction / 405 ii Indian currency / 407 in The economic consequences o f the Peace Treaty / 412 The Melchio r story; Economic Consequences o f the Peace Treaty

iv Monetary policy, the Tract an d The Economic Consequences of Mr Churchill / 425

A Tract on Monetary Reform (1923) ; The Economic Consequences o f M r Churchill (1925)

v From monetary policy to investment policy: the way to the Treatise 1438 vi The Treatise 1448 vii Between the Treatise and the General Theory 1 468 vm Th e General Theory 1 476 ix How to Pay for th e War 1486 x Epilogue / 488 NOTES / 492 BIBLIOGRAPHY/503 AUTHOR INDEX/513 SUBJECT INDEX/517

Foreword

This is not a history of political economy, but rather an introduction to a few o f the grea t books i n the Englis h literature of political economy . It s purpose is to stimulate its readers to read the classics. I hope to induce an interest i n these works, and to foster among those wh o do read them an understanding of them and an appreciation of their quality. It is not an antiquarian interest that I want to promote, for I believe that contemplation of the work of the great economists of the past will increase the reader's understanding of current economic writing and of the contemporary economic world . This last is the most important, and I would add that I a m concerned t o increas e understandin g in order t o improv e the functioning of the economic syste m and thereby the quality of human life. My concer n goe s beyond the positive science o f economics to the ar t of political economy, to problems of economic policy. I recognize, and emphasize here, that the strength of the positive science is o f vita l importanc e t o th e art . Indeed , th e weaknes s o f analysis an d prediction makes many well-intentioned interventions useless or harmful . Professor Milton Friedman in his Essays in Positive Economics conclude s that differences abou t economic policy 'derive predominantly from differ ent predictions abou t the economic consequences o f taking action, differ ences tha t i n principl e ca n b e eliminate d b y th e progres s o f positiv e economics.'1 There remain, of course, 'difference s i n basic values, differ ences abou t whic h men can ultimately only fight.' 2 I concu r in this first proposition an d hope for more rapid improvement in the positive science than has been evident. I believe, however, that persuasion may reduce the differences i n basic values and thus eliminate the need to fight. There will

xii Foreword be som e attention to th e value s assume d in th e normativ e parts o f th e classical literature, and to the alternative values that may underlie differ ences in policy prescriptions then and now. There is, as Professor Redfield3 reminded us, an element of'art' in social science. Alfre d Marshal l had this element in mind when he wrote: 'Th e economist needs the three great intellectual faculties, perception, imagination, and reason, an d mos t of all he needs imagination.' 4 More recentl y Professor Bouldin g has said: 'Insigh t (judgment) and logic (mathematics) are strictly complementary goods. '5 We know a good deal about training in scientific techniques , bu t w e kno w incredibl y littl e abou t th e way s t o develop imaginatio n or judgment. Indeed, I hav e sometime s bee n con cerned lest we kill imagination in the process of training in the science. I cannot prov e tha t stud y of the grea t classic s wil l help to develo p thes e scarce qualities of imagination and judgment: but I assert that it will help some of us. I t i s worth trying, and I tak e great comfor t from Professo r Schumpeter's assertion of this point of view: Our minds are apt to derive new inspiration from the study of the history of science. Some do so more than others, but there are probably few that do not derive from it any benefit a t all. A man's mind must be indeed sluggish if, standing back from th e work of his time and beholding the wide mountain ranges of past thought, he does not experience a widening of his own horizon.6

Similarly, Lord Robbins: 'I suspect that damage has been done, not merely to historical and speculative culture , but also to our practical insight, by this indifference to our intellectual past - this provincialism in time - which has been so characteristic of our particular branch of social studies.' 7 H e went o n t o say : 'I t i s n o exaggeratio n t o sa y tha t i t i s impossibl e t o understand the evolution and the meaning of Western liberal civilization without som e understanding of Classical Politica l Economy.' 8 The con tribution of the classical political economists to this cultural heritage may well have been as important as their contribution to the development of the science of economics. Modern economists have, I believe, some responsibility for conserving and interpreting this part of our cultural and intellec tual heritage. I hope I can make some small contribution to this end. I hav e quote d extensivel y fro m th e classica l work s whic h I see k t o interpret, and , becaus e I wan t m y readers t o g o to thes e works , pag e references to them are given in the text. Quotations from other writers have accumulated i n my notes ove r th e forty-fiv e year s durin g which I hav e lectured o n this literature. I have given references where I would, but I have no t eliminate d quotation s tha t wer e appropriat e simpl y because I

Foreword xiii could not give the proper reference. I am confident that they are reasonably accurate. These references are grouped together at the end of the book. My use of the quotations noted there is in general either to give me courage in making an interpretation whic h is not widel y accepted, o r to giv e me a better exposition of a point which I want to make very clear but find difficult to express as well as it has been in the quotation. I am not trying to provide a guide fo r scholar s t o th e critica l literatur e o f the subject . My writing is directed to undergraduate rather than graduate students of economics; and I hop e that students of all ages and of other disciplines may find that my guide to the literature will lead them to it. I dedicate this book with affection an d respect to the late Charles Ryle Fay, a Fellow o f Christ's College, Cambridge , and for some ten year s a professor o f economic history in the University of Toronto. His encouragement, advice, and criticism were of very great importance ip my intellectual development , and particularly in my work on the classica l litera ture. He recognized that a senior professor had a great responsibility for the education not only of his students but of his young colleagues. Thi s relationship is not alway s easy, but i t is, I believe , on e which every senio r professor shoul d try t o establis h wit h at least tw o or three o f his young colleagues. Finally, let me say that what I have written is the substance of lectures delivered at Scarborough College in the University of Toronto. They ar e the resul t o f man y years ' teachin g i n th e Universit y o f Toronto . M y indebtedness i s so great, an d to s o many people, tha t I canno t begin to acknowledge and thank them individually, but I must express my gratitude to the University of Toronto for having given me, over half a century, the opportunity t o develo p unde r th e stimulu s of a successio n o f brilliant colleagues an d students ; t o Scarboroug h Colleg e i n that Universit y for allowing m e t o cbntinu e t o teac h thoug h 'emeritus, ' an d fo r providing renewed stimulus from a new group of young colleagues; to Massey College for its hospitality since retirement deprived me of my office o n the St George Campus; to Dr Lorie Tarshis for encouraging me to publish; to my daughter Katherine for persuading me to write this book and for assistance in th e earl y stages ; t o Mr s Bradley , one o f the academi c secretaries o f Scarborough College , wh o type d muc h of th e firs t draf t an d al l o f th e second; to Alison Adair for editing the manuscript with skill and sympathetic acceptance of my idiosyncrasies; and to the University of Toronto Press for undertaking publication. VWB January, 1973

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Introduction

Political economist s hav e been , an d are, concerne d wit h wealth. Fort y years ago when I said to students that we did not need to apologize for this most of them wondered why I found it necessary t o offer a defence. In the last few years many, perhaps most, of my students have been critical of this concern for increasing wealth and rapid economic growth. I have therefore included in Book i a Digression on the pursuit of wealth, a defence in these affluent day s of our continued preoccupatio n wit h wealth. Of course th e ultimate concer n i s for well-being , welfare, 'weal. ' Tha t politica l econ omists have concentrated attentio n on the more or less measurable wealth rather tha n o n the quit e immeasurabl e welfare does no t mea n that they have equated wealt h an d welfare or tha t the y hav e assumed tha t al l increases i n wealth promised some increase i n welfare, still less a proportionate increase. But the writers whom I have selected as the great exponents of the classical traditio n of political economy, from Adam Smith to Maynard Keynes , hav e al l bee n distresse d b y th e huma n degradatio n associated with poverty. They believed that increasing wealth was a necessary conditio n o f the eliminatio n of poverty an d they hoped that , eithe r through economic necessity - i.e., through free market forces - or through intelligent state action, increasing wealth would yield decreasing poverty. Adam Smith saw the 'liberal reward of labour' as the 'necessary effect of increasing national wealth': increasing wealth seemed to promise increasing demand for the services o f others. He was optimistic, expecting tha t wealth woul d increas e a s government s gav e up thei r restrictiv e regula tions. Malthus introduced an element of pessimism: population might grow

xvi Introductio n faster tha n wealth , an d th e numbe r o f worker s mov e rapidl y tha n th e demand for their services. That worr y persisted throughou t the literature and th e 'Malthusia n Devil ' ha s not yet been finall y exorcised . Ricardo's worry was with the threat of declining profit. This was not a simple class concern o f th e capitalist , bu t rathe r tha t lo w profi t woul d caus e slo w accumulation, slo w growth in wealth, and in the demand for labour, an d thus elimination of the chance that wages would be above subsistence long enough for the necessary standar d of subsistence to be revised upward and a permanent improvement in the condition of the workers be achieved. Mill also feared population growth, but was impressed by the increasing rate of growth in productivity and was hopeful that education of the working class would lead the m to intelligent famil y planning . Marshall was even mor e optimistic: he also stressed education, but saw it as increasing the productivity of the workers so that the demand for their services would increase, rather tha n th e suppl y o f worker s decrease . I n Keyne s th e optimis m became greater : i n hi s essa y o n 'Th e Economi c Possibilitie s fo r Ou r Grandchildren' (1928) he argued that 'assuming no important wars and no important increase in population the economic problem may be solved, or be at least withi n sight of solution, withi n a hundred years.' 1 If war, and population growth in the Third World, make us less optimistic today, the enormous advance s i n science an d technology mak e the prospect of the solution of the economic problem in the next hundred years not unreasonable. There will remain the human problem of achieving welfare, of making intelligent use of the leisure and the plenty that we achieve. Political economist s in their studies of wealth and 'plenty' have interpreted wealth to mean 'wanted' things. They have analysed the working of an economi c syste m i n which productive resource s ar e allocate d i n re sponse to consumer demand. They went beyond description and analysis to approval. In my Digression on consumer sovereignty I discuss some of the issues involved. Through the literature one finds frequent references to the unsatisfactor y character o f muc h o f th e wealt h produced . Thi s i s particularly evident in Mill and Marshall. So, along with scientific analysis of the conditions of increasing wealth and of the influences determining its distribution there will be found a lot of preaching about the use and abuse of wealth. This may shock the 'scientists': but surely it is, a salutary shock. Few of them can refrain fro m prescription, thereb y imposing on the community thei r ow n values , no t botherin g t o preac h the m bu t assumin g agreement. Economists must recognize that increasing welfare depends on improvement in the arts of consumption as well as in the arts of production: but the y mus t als o b e awar e tha t the y ar e no t th e sol e judges o f what

Introduction xvi i constitutes 'improvement'; they must recognize that the workers' welfar e depends on the wisdom with which they employ their increasing ability to consume, but they must realize that they are not appropriate judges of such 'wisdom.' The preaching of the economists may offend some by its limited, middle-class, Victorian , standards . Bu t i t raise s issue s o f importance , perhaps increasingl y s o as affluenc e develops , a s the art s o f productio n develop to the point where the economic problem comes nearer to solution. In passin g fro m th e earlie r t o th e late r economists , on e finds some, though unhappil y slow , improvemen t i n th e qualit y o f th e scientifi c analysis of the economi c process . Th e natur e of this development i s described in Appendix B of Marshall's Principles. The changes may, perhaps, be regarded as passing onward from that early stage in the developmen t o f scientifi c method , i n whic h th e operation s o f Natur e ar e represented a s conventionally simplified fo r the purpos e o f enabling them to b e described in short and easy sentences, to that higher stage in which they are studied more carefully an d represented mor e nearly as they are, even at the expens e of some loss of simplicity and definiteness, and even apparent lucidity. And in consequence general reasoning in economics has made more rapid progress, and established a firmer position in this generation in which it is subject to hostile criticism at every step , than when it was at the height of its popularity and its authority was seldom challenged.2

The 'newe r an d stronge r machinery ' whic h he sa w being 'steadil y an d patiently built, ' muc h of which he himself built, enabled economists , h e said, 't o be more scientific and much less dogmatic than those good and great me n wh o bor e th e firs t brun t o f the battl e wit h the difficultie s o f economic problems; and to whose pioneering work we owe our own more easy course.' But the change was not simply in the skill in developing more satisfactory answer s t o th e ol d questions ; i t wa s th e question s tha t changed, mainly under the insistent external pressure of economic events but partly under the internal pressure of 'idle curiosity' and the spillover of ideas from othe r sciences . Four periods may be roughly defined by reference to this change in the questions bein g asked, though of course a t no time was there exclusive concentration on one of the broad areas of inquiry which I identify . Ye t each period showe d a characteristic preoccupatio n with a particular area. From Adam Smith to John Stuart Mill the principal concern wa s with productivity and growth. The neoclassical economist s represented b y Jevon s an d Marshal l induce d a preoccupatio n wit h th e problems o f 'allocation ' o f given productive resources . Th e distressin g

xviii Introductio n unemployment i n Englan d i n th e twentie s an d throughou t th e Wester n world i n th e thirties , an d th e impac t o f Keynesia n theory , distracte d attention from allocatio n an d led to a period o f preoccupation wit h 'employment.' After worl d war n attentio n shifte d t o 'growth, ' comin g in a sense in full cycl e to the concern o f the first period, thoug h with new and improved engines of inquiry. Each generation ha s allowed its own preoccupation to colour its view of the work of its predecessors. The work of the classical economist s is now more generously, and I think more correctly, interpreted b y the present generation o f 'growth' economists tha n by the old generatio n o f 'allocation, ' 'equilibrium ' economists . I t i s scarcel y necessary t o ad d that, thoug h improvement in theory i s likely to be associated wit h preoccupatio n wit h a particula r aspect , improvemen t i n policy must come from an integrated attack on all aspects: the problem may be t o induc e a n increas e i n resource s an d i n thei r productivit y an d t o guarantee thei r full utilizatio n and rational allocation . Undu e preoccupa tion with one aspect ma y lead to unwise neglect of another, the gain from improved understanding of the one may be partly offse t b y the loss fro m neglect of another. Finall y one must not ignore the alternative form s the gain may take: more goods or more leisure, more goods or less human cost of the present supply , more goods for the rich or more for the poor, more private goods or more public goods. I must now introduce my nine 'principals' and say something about the supporting cas t whos e performances I neglect. 3 They ar e no t neglecte d because I think their work is negligible, but because I think that intensive study o f a fe w i s educationall y more valuabl e than superficia l stud y of many: lecture time and book space are limited, as indeed are the time and energy which may reasonably be devoted to the literature of the past by an undergraduate student in economics. The criterion of selection of the few (a very orthodox one) is my estimate, based on half a century of teaching, of the valu e o f th e stud y o f thes e author s i n th e educatio n o f politica l economists. I have dealt with each so as to show, as far as possible, each aspect of his work in the context of an integrated whole. I have read many histories o f doctrine which are organize d by subjec t rather than author: they assess the contribution to the theory of value, or wages, or profit, or whatever, of one economist after another. By isolating the treatment of one element i n a comple x an d integrate d syste m of thought they frequently misrepresent eac h author' s treatmen t o f that particula r element . Adam Smith on wages must be studied in the context of the dynamics of growth, of the total inquiry into the Wealth o f Nations: Ricardo on profits must be studied in the context of th e Principles wit h its special definition of'value '

Introduction xix and its peculiar view of what constitutes an increase in profits (an increase in th e rea l valu e o f th e shar e o f th e nationa l dividen d accruin g t o th e capitalist class). First, I introduce Adam Smith (1723-90) ,4 who was graduate of Glasgow and Oxford. He was so well educated at Glasgow, where he was a pupil of the liberal philosopher France s Hutcheson, tha t seven years of neglect at Balliol College, Oxford, provided a valuable opportunity to read and think undisturbed. After three years as a free-lance lecturer in Edinburgh, he was appointed in 1751 Professor o f Logic, and very soon afterwards Professor of Mora l Philosoph y i n th e Universit y o f Glasgow . Mora l philosoph y embraced, in those days, economics. A set of student notes of his Glasgow lectures were found, edited, and published by Edwin Cannan; Lectures on Justice, Police, Revenue and Arms (1896). In them 'cheapness and plenty' are matter s of'police. ' Durin g his tenur e o f this chai r h e publishe d The Theory o f Moral Sentiments (1759) which earned him a considerable liter ary and scholarly reputation. H e resigned from his chair in 1763 to become tutor to the Duke of Buccleuch, and spent some four years on the continent with him : the intellectua l stimulatio n o f Paris, o f conversation wit h th e Physiocrats, o f meeting s wit h Quesna y an d (i n Geneva ) wit h Voltaire , made this period as tutor to a nobleman very valuable to the scholar. On the conclusion of this task he was given a generous pension and spent the next ten year s writin g Th e Wealth o f Nations. I n 177 8 h e wa s appointe d a Commissioner of Customs for Scotland , whic h was a real job an d not a sinecure. In the Wealth of Nations Adam Smith said: In th e progres s o f society, philosophy or speculatio n becomes, like every other employment, the principal or sole trade of a particular class of citizens. Like every other employment too, it is subdivided into a great number of different branches , each of which affords occupatio n to a peculiar tribe or class of philosophers; and this subdivisio n of employment in philosophy .. . improve s dexterity and save s time.5

This subdivisio n is no t wel l illustrated b y hi s ow n work : the survivin g student lecture notes, those on Be lie Lettres which have now been added to those on Justice and Police, the Dissertation on the Origin of Languages appended t o the Moral Sentiments, and the Essays on Philosophical Subjects published by his executors, indicat e the range of his interests rathe r than 'subdivision' of philosophical inquiry. One of the Ess ays, that on 'Principles which lead and direct Philosophi-

xx Introduction cal Enquiries : illustrate d b y th e Histor y o f Astronomy,' wa s calle d b y Schumpeter 'th e pearl of the collection.' Schumpeter added : 'nobody .. . can have an adequate ide a o f Smith's intellectua l statur e wh o does no t know these essays.'6 As a tribute to the fact that dexterity was high though division of labour was low, Schumpeter's commen t is important: but it is characteristic of his treatment of Adam Smith that it disparages the intellectual achievement of the Wealth of Nations. Much as I admire Schumpeter, my admiration for Adam Smith is not diminished by his disparaging comments . Of course, economic thinking did not begin with Adam Smith, and it is not difficult t o show that individual ideas were not original; but it was Adam Smith who became, a s Schumpeter admits , the teacher o f the professionals. 'Th e thought of most of them, including Ricardo, started fro m him and most of them again never got beyond him. For half a century or more .. . Ada m Smit h supplie d th e bul k o f th e idea s o f th e averag e economist.'7 Adam Smith came to be thought of as the 'founder' and earlier economists as 'precursors' in whom, said Schumpeter, 'it was just wonderful t o discove r wha t nevertheless remaine d Smith's ideas. ' Perhap s th e historian of ideas is too ready to give credit to the earliest, s o far discovered, exponent of an 'original' idea rather than to the author who secured acceptance of the idea and worked it into his system of thought. It is not the originality of Adam Smith but the effectiveness of his systematic exposition as a foundation on which others woul d build, tha t justifies the title founder, and explains why I begin with him and think of him as one of my heroes. Of the Wealth of Nations I want to say here three things. First, it was a superb literary achievement ranking, I suggest, with Gibbon's Decline and Fall. Second, it was a crusading political pamphlet: a plea for liberty, free choice by the consumer, freedom to innovate for the capitalist, freedom to move fro m plac e t o plac e an d fro m occupatio n t o occupatio n fo r th e worker. I have quoted some of his vigorous pleas for liberty. But the plea for liberty did not mean a policy of rigid laissez faire. This I have discussed in Book i, chapter 12 . Again I note in Schumpeter what I believe to be the common misrepresentation: writin g of Justi he said:' His laissez-faire was a laissez-faire plus watchfulness, his private-enterprise economy a machine that was logically automatic but subject to breakdowns.'8 Compared with Adam Smit h 'his vision of economic policy migh t look like laissez-faire with the nonsense left out.' There was, in my view, no 'nonsense' in Adam Smith's version : tha t appeare d i n some of his less intelligent followers. Third, it was a wise blending of analysis and history, not a 'mixture' but a 'compound.' When its centenary was celebrated by the Political Economy

Introduction xxi Club 9 the 'wa r of the methods' wa s being waged, bu t Adam Smith was praised b y both parties. Mr Lowe claime d him for the deductive school , attributing to him 'the unique merit... of having founded a deductive and demonstrative science. ' M . Lavaley e recognize d hi s wor k a s a perfec t example o f th e 'allianc e de s deu x methode s scientifiques , l a method e deductive e t l a method e inductive. ' Thorol d Roger s claime d a n eve n greater share in the glory of the master for the historical school: 'He always appealed t o facts, i.e. he framed inductions for the conclusions at which he arrived.' O f thes e judgments surel y tha t o f Lavaleye wa s th e best : th e Wealth of Nations showe d that the 'alliance' was 'fecond en consequences utiles.' It doe s no t see m necessar y t o introduc e m y other principal s a t suc h length; the understanding of the literature does not depend on biographical information, but some such information emerges from the discussion of the literature. Perhap s on e should draw attention to the slowness with which the divisio n o f labou r proceed s t o th e poin t wher e th e professio n o f economics i s established , an d th e professor s o f economic s becom e it s leaders. Thoma s Rober t Malthu s (i766-i834) 10 wen t t o Jesu s College , Cambridge as a 'pensioner' in 1784, graduated as Ninth Wrangler in 1786, was elected to a fellowship in the College in 1793. He took orders and held a curacy at Albury, and later held a living in Surrey. In 1804 he was appointed Professor of Modern History and Political Economy at East India College, Haileybury. He was a professor, like Adam Smith, but of political economy rather tha n moral philosophy. Hi s appears t o have been the first chair in political econom y established i n England: though others were soon established i t i s only with Jevons an d Marshal l that professors o f economic s appear as 'principals.' If Adam Smith was concerned with the causes of the wealth o f nations, Malthu s may be sai d t o have concerne d himself with their poverty, first with over-population and later with under-employment. His writing s o n mone y an d ren t I hav e use d largel y fo r th e purpos e o f contrast wit h Ricardo: the bulk of his Principles I have ignored as not very helpful for my purposes, but I do refer to the parts dealing with over-saving and depression. Henry Thornton (I76o-i8i5) n wa s a banker, a member of parliament from the age of twenty-two until his death, and, with William Wilberforce, the founder of an evangelical wing of the Church of England known as the 'Clapham Sect.' He gave evidence before the Committees of the House of Commons and of the House of Lords at the time of the suspension of cash payments in 1797; he was a member of the Committee on Irish Currency in 1804 and of the Bullio n Committee in 1810 . He played a major role in the

xxii Introductio n writing of the Bullion Report an d in the ensuing debates in the House of Commons. I have included his Paper Credit of Great Britain because of its superb quality, incredible modernity , and contrasts wit h Ricardo's High Price of Gold Bullion. His later speeches sho w how much agreement there was on 'long run' policy; the Paper Credit emphasized th e importance of recognizing short-run problems and the difficult y o f reconciling th e longrun and short-run solutions. H e and Malthus may have been too ready to accept the short-run solution: Ricardo was certainly too ready to ignore the short-run difficulties . David Ricardo (i772-i823)12 was the son of a Sephardic Jewish family which had come to England from Hollan d i n 1760 . He was sent back t o Holland t o be educated a t the Talmud Tora attache d t o the Portugues e Synagogue i n Amsterdam. H e wa s disinherite d b y hi s famil y whe n h e married a Quaker, but a s a stockbroker an d loan contracto r h e mad e a sufficient fortun e to retire a t the ag e of forty-two. He bought an estate, Gatcombe Park , i n Gloucestershir e an d devote d himsel f t o stud y an d writing. In 181 9 he became a member of the House of Commons. When he died his fortune was shown as £750,000. He, like Thornton, was a professional financier and an amateur economist. Hi s earlier writing s are pamphlets directed to the urgent problems of the day, currency and the corn laws. Hi s Principles wa s th e produc t o f hi s leisur e i n retirement . H e appears to have written it to clear up for himself and a few friends disputed and doubtful points of theory. He was persuaded, almost bullied, to publish by James Mill. It is a difficult book. Professor Blaug praises him for having 'literally invented the techniques of economists' an d for his 'gift for heroic abstraction.' Marshall said that he built his own Principles, or rather Book v, o n his early effort s t o make more general the Ricardian analysis. Bu t Marshall was acutely awar e of the danger of heroic abstraction : To r th e sake of simplicity of argument, Ricardo and his followers spoke as though they regarded man as a constant qualit y .. . The people the y knew most intimately were city men.' This seeme d t o 'impl y that other Englishme n were very much like those they knew in the city ... The same bent of mind that led our lawyers to impose English civil law on the Hindoos, led our economists to work out their theories on the tacit assumption that the world was made up of city men.'13 Marshall gave credit to John Stuart Mill, who may be considered i n one sense a s the great Ricardian, for directing th e attention o f economists t o th e 'pliability ' o f human nature, an d t o th e human as distinguished from the mechanical view of economic behaviour . Heroic abstractio n continued , indee d mathematica l formulation made it even more productive: but heroism implies recognition of danger.

Introduction xxii i John Stuart Mill (i806-73)14 needs less introduction since I have quoted at some length from his Auto biography. Lik e his father, James Mill before him, John Stuart was a servant of the East India Company. He entered as a clerk in his late teens, and was chief clerk from 185 6 to 1858. He retired on pension when the government of India was transferred from the Company to the Queen. In retirement he devoted himsel f entirely to writing, except for thre e year s servic e a s a membe r o f th e Hous e o f Commons . Th e 'subdivision' o f the trad e o f philosophy i s no more evident in his caree r than in that of Adam Smith. He wrote his two great books, the Logic and the Principles of Political Economy whil e performin g important officia l duties. But, further, his writings as a whole are voluminous and cover an extraordinary diversit y o f subject. Apart fro m th e man y articles i n journals, he wrot e th e Essay o n Liberty (1859) , Representative Government (1861), Utilitarianism (1863), his Examination o f Si r William Hamilton's Philosophy (1865) , Auguste Comte and Positivism (1865), The Subjection of Women (1869). All this new writing was done while continuing his work on the Principles a s one revised edition followed another from th e first in 1848 to the seventh in 1871. His great editor W.J. Ashley, writing in 1909, said of the Principles that 'it will continue to be read and will deserve to be read. It represent s a n interesting phas e i n the intellectual histor y o f the nineteenth century . Bu t its meri t i s more than historical .. . I t i s a great treatise, conceive d an d executed o n a lofty plane , an d breathing a noble spirit... For a long time there will be much that even those who most diffe r from him will still be able to learn from his pages.M 5 It is well that it has been superseded a s the usual introduction to economics (as in the Oxford of my day or the McGill of Jacob Viner's ) but it would be unfortunate if it were relegated to the historian and the antiquarian. Karl Marx (i8i8-83)16 was the so n of a Prussian lawyer. He took hi s doctorate in philosophy at the age of twenty-three but was precluded fro m the academi c caree r fo r which he was eminently qualified becaus e o f his radical philosophical views . He went into journalism, becoming editor of a new radical paper, Rheinische Zeitung. After fifteen months the paper was suppressed and Marx went into exile, first to Paris till the Prussians secured his expulsion from France, then to Brussels where he wrote, amongst other things, The Communist Manifesto. Th e revolutionary movements of 1848 took him back to Paris an d to the Rhineland to edit the Neue Rheinische Zeitung. The collapse o f the revolutions forced him to leave Germany for France. He was not welcome there and so he went to England. He lived in London and worked in the British Museum for the rest of his life. Throughout thi s perio d hi s grea t frien d Frederic k Engel s gav e hi m vital moral ,

xxiv Introductio n intellectual, an d financial support. The two names, Marx and Engels, are inextricably intertwined. I have explained i n my chapter o n Marx why I have felt that I should discuss his economics without reference to his total philosophy. Here I think I should draw attention no t to the philosophica l works tha t I neglect , bu t t o th e pamphlet s o n political strategy . Som e articles in the Neue Rheinische Zeitung were reprinted as Revolution and Counter-revolution in Germany. The experience of France was examined in Class Struggles in France, 1848-50 and in The Eighteenth Brumaire of Louis Bonaparte. Later h e wrote a critical accoun t o f the leaders o f the Paris Commune. In his writing and in personal contacts Marx continued to advise and to direct the revolutionary leaders of Europe. But this book is not concerne d wit h the histor y o f Communism. It i s a very limited an d 'bourgeois' interes t i n Marxian economics tha t explain s hi s inclusion a s one of my 'principals.' William Stanle y Jevon s (i835-82) 17 wa s th e so n o f a Liverpoo l iro n merchant. H e wen t t o Universit y College , London , t o stud y science , especially botan y an d chemistry. Walkin g through the streets of Londo n when a student he became aware of the problem of poverty and anxious to play some part in its solution. Before completing his degree he accepted an appointment as Assayer at the Mint in Sydney, Australia. While there he made carefu l meteorologica l observations , developin g a n approac h t o statistical work which was later directed to his economic studies. Having saved a little mone y h e returned to Londo n t o complet e hi s bachelor' s degree in science and to take his master's degree in economics: h e then secured a n appointmen t a s a tutor a t Owen's College , Manchester . H e returned t o Londo n i n 187 6 a s Professo r o f Economic s a t Universit y College. H e i s mos t generall y remembere d fo r hi s pure , mathematica l theory: bu t hi s wor k reall y illustrate s th e fecundit y o f tha t allianc e o f deductive an d inductive studie s abou t whic h M. Lavaleye spok e a t th e Adam Smit h Centenary . An d i t wa s onl y a t Londo n tha t hi s teachin g appointment was in the economics subdivision: at Owen's College he also taught Logic , an d hi s Principles o f Science, A Treatise o n Logic an d Scientific Work i s a n important book . Late r i n his lif e h e wrot e severa l elementary outlines of economics an d logic: Elementary Lesson in Logic (1870), Primer ofLogic ( 1876), and Primer of Political Economy (1878). He also wrote a somewhat more elaborate elementar y textbook o n money: Money an d th e Mechanism o f Exchange (1875) . O f thes e textbook s Keynes wrote: 'For a period of half a century all elementary students both of logic and of political economy in Great Britain and also in India and the Dominions were brought up on Jevons. Hi s little books involve few per-

Introduction xx v plexities, ar e neve r dull , and giv e the effec t o f lucidity and certaint y of outlook without undue dogmatism.' But though his elementary texts were effective in teaching the elements of the subject, he was not a good teacher and did not leave, a s Marshall did, a team of old students to carry on his work. Alfred Marshal l (i842-i924)18 was the so n of a cashier i n the Bank of England. At th e Merchan t Taylor's Schoo l Alfre d became entitle d t o a scholarship at St John's College, Oxford which would have led to a Fellowship . His father expected him to pursue this path on the way to ordination in the Evangelica l ministry . Alfred revolte d agains t what he fel t woul d be continued servitude to the Classics an d went instead to St John's College, Cambridge to stud y mathematics, financing himself by a small exhibition and a loan from a wealthy uncle. He graduated as Second Wrangler (Lord Rayleigh was the Senior) and was elected to a Fellowship. He proposed t o work in molecular physics. But first he had to pay off his loan which he did by teachin g mathematic s at Clifto n College . The n h e began to associate with some of the Cambridge intellectual leaders; this led him to reconsider his religious beliefs, to stud y metaphysics, ethic s an d finally economics . Marshall explains how a friend kept saying to him: 4Ah! if you understood Political Econom y yo u would not sa y that.' S o he read Mill's Principles 'and got much excited about it.' His career as an economist was begun as a lecturer in Moral Science in St John's College. From that time he dedicated his lif e t o th e stud y of economics, believin g that th e scientifi c study of economics was relevant to the problems of human happiness and of extending the opportunities for a good life to the many. With the Professor, Henry Fawcett, and with Henry Sidgwick, Marshall worked to develop the serious study of economics at Cambridge: and two of their early pupils, H. S. Foxwell and John Neville Keynes, joined them as lecturers in the University. Marriage to Mary Paley Marshall, a former pupil who was lecturing in economics a t Newnham, in 1877 , involved loss of his fellowship. After a short period as Principal of University College, Bristol, and as a Fellow and Lecturer i n Economics a t Ballio l College, Oxford, he returne d to Cambridge in 1885 as Professor. I have written about his achievement as teacher and educational architect in my chapter on Marshall. No more need be said except to note that the process of subdivision of labour seems to have been completed an d th e gai n i n skil l an d dexterit y demonstrated . Marshal l founded modern English economics. Finally, I introduc e Joh n Maynar d Keynes (1883-1946), 19 th e mos t exciting person amon g my nine principals, perhaps the most immediately influential, and certainly the mos t vigorous controversialist. He was the

xxvi Introductio n son o f tha t Joh n Nevill e Keyne s mentione d above , wh o ha d becom e Registrar of the University of Cambridge and had written a very good little book o n Th e Scope an d Method o f Political Economy (1890) . Joh n Maynard Keynes was educated a t Eton an d King's College , Cambridge . After graduatin g as Twelfth Wrangler he spent a year of intensive study of economics as a pupil of Marshall and Pigou. He entered the Civil Service, but two years at the India office was enough. He returned to Cambridge as a lecturer i n economics an d was elected in 190 9 to a Fellowship a t King's College. His fellowship dissertation was on the theory of Probability which was the basis of his book A Treatise o n Probability publishe d i n 1921 and reprinted wit h a n importan t editoria l forewor d b y R.B . Braithwait e a s volume vi n o f th e Collected Works o f John Maynard Keynes. Hi s academic career was interrupted by world war i: he served in the Treasury and went to Paris on Lloyd George's staff. What I say about the Economic Consequences of the Peace Treaty make s further commen t on that experience unnecessary. From then till world war n Keynes combined teaching and College administration at Cambridge with an almost incredible activity in London as financier (he was chairman of the National Mutual Insurance Company, 1921-38) ; as contributor to , an d part owner of, the Nation t o which was later added the New Statesman; as adviser to the Liberal Party; as editor of the Economic Journal', as collector o f books and pictures, a s supporter o f theatre an d ballet. H e ha d a very wide circl e o f friends o f whom th e member s of the 'Bloomsbury ' grou p were perhaps th e mos t stimulating. Wynne Plumptre, a pupil of Keynes in the years 1928-30, has told me that he generally spent Tuesday to Friday in London, and the long weekend in Cambridge. Plumptre20 has written of him as a teacher: In any pedantic sense Keynes was not my best teacher, but in terms of impact and influence h e wa s incomparable . As a n economis t hi s dominan t concern, a s h e explained in his introduction to the Cambridge Economic Handbooks, was not with a body of doctrine to be imbibed and duly regurgitated by students, but rather with methods of thought which would reduce to rationality and manageability whatever might be the pressing issues of the day. When he discussed these issues, whether in supervisions o r in his Club or elsewhere, h e was developing and refining his own thought. He was, moreover, happy to involve in his thought-development process, not a group of students to be indoctrinated, but rather a group of junior members of his own much beloved Colleg e and University who might in some measure make a contribution. I, unhappily , never me t him or heard him speak, bu t I think that my chapter on his work will make it clear how great was his influence on me,

Introduction xxvi i how exciting I found the intellectual fermen t which he created, ho w valuable I believe his contribution to our subject t o have been. As with Adam Smith, Mill , an d Marshall , hi s greatnes s la y no t onl y i n hi s skil l a s a n economist, bu t also in the quality of his philosophy, discussio n an d choic e of values, whic h mad e hi m a great politica l economist . Concerne d wit h wealth h e indicate d hi s understanding o f why wealt h mattere d whe n h e said: Economists 'ar e the trustees not for civilization, but for the possibility of civilization.'21 The part played by John Maynard Keynes, Baron Keynes of Tilton as he became in 1942, in world war n is a matter of history. Economists ma y take pride in his achievement, particularl y in his part in the establishment o f the International Monetar y Fun d and the World Bank, and in his negotiation s for th e u s loa n to Great Britain . While in the mids t of these negotiation s with the United States he made a statement which is a fitting conclusion to this introduction . ' I find myself moved , no t for the first time, to remind contemporary economist s tha t the classical teachin g embodied som e permanent truths which we are liable to overlook becaus e w e associate the m with othe r doctrine s whic h w e canno t accep t withou t muc h qualifica tion.'22

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BOOK ON E THE WEALT H O F NATION S

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I

The role of labour"

The annua l labour of every nation is the fund whic h originally supplies it with al l the necessarie s an d convenience s o f life whic h i t annually con sumes' (Ivii) . Neoclassica l economics , wit h it s preoccupatio n wit h th e rational allocation o f scarce resource s betwee n alternativ e uses , rejecte d notions of human cost and established th e concept o f alternative opportu nity cost. To understand the classics it is necessary to reconsider the notion of cost and in the course of that consideration on e may discover tha t the old notion is still relevant, though not to the theory of allocation and exchange value. Professor E . S . Furniss, in The Position of th e Laborer in a System o f Nationalism (1920) , an d Professo r E.A.J . Johnso n i n Predecessors o f Adam Smith (1937), have shown how universal was the concept of man as purchasing with his labour goods from a reluctant nature. In the theology of the sixteenth century, 'God sends food for the body and sole but he will not send i t withou t labour. 1 Wit h th e secula r writer s o f late r time s natur e replaced Go d and the transaction wa s stated i n commercial terms. Thu s Thomas Mun : The fishing in his Majesties sea s of England, Scotland an d * Pag e references in the text throughout Book i are t o the Edwi n Cannan edition of Adam Smith's Inquiry into the Nature an d Causes of th e Wealth o f Nations, reprinted i n th e Modern Library (1937). The absence of references throughout this book to The Economics of Adam Smith (Toronto : Universit y of Toronto Press , 1973 ) by m y colleague Samuel Hollander is explained by its publication after I had completed my work. It is a brilliant contribution to economic scholarship which every serious student of Adam Smith must read

4 Fro m Adam Smith to Maynard Keynes Ireland is our own natural wealth, and would cost nothing but labour.'2 Or Hobbes: 'Plent y Go d usually either freel y givet h o r for labour selleth t o mankind.'3 Adam Smith was, then, using an approach tha t was familiar to his contemporar y readers , an d t o understan d him , an d th e classica l economists, on e must return to their way of thinking. This means that we must look at the economic process in human terms, in man-centred terms, as one of men working and commanding the work of others with a view to provision o f the necessaries and conveniences of life, or, a s we would be more likely to phrase it, to the satisfaction of our wants. That I a m no t alon e i n arguing that thi s i s no t a wron g approach , a primitive error, is indicated by the modern presentation o f the basic idea in an article by Kenneth Boulding on 'Equilibrium and Wealth.'4 In a societ y withou t capital, o r wit h immortal equipment .. . th e thin g which a society, like an individual, has to spend is the time of its members ... In a society with capital embodied in mortal goods -i.e., goods with a finite length of service life - thi s situation is complicated by the fact tha t such a society can spend currently beyond, or not up to, its 'means' by the process of decumulating or accumulating valuable goods. It still remains true, however, even in a society which has capital, that the current resources whic h are to be used consist in the 'time-income' at the disposal of its members, even though these current resources ma y not bear frui t until som e futur e date , an d eve n thoug h current wealth-income comes fro m re sources which have been employed in the past.

Professor Bouldin g note d tha t thi s vie w o f resource s a s consistin g o f man-hours sails dangerously near to the rocks of the labour theory of value, but reminded his readers that he was considering not 'the determination of prices, nor the distribution o f income, but the sources of wealth.' He then argued that it was perfectly legitimate 'to regard man-time as an original, homogeneous resource' and to introduce the factors which co-operate with man in the guis e of 'coefficients o f transformation of man time into products.' This does not 'debar us from considering the effects of an abundance or a scarcit y o f co-operatin g lan d o r o f co-operatin g equipment . Th e presence o r absence o f these co-operating factors can be reflected for our purposes perfectl y adequately in the coefficients of transformation; when man i s co-operating wit h large amount s of good lan d and equipment , or when his skill, energy and ability are high the coefficient o f transformation of man-time into product i s high, i.e. on e man-hour will produce a larg e quantity of goods and services.' Finally let me note Boulding's use of the term, 'man-tim e price,' whic h is the 'numbe r of man-hours necessary t o

The role of labour 5 produce a unit of commodity' and which is, of course, 'the reciprocal of the coefficient o f transformation,' i.e. , the numbe r of units of a commodity produced by a man-hour. This man-centred view of production from Pro fessor Boulding provides the attitude of mind necessary to approach Adam Smith, an d th e classica l writer s t o Mil l and Marx , with sympath y and understanding, and with the possibility of improving our understanding of the real processes of the modern economy. There has been great resistance to the concept of real cost as man-time, or pain, o r wea r an d tea r o f human tissue. Professo r F.H . Knigh t conceded that the cost 'to an individual or society, of securing an income in the sens e o f his (or its) total aggregate of satisfaction does consist of the "pain" (o r sacrific e of pleasure, i f there b e an y difference , o r both ) involved in' 'production''.' But he added: 'if the aggregate [income] is a fixe d magnitude and the actual range of choice under consideration involves only its detaile d composition , the n th e rea l "cost " o f an y particula r smal l increment... is the sacrifice of the competing increment which was actually given up.'5 Now I not only do not dispute this view, but I press for fulle r recognition of its utility. Really effective an d intelligent application of the notion o f opportunit y cos t provide s a clu e t o man y problem s an d a n antidote to many poisonous fallacies. But these problems and fallacies are related t o the rational allocation o f resources. Ther e are other problems. An inquir y into the wealt h o f nations involves problems o f productivity ahead o f problems of allocation, an d involves problems of growth in th e resources to be allocated. Let me illustrate by a simple parable, the parable of the pioneer farmer. Even Professor Knight agrees that it is not unreasonable to picture this pioneer as buying his aggregate income of goods with his labour. The cost to him, however, of any one item, say bacon, i s not the time spent raising his pig, but the eggs he could have had, or the renewed roof he might have had, if he put less of his time into raising pigs. Rational decision o n his part a s t o whethe r t o gro w mor e o r fewe r pigs require s estimates o f the physica l quantities o f the othe r thing s forgone and th e relative satisfaction which might have resulted from the consumption of the most desirable forgone increments an d that resulting from the increment s of baco n actuall y produced . Bu t thi s doe s no t mea n tha t w e ar e no t properly intereste d i n th e man-tim e price. Suppos e a ne w metho d o f feeding makes the same man-time produce more (or better) bacon, or that a new method of handling enables him to produce the same amount of bacon with less man-time. The man-time price of bacon has fallen; the coefficien t of transformation of man-time into bacon has increased. Th e opportunity cost of bacon has therefore fallen. Because you can produce a unit of bacon

6 Fro m Adam Smith to Maynard Keynes with less man-time, you forgo less of the other products of man-time which have not been influence d b y the change in technology. Bu t what is more important than the change in allocation is the increase in aggregate production: the pioneer can have more bacon and no less of other things, or the same amount of bacon and more of other things, or still more bacon and not quite so much of the other things. If one is interested i n the growth of the aggregate, i n increasin g productivity , i n increasin g wealth , on e i s in terested i n change s i n man-tim e price (i.e. , i n productivity) , on e i s in terested in attempting to measure such changes, and in understanding the conditions under which man-time prices are likely to fall. Surely on e ca n b e aware of the dange r of the notio n of labour cos t in impeding th e understandin g of rational allocatio n o f resources, an d ye t recognize the importance of inquiring into labour cost, man-time price, in the study of the causes of wealth, or, in Adam Smith's phase, the causes of 'cheapness and plenty.'

2

Some problems of terminology

Before turnin g to th e tex t o f Th e Wealth o f Nations, som e terminolog y should be clarified. Real price Adam Smith uses the term the 'real price' of anything to mean 'the toil and trouble o f acquiring it ' (30) . This is Boulding's man-tim e price ; i t is th e obverse o f productivity or of Boulding's 'coefficient s o f transformation.' Growth i n th e wealt h o f a nation , increas e i n 'plenty, ' i s th e resul t o f increasing productivity of labour. If you think of man as buying goods from a reluctant nature with his labour then this increase in productivity may be said to spell 'cheapness.' This increasing productivity; this development of cheapness an d plent y surel y deserve s a s muc h stud y a s th e proces s o f allocation. Le t me anticipate later discussion by saying here that real prices decline as the quality of labour improves, as the quantity and quality of the equipment wit h which th e laboure r work s increases , an d a s technolog y improves. Two comment s ar e necessar y befor e passin g t o th e secon d concept . First, we shall find Adam Smith sometimes using the work 'value' for 'real price.' We have to be careful i n reading and interpreting him not to insist that when he uses the word 'value' he means what we mean by that word, or that he always means the same thing by it. In the infancy o f a science, terminology is loose an d ill-defined; we must not be surprised t o find the same word used in different senses without warning. But there is no excuse for refusa l to recognize tha t the context generally makes clear the partial-

8 Fro m Adam Smith to Maynard Keynes lar case. This i s a problem commo n to the interpretation o f the classica l economists i n general (an d perhaps ha s mor e genera l applicatio n t o al l economists). Professo r L.M . Fraser, 1 fo r instance, said : 'Bailey' s stric tures on Ricardo seem to me wholly justified provided that he assumed that Ricardo always meant - or thought he meant -by valu e exchange value. I cannot believe this.' Nor can I, and I shall later refer to a similar stricture by Bailey on Adam Smith. The second comment is this: while the concept of real price is clear, and the concern wit h it proper, th e problem of measuring it, or of measuring changes in it, is very difficult. I propose to discuss Adam Smith's efforts t o deal, not very successfully, with this problem of measurement. But let me say i n his defence , tha t measuremen t of productivity i s difficul t to o an d modern economist s hav e not ye t bee n wholl y successful . The failur e t o provide anything but a rough index of changes in real price should not lead readers t o confuse hi s concern t o measure changes in real price with his interest in explaining the determination of exchange value. Professors Gide and Rist2 fell into this trap. Hitherto th e 'real ' pric e ha s signifie d th e price tha t i s based o n labour. No w th e 'natural' price is defined as the price of goods valued at their cost of production. Th e change of name is not of any great significance. What Smith was in search of on both occasions wa s that true value which always kept in hiding behind the fluctuations of market prices. It is the same problem, but with a new solution.3

It cannot be too strongly stated that it was not 'th e same problem.' In the one place Adam Smith was concerned wit h changes in productivity, in the other with allocation of resources an d equilibrium prices in the market. What I have said about the necessity o f seeking the intended meaning of the supposedly well-defined word in its particular context may be reinforced by a further warning - relevant to the misinterpretation quoted fro m Gide and Rist. Many of the supposed inadequacie s o r errors in the classical economists ar e the product o f misinterpretation, the inadequacy being in the modern reader rathe r tha n in the classical writer. Mos t frequently the source of misinterpretation lies in the failure to identify the question which the writer wa s trying to answer. To o ofte n w e assume tha t th e ancient s asked the same questions that we ask: their answers seem stupid in relation to our questions, bu t they may be very intelligent i n relation t o their own . Now that the preoccupation wit h 'allocation' has been largely succeede d by a preoccupatio n wit h 'growth, ' i t ha s becom e easie r t o accep t th e classical question s a s proper one s t o ask , and to recogniz e th e valuable insights which inadequate analytical techniques failed to stifle.

Some problems of terminology 9 Value A glanc e a t the dictionar y wil l show ho w many are the meaning s of the word 'value'; but for economists i t has come to have one precise meaning. The valu e o f an y commodity (o r service ) i s th e amoun t o f som e othe r commodity o r servic e fo r whic h i t wil l exchange i n the market . This i s precise, observabl e an d measurable. However , economist s ar e generally concerned wit h something they cal l the normal , long-run, or equilibrium value of a commodity; the amount of some other commodity for which the one might be expected to exchange if all the determinants of this exchange relationship ha d tim e t o wor k out , withou t interruption , t o thei r fina l conclusion. Thi s is clearly not observable an d not measurable, indeed it is never achieved. Before long-run equilibrium of a given set of determinants is reached some of those determinants are sure to have changed. We should not use value in both these senses, but we do; and this should make us more tolerant o f the much greater numbe r of senses i n which Adam Smith uses the term . I n tryin g t o interpre t Ada m Smit h I shal l us e valu e t o refe r exclusively to this relationship in exchange and shall generally qualify it by the adjective 'normal' or 'equilibrium' when I am concerned wit h the long run. But as I ask tolerance for Adam Smith, so I ask it for myself. I believe that the context will always make it clear whether I am talking about 'value' or 'normal value.' Because we are concerned with a monetary economy, we now rarely talk about value , but rathe r abou t price , i.e. , abou t th e amoun t of one other specially chose n commodity , money , fo r whic h th e on e commodit y o r service wil l exchange. So did Adam Smith. Though h e defined exchang e value as 'the power of purchasing other goods,' and proposed t o 'investigate the principles which regulate the exchangeable value of commodities' (28) he proceeded in Chapter vn to discuss their natural and market price. Whether we talk of value or price it is clear that we are concerned with a relationship between two things. There is nothing intrinsic in value as we define an d us e it . Yo u canno t tal k abou t th e valu e o f an y on e goo d i n isolation. You canno t say , when valu e changes , when a unit of A which used to exchange for 2 units of B now exchanges for 3 units of B, that it is A that has risen in value not B that has fallen (or vice-versa). When you find Adam Smith appearing to fall into this error, you should consider carefull y whether he is using value in our sense. Of cours e yo u ma y b e abl e t o sho w tha t th e chang e i n the exchang e relationship between A and B is the resul t of some technological improvement that affected A and not B. Then the Adam Smith term becomes useful the rea l price of A has fallen while that of B has remained unchanged. But one must notice that the same change in relative exchange value could be

io Fro m Adam Smith to Maynard Keynes associated wit h either an increase in the real price of A, that of B remaining unchanged; or a decrease i n the rea l pric e o f both A and B but a bigger decrease in that of B than that of A ; or an increase in the real price of both A and B but a smaller increase in the real price of B. In other words a change in the value (or price) o f commodities does no t report change s i n their rea l prices. It does reflect, roughly, changes in relative real prices. One other comment: because value is a relative concept one cannot say the valu e o f a commodit y (A ) fell betwee n 180 0 an d 1900 . Al l on e ca n properly say i s that the valu e of A in terms of B was lowe r in 180 0 than in 1900. The plac e of A in the hierarchy of values has changed. Adam Smith will talk about the value of wheat changing through time, but he will not be thinking of changes in its value relative to other things. He will mean, in this context, rea l price ; he will be concerne d with the historica l question o f whether things in general, and particular things, are easier come by. And may one not reasonably say that the wealth of nations depends at least as much, probably much more, on the historical process o f improving technology tha n on th e improvemen t in the proces s o f rational allocatio n o f given resources ? Labour command or purchasing power A man, said Adam Smith, 'must be rich or poor according to the quantity of that labour [i.e., the labour of other people] which he can command' (30). This is an unfamiliar concept now, but it is found in Alfred Marshall and in John Maynard Keynes. 'I have found myself, ' sai d Alfred Marshal l in his evidence before the Gold and Silver Commission, often unabl e to follow wha t was said, because I could not make out how the word was used, when an appreciation of gold was contrasted with a fall of general (gold prices. Therefore, in order to make my position clear, I would like to say that when it is so contrasted, and used as denoting a rise in the value of gold, I then regard it as measured by the increase in the powe r which gold has o f purchasing labour of all kinds.4

And J.M. Keynes in the Treatise on Money raised the question of whether one should aim at stabilizing 'the Labour Power of Money rather than its Purchasing Power. '5 To give a concrete example of the problem underlying this choic e o f a monetar y standar d le t m e tak e th e chang e i n averag e earnings o f physician s i n Canad a betwee n 195 7 an d 1965 : th e averag e money income rose some 80 per cent; because prices were rising the 'real' income (or the purchasing power of the money income) rose only some 54

Some problems of terminology 1 1 per cent; but because average earnings of labour generally were rising, the labour command of the incom e rose onl y some 30 per cent . T o thi s one might add that the real income of pensioners, veterans, and employees with fixed incomes, fel l b y som e 2 0 per cen t ove r thi s period an d th e labou r command of that income fell by some 30 per cent. What does one really give up in lending $1000 in 1957 and what does one really receive in repayment in 1965? A thousand dollars, the command of 20 per cent less goods, or the product of 30 per cent less (more productive) labour? It was possible for Alfred Marshall to argue that prices in general should be slightly falling in a period of technological advance so that the rentier might secure some part at least of the advantage of that advance: it now seems a hopeless expecta tion that purchasing power in goods will decline, which means that labour command will decline much more. Said Carlyle: 'Who has sixpence is sovereign (to the length of sixpence) over al l men: commands cooks t o fee d him , philosophers t o teach him, kings to mount guard over him -to th e extent of sixpence.' This view of the real economic process as one of men working and commanding the work of others was of great importance in the development of classical, and later of socialist theory; it is still relevant. Adam Smith in that 'Early Draft of the Wealth of Nations,' published b y Professor W.R . Scott, 6 presented tha t view: It is very easy to conceive tha t the person wh o can at all times direct the labour of thousands t o his own purposes, shoul d b e better provide d wit h whatever he has occasion for, than he who depends upon his own industry only ... In a society o f a hundred thousand families, there will perhaps b e one hundred who don't labour at all, an d wh o yet, eithe r b y violence , o r b y th e mor e orderl y oppressio n o f law, employ a greater part of the labour of society tha n any other ten thousand in it.7

Having in mind the context ('the monied man indulges himself in every sort of ignoble and sordid sensuality ... All the indolent and frivolous retainer s upon a cour t are , i n the sam e manner, fed, cloathed an d lodged b y th e labour of those who pay the taxes which support them.' 8 1 think one can properly interpret 'direct' and 'employ' in the quotation as meaning 'command.' The 'oppressiv e inequality' o f which he wrote is an inequality in labour command . It i s not a very far cr y fro m thi s to volum e i of Karl Marx's Capital where the capitalist process is described as one in which the working class has to give up part of its product to the owners of property, or putting it another way, has to work part of the day for the propertied class. 'Whenever,' sai d Marx, 'a part of society possesse s the monopoly of the means of production, the labourer free or not free, must add to the working

12 Fro m Adam Smith to Maynard Keynes time necessary for its own maintenance an extra working time in order t o produce the subsistence for the owner of the means of production.'9 Labour command of particular goods In the Wealth of Nations this view of income as command over labour leads to a view 'that what everything is really worth to the man who has required it and wants to dispose of it, or exchange it for something else, is the toil and trouble .. . whic h it can impose on other people'Oo). The tw o views ar e stated in the following paragraph: 'His fortune is greater or less, precisel y in proportion ... to the quantity either of other men's labour, or, what is the same thing, of the produce of other men's labour, which it enables him to purchase or command. The exchangeable value of everything must always be precisely equal to the extent of this power which it conveys to its owner' (31). What we have here is not a theory of value, but a definition o f 'real' value or of'real worth.' One can only understand Adam Smith if one is alert to recogniz e whe n he use s th e wor d value , eve n 'exchangeabl e value, ' whether he means, as we would, the quantity of some other thing for which the goo d wil l (ma y be expecte d to ) exchange , or whethe r h e mean s th e quantity of average labour (man-time) for which it will (may be expected to) exchange. This concept is not quite unknown today but it is more often journalists than economist s wh o use it . The y deligh t to tel l u s ho w many hours of labour are necessary to earn the price of a shirt, let us say, in Canada and the USSR. We shall see that Adam Smith referred to its use for international comparisons, but his main use of the concept was for historical enquiries. He believed, and I shall argue that he was not unreasonable in believing, that changes over time in the labour comman d of particular good s was a useful index of changes in the 'real price' of such goods.

3

The Wealth of Nations: the theory of production

The subject of this book is wealth not equilibrium; discussion of the growth in productivit y take s precedenc e ove r discussio n o f th e operation s o f exchange i n the market. I quote agai n the opening sentence: 'th e annual labour o f every natio n is the fund whic h originally supplie s i t with all the necessaries and conveniences of life' (Ivii). Adam Smith went on to outline the basis of a theory of production. How well the nation will be 'supplied with all the necessaries an d conveniences' i s regulated by two different circumstances; first, by the skill, dexterity, and judgment with which its labour is generally applied; and, secondly, by the proportion between the number of those who are employed in useful labour, and that of those who are not s o employed . Whateve r be th e soil , climate , o r exten t o f territor y o f an y particular nation, th e abundanc e or scantines s o f its annual supply must, in that particular situation, depend on those two circumstances (Ivii).

The second of these circumstances is dealt with in Book n, and discussion of it will be left until later: but I must put in an immediate warning that this does no t refer , as a modern reader migh t at first assume, to th e leve l of employment. I shal l argue that i t is concerned wit h the redeploymen t of menial servants into the industrial sphere. The productivity of labour is clearly seen to depend on the quality of the environment, bu t tw o element s ar e ignored : capita l equipmen t an d developing technology. Not quit e ignored for, in dealing with the division of labour, Adam Smith said: 'Everybody must be sensible how much labour is

14 Fro m Adam Smith to Maynard Keynes facilitated an d abridge d b y th e applicatio n o f proper machinery ' an d h e added that 'th e invention of those machines .. . seems to have been origi nally owing to the divisio n o f labour' (9). One may doubt ho w importan t were th e contribution s o f 'common workmen , who , bein g eac h o f them employed i n some ver y simpl e operation , naturall y turne d thei r though t towards finding out easier an d readier method s o f performing it' (9) . But one must recognize tha t breaking down the human operations int o simpl e movements i s th e prelud e t o inventio n o f machine s t o perfor m thes e operations. An d on e mus t not e tha t th e divisio n o f labour, abou t whic h Adam Smit h talked, include d mor e tha n th e divisio n of pin making into 'about eighteen distinct operations'^) In th e progres s o f society, philosoph y or speculatio n becomes, lik e every other employment, th e principa l or sol e trad e an d occupatio n o f a particula r class o f citizens. Like every other employment too, it is subdivided into a great number of different branches ... and this subdivision of employment in philosophy as well as in every other business, improves dexterity and saves time. (10)

Adam Smith may have been naiv e in accepting the romantic story of the boy's improvement o f the fire engine, bu t he did recognize the role of the inventor an d the scientist : 'man y improvement s have bee n mad e by th e ingenuity of the makers of the machines, when to make them became th e business o f a peculia r trade ; an d som e b y tha t o f thos e wh o ar e calle d philosophers, o r men of speculation, whos e trade it is not to do anything, but to observe everything' (10). I would like to be able to add a quotation to justify a last comment. I cannot, bu t I believe tha t the tone o f the whole book makes it clear that Adam Smith would agree with enthusiasm if one said to him: is not freedom to innovate and to reap the rewards of successful innovation the basis for your expectation of increasing wealth? Division of labour 'The greatest improvemen t in the productiv e power s o f labour, an d th e greater part of the skill, dexterity, and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labour' (3). In Chapter i Adam Smith explained the increased productivity, resulting from the division of labour, as due to three circumstances: improve d dexterity through practice, saving of time in passing from one operation t o another, and the invention of machinery to perform the simple operations. It is surprising that there is no consideration of the economy of full utilization of special skills . Surprising , not onl y because o f its importance, bu t

The Wealth of Nations 1 5 because in his discussion of the international division of labour this element becomes a primar y consideration. Tha t h e ignore d i t i n this chapte r i s related to his egalitarian attitude as expressed in the next chapter. The difference of natural talents in different men is, in reality, much less than we are aware o f .. . Th e differenc e betwee n th e mos t dissimila r characters, betwee n a philosopher and a common street porter, for example, seems to arise not so much from nature, as from habit, custom, and education... By nature a philosopher is not in genius and disposition hal f so different from a street porter, as a mastiff is from a greyhound, or a greyhound from a spaniel (15-16).

Adam Smith contrasted manufacture and agriculture as subjects for the division of labour. The natur e of agriculture, indeed, does not admit of so many subdivision s o f labour , no r o f s o complet e a separatio n o f on e business fro m another , a s manufacturers ' (6) . Nevertheles s 'th e mos t opulent nations, indeed, generally excel all their neighbours in agriculture as well as in manufactures ... Their lands are in general better cultivated , and having more labour and expence bestowed upon them, produce more in proportion t o the extent and natural fertility of the ground (6).' That the opulent nations did excel in agriculture too should surely have been credited to the advance of science or, perhaps one should say, to the development o f a scientifi c approach , an d t o th e improvemen t in technolog y derived from that new approach, to a new readiness to innovate and to the expectation tha t there would be personal rewards from suc h innovation. The agricultural revolution was in full flood in 1776. Having noted th e superiorit y o f the agricultur e o f the opulen t nation s Adam Smith seems to have found it paradoxical that the corn o f the rich country .. . will not always, i n the sam e degree of goodness, come cheape r t o marke t than tha t o f the poor. The cor n o f Poland, i n the sam e degree of goodness, is as cheap as that of France .. . The corn of France is ... nearly about the same price with the corn of England, though, in opulence and improvement, France is perhaps inferior to England. The corn lands of England, however, are better cultivated tha n those of France, and the corn-lands of France are said to be much better cultivated than those of Poland .. . the poor country, notwithstand ing th e inferiorit y of it s cultivation , can , i n som e measure , riva l the ric h i n th e cheapness and goodness of its corn (6).

The apparen t paradox woul d be dispelled b y Ricardo's doctrin e o f comparative advantage ; bu t i t can als o b e dispelle d b y recognizin g th e tw o

16 Fro m Adam Smith to Maynard Keynes possible meaning s o f 'cheap.' In term s o f effort, man-time , 'rea l price,' corn wa s cheape r i n England tha n in Poland. Bu t in terms o f alternativ e opportunity cost , o f rea l cos t i n th e sens e appropriat e t o decision s t o allocate resources, corn was dear in England because the employment of labour i n it s productio n involve d forgoin g othe r things , manufacture d things, whic h wer e mor e valuabl e tha n th e cor n tha t migh t hav e bee n produced. On e shoul d ad d tha t becaus e th e expense s o f production i n England would be high, owing to the higher wages that could be earned in manufactures, only the better, more fertile and better located, lands would be cultivated , thu s furthe r reducin g th e labou r involve d i n producing a bushel of corn. I have argued that we must be alert, in reading Adam Smith, to recogniz e differen t meaning s of the sam e term. Here , I think , Adam Smith was himself trapped by the ambiguity in the term 'cheap.' From discussion of the advantages of the division of labour Adam Smith proceeded i n Chapter n to discuss the 'principl e which gives occasion to the division of labour' (13), in Chapter m to discuss th e limitation o f the division of labour by the 'extent of the market,' (17) and in Chapter iv, 'the origin and use of money' and how the division of labour is thereby facilitated (22). To explain the origin of the division of labour by reference to a 'propensity to truck, barter, and exchange' (13) is not very convincing (even if one has watche d childre n enjoyin g swapping stamps or marbles) . 'Nobody, ' said Adam Smith, 'ever saw a dog make a fair and deliberate exchange of one bone for another'(13). But surely the difference betwee n man and dog was no t i n th e presenc e o r absenc e o f a 'propensit y t o barter ' bu t i n superior intelligence in estimating the advantage and in directing the activity. Surely Adam Smith was on firm ground when he indicated th e opera tion of 'self interest' in developing specialization and exchange. 'I t is not from th e benevolenc e o f the butcher , th e brewer , or th e baker, tha t we expect our dinner, but from their regard to their own interest. W e address ourselves, no t t o thei r humanity but t o their self-love, and never talk to them of our own necessities but of their ad vantages'(14). This is a dictum which i s stil l relevant . Som e year s ag o whe n I wa s aske d t o discus s a 'winte r work' progra m of the Canadian government I argued that they should no t b e relyin g o n directive s an d exhortations . The y shoul d b e thinking of the operation o f the market and of self interest, an d should be trying to devise such 'rules of the game' as would make the market operate, under the pressure of self interest, so as to promote most fully th e public interest. I then quoted Adam Smith's dictum; and I added a quotation fro m Alfred Marshall . 'Progres s chiefl y depend s o n th e exten t t o whic h th e

The Wealth of Nations 1 7 strongest and not merely the highest forces of human nature can be utilized for the increase of the public good.'11 also quoted Sir Dennis Robertson : There is a saying in England, that there are two ways of getting a donkey to progress along a road - by holding a carrot in front of his nose and by applying a stick to his behind. Bu t experts sa y there i s also a third way, of which we normally hear less , namely b y strokin g his ear s .. . Persuasivenes s an d persuadabilit y ar e valuabl e things, limited in supply, it is the duty of society t o create a framework .. . and to operate a regime of incentives an d disincentives whic h will prevent these preciou s qualities of persuasiveness an d persuadability fro m bein g wastefully squandere d through being set tasks which it is outside their compass to perform. 2

So in his explanation of the origin of the division of labour, i s found a first statement o f one o f the principa l theme s o f the book , th e importanc e o f incentives, o f getting things done by appeal to self interest: a doctrine very relevant t o modern economic policy . Chapter HI , on th e divisio n o f labour a s limite d b y th e exten t o f th e market, needs little gloss; clearly the specialized worke r must have enough employment t o earn a living comparable t o that o f other specialists , and must b e full y employe d i f th e societ y i s t o ge t th e ful l benefit s o f thi s division of labour. Perhap s al l we need to add is that the machines 'whic h facilitate an d abridg e labour ' (7 ) must b e full y employe d too . Th e onl y comment I would make on this chapter, i s to note the emphasis placed on the importanc e o f development s i n transportatio n i n th e proces s o f economic growth . Here Adam Smith talked of 'water carriage' as opening an extensive market to every sort of industry. Later, in Chapter xi, he said: 'Good roads , canals , an d navigabl e river s .. . ar e th e greates t o f all improvements '(147). Money In Chapte r i v th e rol e o f mone y i n facilitatin g th e developmen t o f th e division of labour is discussed . When th e divisio n of labour first began to tak e place , thi s powe r of exchanging must frequently have been ver y much clogged and embarrassed in its operations. One man, we shall suppose, has more of a certain commodity than he himself has occasion for, while another has less ... The butcher has more meat in his shop than he himsel f ca n consume , an d th e brewe r an d th e bake r woul d each o f them be willing to purchase a part of it. But they have nothing to offer i n exchange, except the differen t production s o f thei r respectiv e trades , an d th e butche r i s already

18 Fro m Adam Smith to Maynard Keynes provided with all the brea d an d beer whic h he has immediate occasion fo r .. . In order to avoid the inconvenienc y of such situations , every pruden t man in every period o f society , afte r th e firs t establishmen t o f th e divisio n o f labour , mus t naturally have endeavoured to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as he imagined few people would be likely to refuse in exchange for the produce of their industry (22-3).

He went on to discuss the choice of gold or silver as that 'one commodity' and the development of coinage to eliminate the inconvenience o f weighing and assaying. H e also referred t o the 'avarice and injustice o f princes and sovereign states' (27) in diminishing the quantity of metal in coins of given denominations. The Englis h poun d an d penny contai n a t presen t abou t a third onl y .. . and the French pound and penny about a sixty-sixth part of their original value. By means of those operation s th e prince s an d sovereig n state s whic h performed the m wer e enabled, in appearance, to pa y their debts an d to fulfi l thei r engagements with a smaller quantity of silver than would otherwise have been requisite. I t was indeed in appearance only; for their creditors were defrauded o f a part of what was due to them. All other debtors in the state were allowed the same privilege (27).

We are less concerned no w with the equivalent i n gold or silver an d think rather in terms of purchasing power. It will be seen later that Adam Smith knew that maintenance of the integrity of the metallic coinage did not mean stability o r prices o r of 'labour command.' Bu t he was readier t o accept changes that were accidental if, thereby, princes and sovereign states could be inhibited from deliberate self-intereste d changes . Adam Smith explained th e reason wh y people hold money , but he did not go the next step to analyse the influences tha t led them to change th e amount they held. The Cambridge approach t o the value of money follows naturally from th e Adam Smith approach, developin g th e analysis h e had omitted. But if he failed to examine the influences determining the demand of the individual, and particularly the influence of the level of prices on that demand, h e did discuss in Chapter x i the factors determinin g th e increase in the aggregate demand for the money metal over several centuries.

4 Adam Smith on value

Utility At the end of Chapter i v Adam Smit h state d hi s intention t o proceed t o examine th e rule s whic h 'determin e wha t ma y be calle d th e relativ e o r exchangeable valu e o f goods' (28) . Firs t h e distinguishe d tw o differen t meanings of the wor d value. I t 'sometime s expresses th e utilit y of some particular object , an d sometime s th e powe r o f purchasin g othe r good s which th e possessio n o f tha t objec t conveys ' (28) . H e the n state d th e paradox: 'Nothin g is more usefu l than wate r bu t i t will purchase scarc e anything ... A diamond, on the contrary, has scarce any value in use; but a very great quantit y of other goods ma y frequently be had in exchange for it' (28) . One aspec t o f th e parado x remaine d unexplaine d for nearl y a century whe n at last th e concept of marginal utility came to be generally understood. Decision s mus t alway s be relate d t o th e utilit y o f th e littl e more or less as a result of trading, not to the utility of the whole amount. It has been less often tha t another aspect of the paradox has been noted. We now recogniz e tha t th e ter m valu e i n use, o r utility, must be freed fro m personal value judgments; it now means 'wantedness' an d whether a thing is wanted can be determined by observation. Whether it ought to be wanted will depend on the mora l and aesthetic attitude s of the individual . To th e Scottish moralis t diamond s ha d 'scarc e an y valu e i n use' (28) . T o th e impartial observer it was clear that they were greatly wanted. Having stated this paradox Adam Smith reverted t o the statement of his purpose i n the next few chapters, viz. , to investigate the principles which regulate the exchangeable valu e of commodities, an d first to determin e

20 Fro m Adam Smith to Maynard Keynes what is the real measure of this exchangeable value ; or, wherein consists th e rea l price of all commodities. Secondly, what are the different part s of which this real price i s compose d .. . And , lastly , what ar e th e differen t circumstance s whic h sometimes raise some or all of these different part s of price above, and sometime s sink the m below thei r natural , or ordinar y rate; or , wha t ar e th e cause s whic h sometimes hinder the market price .. . from coincidin g exactly with what may be called their natural price? (28-9)

Real price One has been led to expect that Chapter v, 'Of the Real or Nominal Price of Commodities, or of their Price in Labour and their Price in Money' (30) will be concerne d wit h what w e cal l th e 'theor y o f value,' tha t is , wit h th e explanation of the market, or equilibrium, value in exchange, or the price , of particular commodities. There i s some excuse for those who have been misled in this way. I argue, and with considerable confidence, that Chapter v is concerned not with the determination of exchange value in its accepte d sense (indeed in the sense in which Adam Smith had just defined it) but is concerned wit h the measurement o f changes i n the rea l price , man-tim e price, o f particular good s a s productivit y changes , generall y increases . After all , his subjec t wa s a n inquiry into the wealt h of nations, an d tha t wealth increase s a s productivit y increases . W e launc h inquirie s int o changing productivit y and mee t formidabl e difficultie s o f measurement. He phrased the problem in terms of real price, the obverse of productivity; he talked of 'cheapness' rather than productivity, but this was only another way of attacking the same problem. He also ran into formidable problems of measurement, his solution of which was far from satisfactory . H e wa s asking important and difficult questions ; his answers must be examined in the light of those questions and must not be supposed to have been answers to the questions that we expected hi m to ask. What he was really trying to do becomes more evident when one goes beyond Chapter v to the investigations of changes in the real price of particular commodities in Chapter xi, which being entitled 'O f the Rent of Land' has often bee n excluded fro m the attention of those writing about his theory of value. I shall have much to say about that chapter in a later section, bu t perhaps it would be of help at this point if I referred to a passage in Chapter vm 'On the Wages of Labour' which is also generall y ignored i n those discussions . H e there explaine d that with improvements in the productive power of labour 'all things would gradually hav e becom e cheaper . The y woul d hav e bee n produce d b y a smaller quantity of labour' (64) . In th e passage tha t follow s the contras t between real price and value shows up, as does the ambiguity in the use of the word cheap.

Adam Smith on value 2 1 Though all things would have become cheaper in reality, in appearance man y things might hav e becom e deare r tha n before , o r hav e bee n exchange d fo r a greate r quantity of other goods . Le t u s suppose , fo r example , that i n the greate r part of employments the productive powers of labour had been improve d tenfold .. . but that i n a particula r employmen t they ha d bee n improve d onl y t o doubl e .. . I n exchanging the produce o f a day's labour in the greater par t of employments, for that of a day's labour in this particular one, ten times the original quantity of work in them would purchase only twice the original quantity in it. Any particular quantity in it... would appear to be five times dearer than before. In reality it would be twice as cheap. Though it required five times the quantity of other goods to purchase it, it would require only half the quantity of labour eithe r to purchase o r to produce i t (64-5).

It is this real cheapness tha t Adam Smith is exploring in Chapters v and xi. But ther e i s an assumption tha t the change s i n relative rea l pric e wil l be reflected in changes i n price. This may be thought to indicate adherence to the 'labour theory of value.' However it should be noted that he is talking about changes through time, not determination of price at a given time. One does no t have to believe tha t equilibrium value at a given time is adequately explaine d b y relativ e labou r cos t i n orde r t o recogniz e tha t changes over long periods in the relative value of particular goods will be in the same direction an d of roughly the same magnitude as changes in their relative real prices. In Adam Smith's example one really only has to add the word 'roughly.' 'In reality it would be [roughly] twice as cheap.' Surely this is not unduly generous interpretation. Chapter v opens wit h a presentation o f the concepts discussed above: (i) a man 'mus t b e rich o r poor accordin g t o the quantit y of that labou r which he can command' (30); (2) 'the real price of everything ... is the toil and trouble of acquiring it' (30); (3) 'what everything is really worth to the man who has acquired it... is the toil or trouble which ... it can impose upon other people' (30). This i s the man-centred vie w of the economic proces s continued. But Adam Smith was aware of many of the difficultie s an d h e struggled with some of them. Labour i s not homogeneous. Ther e may be more labour i n an hour' s hard work than two hours eas y business ; or in an hour's applicatio n t o a trade which it cost ten years' labour to learn, than in a month's industr y at an ordinar y and obviou s employment ' (31) . The solutio n by takin g the valuations resulting from the 'higgling and bargaining of the market' (31) is not ver y satisfactory. W e are face d wit h the sam e problem i n studies of productivity when, in the process of improvement, the factor mix changes. Suppose a t the beginning of the period unde r examination, x of one kind of

22 Fro m Adam Smith to Maynard Keynes labour (o r on e kin d o f input ) an d y o f anothe r kin d produce d A of th e particular product. If now 0.5* and 0.53; produce the same quantity A it can be said that the real price of that commodity has halved, that productivity in this industry has doubled. Bu t suppose the change in technology involves , as it almost certainly wil l do, a change in the mix, so that, say, o.yc and o.Sy may produce A . Then one would say that the real price has fallen but one could not give a satisfactory measur e o f the degree of decrease. And if the new mix was 0.5* and i.2y, one could not satisfactorily determin e whethe r the real price had fallen, risen, or remained the same. An answer could be given if one could establis h equivalenc e betwee n unit s of x an d y; but t o take the equivalents from the market is a very doubtful procedure. I repeat that thi s problem still plagues th e student s o f changing productivity; but much depends o n the degree o f precision required . If a precise answe r is impossible shoul d on e refus e t o explor e th e possibilit y o f a rough , ye t possibly quite useful, one? 'But though labour be the real measure of the exchangeable valu e of all commodities it is not that by which their value is commonly estimated' (31). It i s 'mor e frequentl y estimate d b y th e quantit y o f mone y tha n b y th e quantity either o f labour o r of any other commodity ' (32). If Adam Smit h was really talking here about exchange value in the strict sens e this would seem trite; but he was not concerned wit h relative values at a given time but with change s i n somethin g he think s of a s th e 'real ' valu e o f particula r commodities over long periods of time. For this purpose change in money price are not good indicators of changes in this 'real value.' Gold an d silver , however , like every othe r commodit y vary i n their value , ar e sometimes cheape r an d sometime s deare r .. . Th e quantit y of labour whic h any particular quantit y o f them can purchase or command ... depends always on th e fertility or barrenness of the mines which happen to be known ... The discovery of the abundant mines of America reduced, in the sixteenth century,the value of gold and silver in Europe to about a third of what it had been before. As it cost less labour to brin g those metal s from th e min e to th e market , so when they wer e brought thither they could purchase or command less labour ... a commodity which is itself continually varying in its own value, can never be an accurate measure of the value of other commodities (32-3).

Of course mone y is the best measure of value in our modern sense since we are talking about relative values at a given time, and at those given times it is relative mone y prices tha t ca n be observed. Bu t when Adam Smith finds money to be a poor measure it is as a measure of changes in real value,

Adam Smith on value 23 and I think it appears fro m careful study, of this chapter as a whole, of the passage in Chapter v m alread y noted , an d of the use o f the concept s in Chapter xi , that h e was primarily concerned t o measure changes i n 'real price' and that his interest i n changes in 'labour command' arises from his belief that such changes are the best (though far from precise) indications of changes i n real price. Whe n he referred t o the change in the value of the money metals , he wa s no t concerned , a s w e would be , wit h change s in general purchasin g power, bu t in changes i n labour command. Hi s state ment that silver 'as it cost less labour ... would command less labour' (32) both rules them out as good measures, but also gives a basis for accepting changes i n labour comman d (whic h i s difficul t t o determin e ove r lon g periods o f time in view of the inadequacy o f the records) a s a measure of changes in real price, or man-time price (which is impossible t o determin e over long periods of time in the absence of records). I have said earlier that this rough relationship between changes in real price and changes in labour command does not imply a simple labour theory o f equilibrium value at a given time. Nor doe s i t imply some mechanical relationship: Adam Smith was full y awar e o f the proces s whereb y th e chang e i n real pric e bring s about a change in labour command by way of increasing supply. In Chapter xi he went further, recognizing that one must look at the changing conditions of demand as well as the changing conditions of supply. Study o f changes i n real price , and the us e o f changes i n labour com mand t o measur e suc h change s implie s tha t man-tim e i s a reasonabl e measure o f 'toi l an d trouble. ' I t becam e necessar y therefor e fo r Adam Smith to defend duration of labour as a test of'the hardship involved.' Equal quantities of labour, at all times and places, may be said to be of equal value to the labourer. In his ordinary state of health, strength and spirits; in the ordinary degree of his skill and dexterity, he must always lay down the sam e portion of his ease, hi s liberty, and his happiness. The pric e which he pays must always be the same, whatever may be the quantity of goods which he receives in return for it. Of these, indeed , i t ma y sometime s purchas e a greate r an d sometime s a smalle r quantity; but it is their value which varies, not that of the labour which purchases them (33).

In this quotation the word value is used in an extremely loose way; but the meaning is surely clear - 'i t is their value [i.e., real price] which varies, not that [i.e., the disutility] of the labour.' Only by assuming that he must have used th e wor d valu e 'correctly ' i s i t possibl e t o justify th e criticis m o f Samuel Bailey on Malthus and, indirectly, on Adam Smith:

24 Fro m Adam Smith to Maynard Keynes He [Malthus] maintains, after Adam Smith, that labour is always of the same value; that is, according to his own definition, always retains the same power of commanding other objects in exchange; and yet, in the treatise, he speak s of the labourer earning a greater or smaller quantity of money or necessaries, and insists that it is not th e valu e o f th e labou r whic h varies, bu t th e valu e o f th e mone y o r th e necessaries. As i f produce or mone y could change in value relatively to labour, without labour changing in value relatively to produce or money1

It is legitimate to criticize the loose use of the word value; it does not seem legitimate, or useful, t o make nonsense of an author's wor k by assuming that he has used a word in one sense only, when he has quite clearly used it in three or four different ones . If his meaning is clear, his proposition remains debatable. Is disutility so clearly relate d t o duratio n o f labour, an d has th e disutilit y o f an hour's labour remained unchanged over the last century? Probably it has not; but it cannot be measured now and then. Though it may not tell us all we would like to know it remains significant to know even roughly what changes have been i n real price , eve n i f we cannot equat e thes e with changes i n what Alfred Marshall would call 'real cost.' Recognizing that 'a t the same time and place, therefore , mone y is the exact measur e o f th e rea l exchangeabl e valu e o f al l commodities ' (37 ) Adam Smith said that comparison of 'the different rea l values of a particular commodit y at differen t time s an d places, o r th e differen t degree s o f power over the labour of other people which it may, upon different occa sions, have given to those who possessed it ' (38) requires comparison not so much of 'the different quantitie s of silver for which it was commonly sold, as the different quantities of labour which those different quantities of silver could have purchased (38).' But he noted that the 'current prices of labour a t distan t time s an d place s ca n scarc e eve r b e know n with any degree o f exactness' (38) . Current prices o f corn wer e in general better known, and Adam Smith decided tha t he must settle fo r changes in corn command as a rough measure of changes in labour command and therefore of changes in 'real price'; 'not as being always exactly in the same proportion as the current prices of labour, but as being the nearest approximation which can commonly be had to that proportion' (38). The selectio n o f cor n a s a roug h measur e o f change s i n rea l valu e requires that it have a constant labou r command and a constant rea l pric e over centuries. Th e basis for its choice was first on empirical grounds, 'the rents which have been reserve d i n corn have preserved thei r value much better than those which have been reserved in money' (34).

Adam Smith on value 25 Theoretical support for choosing cor n was found along two lines. First, Adam Smit h maintaine d tha t h e who possesses corn, 'the subsistence o f the labourer,' commands labour . Equal quantitie s o f corn, therefore , will , at distan t times , b e mor e nearly of the same real value, or enable the possessor t o purchase or command more nearly the same quantity of the labour of other people. The y wil l do this, I say, more nearly than equal quantities of almost any other commodity; for even equal quantities of corn will not do it exactly. The subsistence of the labourer ... is very different upon different occasion s (35).'

Second, he later maintained tha t th e 'rea l price' o f corn had been stabl e over lon g periods in spite o f the agricultura l revolutio n o f the eighteent h century. In every different stag e of improvement, besides, th e raising of equal quantities of corn in the same soil and climate, will, at an average, require nearly equal quantities of labou r .. . th e continua l increas e o f th e productiv e power s o f labou r i n a n improving state of cultivation being more or less counterbalanced by the continually increasin g price o f cattle, th e principa l instruments of agriculture. Upon al l these accounts, therefore, we may rest assured, that equal quantities of corn will, in every stat e o f society, i n every stage of improvement, more nearly represen t .. . equal quantitie s of labour , tha n equa l quantitie s of an y othe r par t o f th e rud e produce of land' (187).

One mus t admit tha t th e theoretica l suppor t fo r hi s choic e o f corn a s a measure of changing real value is very weak. Recognition of the Ricardian threat of diminishing returns was still several decades away ; but the expectation tha t th e opposin g element s makin g for increasin g an d decreasin g costs would cancel out was surely unreasonable. However critical one may be of his choice of a measure one must be prepared t o follow him in its use. In the 'Digression on Silver' in Chapter x i it will be necessary t o remember that the subject i s not, as we would expect, changes i n general purchasin g power, bu t change s i n the cor n pric e o f silve r a s indicatin g change s i n labour command and, ultimately, of real price. Natural price

In tha t earl y and rud e stat e o f society whic h precedes bot h th e accumulatio n of stock and the appropriation of land, the proportion between the quantities of labour necessary for acquiring different object s seem s to be the only circumstance which

26 Fro m Adam Smith to Maynard Keyne s can affor d an y rul e fo r exchangin g them fo r on e another . I f amon g a natio n of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer (47)

As history, or anthropology, this is not very convincing; but I suggest that this wa s merel y th e contemporar y fashio n i n which t o presen t wha t w e would cal l a simpl e model . Th e kin d o f mode l whic h i s implie d b y th e phrase, a 'nation of hunters,' is the 'hypothetical handicraft model' which I have used for nearly fifty year s as a first introduction to the social function of the pric e syste m an d to the natur e o f long-run equilibrium. 2 It i s 'the imaginary world' of Alfred Marshall's chapte r o n the earnings of labour: Let us begin by studying the influence of demand on the earnings of labour, drawn from a n imaginary world in which everyone owns the capita l that aids him in his labour .. . let us suppos e bu t little capita l to be used .. . an d the gifts o f nature so abundant tha t the y ar e fre e an d unappropriated . Le t u s suppose , further , tha t everyone is not only of equal capacity, but of equal willingness to work, and does in fact wor k equally hard: also that all work is unskilled - o r rather unspecialized .. . Lastly let us suppose that everyone produces things ready for sale without the aid of others, and that he himself disposes of them to their ultimate consumers ... In this case th e proble m of valu e is ver y simple . Things exchang e for on e anothe r in proportion to the labour spent in producing them.3

Marshall i s referring , of course , t o long-run , equilibrium value; an d h e tacitly assumes 'constant cost.' Three point s call for emphasis. First, by 'natural' Adam Smith meant, I believe, what could be expected t o happen in the long run without interference. Mrs . Robinson,4 argues that the beaver-deer relationshi p i s derived from mora l preconceptions : 'Tha t i s ho w i t ough t t o hav e been . Th e hunters wer e livin g in a n idylli c pas t whe n th e economi c syste m wa s morally satisfactory. ' Ther e ar e overtone s o f thi s kind, derivin g fro m earlier thought and emerging later in the Ricardian socialists. 'Landlords,' Adam Smith said a few paragraphs later, 'like all the other men, love to reap where they neve r sowed ' (49) . But, a s Mrs Robinson late r notes , Adam Smith is hard headed; his book 'i s devoted no t to moral sentiments but to expediency.' Second , le t me state th e obviou s fac t tha t th e beaver-dee r relationship in no way ignores the influence of demand. Professor Knight 5 put the correct positio n fully an d forcefully : In the famous example, if it costs two days' labor to kill a beaver and one day to kill a deer, then productive adjustment will establish an equilibrium such that one beaver

Adam Smith on value 27 exchanges for two deer. So far is this 'cost theory' from being in contradiction with or even divergent from 'utilit y theory' that the latter is absolutely presupposed i n the argument. The reaso n this exchange ratio must prevail is that if one beaver is exchanging for more than two deer, anyon e who wants deer will hunt beaver and exchange for dee r instea d o f hunting deer, an d conversely ; and that whe n more beaver and fewer deer are brought to the market the price of the former will fall and that o f th e latte r ris e unti l the y correspon d wit h th e cos t rati o .. . I t make s n o difference wha t consumers think o f the relativ e utilities of deer and beaver. Th e only questio n i s that o f whether, a s mor e beave r an d fewe r dee r ar e killed , th e relative costs will remain unchanged.

Third, even at this stage Adam Smith noted that deviations from this simple man-time formula result when one species o f labour is 'more severe' than another, o r when 'one species of labour requires an uncommon degree of dexterity and ingenuity.' Adam Smit h passe d quickl y fro m th e 'natio n o f hunters' t o th e rea l world o f his time . H e recognize d th e emergenc e o f profit a s productio n comes to require accumulation of'stock' and as the 'employer' is differentiated fro m th e worker . 'H e [th e employer ] coul d hav e n o interes t t o employ them [the workers], unless he expected fro m the sale of their work something more than what was sufficient to replace his stock to him; and he could hav e n o interest t o employ a great stoc k rathe r tha n a smal l one, unless his profits were to bear som e proportion t o the extent of his stock' (48). In this stat e o f things 'the whole produce o f labour does no t always belong t o th e laboure r .. . Neithe r i s th e quantit y o f labou r commonl y employed ... the only circumstance which can regulate the quantity which it ought commonly to purchase' (49). With private ownershi p o f the land there enter s a further cause o f divergence fro m th e simple labour theory . He therefor e move d i n Chapter v n t o a 'cos t o f production' theor y o f natural price. Of this analysis Mr s Robinson sai d 'we really cannot do any better.'6 I shal l present hi s analysis, not e the qualifications he made, and add some further qualification and criticism. There i s in every societ y o r neighbourhood a n ordinary or averag e rat e bot h of wages and profit i n every differen t employmen t of labour an d stock . Thi s rat e i s naturally regulated .. . partly by the general circumstances of the society .. . partly by the particular nature of the employment. There i s likewise in every society or neighbourhood a n ordinary or average rate o f rent .. . [These] ma y be called th e natural rates... When the price of any commodity is neither more nor less than what is sufficient t o pay the rent of the land, the wages of labour, and the profits of the stock employed ... according to their natural rates, the commodity is then sold for

28 Fro m Adam Smith to Maynard Keynes what may be called its natural price ... The actual price at which any commodity is commonly sold is called its market price (55-6).

Adam Smith then introduced th e concept o f 'effectual demand ' which for him meant the amount of a commodity tha t would be bought a t its natural price. From what follows it is clear that he fully understood tha t the amount actually bought would increase with any fall in its price, and that the degre e of increase (th e elasticity of demand in our language) would vary betwee n different commodities . When the quantity of any commodity which is brought to market falls shor t of the effectual demand , al l those wh o are willin g to pa y th e whol e value o f the rent , wages, and profit, which must be paid in order to bring it thither, cannot be supplied with the quantity which they want. Rather than want it altogether, some of them will be willing to give more. A competition will immediately begin among them, and the market price will rise more or less above the natural price, according as either th e greatness of the deficiency , o r the wealth and wanton luxury of the competitors , happen to animate more or less the eagerness of the competition (56).

When the supply exceeds th e effectual demand the market price will 'sink more or less below the natural price'; when the supply is just equal to the effectual demand the 'market price naturally comes to be either exactly, or as nearly as can be judged of, the same with the natural price' (57). He then went o n to explai n how the suppl y of every commodit y 'naturall y suits ' itself to the effectual demand. If at any time it exceeds the effectua l demand , some of the component parts of its price must be paid below their natural rate. If it is rent, the interest of the landlords will immediately prompt them to withdraw a part of their land; and if it is wages or profit, th e interes t of the labourer s in the one case, and o f their employers in the other, wil l promp t the m t o withdra w a par t o f thei r labou r o r stoc k fro m thi s employment. The quantity brought to market will soon be no more than sufficient to supply the effectual demand (57).

In the contrary cas e of a market price being above th e natural price ther e will be a n influ x o f land, labour an d capital , til l the quantit y produced i s sufficient t o 'suppl y th e effectua l demand ' an d th e pric e wil l fall t o th e natural price. 'Th e whole quantity of industry annually employed in order to bring any commodity to market, naturally suits itself... to the effectual demand' (58). This result appears to Adam Smith not only 'natural,' in the

Adam Smith on value 29 sense tha t i t ma y b e expecte d t o b e achieve d i n the absenc e o f certai n 'accidents' and 'obstacles,' it is also a desirable result as reflecting the free choices of individual citizens. His is not only a theory of price, it is a theory of allocation of resources an d a major element in his case for laissez faire. Qualifications to the simple cost of production theory follow, or perhaps one should say that some of the 'accidents' and 'obstacles' are identified. First there is the problem of 'husbandry' with an annual and highly variable harvest. 'I t is only the average produce .. . whic h can be suited .. . t o the effectual demand; and as its actual produce is frequently much greater and frequently muc h less than its average produce ... their market price will be liable t o grea t fluctuations , wil l sometime s fal l a goo d dea l below , an d sometimes rise a good deal above, their natural price' (58). These fluctuations in market price, above and below the natural price, affect wage s and profits ; ren t i s generally a matter o f long-run contract . Adam Smit h argued that the majo r influenc e wil l be on wages or profit s according 'as the market happens to be either overstocked or understocked with commodities or with labour; with work done, or with work to be done' (59). Hi s exampl e wa s a 'publi c mourning. ' Thi s wil l raise th e pric e of black clot h 'an d augment s the profit s o f the merchant s who possess any considerable quantity of it.' It will have no effect on the wages of weavers, but i t will raise th e wage s of journeymen tailors. I t wil l sink the price of coloured silks and thus 'reduces the profits of the merchants who have any considerable quantit y of them upon hand . I t sink s too th e wage s o f the workmen employe d i n preparin g suc h commodities ' (59) . Wage s wer e obviously suppose d t o b e highl y flexible; if they were not, th e effec t o n profits migh t be greater and the effec t on the worker s be unemployment rather than lower wages. The secon d qualification , or se t o f qualifications are 'particula r acci dents, sometimes natural causes, an d sometimes particular regulations of police' which may 'keep up the market price, fo r a long time together, a good dea l abov e th e natural price' (59). Imperfect knowledge, he noted , may delay adjustment. When profits become high, producers 'are generally careful to conceal this change. If it was commonly known, their great profit would tempt so many new rivals ... that, the effectual deman d being fully supplied, the market price would soon be reduced to the natural price .. . Secrets o f this kind ... can seldom be kept long.' Secrets i n manufactures are capable of being kept longer than secrets in trade. The inventor of a new process, 'a dyer who has found the means of producing a particular colour,' may 'enjo y th e advantag e of his discovery a s long as he lives, an d even leave it as a legacy to his posterity' (60).

30 Fro m Adam Smith to Maynard Keynes Adam Smith next referred to a group of natural products whic h requir e 'such a singularity of soil and situation, that all the land in a great country ... may not be sufficient t o supply the effectual demand ... Such commoditie s may continue for whole centuries together to be sold at this high price' (60), i.e., abov e thei r natura l price. 'Tha t part o f it [the price] whic h resolve s itself int o the ren t o f land is in this case the par t whic h is generally pai d above its natural rate' (61). It may be a rather odd use of 'natural' to refer to a price which may not be achieved over 'whole centuries,' but Adam Smith handled with great skill the problems arising from the existence of' specific' factors of production. This is evident in Chapter xi. I shall revert to it when I discuss tha t chapter, an d particularly when I examine his handling of the problem o f the relatio n o f rent an d price. I would onl y ad d here tha t h e failed t o recognize th e generality o f the notion o f 'specific' factors : ther e are cases of singularity of skill as well as of soil. Finally Adam Smith dealt with 'regulations of police.' A monopoly granted either to an individual or to a trading company has the same effect a s a secret i n trade or manufactures ... The exclusive privileges of corporations, statute s o f apprenticeship, an d al l those law s which restrain, in particular employments, the competitio n to a smaller number than might otherwise go into them, have the sam e tendency, though in less degree. They ar e a sort of enlarged monopolies (61).

It will appear i n later chapters tha t his interest in these monopolies, base d on grants of special privilege , wa s not just a scientific one, t o determin e their effect on prices, but was normative. He disliked monopoly as interfering with the allocation o f resources s o that suppl y would 'suit itself to the effectual demand, ' as making for inefficiency, a s inhibiting improvement, and a s givin g specia l privilege s no t justifie d b y specia l servic e t o th e community. Study of later chapters will , I hope, justify these statements . Having noted the qualifications to the cost of production theory of value stated b y Adam Smith , I propos e t o presen t som e o f the qualification s which a moder n economis t woul d make ; man y o f thes e ar e condition s which are clearly implied, though not specifically stated, i n his analysis. It must first be made clear tha t this is a theory of 'particular equilibrium.' It suffers fro m al l the deficiencies of such analysis, but one must remember that modern economists stil l make more frequent use of particular than of general equilibriu m whe n tacklin g practical problems . I t ma y b e inade quate but it is very useful. The analysis is, then, valid for the examination of the pricing of some one commodity on the assumption that the prices of all

Adam Smith on value 3 1 other commodities and of all factors of production are given. This requirement that the prices of the factors of production be taken as given requires the condition tha t only a insignificant proportion of the total supply of any factor b e employed i n the production o f the particular commodity under study. Thi s limit s th e validit y o f th e analysi s t o smal l industries . I f a significant proportio n o f som e on e o r mor e factor s (10 0 pe r cen t o f th e supply i f the facto r b e 'specific') , i s employe d i n thi s industr y the n a n increase i n th e deman d fo r th e particula r commodity , b y increasin g significantly th e deman d for suc h factors , increase s thei r price s an d s o increases th e cos t o f production. On e ca n n o longer defin e cos t without reference t o quantit y supplied . Cos t i s n o longe r constant . Change s i n demand then affect pric e not just supply. But, as Piero Sraffa s o brilliantly showed in his article in the Economic Journal in 1928, the real trouble lies in the limitatio n o f th e validit y an d usefulnes s o f particula r equilibriu m analysis. For the change in the price of the scarce factors will change the costs an d therefor e ultimatel y th e price s o f man y othe r commodities , which prices hav e been take n a s given for the analysis. When one adds, with Dr Sraffa , tha t diminishing cost mus t also be ruled ou t in particular equilibrium analysis , under perfect competitio n - fo r under competitio n there can be no unexhausted internal economies of large-scale production, and, since most, if not all, external economies ar e shared by many industries - again one cannot take other prices as given. Thus one is led by him to the proposition that 'constant cost,' assumed by Adam Smith, is in fact the only vali d condition fo r particular equilibriu m analysis. To rever t t o th e implicit assumptions , on e must add perfect competition , perfec t mobilit y of the factors, an d concentration o n the 'lon g run.' I woul d add that for many purpose s a les s perfec t mode l i s ver y useful ; bu t it s usefulnes s generally is the greater when its limitations are fully recognized by the user. When Adam Smith noted that 'some natural production require such a singularity of soil and situation ' tha t thei r supply always fell shor t o f the effectual demand , he referred to the vineyards of France by way of illustration. In Chapter xi he elaborated an d extended his illustrations to the sugar and tobacco plantations of America. The vine is more affected by the difference o f soils than any other fruit tree. From some it derives a flavour which no culture or management can equal, it is supposed, upon an y other . Thi s flavour , rea l o r imaginary , is sometime s peculia r t o th e produce of a few vineyards; sometimes it extends through the greater part of a small district... The whole quantity of such wines that is brought to market falls short of the effectual deman d ... The whole quantity, therefore, can be disposed t o those

32 Fro m Adam Smith to Maynard Keynes who are willing to pay more [than the natural price] .. . The difference is greater or less, according as the fashionableness an d scarcity of the wine render the competition of the buyers more or less eager. Whatever it be, the greater part of it goes to the rent of the landlord (155-6). It i s clearly assume d tha t there is no singularit y o f skill in husbandry o r management. Wages and profits are then determined by alternative opportunity, i.e., ar e paid at the 'natural' or going rates. As further evidence that he fully understood the process it is well to look at the treatment of taxation of wine and beer in Book v. The rent and profit of barley land ... must always be nearly equal to those of equally fertile an d equally well cultivated land . If they were less, some part of the barley land would soo n be turned t o some other purpose; an d if they were greater, more land would soon be turned to the raising of barley. When the ordinary price of any particular produce of land is at what may be called a monopoly price, a tax upon it necessarily reduce s the rent and profit o f the land which grows it. A tax upon the produce of those preciou s vineyards, of which the wine falls s o much short o f the effectual demand, that its price is always above the natural proportion to that of the produce of other equally fertile and equally well cultivated land, would necessarily reduce the rent and profit of those vineyards. The price of the wines being alread y the highest that could be got for the quantity commonly sent to market, it could not be raised highe r without diminishing that quantity ; and the quantity coul d no t be diminished without still greater loss, because th e lands could not be turned to any other equally valuable produce. The whole weight of the tax, therefore, would fall ... upon the rent of the vineyard ... But the ordinary price of barley has never been a monopoly price; and the rent and profit of barley land have never been above their natural proportion to those of other equally fertile and equally well cultivated land. The differen t taxe s which have been impose d on malt, beer, an d ale, have never lowered the price of barley; have never reduced the rent and profit of barley land. The pric e o f mal t to th e brewe r ha s constantl y rise n i n proportion t o th e taxe s imposed upon it (843-4). After vineyard s Adam Smit h mentione d suga r lands. 'I t i s commonly said that a sugar planter expects that the rum and molasses should defra y the whole expence of his cultivation, and that his sugar should be all clear profit' (157) . S o when i t comes t o taxatio n th e 'suga r planter s hav e fre quently complained that the whole weight of such taxes fell, no t upon the consumer, but upon the producer ... the price had, i t seems, before the tax been a monopoly price; and the argument adduced to shew that sugar was

Adam Smith on value 33 an imprope r subjec t o f taxation , demonstrated , perhaps , tha t i t wa s a proper one' (844). Tobacco is a rather differen t story . Virginia and Maryland have a degree of monopoly, but it 'seems not to be so advantageous as that o f suga r .. . Ou r tobacc o colonie s sen d u s hom e n o suc h wealth y planters a s we see frequently arriv e from ou r sugar islands' (158) . Indeed Adam Smith reported legislativ e restriction s o n planting, and a rumour of burning part of the product in plentiful years . 'If such violent methods are necessary t o keep up the present price of tobacco, th e superior advantage of its culture over that of corn, if it still has any, will not probably be of long continuance' (158-9). To all this I add two comments. First, the use of the word monopoly is misleading: th e distinctio n shoul d b e betwee n natura l scarcit y an d con trived scarcity . Ther e di d no t hav e t o b e a n associatio n o f owner s o f vineyards an d ther e probabl y wa s n o concerte d action . Th e stengt h o f these lan d owner s wa s i n th e absenc e o f competitio n fro m additiona l entrants t o th e industr y because o f the absenc e o f availabl e supplie s o f equally suitable land . Only the tobacco growers seem to have resorted t o monopolistic practice s in the stric t sense . Second, while these example s may be said to involve 'specific' factors, it should be recognized tha t they are not perfectly specific. There are alternative uses, but these are so much less remunerative that they can be ignored for any level of taxation, or any degree o f reduction in demand, that ma y be reasonably expected . Bu t at some leve l of prices an d rents th e vineyards would be converted t o more ordinary agricultural produce, probably to vegetables rather than to corn.

5

On distribution

In Adam Smith, and indeed in the classical writers generally, wages, profits and rents, the incomes of the workers, the capitalists and the landlords, are each treate d separately . I t wa s no t unti l th e neoclassica l revolutio n o f nearly a centur y late r tha t th e pricin g o f the factor s o f production wa s integrated wit h th e pricin g o f thei r products . Thu s emerge d a genera l theory of distribution rather than three specia l theorie s o f wages, profits , and rent. In the understanding o f the forces making for the distribution of income this constituted a very important advance; but it has too often been assumed that the theory of the pricing of the factors constitutes an explanation of the distribution of income, rather than one important element in that explanation. If one is concerned t o explain why the incomes of particular individuals, or groups, ar e as high or low as they are, one must ask why some people hav e for sale specia l skills , and also hav e capital to lend or employ, and have land to rent or use. Clearly distribution depend s not just on profit per cent and rent per acre: it depends on how much capital one has to lend or employ at the determined rate, how many acres one has to lease or use at the determined rent per acre. Studies of the distribution of wealth, requiring institutiona l historical , sociologica l techniques , hav e bee n ne glected. The stud y of the pricing of the factors without reference to their ownership i s easier , mor e amenabl e t o th e preferre d theoretica l tech niques. Yet the distribution of wealth is of great importance in itself and an essential elemen t i n the explanatio n o f the distributio n of income , wh y some of us are better off, and some worse off, than the average. While differences i n wages between different types of labour may be, in

On distribution 35 part, du e t o difference s in ability , the y appea r t o b e eve n mor e du e t o differences in opportunity. The existing unequal distribution of the ownership of property and the consequent unequal distribution of current incom e are largel y responsible fo r th e difference s in the qualit y of labour which different groups have for sale. The poverty o f the poor is their destruction; because thei r parents were poor many children were undernourished, and had to enter industry at an early age in an occupation whic h gave maximum immediate earning s bu t whic h might prove a 'blin d alley. ' O n th e othe r hand, one must notice the advantage of the 'old school tie,' most obvious in an olde r countr y lik e England , bu t no t quit e absen t eve n i n a pionee r country like Canada. Professor R.H. Tawney put the point cogently: in his book Equality. 1 We are all disposed t o attribute our failures to our circumstances and our successes to ourselves; that the race is to the swif t an d the battle to the stron g and that we richly deserve our victory. But the successful, who had a good start in life, would do well t o as k himsel f what his position would have been i f his father ha d bee n a n unemployed mine r or a casua l dock labourer . The rac e i s not fro m scratch , th e handicaps ar e considerabl e .. . Ther e i s th e unequa l pressure o f mer e material surroundings, o f housing, sanitation, and liabilit y t o disease , whic h decides that social group s shal l diffe r i n thei r abilit y t o mak e the bes t us e o f thei r natura l endowments. There i s inequality o f educational opportunity .. . whil e a favoure d minority ca n cultivat e their powers till manhood , the grea t majorit y o f children, being compelled to compete for employment in their early adolescence, must enter occupations i n which, because the y are overcrowded, th e remuneration is low ... There is the nepotism which allows jobs in the family business to sons and relatives, and the favouritism which fills them with youths belonging to the same social clas s as its owners. There i s inequality of access t o financial information, whic h yields fortunes o f surprising dimensions, if occasionally, also, of dubious repute, to th e few who possess it.

If inequality in wealth is a cause of inequality of labour earnings, as well as a source of property income, one should ask why is ownership of wealth so unequal , mor e unequa l tha n income . Th e reason s wer e trenchantl y summarized by Professor Irving Fisher when he said that the distribution of property 'depend s on inheritance , constantl y modifie d by thrift, ability, industry, luck and fraud.' Ther e has been to o little attention pai d to this problem. Josiah Wedgwood's book, The Economics o f Inheritance, is one classic stud y but i t is dated (1929) . Hugh Dalton's stud y o f Inequality o f Income (1929 ) is equally dated. They remain important nevertheless.

36 Fro m Adam Smith to Maynard Keynes Wages Judged by the standard of the modern theory Adam Smith cannot be given as high marks for his chapter on wages as for that on value. Not only did he isolate wage s from th e pricing process generally, bu t in that isolation he conceived o f the forces of supply and demand in terms that are of little use in a static theory of the labour market. The supply of labour was pictured as suiting itself to the effectual demand. An increase in demand causing a rise in wages would lead to an increase of the numbers of the working class by reducing mortality and increasing fertility. In civilized society it is only among the inferior ranks of people that the scantiness of subsistence can set limits to the further multiplication of the human species; and it can do so in no other way than by destroying a great part of the children which their fruitful marriage s produce. The liberal reward of labour, by enabling them to provide better for their children, and consequently to bring up a greater number, naturally tends to widen and extend these limits ... it necessarily does this as nearly as possible i n the proportion whic h demand for labour requires. I f this demand is continually increasing, the reward of labour must necessarily encourage in such a manner the marriage and multiplication of labourers, as may enable them to supply that continually increasing demand ... It is in this manner that the demand for men, like tha t fo r an y othe r commodity , necessaril y regulate s th e productio n o f men (79-8o).

I shall make only two comments: first, the time required for the supply of labour to respond to a change in demand must be many years: babies must grow up. Second , the simple explanation of population growth as responsive to wages, particularly of fertility a s responsive t o wages, is far fro m satisfactory. Perhaps it was nearer to being true in the days of the classica l writers, so that our rejection i s based partly on a change in the underlying conditions of population growth. The deman d for those who live by wages, it is evident, cannot increase but i n proportion t o the increas e o f the funds whic h are destined fo r th e payment of wages' (69). These funds are said to be of two kinds; first, 'the revenue which is over and above what is necessary for the maintenance; and secondly, the stock which is over and above what is necessary for the employment of their masters' (69) . First, then, revenue: 'When the landlord, annuitant, or monied man, has a greater revenue than what he judges sufficient to maintain his own family, he employs the whole or a part of the surplus in maintaining one or more menial servants. Increase this surplus and he will naturally increase the number of those servants' (69). But may he no t instea d increas e hi s purchas e o f goods , 'equipage, ' rathe r tha n

On distribution 37 service? And is it not essential to this theory of demand to know something about the determinants of the size of that part of the surplus which will be devoted t o hiring menial servants? Second, stock : 'Whe n an independent workman, such as a weaver or shoe-maker, has got more stock than what is sufficient t o purchas e th e material s o f hi s ow n work , an d t o maintai n himself til l he can dispose o f it, h e naturally employ s on e or more journeymen wit h th e surplus . Increas e thi s surplus , an d h e wil l naturall y increase the number of his journeymen' (69). Will he use the whole of the surplus, must he use any part of it for this purpose? Has not Adam Smith ignored th e alternativ e o f spendin g part, o r eve n all , o f the increas e o n machinery t o increase th e productivity o f his present labou r forc e rathe r than on an increase of the number he employs? As a theory of equilibrium wages this treatment o f the demand for labour is unsatisfactory: i t fails to recognize th e importance of the expected deman d for the product, and it fails t o recogniz e tha t th e capitalis t mus t buy materials, machinery , and land as well as labour. The demand of the employer is both 'derived' and 'joint.' The confusion caused by failure to recognize these characteristic s of the demand for labour, or for any other factor of production, persisted till the era of the Jevonian revolution . Though Ada m Smit h doe s no t rat e hig h i n equilibriu m distributio n theory, he does have some important things to say about wages. First let me refe r t o hi s discussio n o f th e inequalit y o f th e partie s t o th e wag e bargain. The masters, being fewer in number, can combine much more easily; and the law, besides, authorises, or at least does not prohibit their combinations ... Masters are always and everywhere in a sort of tacit, but constant and uniform combination, not to raise the wages of labour above their actual rate. To violate this combination is every where a most unpopular action, and a sort of reproach to a master among his neighbours and equals (66).

The workers though prohibited fro m combining did so. 'They are desper ate, an d act with the folly an d extravagance o f desparate men , who must either starve, or frighten their masters into an immediate compliance with their demands. The master s upo n these occasion s ar e just a s clamorou s upon the other sid e and never cease to call aloud for the assistance o f the civil magistrate' (67). The picture has changed sinc e 1776 ; but what Adam Smith sai d her e shoul d b e a useful reminde r t o the moder n theoris t tha t wages in the real world are affected by institutional factors as well as by the underlying economic force s of the market . Second, Ada m Smit h wa s concerne d no t wit h equilibrium at a given

38 Fro m Adam Smith to Maynard Keynes time, but with change over long periods of time. His treatment of demand for labour when applied t o the problem o f long-run trends make s sense . 'The demand for those who live by wages, therefore, necessarily increase s with the increase of the revenue and the stock of every country ... [which] is the increase of national wealth' (69). He based his proposition on empirical grounds. Wages he saw were high in North America where wealth was growing rapidly; they were low in Bengal which was stagnant. This led to one o f th e man y sentence s i n th e Wealth o f Nations whic h stres s th e importance fo r economi c growt h of peace, orde r an d good government . 'The difference between the genius of the British constitution whic h protects an d govern s Nort h America , an d tha t o f the mercantil e compan y which oppresse s an d domineer s i n th e Eas t Indies , canno t perhap s b e better illustrate d tha n by the different stat e of those countries' (73) . What remains t o b e sai d i s that Ada m Smit h believed tha t the increas e i n the wealth o f nation s woul d mea n a n improvemen t i n th e conditio n o f th e many. Perhaps th e mos t importan t passag e i n the chapte r o n wage s i s on e which t o u s seem s obvious , bu t whic h marke d a revolutio n i n socia l thought. Is thi s improvement in the circumstances o f the lower ranks of the people t o be regarded as an advantage or as an inconveniency to the society? The answer seems at first sight abundantly plain. Servants, labourers and workmen of different kinds, make up the far greater part of every great political society. But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of th e member s ar e poo r and miserable . It i s but equity , besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged (78-9).

Contrast wit h this, statement s i n the mercantilis t writer s suc h a s these. 'Penury an d want, ' sai d Thoma s Mun , 'd o mak e a peopl e wis e an d industrious.'2 O r Arthu r Youn g as lat e a s 1771 : 'Everyon e bu t a n idio t knows tha t th e lowe r classe s mus t be kep t poo r o r the y wil l neve r b e industrious.'3 Or Fauquier: 'If the price of labour in any country is so great that th e poo r b y working part o f the wee k can maintai n themselves and family fo r a whol e week, 'ti s a n evi l to tha t countr y which requires th e strictest attentio n to the magistrates.'4 Adam Smith not only made the improvement of the lot of the mass of the

On distribution 39 people a matte r o f policy, h e als o argue d tha t 'hig h wage s increas e th e industry of the common people.' In cheap year s it is pretended, workme n are generally more idle, and in dear one s more industriou s tha n ordinary . A plentifu l subsistenc e therefore , i t ha s bee n concluded, relaxes , and a scanty on e quickens thei r industry. That a little mor e plenty than ordinary may render som e workmen idle, cannot well be doubted; but that it should have this effect upo n the greater part, or that men in general should work bette r whe n the y ar e il l fed tha n whe n the y ar e wel l fed , when the y ar e disheartened than when they are in good spirits, when they are frequently sic k than when they are generally in good health, seems not very probable (82-3). I maintain that Adam Smith and the classical economists played no small part in developing in the upper and middle classes th e liberal democrati c attitude towards the working class. I cannot here develop this theme, but I suggest that a study of this change of attitude, as reflected in the classica l literature of political economy and in the novels of the period, would throw valuable ligh t o n th e developmen t o f political democracy . If alon g with study of the attitudes to the workers went careful stud y of the character of the workers, there might develop mor e sympathetic understanding of the earlier attitude. I suspect that a complicated pattern of relationships would be revealed in which changing attitudes towards the worker would be found both a result of, and a cause of, change in the character of the workers. The proportion of the 'Lumpen-proletariat' seems to have been very high in the eighteenth an d early nineteenth centuries. Doroth y George in her London Life i n th e Eighteenth Century (1930 ) show s tha t ther e wa s a marke d improvement i n the characte r o f the workin g class fro m 178 0 to 1820 . I shall revert to this theme when I discuss J.S. Mills ' chapter on the 'Probable Futurity of the Working Class.' I have referred to these passages a s indicating a great change in social attitudes, but I must add that the effect of the leve l o f wages o n the quantit y an d quality o f service, tha t is , o n th e productivity o f th e workers , i s on e whic h stil l require s attentio n an d increased understanding. Finally I draw attention to the last paragraph in the chapter on wages, in which Adam Smith examined the relation of increasing wages to the prices of commodities. The increas e i n th e wage s o f labou r necessaril y increase s th e pric e o f man y commodities .. . The sam e cause, however , which raises th e wages of labour, the increase of stock, tends to increase its productive powers ... The owner of the stock

40 Fro m Adam Smith to Maynard Keynes ... endeavours, for his own advantage, to make such a proper division and distribution of employment, that they may be enabled to produce the greatest quantity of work possible. Fo r the same reason, he endeavours to supply them with the best machinery ... More heads are occupied in inventing the most proper machinery for executing the work of each, and it is, therefore, more likely to be invented. There are many commodities, therefore, which ... come to be produced by so much less labour than before, that the increase of its price is more than compensated by the diminution of its quantity (86). So high wages ar e foun d t o b e a proper ai m of socia l policy ; t o hav e a favourable effect o n the productivity of workers; and to be consistent with low prices of commodities as long as productivity increases at least as fast as wages. A new era indeed! Profits The increase of stock, which raises wages, tends to lower profit. When the stocks of many ric h merchant s are turne d int o th e sam e trade , thei r mutua l competition naturally tends to lower its profit; and when there is a like increase of stock in all the different trades carried on in the same society, the same competition must produce the same effect i n them all (87). The first part of this sentence is, of course, correct onl y if one assumes the conditions o f demand and cost t o remain unchanged; but the increas e of stock ma y be expected t o reduce cost . The second hal f of the sentence is fallacious: the increased investment in other trades must affect th e demand for the product of the one, and many of its costs. Adam Smith proceeded t o give unconvincin g empirica l proo f o f hi s propositio n an d t o ignor e th e application t o the problem of profit o f some important propositions whic h appear at other points in his book. First, the empirical evidence: It generally requires a greater stock to carry on any sort of trade in a great town than in a country village. The grea t stocks employed in every branch of trade, and the number of rich competitors, generally reduce the rate of profit in the former below what it is in the latter. But the wages of labour are generally higher in a great town than in a country village . In a thriving town the people wh o have great stock s to employ, frequently cannot get the number of workmen they want, and therefore bid against one another in order to get as many as they can ... In the remote parts of the country ther e i s frequentl y not stoc k sufficien t t o emplo y al l th e people , wh o therefore bid against one another in order to get employment (89-90).

On distribution 4 1 Second thought s le d Ada m Smit h himsel f i n th e ver y nex t chapte r t o reverse this position. In every country in Europe we find, at least, a hundred people who have acquired great fortunes from small beginnings by trade and manufactures, the industry which properly belongs to towns, for one who has done so by that which properly belong s to the country ... Industry, therefore, must be better rewarded, the wages of labour and the profit s o f stock mus t evidently be greater in the on e situatio n than in the other(125).

Other conflictin g empirica l evidenc e wa s cite d bu t dismisse d a s reflecting 'peculiar ' conditions. 'I n our North American an d West Indian colonies, not only the wages of labour but... the profits of stock, are higher than in England... High wages of labour and high profits of stock, however, are things, perhaps , whic h scarce ever g o together except in the peculia r circumstances o f new colonies' (92). The exampl e of the colonies shoul d have le d Ada m Smit h t o doub t hi s origina l proposition . No r i s i t onl y colonies tha t he noticed a s creating the inversion of his proposition: 'ne w branches o f trade, may sometimes rais e the profits of stock .. . even i n a country which is first advancing in the acquisition o f riches. The stoc k of the countr y no t being sufficient fo r the whol e accession o f business .. . is applied t o those particula r branche s onl y which affor d t o greatest profit ' (93). He reverted to his general proposition i n Book n. As capital s increase in any country, the profit s which can be made by employing them necessarily diminis h ... It becomes graduall y more and more difficult t o find within the country a profitable method of employing any new capital. There arise s in consequence a competition between different capital s ... H e must not only sell what h e deal s i n somewha t cheape r .. . bu t i n orde r t o ge t i t t o sell , h e mus t sometimes too buy it dearer. Th e demand for productive labour, by the increase of the funds which are destined for maintaining it, grows everyday greater and greater ... competition raises the wages of labour, and sinks the profits of stock (336).

This i s a curiously stati c approac h i n the dynami c context o f the Inquiry into the Nature an d Causes o f th e Wealth of Nations. Is no t demand for products increasing, is there no innovation, are there no new processes, n o new products? Is the new capital all directed to hiring workers, and none to equipping them with new machinery? Second, le t m e note som e proposition s fro m othe r part s o f his boo k which should have made him doubt the validity of his proposition abou t the

42 Fro m Adam Smith to Maynard Keynes effect of the growth of wealth on profits. He said that 'it may be laid down as a maxim, that wherever a great deal may be made by the use of money, a great deal will commonly be given for the use of it' (88). In the context he was justifying the use of the rate of interest (of which there is some record) as indicating roughly the rate of profit of which there is almost none . But might he not have applied thi s maxim equally to wages: whenever a great deal may be made by the use of labour, a great deal will commonly be paid for it . What is more he might have remembered wha t he had written onl y three pages earlier: 'the same cause... which raises the wages of labour, the increase of stock, tends to increase its productive power' (86). And finally when he came to discuss the value of the money metals in Chapter xi he noted that an increase of supply will not lower their value if the demand for them is increasing sufficiently t o offset tha t increase i n supply. Why then was he so ready to consider an increase in the supply of stock as necessarily lowering th e rat e o f profi t withou t considerin g th e rat e o f increas e o f demand for capital which accompanies th e very growth that increases the supply? Th e expectatio n tha t profit s woul d fal l wit h increasin g wealt h remained a source of worry for the Ricardians, and of hope for the Marxists. That th e word profit ma y be used to mean different thing s to differen t generations of economists, and even to differen t economist s of the same generation, did not make scientific advance easy. I shall not here discuss the modern theory of profit, but merely say that in my view the most useful contributions have been made by F.H. Knigh t in recognizing the crucial importance of uncertainty and by Joseph Schumpeter in identifying the role of'innovation.' On wage differences In Chapter x Adam Smith examined the differences of wages and profits in different employments . I shal l discus s onl y what he wrote abou t differ ences in wages. In the first part he dealt with 'inequalities arising from th e nature of the employments themselves' (100). This is plausible, one might almost say charming; while in many ways unsatisfactory it is still suggestive. Let me comment on each of his five 'principal circumstances.' 'First, The wage s o f labour var y with the eas e o r hardship , th e cleanlines s o r dirtiness, th e honourableness o r dishonourableness o f the employment... The trade of a butcher i s a brutal and an odious business; but it is in most places more profitable than the greater part of common trades' (100). One is inclined t o point out that earning s i n fact seem to be higher in the clean, interesting, honourable jobs, and lower in the dirty, dull jobs which, if not

On distribution 43 dishonourable, certainl y attrac t n o honourabl e recognition . T o mak e Adam Smith' s propositio n useful i t was necessary t o recognize th e exis tence o f 'non-competing ^ groups . Withi n suc h group s ther e woul d b e a tendency to equality of what Alfred Marshall called 'net advantages' rather than of money wages. That Ada m Smit h made the proposition genera l is perhaps relate d to his belief i n the equality o f the natural talents o f man, referred t o earlier . H e shoul d hav e note d inequalit y o f opportunity, in equality of access to the means of developing skills. 'Secondly, The wages of labour vary with the easiness an d cheapness , or th e difficult y an d expenc e o f learnin g th e business ' (101) . Whe n a machine i s erected it is expected that its earnings wil l replace the capita l invested i n i t wit h a t leas t th e ordinar y profit . ' A ma n educate d a t th e expence o f muc h labou r an d tim e t o an y o f thos e employment s which require extraordinary dexterity and skill, may be compared to one of those expensive machines . Th e wor k whic h h e learn s t o perform , i t mus t b e expected .. . will replace t o him the whole expence of his education, with at least the ordinary profits of an equally valuable capital' (101). This recognition of 'human capital' is further developed i n Book n where Adam Smith listed as one of the categories of capital 'the acquired and useful abilities of all th e inhabitant s o r member s o f th e society . Th e acquisitio n o f suc h talents ... costs a real expence, which is capital fixed and realized as it were, in his person. Those talents, a s they make a part of his fortune, so do they likewise o f that o f the societ y t o which he belongs' (265-6) . Nearly tw o centuries passe d befor e really seriou s analysi s of the problems o f investment in human capital began, and serious efforts were made to measure the individual and social return to such investment. There then developed suc h enthusiasm for the 'investment ' aspect of education, an d for rational allo cation of capita l betwee n investmen t in men and machines , tha t the humane aspects , th e consumptio n aspects, cam e t o b e dangerousl y ne glected . Surely the development of people is a proper end in itself: but since it is very expensive i t is good t o know that muc h of it pays of f i n increase d productivity. It woul d be wrong, however, to let the rate of return alon e determine the amount spent on education, even if the social rather than the private return is used. There would be a serious danger that the character of education woul d b e perverte d t o emphasiz e productivit y rathe r tha n human quality. We should educate citizens not workers, even if the citizens are not as productive as specially traine d slaves. 'Thirdly, The wage s o f labour i n different occupation s var y with th e constancy o r inconstanc y o f employment' (103) . Adam Smit h seem s t o argue that weekly earnings in seasonal occupations shoul d not only be high

44 Fro m Adam Smith to Maynard Keynes enough to 'maintain him while he is idle, but to make him some compensation for those anxious an d desponding moment s which the thought o f so precarious a situatio n mus t sometimes occasion ' (103) . We still pay to o much attention to weekly earnings -even to hourly earnings -and too littl to the numbers of weeks or hours worked and so to yearly earnings. Study of yearl y earnings i s stil l no t enough . One need s t o stud y th e expecte d life-time earnings. I think of the dancer who is scarcely likely to have more than twenty years of performing life; and I think of the surgeon who may be nearly thirty before his professional earnings begin and who is not likely to be abl e t o operat e afte r sixty . On e shoul d ad d tha t th e estimatio n o f expected earnings over a lifetime, though necessary for rational decision as to investment in the training required, is subject to such uncertainty that a rational investment decision is impossible. Fourthly, The wages of labour vary according to the small or great trust which must be reposed in the workmen... We trust our health to the physician; our fortunes and sometimes ou r lif e an d reputatio n t o th e lawye r and attorney . Suc h confidenc e could not safely be reposed in people of a very mean or low condition. Their reward must b e such , therefore , a s ma y giv e the m tha t ran k i n th e societ y whic h s o important a trust requires (105).

This is a very Veblenian proposition: t o acquire our confidence the physician, or the lawyer, must indulge in such 'conspicuous consumption' as will demonstrate his pecuniary success whic h we hope indicates hi s real skill. Much o f his consumptio n expens e become s a cost incurre d i n order t o maintain his income, a sort of advertising expense. Fifthly, Th e wage s o f labou r i n differen t employment s vary accordin g t o th e probability o r improbabilit y o f success in them .. . Pu t you r son apprentice to a shoemaker, there is little doubt of his learning to make a pair of shoes. But send him to study law, it is at least twenty to one if ever he makes such proficiency a s will enable him to live by the business (106).

We revert to the theme of uncertainty but there is an important additiona l comment. The overweenin g conceit which the greater part of men have of their ow n abilities , i s an ancient evi l remarked by th e philosopher s an d moralists of all ages. Their absurd presumption in their own good fortune , has been less taken notice of... The chance of gain is by every man more or less overvalued, and the chance of loss ... undervalued' by any man 'who is in tolerable health an d spirits' (107) . 'Th e contempt o f risk an d the pre -

On distribution 45 sumptuous hope of success, are in no period o f life more active than at the age at which young people chus e their professions' (109) . Adam Smith noted three necessary condition s of this tendency to equality o f ne t advantages , simila r t o th e qualification s i n Chapte r v n wit h reference to the equality of price and cost. The employments must be 'well known, and have been lon g established i n the neighbourhood' (114). Th e equality 'ca n take plac e onl y i n the ordinary, o r what may be called th e natural stat e o f those employments' (115) ; and the employments must be 'the principa l employment s o f those wh o occup y them ' (116) . Thi s las t condition leads to his remarkable disquisition on the difference in the price of student lodgings in London an d Edinburgh. In the former student lodging was a by-product of retail trade. The tradesman 'expects to maintain his family by his trade, and not by his lodgers' (i 18). In Edinburgh 'the price of the lodging must pay, not only the rent of the house, but the whole expence of the family' (118). In Part n of Chapter x Adam Smith turned to 'Inequalities occasioned by the Policy of Europe.' The polic y o f Europe , b y no t leavin g things at perfec t liberty , occasions othe r inequalities of much greater importance ... First, by restraining the competition in some employments to a smaller number than would otherwise be disposed to enter into them; secondly, by increasing it in others beyond what it naturally would be; and thirdly , by obstructing the fre e circulatio n of labour ... from employmen t to employment and from place to place (i 18).

I shall not discuss the detail of his case against the apprenticeship laws and the settlemen t laws , bu t I shal l mak e som e incidenta l quotation s whic h throw light on his general attitude to freedom and regulation, or which are suggestive for modern policy-making. The property which every man has in his own labour, as it is the original foundation of all property, so it is the most sacred and inviolable. The patrimony of a poor man lies in the strength and dexterity of his hands; and to hinder him from employing this strength an d dexterit y i n wha t manne r h e think s prope r without injur y t o hi s neighbour, i s a plai n violatio n o f thi s mos t sacred property . It i s a manifes t en croachment upon the just liberty both of the workman, and of those who might be disposed t o emplo y him . As i t hinder s th e on e fro m workin g a t wha t h e thing s proper, so it hinders the others from employin g whom they think proper. To judge whether h e i s fit to b e employed , may surel y b e truste d t o th e discretio n of th e employers whos e interest it s o muc h concerns . The effecte d anxiet y o f the law-

46 Fro m Adam Smith to Maynard Keynes giver lest they should employ an improper person is evidently as impertinent as it is oppressive (121-2).

For furthe r understandin g o f thi s poin t o f vie w on e shoul d rea d Ada m Smith's letter s o n medica l degree s quote d i n Rae' s Life, 55an d Milto n Friedman's discussion of licensure in his Capitalism and Freedom. People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either coul d b e executed , o r woul d b e consisten t wit h libert y an d justice. Bu t though the law cannot hinder people of the same trade from sometime s assembling together, it ought to do nothing to facilitate such assemblies; muc h less to render them necessary (128).

This is not quite irrelevant at the time of writing. To remove a man who has committed no misdemeanour from th e parish where he chuses to reside, i s an evident violation of natural liberty and justice .. . There is scarce a poor man in England of forty years of age, I will venture to say, who has not in some part of his life felt himself most cruelly oppressed by this ill-contrived law of settlements (141).

The passionate belie f in liberty is evident in this as in the earlier quotatio n on apprenticeship. To Adam Smith the most important causes of inequality were the resul t of government interference. Perhap s the y were in his day. But even in his day ther e wer e 'natural ' obstacles as well as legal obstacles. Perhaps th e best analysis of the natural obstacles i s to be found i n Pigou's Wealth and Welfare (1912). 6 A new role of the state emerges, to eliminate or lower the natural obstacles. The earlier form of such action was to promote mobility, a later form was to relocate industry.

6

The neglected and excitin g Chapter xi : on the rent of land

In Chapter vn Adam Smith had treated rent as price determining, as one of the costs , alon g wit h wage s an d profits , whic h mus t i n the lon g ru n b e covered by the price. Now at the beginning of Chapter xi he said: Rent, i t is to b e observed, therefore, enter s int o th e compositio n of the pric e of commodities i n a different way from wages and profit. High or low wages and profit, are the causes of high or low prices, hig h or low rent is the effect o f it... It is because its price is high or low; a great deal more, or a very little more, or no more, than what is sufficient t o pay those wages and profits, that it affords a high rent, or a low rent, or no rent at all (145-6).

Can Ada m Smit h reall y hav e i t bot h ways : ren t pric e determinin g in Chapter vn and rent price determined in Chapter xi? The answer is clearly yes, fo r i n th e contex t o f th e statement s h e i s correct . I hav e alread y discussed his analysis of the relation of rent and price in the two opposite cases wher e lan d is non-specific - havin g many alternative use s (barle y land) - an d highly specific havin g no alternative use (vineyards). Here in Chapter xi h e was concerned with land in the aggregate. The choic e is to use i t (preferabl y i n it s mos t productiv e use ) o r no t t o us e it . Tha t h e understood th e proble m ca n b e demonstrated , a s I demonstrate d wit h reference to barley land and vineyards, by his proposition on the incidence of a tax on rent. 4 As it has no tendency to diminish the quantity, it can have none to raise the price of that produce. It does not obstruct the industry of the people. I t subjects the landlord to no other inconveniency besides the unavoidable one of paying the tax' (780).

48 Fro m Adam Smith to Maynard Keynes But hi s really interesting , even exciting , analyses o f rent ar e not con cerned with long-run equilibrium in a static model, but with a much longer, secular, run in which more variables change. Take for instance the effect of the improvement of transportation on the rent of land in remote parts and in the neighbourhood of the town. Good roads, canals, and navigable rivers, by diminishing the expence of carriage , put th e remot e part s o f the countr y mor e nearly upo n a level wit h those in th e neighbourhood of the town. They are upon that account the greatest of all improvements. They encourag e th e cultivation of the remote, whic h must always be th e most extensiv e circl e o f th e country . The y ar e advantageou s t o th e town , b y breaking down the monopoly of the country in its neighbourhood. They are advantageous even to that part of the country. Though they introduce some rival commodities int o th e ol d market , the y ope n man y ne w market s t o it s produce . Monopoly, besides, i s a great enemy to goo d management , which can neve r b e universally established bu t in consequence o f that free an d universal competitio n which forces everybody to have recourse to it for the sake of self-defence (147).

The mor e usua l analysi s o f rent following the later Ricardian lead woul d stop short at the initial fall in rents in the neighbourhood o f the town as new supplies of produce brought down prices. Tha t th e same improvements in transportation permi t an increase in the market for the produce of the town, and that competitio n ma y force bette r managemen t an d therefore lowe r costs, would be ignored. Adam Smith did not, however, make it quite clear that th e ne w market s opene d b y improve d transportatio n ar e primaril y markets fo r th e manufacture d produce o f th e town , an d tha t th e ne w markets fo r th e lan d i n it s neighbourhoo d deriv e fro m th e consequen t increased prosperity o f the town. In the neighbourhood of a great town, the demand for milk and for forage to horses, frequently contribute , together wit h the high price of butcher's meat, to raise the value of grass above what may be called its natural proportion to that of corn. This local advantage , i t i s evident , canno t b e communicate d to th e land s o f a grea t distance (149).

This is an advantage that grows with the growth of the town, which growth is facilitated b y cheaper food . So in spite of the influx of supplies fro m th e remote counties , th e rent s o f lan d nea r Londo n 'hav e risen , an d thei r cultivation ha s bee n improved ' (148) . Th e experienc e o f English whea t farmers afte r th e railroa d an d the steamshi p brough t whea t fro m Nort h

The neglected and exciting Chapter xi 49 America is not very different fro m tha t of these farmers in the neighbourhood of London. But further improvements in transportation, refrigeration for instance, reduced stil l further the local advantages. At the end of Part i of this chapter Adam Smith discussed the size of the population tha t coul d b e maintaine d in Europ e i f the subsistenc e o f th e people wer e potatoes rathe r than bread. 'Shoul d this root ever become in any par t o f Europe , lik e ric e i n som e ric e countries , th e commo n an d favourite vegetable foo d of the people .. . th e sam e quantity of cultivated land would maintain a much greater numbe r of people' (160) . There followed commen t o n th e relativ e nutritiona l qualit y o f wheat , oats , an d potatoes. The common people in Scotland, who are fed with oatmeal, are in general neither so strong nor s o handsome as the same rank of people in England, who are fed with wheaten brea d .. . Bu t i t seem s t o b e otherwis e wit h potatoes . Th e chairmen , porters, an d coalheaver s i n London, an d those unfortunat e women who live by prostitution, the strongest men and the most beautiful women perhaps in the British dominions, are said to be, the greater part of them, from the lowest rank of people in Ireland, who are generally fed with this root (161).

This discussion of the size of the population which could be maintained if the people woul d accept a 'cheaper' food led to a n examination of the effect o f increasing productivit y i n the food-producing secto r on the de velopment o f th e economy , an d o n th e fortune s o f landlords . 'Amon g savage and barbarous nations' ninety-nin e per cent of their labour is 'fre quently n o mor e tha n enoug h t o provid e the m wit h food ' (163) . I n th e England of his day 'the labour of one half the society becomes sufficien t t o provide food for the whole' (163). The other half can then be employed in providing other things: cloathing an d lodging, household furniture , and what is called Equipage , are th e principal objects of the greater part of those want s and fancies ... Henc e arise s a demand fo r ever y sor t o f materia l whic h huma n invention can employ , eithe r usefully o r ornamentally, in building, dress, equipag e or household furniture; fo r the fossils and minerals contained i n the bowels of the earth, the precious metal s and precious stones (163-4).

So cheap food by increasing the surplus product of society, surplus above the amoun t o f product s necessar y fo r subsistenc e ('ne t revenue ' i n Ricardo's language , 'surplu s value' i n Marx's) increase s th e demand for

50 Fro m Adam Smith to Maynard Keyne s other scarc e natural resources which ar e owned b y the landlord s whose agricultural rent s ar e thu s supplemente d b y royalties . Ada m Smit h re verted to this theme a few pages later : The value of the most barren lands is not diminished by the neighbourhood of the most fertile. On the contrary, it is generally increased by it. The grea t number of people maintained by the fertile lands affords a market to many parts of the produce of the barren , whic h they could neve r have found amon g those who m their ow n produce could maintain. Whatever increases th e fertility of land in producing food, increases not only the value of the lands upon which the improvement is bestowed, but contribute s likewise to increas e that of many other lands, by creating a new demand for their produce (173-4).

We are here in the realm of the economics of growth having passed beyond the 'static ' realm . I n thi s real m w e find dynamic studie s o f the prices of various kinds of produce whic h merit careful consideration . Precious metals The deman d for those metal s arises partl y from thei r utility and partly from thei r beauty ... The merit of their beauty is greatly enhanced by their scarcity. With the greater part of rich people, th e chief enjoyment of riches consists i n the parade of riches, which in their eye is never so complete as when they appear to possess thos e decisive marks of opulence which nobody can possess but themselves. In their eyes the merit of an object... is greatly enhanced by its scarcity (172).

This Veblenian thesis is also applied to precious stones: 'they are of no use, but as ornaments; and the merit of their beauty is greatly enhanced by their scarcity' (172). But to revert to the precious metals , one must next note, as Adam Smith did, that their employment as coin occasioned a new demand. This monetar y deman d he discussed i n the 'Digressio n on Silver.' H e was ther e concerne d wit h th e change s i n th e valu e o f silve r ove r th e previous four-hundre d years . H e recognize d ver y grea t change s i n th e supply of the precious metal s over that period, but took a very sound view that th e chang e i n suppl y mus t b e relate d t o th e chang e (increase ) i n demand if the change in value was to be understood . If b y th e genera l progres s o f improvemen t the deman d o f thi s marke t shoul d increase, while at the same time the supply did not increase in the same proportion, the value of silver would gradually rise ... If, on the contrary, the supply by some accident shoul d increas e fo r man y years together i n greater proportio n tha n th e

The neglected and exciting Chapter xi 5 1 demand, that metal would gradually become cheape r .. . But if, on the other hand, the suppl y o f th e meta l shoul d increas e nearl y i n th e sam e proportio n a s th e demand, it [the value] would continue .. . very nearly the same (176). We have here Gustav Cassel's theory of the relativ e gold 1 suppl y minus only it s controversia l quantitativ e feature , viz. , th e calculatio n tha t a n annual cumulative three per cent increase in the gold stock is necessary to keep pac e wit h the demand . Adam Smith examined the relativ e rat e of growth o f suppl y an d deman d i n thre e periods : (a ) 1350-1570 , (b) 1570-1640, (c) 1640-1776. He had this to say about the growth of demand in each of the periods: (a) Th e first period, 1350-1570 In the end of the fifteenth and beginning of the sixteenth centuries, the greater part of Europe was approaching towards a more settled form of government than it had enjoyed for several ages before. The increase of security would naturally increase industry and improvement; and the demand for the precious metals , as well as for every othe r luxur y and ornament , woul d naturally increase wit h the increas e o f riches. A greate r annua l produc e woul d requir e a greate r quantit y o f coi n t o circulate it; and a greater number of rich people would require a greater quantity of plate and other ornaments of silver (181). (b) Th e second period, 1570-1640 The discovery of abundant mines of America, seems to have been the sole cause of this diminution in the value of silver in proportion t o that of corn. It is accounted for accordingly i n th e sam e manne r b y ever y body ; an d ther e neve r ha s bee n an y dispute either abou t th e fact, or about the cause of it. The greate r part of Europ e was, during this period advancing in industry and improvement, and the demand for silver must consequently have been increasing. But the increase of the supply had, it seems , s o far exceede d tha t o f the demand , tha t th e valu e of that meta l sun k considerably (190). (c) Th e third period, 1640-177 6 Four reasons for the growing demand for silver are elaborated. First, The market of Europe has become gradually more and more extensive ... The increasing produce of the agriculture and manufactures of Europe must necessaril y have required a gradual increase i n the quantity of silver coin to circulate it; and the increasing number of wealthy individuals must have required the like increase in the

52 Fro m Adam Smith to Maynard Keynes quantity of their plate and other ornaments of silver... Secondly, America is itself a new market for the produce of its own silver mines; and as its advances in agriculture, industry, and population, are much more rapid than those of the most thriving countries in Europe, it s deman d must increase muc h more rapidly. The Englis h colonies ar e altogethe r a new market, which partly for coin an d partly for plate , requires a continually augmenting supply of silver through a great continent where there never was any demand before.... Thirdly, The East Indies is another market for th e produc e o f the silve r mines of America, and a market which .. . ha s bee n continually taking off a greater and greater quantity of silver (202-4).

This drai n o f silve r t o th e Eas t Ada m Smit h relate d t o th e increasin g demand for certain products of that region. Tea, for example, was a drug very little used in Europe before the middle of the last century. At present the value of the tea annually imported by the English East India Company, for the use of their own countrymen, amounts to more than a million and a half a year ... The consumption of the porcelain of China, of the spiceries of the Moluccas, o f th e piec e good s o f Benga l .. . ha s increase d ver y nearl y i n a like proportion ... the precious metals are a commodity which it always has been, and still continues to be, extremely advantageous to carry from Europ e to India. There is scarce any commodity which brings a better price there (205-6).

Some ligh t o n thi s drai n t o th e eas t i s throw n b y th e 'Mandate ' o f th e Chinese empero r t o Georg e H I on th e occasio n o f Macartne y Mission , 1793: 'Ou r dynasty' s majesti c virtu e ha s penetrate d int o ever y countr y under Heaven, an d Kings of all nations have offered thei r costly tribute by land an d sea . A s you r Ambassado r ca n se e fo r himself , w e posses s all things. I set no value on objects strang e and ingenious and have no use for your country's manufactures.' 2 Th e eas t may have had no use for Euro pean manufactures, but it had an almost insatiable desire for silver. There remains th e fourt h factor , 'th e continua l consumptio n o f th e preciou s metals in coin by wearing, and in plate both by wearing and cleaning,' the loss in transporting those metals both by sea and land, and the loss of buried treasure 'o f which th e knowledg e frequentl y die s wit h the person ' wh o buried it . 'I n orde r t o suppl y s o ver y widel y extende d a market , th e quantity o f silve r annuall y brough t fro m th e mine s mus t no t onl y b e sufficient to support that continual increase both of coin and of plate which is required i n all thriving countries; but to repair that continual waste and consumption of silver which takes place in all countries where that metal is used' (207).

The neglected and exciting Chapter xi 5 3 This concern wit h the supply of the money metal may sound irrelevant in the present era . But there are two senses in which it is suggestive. First, one may recognize the same problem o f the required rat e of growth of the total money supply of any country, the rate of growth required, that is, for rough stabilit y o f prices. Professo r Friedman 3 suggest s that the required rate of growth for the United States is roughly four per cent per annum, and he has suggested that the monetary authority be required to provide for that rate of growth, no more, no less. His study of the history of prices and of variations i n the money supply suggests t o him that adherence t o such a rule would have been preferabl e to the actual behaviour o f the monetary authority fro m 192 9 t o th e presen t day . Thi s raise s ver y controversia l issues which I shall not attempt to resolve. Second, one must recognize the problem o f the adequac y o f national reserve s fo r international liquidity . The extension of the world market and the increase in the volume of world trade and in the numbers of trading nations means an increase i n the total volume o f suc h reserve s required , eve n thoug h devices fo r econom y of reserves hav e develope d an d continue t o develop. I n s o far as gold continues t o b e th e ultimatel y acceptabl e mediu m for settlin g internationa l advances, or in so far as us dollars are acceptable for such purposes only so long as they are convertible int o gold, the suppl y of gold remains of great monetary significance . If internationa l reserve s o f gold ar e inadequate , three possibilitie s appear , i ) World-wid e deflatio n o f price s t o a poin t where th e reserve s ar e adequat e t o th e ne w level o f values. Thi s i s no longer acceptable. 2) International agreement on means of economizing in the use of gold or on the creation of an additional (or alternative) means of settling balances. Special drawing rights at the IMF represent a move in that direction. 3 ) International agreemen t on monetary policy with a view to such consistency i n various nationa l policies a s would greatly reduce th e actual and expected imbalance s and s o reduce the siz e of the total international reserves felt to be necessary. Changing real price of cattle The rise in prices in the 'second period,' 1570-1640, was so great that there was no difficulty i n establishing it; but the fall of prices o f the first period, and the trend of prices in the third period, were more difficult t o establish. Adam Smith had no index number of prices, and not very much raw price data. Of the first period he said: 'it is not, however, so much from the low price of corn, as from that of some other parts of the rude produce of land, that th e mos t judicious writer s have inferred the grea t valu e of silver in those very ancient times' (185) . It i s natural to suppos e that this is just a

54 Fro m Adam Smith to Maynard Keynes matter o f appropriate weight s i n the inde x numbe r o f prices. But Adam Smith was not investigating changes in general purchasing power as we do by th e us e o f inde x numbers . H e wa s concerne d wit h changin g labou r command. In thos e time s o f poverty an d barbaris m thes e [cattle , poultr y an d game ] wer e proportionably much cheaper than corn ... But this cheapness wa s not the effect of the hig h valu e of silver , but o f the lo w valu e of those commodities . I t wa s no t because silve r would in suc h times purchase o r represen t a greate r quantit y of labour, bu t becaus e suc h commoditie s woul d purchas e o r represen t a smalle r quantity than in times of more opulence and improvement (186).

The reaso n wa s briefly state d her e an d elaborated whe n he came t o examine the third period. 'As they [these rude products] are the spontaneou s production o f nature, s o sh e frequentl y produces the m i n much greate r quantities than the consumption o f the inhabitants requires' (186). When Adam Smit h examine d th e 'Ground s o f the Suspicio n tha t th e Value of Silver stil l continues t o decrease' (216 ) he dealt a t considerabl e length wit h 'the Differen t Effect s o f the Progres s o f Improvement upo n three different Sort s o f rude Produce' (217). The first sort, game and wild fowl, which 'nature produces only in certain quantities' (218 ) and 'which it is scarce in the power o f human industry to multiply at all' (217) may be expected t o ris e i n price. Thi s i s because 'whe n wealth , an d the luxury which accompanies it increase, the demand for these is likely to increas e with them.' The suppl y cannot increas e an d 'their price ma y rise t o any degree of extravagance' (218). Again one must remember that Adam Smith was concerned with labour command . 'I t is not their nomina l price only, but their real price which rises ... in the progress of improvement. The rise of their nominal price i s the effect , no t o f any degradation of the value of silver, but of the rise in their real price' (217). The 'second sort' comprised those raw products 'whic h human industry can multiply in proportion to the demand' (219). In the process of development the deman d for meat increases, an d the price (labour command) of meat increases s o long as the suppl y of cattle i s limited by the amoun t of common pasture. 'Thei r real value, therefore, the real quantity of labour which they will purchase or command, gradually rises, till at last it gets so high a s to rende r the m a s profitabl e a produce a s an y thin g els e whic h human industry can raise upon the most fertile and best cultivated lan d ... and mor e industr y woul d soo n b e employe d t o increas e thei r quantity ' (220). This however is not the end of the story. When the price of cattle has

The neglected an d exciting Chapter xi 55 risen to the point where it pays to grow fodder to feed cattle, and to stable them over winter , the availabilit y o f manure transforms the character o f farming. Till the price of cattle, indeed, has got to this height, it seems scarce possible that the greater part, of those lands which are capable of the highest cultivation, can be completely cultivated. In all farms too distant from any town to carry manure from it .. . the quantit y of well cultivated land must be in proportion to the quantit y of manure which the farm itself produces; and this again must be in proportion to the stock of cattle which are maintained upon it (220-1).

And so to Scotland. Before the Union the price of cattle was such that no more cattle could 'wit h profit, be fed than what are necessary fo r tillage . But these can never afford manure enough.' What there was was applied to a small area; 'the rest will... be allowed to lie waste, producing scarce any thing but some miserable pasture, just sufficien t t o keep alive a few straggling, half-starved cattle.' Th e openin g o f the Englis h market raised th e price of cattle and opened the door to agricultural improvement. 'Of all the commercial advantages .. . which Scotland has derived from the union with England, this rise in the price o f cattle is , perhaps, th e greatest' (221-2). But Adam Smith recognized th e slownes s and difficulty o f the transition. The old system continued to prevail owing 'to ignorance and attachment to old customs' (222) , but also to 'unavoidable obstructions.' The poverty of the tenants made it difficult for them to acquire more cattle, and 'the same rise of price whic h would render i t advantageous for the m to maintain a greater stock [rendered] it more difficult fo r them to acquire it.' Further, it required time 'to put their lands in condition to maintain this greater stock ... Without some increase of stock, there can be scarce any improvement of land, but there can be no considerable increase of stock but in consequence of a considerable improvement of land.' To remove these natural obstructions there was required a 'long course of frugality an d industry ... half a century or a century more, perhaps, must pass away before the old system ... can be completely abolished' (222). From cattl e Ada m Smit h wen t o n t o poultry , fe d wit h wha t woul d otherwise be lost, a mere 'save all,' till the demand increases and raises the price so 'that it becomes profitable to cultivate land for the sake of feeding them' (225) . The n t o th e ho g wh o 'find s hi s foo d amon g ordure , an d greedily devours many things rejected by every other useful animal... like poultry, originally kept as a save-all.' But as the price rises with increasing demand 'i t become s necessar y t o rais e foo d o n purpose fo r feeding and

56 Fro m Adam Smith to Maynard Keynes fattening hogs' (225). Finally, milk, butter and cheese: 'the business of the dairy .. . is originally carried o n as a save-all.' The increase i n price with increasing demand 'pays for more labour, care, and cleanliness. The dairy becomes mor e worth y o f th e farmer' s attention , an d th e qualit y o f it s produce gradually improves. The price at last gets so high, that it becomes worth while to employ some of the most fertile and best cultivated lands in feeding cattle merely for the purpose of the dairy' (227). The third sort of raw produce included wool and mutton, hides and beef. Adam Smit h handled the proble m o f joint suppl y with elegance. I n th e process of improvement the price of the whole beast necessarily rises, as he had demonstrated . Th e marke t for meat being confined to the domesti c market while the market for wool and hides being international, the price of meat migh t be expecte d t o ris e an d those o f wool an d hides t o b e un changed. 'Our tanners... have not been quite so successful as our clothiers, in convincing th e wisdo m of the nation , tha t th e safet y of the common wealth depends upon the prosperity of their particular manufacture' (233). These regulations hav e tended t o sink the price of wool and hides belo w what it naturally would have been and have thereby had some tendency t o raise the price of meat. The price of the cattle must be sufficient to cover the expenses of production; the less the contribution of wool and hides to this total expense , th e highe r mus t be th e contributio n o f the meat . 'Must ' because if the two contributions do not make raising the cattle profitable, fewer will be raised, less meat will come to market and its price will rise. How thoroughly this process wa s understood appear s fro m th e contras t Adam Smith drew between the improved and unimproved country. In the latter a regulation that lowere d th e pric e o f wool would not reduc e th e number of cattle, 'th e lands of the countr y being applicable to n o other purpose.' S o the 'sam e quantit y o f butcher's-meat woul d stil l com e t o market... its price, therefore, would be the same as before' (234). While the effect o f progress was expected t o increase the labour command of raw produce up to the point where the supply became responsiv e to price, little attention was paid to the probable lowering of the 'real price,' through increasing productivity, which would begin to lower the ceiling on the rise in the price of rude produce. But Adam Smith did expect tha t the real price of manufactured goods would diminish 'in consequence o f better machinery, of greater dexterity, and of a more proper division and distribution of work' (242-3). However, 'there are, indeed, a few manufactures in which the necessary rise in the real price of the rude materials will more than compensat e al l the advantage s which improvement can introduce ' (243). In Ada m Smith the concer n wa s with secular change , but a very similar picture was drawn by Alfred Marshall 4 when he suggested that a

The neglected and exciting Chapter xi 57 constant cos t industr y is one where these tw o offsetting influence s are at work, say blankets. It was Sraffa5 who asked whether the case of constant cost wa s no t bette r though t of as arisin g from th e absenc e o f influences making for either increasing or decreasing costs. But the constancy of cost that Adam Smit h was discussin g was a historical concep t rathe r tha n a static one. The three orders of man This extraordinary chapte r end s wit h a discussion o f the interests of the three orders of men: landlords, workers, and capitalists. The interest of the first order is 'strictly and inseparably connected with the general interest of society' (278). Their rent s rise with improvement. They will not be led by self interest to mislead the public when regulations of commerce are under consideration, thoug h the y ma y hav e a defectiv e understandin g o f th e effects o f suc h regulation. Similarly the interes t o f the worker s i s in improvement; wages will be high when wealth is increasing. Very different , argue d Adam Smith , is the positio n o f the capitalists : profit does not rise with prosperity. The interest of the dealers, however, in any particular branch of trade or manufactures, is always in some respects differen t from , o r even opposite to , tha t of the public. To widen the market and to narrow the competition, is always the interest of the dealers . T o wide n th e marke t may frequentl y b e agreeabl e enoug h to th e interest of the public; but to narrow the competition must always be against it, and can serve only to enable the dealers ... to levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens. The proposal of any new law or regulation of commerce which comes from thi s order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefull y examined, not only with the most scrupulous, but with the most suspicious attention (250).

This is a wise warning but one should note that the interest of the 'order' is different from the interest of 'the dealers in any particular branch of trade.' Restriction may pay the particular branch if the others are expansive: but if restriction is general the capitalists injure themselves as well as their fellow citizens. The happ y position i s to be a monopolist i n an otherwise highl y competitive society : t o be a monopolist among monopolists is very differ ent. The individual capitalist, or even the capitalists in a particular indus try, ma y hav e interest s i n conflict with those o f society ; bu t surel y th e capitalist clas s as a whole benefits, as do the landlords and wage-earners , from increasing national wealth.

7 Money

Adam Smit h discusse d the problems o f money a t severa l points. I hav e already note d his explanation o f the reason for holding money: the 'con venience' motive in later terminology. Though he did not indicate that the amount held for convenience woul d depend, othe r thing s being equal, on the leve l o f prices (se e above , 17-18) , surel y h e though t o f the amoun t needed fo r convenience a t the current level of prices. Jus t as in the treat ment of effectual demand , he identified only one point on a demand curve, or in a demand schedule, so in thinking of the amount to be held as money he thought of one point on the liquidity curve. He understood the nature of the functional relationship, but the use of geometry or algebra did not occur to him. When, in the 'Digression on Silver,' he discussed the long-run trends in the valu e o f silver , h e said : 'th e increasin g produce .. . o f Europe mus t necessarily have required a gradual increase in the quantity of silver coin to circulate it' (202), he must again have meant us to assume the qualification; necessary, if prices ar e t o remain at their curren t level . Sinc e th e whol e thrust of the Digression is that the level of prices will rise if the supply of the metals increase s b y mor e tha n th e demand , an d wil l fall i f th e suppl y increases by less than the demand, surely one must take the demand to be the amount people would hold if prices were unchanged. Again the absence of geometry and algebra makes it harder to present the idea with complet e clarity: but I argue that the meaning is still clear. The chapte r specificall y o n monetar y theor y (Boo k n , Chapte r n ) i s largely concerned with banking and paper money, as means of economiz-

Money 5 9 ing in the use of the precious metals . 'The substitution of paper in the room of gold an d silve r money , replace s a very expensiv e instrumen t of commerce with one much less costly and sometimes equall y convenient' (276). The judicious operations o f banking, by substituting paper i n the room of a great part of this gold and silver, enables th e country to convert a great part of this dead stock into active an d productive stoc k .. . The gold and silver money which circulates in any country may very properly be compared to a highway, which, while it circulates and carries to market all the grass and corn of the country, produces itself not a single pile of either. The judicious operations o f banking by providing, if I may be allowed so violent a metaphor, a sort of waggon way through the air; enable the country to convert, as it were, a great part of its highways into good pastures and cornfields, and thereby to increase very considerably the annual produce of its land and labour . Th e commerc e an d industr y o f th e country , however , i t mus t b e acknowledged .. . cannot b e altogether s o secure, when they are thus, as it were, suspended upo n the Daedalian wings of paper money , as when they travel about upon the solid ground of gold and silver (305).

In th e discussio n o f the effec t o f increasing supplie s o f paper mone y Adam Smith talked of a 'channel of circulation' and assumed it to be fixed. If, i n his example, the whole circulation amounte d to one million pounds sterling and paper money were issued to the amount of one million pounds with a reserve of £200,000, there would be £1,800,000. The good s t o b e bough t an d sol d bein g precisel y th e sam e a s before , th e sam e quantity o f money wil l b e sufficien t fo r buyin g an d selling them. The channe l of circulation, if I may be allowed such an expression, will remain precisely as before. One millio n we have suppose d sufficien t t o fill that channe l ... one millio n eight hundred thousan d pound s ar e poure d int o it . Eigh t hundre d thousan d pounds , therefore, must overflow .. . It will, therefore, be sent abroad (278).

Again much is taken for granted: th e size of the 'channel' depended on the price level, but the international use of gold and silver determined the price level in this one country. Adam Smith must have been familiar with David Hume's essay on 'The Balance of Trade'1 and have understood th e process by which 'exces s circulation' woul d driv e u p prices and incomes and so reduce export s an d increase imports , tha t bullio n woul d b e exporte d t o restore th e balance. Th e cas e o f inconvertibl e pape r money , wit h n o determined siz e o f the 'channel ' an d therefore n o automati c limi t t o it s increase, was, I suppose, inconceivable in his time; discussion o f this case would seem a waste of time.

60 Fro m Adam Smith to Maynard Keynes 'The whole paper money of every kind which can easily circulate in any country neve r ca n excee d th e valu e o f th e gol d an d silver , o f which i t supplies the place' (284). As a first approximation and as a guide to long-run policy, this was a useful statement. But as Henry Thornton pointe d out, 2 it was inadequat e and , fo r short-ru n monetar y policy , misleading . Th e in adequacy stem s from the different velocit y o f circulation o f various types of paper mone y or money substitutes. 'It is the quantity not "of th e thing that circulates" that is of the thing which is capable of circulation, but of the actual circulation whic h shoul d rathe r be spoke n o f as the sam e i n both cases.'3 Th e misleadin g aspec t i s the failur e t o recogniz e 'th e different degrees o f rapidit y i n th e circulatio n o f th e same medium s at different times.' I shall discuss in a later chapter Henry Thornton's views on monetary policy in 180 2 and 1811 . Le t m e here simply note his worry that th e policy suggested by Adam Smith's theory was wrong. He [Ada m Smith ] doe s no t proceed , i n an y respect , t o guar d o r t o limi t th e observation in question. An observation which, when thus unqualified, ma y lead the reader t o suppose, that whenever the bank finds itself subjecte d t o any great demand for gold in consequence o f a high price of bullion, the cause of this evil is an excess of circulating paper, and the remedy a reduction of bank notes. There is also danger, lest it should be conceived, that if the remedy should appear to fail, it can only fail because the reduction is not sufficiently great. 4

Long-run maintenance of the monetary standard requires the Adam Smith view; but avoidance of distress in the short run requires the Thornton view; and o f course Thornto n agree d with the long-ru n objective a s i s evident from his speeches i n the House of Commons in 1811.5 After lengthy discussion o f the role of banking in Scotland an d England, Adam Smit h considere d th e nee d fo r regulation . A believer , bu t no t a doctrinaire believer, in laissez faire, he argued for intervention. To restrain private people, it may be said, from receivin g in payment the promissory notes of a banker, for any sum whether great or small, when they themselves are willing to receive them; or, to restrain a banker from issuing such notes, when all his neighbours are willing to accept of them, is a manifest violation of that natural liberty which it is the proper business of law, not to infringe, bu t to support. Such regulations may, no doubt, be considered as in some respect a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the mos t free, a s well as of the mos t despotical. Th e

Money 6 1 obligation of building party walls, in order to prevent to communication of fire, is a violation of natural liberty, exactly o f the sam e kind with the regulation s of th e banking trade which are here proposed (308).

The regulations proposed show the underlying preference for freedom, for the minimum regulation consistent with the social good. If bankers are restrained from issuin g any circulating bank notes .. . for less than a certain sum ; an d i f the y ar e subjecte d t o th e obligatio n o f a n immediat e an d unconditional payment of such bank notes a s soon as presented, their trade may, with safety to the public, be rendered in all other respects perfectly free (313).

So regulated, the multiplication of banks was welcomed. 'Free competition too oblige s al l banker s t o b e mor e libera l i n thei r dealing s wit h thei r customers, les t thei r rival s shoul d carr y the m away . I n general , i f any branch o f trad e .. . b e advantageou s t o th e public , th e free r an d mor e general the competition, i t will always be the more so' (313).

8

Productive and unproductive labou r

In th e 'Introductio n an d Plan' Adam Smit h sai d tha t th e 'natio n wil l be better o r wors e supplie d wit h al l th e necessarie s an d convenience s fo r which it has occasion' according to the 'skill, dexterity, and judgment with which it s labou r i s generall y applied ' an d accordin g t o th e 'proportio n between the number of those who are employed in useful labour, and that of those who are not so employed' (Iviii) . The moder n economist ma y be excused i f he supposed tha t Adam Smit h was here discussin g the importance of high level employment: but, he might ask, why add the words 'in useful labour'; why not just those who are employed and those who are not employed? Hi s suspicio n tha t somethin g differen t fro m th e proble m o f employment is involved might be increased when, a few paragraphs later, he finds another adjectiv e added : 'Th e number of useful an d productiv e labourers .. . i s every where in proportion to the quantity of capital stoc k which is employed in setting them to work' (Iviii). 'Useful' and 'productive' appear to be used as synonyms and the definition of productive is left to the Second Book , a s als o i s th e discussio n o f th e factor s determinin g the 'proportion' of'productive' to 'unproductive' labour. The definition occurs at the beginning of Chapter HI in the Second Book , the title of which, it is relevant t o note, is 'Of the Accumulation o f Capital, or of Productive an d Unproductive Labour.' 'Ther e is one sort o f labour which adds to the value of the subject upon which it is bestowed: ther e is another which has no such effect. Th e former, as it produces a value, may be called productive; the latter, unproductive labour' (314). The contrast is between the 'manufacturer' and the 'menial servant.'

Productive and unproductive labour 6 3 A man grows rich by employing a multitude of menial servants ... the labour of the manufacturer fixes and realizes itself in some particular subject or vendible commodity ... The labour of the menial servant, on the contrary, does not fix or realize itself in any particular subject or vendible commodity. His services generally perish in the very instant of their performance (314-15).

Adam Smith then proceeded t o take the sting out of his definition. The term is no t derogatory : unproductiv e labour , h e said , 'ha s it s value , an d deserves its reward.' The labou r of some of the mos t respectable order s in the societ y is , like that of menial servants, unproductive of any value ... The sovereign, for example, with all the officer s bot h o f justice an d wa r wh o serv e unde r hi m .. . ar e unproductive labourers ... Their service, how honourable, how useful, or how necessary soever , produces nothing for which an equal quantity of service can afterwards be procured (315).

In this class of unproductive labour are included 'some both of the gravest and most important, and some of the most frivolous professions: churchmen, lawyers, physicians, men of letters o f all kinds; players, buffoons , musicians, opera singers , opera dancers , etc.' (315). The distinction thus made between these tw o kinds of labour is, clearly, not a useful one . We now recognize that the real national income consists o f a stream of goods and services (services of people and services of durable goods), and we are concerned that the composition o f this strea m shal l be appropriate t o the preferences o f th e individual s within the limit s that individua l incomes impose. If people prefer more personal services and fewer goods, we would want th e labou r forc e t o adjus t itsel f t o th e provisio n o f suc h services . Goods and service s alik e being valuable, tha t labou r is 'productive,' we would say, which yields valuable goods or valuable services. Why then all this nonsense about the productive labour of the maker of violins and the unproductive labour of the violin player? The rea l proble m emerges , a s on e migh t expect fro m th e titl e o f th e chapter, a s a problem of accumulation. I t has two aspects of which I shall discuss th e secon d an d les s importan t first . Havin g in mind his ple a fo r saving, o r 'parsimony, ' whic h come s late r i n th e chapte r an d whic h I propose t o discuss in the next chapter, a plea for the purchase of durable goods rather than 'things which are consumed immediately ' is not surprising, 'Maintainin g a great number of menial servants' (329 ) is taken as th e important case of this sort of immediate consumption. A man who spend s

64 Fro m Adam Smith to Maynard Keynes 'adorning his house or his country villa, in useful or ornamental furniture , in collecting books , statues, pictures; o r in things more frivolous, jewels, baubles, ingenious trinkets of different kinds; or, what is most trifling of all, in amassing a great wardrobe of fine clothes' (329), has accumulated thing s which give an income o f services a s long as they last. The ma n who thus accumulates will be the richer for doing so; he will enjoy their services over a lon g time : an d s o to o wil l the nation , fo r thes e durabl e good s wil l b e handed down or sold cheap, second hand : The houses, the furniture, the clothing of the rich, in a little time, become useful t o the inferio r an d middlin g ranks of people. The y ar e abl e to purchase them when their superiors grow weary of them, and the general accommodation o f the whole people is thus gradually improved ... In the countries that have long been rich, you will frequently fin d th e inferio r rank s of people i n possession bot h of houses an d furniture perfectl y goo d and entire, but of which neither the one could have been built, nor the other have been made for their use (330).

To exemplify, Adam Smith referred to the Seymour family seat which had become a n inn on the Bat h road , an d the marriag e bed o f James i which became 'th e ornament of an ale house in Dunfermline' (330) . Now all this is a plea for the purchase of durable goods: the purchase of consumable goods is from this point of view identical with the purchase of services. But , Adam Smith would say, the limit to the possible consump tion of consumable goods by the family is soon reached, bu t not so the limit to the possible consumptio n of menial services. Whe n the rich man maintains a 'grea t numbe r o f menia l servants , an d a multitud e o f dog s an d horses' (329) his purchase of consumables increases ; bu t would not thes e same consumables have been bought by the servants for their own use had they been 'productively' employed? The difference when the servants are unproductively employed, Adam Smith would have us believe, is that there will be 'a great deal wasted.' Of two or three hundred weight of provisions, which may sometimes be served up at a great festival, on e half , perhaps , is thrown to the dunghill, and there is always a great dea l wasted and abused . Bu t i f the expenc e of this entertainment had bee n employed i n setting to work masons, carpenters, upholsterers, mechanics, etc., a quantity o f provisions, of equal value, would have been distributed among a stil l greater number of people, who would have bought them in penny-worths ... and not have lost or thrown away a single ounce of them (331-2).

Productive an d unproductive labour 6 5 And there would have been som e durable goods added to the social stock. The othe r an d muc h mor e importan t aspec t i s relate d t o industria l development. Th e proportio n betwee n th e fund s employe d t o maintai n productive and unproductiv e hand s is sai d to determin e 'th e genera l character of the inhabitants as to industry or idleness' (319). This does not appear t o mea n employmen t o r unemployment ; the unproductivel y employed appea r t o be treated a s 'idle. ' 'We are more industriou s tha n our forefathers; because i n the present times the funds destined for the maintenance of industry are much greater i n proportion t o those whic h are likely to be employed in the maintenance of idleness, tha n they were two or three centuries ago ' (319). Adam Smith went on to contrast th e character o f the 'inferior rank s of people' in 'mercantile and manufacturing towns' an d in 'those towns which are principally supported by the constant or occasiona l residence o f a court, an d in which the inferio r rank s of people ar e chiefl y maintained by the spending of revenue.' In the former they are 'in general industrious, sober , an d thriving, ' i n the latter , 'idle , dissolute an d poor' (319). Examples are quoted from all over Europe, concluding with a glance at th e contras t betwee n Glasgo w an d Edinburgh . Befor e I attemp t t o interpret this theme, one other passage shoul d be noted: The annual produce of the land and labour of any nation can be increased in its value by no other means, but by increasing either the number of its productive labourers, or the productive powers of those labourers who had before been employed. The number of its productive labourers, it is evident, can never be much increased, but in consequence o f an increase of capital, or o f the fund s destine d for maintainin g them. The productive powers of the same number of labourers cannot be increased, but in consequence either of some addition and improvement to those machines and instruments which facilitat e an d abridg e labour; or of a more proper division an d distribution of employment (326).

This i s th e crucia l problem : i n wha t sens e ca n on e sa y tha t th e annua l produce i s greater when a number of men have changed their employment from tha t o f 'menia l servants ' (producin g valuable personal services ) t o that o f 'manufacturers ' (producin g valuabl e goods) ? Ho w appropriatel y can such a change be described a s a change from 'idleness ' to 'industry'? To th e neoclassical , equilibriu m economist s suc h question s mad e n o sense. To the modern student of underdeveloped economie s i t makes real sense; for the process of development i s one of shifting employment fro m the relatively unproductive sector where primitive technology reigns to the

66 Fro m Adam Smith to Maynard Keynes more productive sector where advanced technology is applied. It appear s to be a problem not of productive and unproductive, but of more productive and less productive labour. The pictur e I hav e i n mind can b e illustrate d b y a simpl e two-secto r model. In one sector primitive technology still reigns, and marginal productivity of labour is low. This is the sector in which 'menial' services are an important product; they have value, but that valu e is low; the product i s positive but small. In the other sector advanced technology is applied and the marginal productivity of labour is higher; in this sector labour is subject to discipline, is equipped with 'machines and instruments,' is divided and distributed under the direction of intelligent management. Why then does this advance d secto r no t dra w al l th e labou r awa y fro m th e primitiv e sector? Clearl y there must be some immobility, and one may suggest that there i s a difficul t adjustmen t to a very differen t wa y o f life involve d in crossing the boundary of the primitive into the advanced sector. The failure to move across this boundary and equalize marginal products and wages in the tw o sector s ma y i n par t b e explaine d b y consideratio n o f th e 'ne t advantages'; low wages, security, and 'idleness' may be preferred to higher wages, harde r work , tighte r discipline , an d les s security . Ada m Smith , discussing the rea l world of his day, not a model, ma y have taken thes e obstacles t o equalization for granted. To him the chief obstacle was shortage of capital; capital for advances to labour, the product of which will not be sold for some time, and capital to equip that labour with the necessar y 'machines and instruments.' Hence his plea for accumulation. 'Parsimony by increasing the fund which is destined for the maintenance of productive hands tends to increase the number of those hands' (321). In the meantime, in the primitiv e sector , menia l servant s can be hire d ver y cheap ; thei r marginal productivity in such menial occupation is low, but the alternative employments actually open to them are of similarly low productivity. Their potential higher productivity in the advanced sector is irrelevant if one is concerned to explain the existence of this labour supply and the low wages. It i s no t irrelevan t i f one i s engage d i n a n 'Inquir y int o th e Natur e an d Causes o f the Wealt h o f Nations,' o r int o th e proces s o f economi c de velopment. Perhaps one needs to coin a new phrase, 'ful l development,' to parallel the phrase , 'ful l employment, ' i n th e develope d economy . Whe n tha t theoretical stag e o f ful l developmen t i s reache d (o f cours e a s lon g a s technology is developing it is never reached) menial service will be available only to those who value it highly enough to pay the going rate for similar labour in the advanced capital-using sector. When he has to pay more for

Productive an d unproductive labour 6 7 such servic e th e maste r wil l expec t harde r wor k an d mor e discipline d service an d he will provide suc h machine s an d instruments a s 'facilitat e and abridge' domestic labour. Marginal productivity will be equalized, th e primitive sector will be liquidated, and such menial services as remain will be provide d efficientl y an d expensivel y i n the advance d sector . Menia l service and 'idleness' then cease to be synonymous. With growth in wealth I would expect th e volume of personal servic e ultimately to increase fro m the very low level to which it would have fallen; but the cost, efficiency , and dignit y of such servic e woul d increas e too . Th e distinctio n betwee n productive an d unproductive labou r appears then to have references no t to the value of things and the lack of value of services, but to the disadvantage to the nation when a large part of the people are engaged in work that is of little value when it might be employed, if full development were achieved, in work that would be much more valuable. Undue concentratio n o n genera l equilibriu m i n static model s ha s di verted attention from the problems which arise from uneven development of the different sector s of the economy. These were problems that Adam Smith wa s attackin g i n hi s discussio n o f productiv e an d unproductiv e labour. It might be argued that the reserve army of unemployed that Marx made a key t o hi s theory o f exploitation an d 'immiserization ' (Verelen dung) wa s reall y a reserv e arm y of 'under-employed, ' o f 'unproductiv e workers,' of persons employed at low productivity in the backward secto r of the economy. As long as the poor ca n affor d servants , one can expect wages to be low in industrial occupations, eve n in those industries where advanced technolog y i s exploited. (In Jamaica, I am told by my Jamaican students, the poor have servants: in Sierra Leone, I am told, the servants ' servants hav e servants. ) I n m y yout h i n Englan d th e middl e clas s ha d servants; few of them stil l have. I n Nort h Americ a w e ar e reachin g th e point where the domestic servant is rare, but where such as exist are paid a wage equivalen t t o tha t earne d b y worker s i n the advance d sector , ar e equipped with machinery, are required to meet high standards of discipline and efficiency, an d are no longer semi-feudal dependents but rather independent purveyors of an important professional service. To the 'word minded' Adam Smith appears to have introduced a distinction, betwee n productiv e an d unproductiv e labour , whic h ha s n o significance. Other s wil l absolv e hi m fro m thi s mino r charge o f useles s definition i n recognition of the valu e of his insight into a problem of real significance. I a m encouraged t o find Professor Arthu r Lewis amon g the 'others.' 'The distribution between productive and unproductive workers had nothing to do with whether the work yielded utility, as some neoclassi-

68 Fro m Adam Smith to Maynard Keynes cists hav e scornfull y bu t eroneousl y asserted.' 1 Professo r Lewi s note d further tha t 'th e lin e betwee n employee s an d dependent s i s ver y thinly drawn.' This T.R. Malthus clearly had in mind when he said: Three o r fou r hundre d year s ago , there wa s undoubtedl y muc h les s labou r i n England, in proportion to the population, than at present; but there was much more dependence: an d w e probably shoul d no t no w enjo y ou r presen t degre e o f civil liberty, if the poor, b y the introduction of manufactures, had not been enable d t o give something in exchange for the provisions of the Great Lords, instead of being dependent upon their bounty.2

9

Saving and investment

'The proportio n betwee n capita l an d revenue , therefore , seem s every where to regulate the proportion between industry and idleness' (320). As I have argued in the last sectio n thi s is not a theory of employment, but of development. I f industr y i s to increase , individual s must decid e t o hir e 'productive' labour with a view to profit, rather than menial servants with a view to comfort and prestige. The emphasis is on funds for the employment of 'productive' labour rather than for the purchase of materials for them to work up and for equipment to increase their productivity. Adam Smith did, however, recognize that increase in the annual produce required 'increasing either the number of its productive labourers, or [it should be and/or] the productive powers of those labourers who had before been employed ... In either case an additional capital is almost always required' (326). The concern is for growth: once 'an additional number of productive hands' has been set to work there has been established 'as it were a perpetual fund for the maintenance of an equal number in all times to come' (322). Proceeds from sal e of the product could, of course, be devoted to 'revenue,' i.e., to personal consumption: but 'the plain and evident interest' of the individuals 'makes this unlikely.' 'No part of it can ever afterwards be employed to maintain any but productive hands without an evident loss to the perso n who thus perverts it from it s proper destination' (322). As Karl Marx later put it: 'His [the capitalist's] own private consumption is a robbery perpe trated on accumulation just as in book-keeping by double entry, the private expenditure o f the capitalis t i s placed o n th e debto r sid e of his accoun t against his capital.'1

70 Fro m Adam Smith to Maynard Keynes The proble m fo r Adam Smit h wa s no t th e reinvestmen t o f industria l earnings, but the provision of funds for expansion. 'Capital s are increase d by parsimony, and diminished by prodigality and misconduct. Whenever a person saves from his revenue he adds to his capital, and either employs it himself i n maintaining an additional numbe r of productive hands , o r en ables some other person to do so by lending it to him for an interest, that is, for a shar e o f th e profits ' (321) . H e assume d suc h a direc t relationshi p between the act of saving and that of investing that no problem of employment could arise. What is annually saved is as regularly consumed as what is annually spent... but it is consumed by a different se t o f people. Tha t portio n of his revenue which a man annually spends, is in most cases consumed by idle guests and menial servants ... That portio n which he annuall y saves , a s for th e sak e of profit i t is immediately employed a s a capital, is consumed in the sam e manner ... but .. . b y labourers, manufacturers, and artificers (321).

Again th e emphasi s i s o n capita l use d t o pa y wages ; bu t spendin g t o purchase material s o r machiner y coul d b e though t o f a s employing , a t various removes, productive labourers. So for Adam Smith 'every prodigal appears t o be a public enemy, and every frugal ma n a public benefactor ' (324). Adam Smith's defence of parsimony must be read in the context of the literature o f th e centur y befor e h e wrote . Tw o sample s mus t suffice . 'Prodigality i s a Vice tha t i s prejudicial to the Man , but no t t o Trade .. . Covetousness i s a Vice, prejudicia l both t o Ma n and Trade.' 2 S o wrote Nicholas Barbon ; bu t th e bes t know n statemen t wa s tha t o f Bernar d Mandeville in his satire, The Fable of the Bees.3 In the poem he describe d the distress which develops i n a prosperous communit y when the citizens become frugal (parsimonious as Adam Smith would put it) and the government reduces it s armaments: Livries in Brokers Shops are hung, They part with Coaches for a Song; Sell stately Horses by whole Sets; And Country-Houses, to pay debts. Vain Cost is shunn'd as moral Fraud; They have no Forces lef t Abroad;

The result of this new outbreak of thrift i s then described :

Saving and investment 7 1 The She w is gone, it thins apace; And looks with quite another Face, For 'twas not only that They went, By whom vast Sums were Yearly spent; But Multitudes that liv'd on them, Were daily forc'd to do the same. In vain to other Trades they'd fly; All were o'erstock'd accordingly. The building Trade is quite destroy'd, Artificers are not employ'd; No Limner for his Art is fam'd, Stone-cutters, Carvers are not nam'd.4

In the commentary which accompanies th e verse the doctrine is hammered home. That the English would be richer if they were more frugal is, he said, 'an Error.'5 Though Adam Smit h disagreed abou t th e effec t o f frugality; h e was in agreement o n sumptuary regulation. Mandevill e argue d that the first care of the governmen t wa s t o 'promot e a s grea t a variet y o f Manufactures , Arts, an d Handicrafts , a s Huma n Wi t can invent ; an d .. . t o encourag e Agriculture an d Fisher y .. . I t i s fro m thi s Polic y an d no t fro m triflin g Regulations of Lavishness and Frugality that the Greatness and Felicity of Nations mus t be expected.' Adam Smith wrote: It is the highest impertinence and presumption, therefore, in kings and ministers, to pretend to watch over the economy of private people, and to restrain their expence either by sumptuary laws, or by prohibiting the importation of foreign luxuries ... They ar e themselves always, and without any exception, the greatest spendthrift s in the society. Let them look well after their own expence and they may safely trust private people with theirs (329).

Thrift became the Victorian virtue, and orthodox economist s approved . The heretical Malthu s agreed tha t Adam Smith's proposition tha t capital s are increased b y parsimony, and that every frugal man is a public benefac tor wa s true 't o a great extent ' bu t 'th e principle s o f saving, pushe d t o excess, would,' he argued, 'destroy the motive to production .. . It follows that there must be some intermediate point... where, taking into considera tion both the power to produce and the will to consume, the encouragemen t to the increase of wealth is the greatest. 6' Starting from this proposition and using Keynesian analysis , Oscar Lange 7 develope d th e theory o f the 'op-

72 Fro m Adam Smith to Maynard Keynes timum propensity to consume,' or to save. Because Lange was writing in a period o f depression an d unemployment , it is , perhaps , natura l tha t hi s optimum propensity t o consum e is that rate which is consistent wit h ful l employment in an otherwise stationary state . Adam Smith was concerned with growth, as have been mos t of the economist s o f the nineteen-fiftie s and -sixties. For him, as for some of us, the problem is the adequacy of the propensity to save to provide for the expansion of industry that is thought desirable. The optimum rate of saving from the point of view of growth then depends on a prior decision as to the optimum rate of growth. The reconciliation of the employment optimum and the growth optimum is not easy. From one point of view and at one period we fear a degree of thrift that is so high i n relation t o th e volum e of investment that w e suffe r deflatio n and unemployment. From another point of view, and at another time, we fear lest th e degre e o f thrif t b e s o inadequat e i n relatio n t o th e volum e o f investment that we want, as a basis for our desired growth in GNP, that we must either forego that rate of growth or force a reduction of the consumption of a part of the society by inflation. For Adam Smith inflation was not a feasible, let alone an acceptable, means of solving the problem. Parsimony was necessary for the rate of growth he believed desirable: as for the level of employment, he assumed that it would be high, or that it was something that, like the weather, one had to accept as it came. Accumulation a s suc h is , o f course , no t th e onl y consideration , th e effect o n the growth of productivity depends on the appropriate quality of the accumulation given any quantity. Adam Smith showed som e concern lest the savings of the frugal go into the wrong hands and this worry led him to argue for the usury laws, for a legal maximum rate of interest. If the legal rate of interest in Great Britain, for example, was fixed so high as eight per cent or ten per cent, the greater part of the money which was to be lent, would be lent t o prodigal s and projectors , wh o alon e woul d b e willin g t o giv e thi s hig h interest. Sober people, who will give for the use of money no more than a part of what they are likely to make by the use of it, would not venture into this competition (339).

This fea r tha t lender s wil l be le d b y th e offe r o f high return t o len d t o 'prodigals and projectors' withou t properly discounting the risk, and that capital wil l be wasted , parsimon y abortive , i s surprisin g in vie w o f hi s general belief i n the efficac y o f the free market . 'Every individual, therefore, endeavours ... so to direct that industry that its produce may be of the greatest value ... he intends only his own gain, and he is in this, as in many

Saving and investment 7 3 other cases, led by an invisible hand to promote an end which was no part of his intention' (423). There followed the statement whic h Jeremy Bentham used i n hi s Defence o f Usury (1816 ) t o refut e Adam Smit h b y hi s ow n arguments: The statesman , who should attempt to direct privat e people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assum e an authorit y which could safel y b e trusted, not onl y t o n o single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it (423).

Progress, Bentham argued , demande d th e taking of risks: Adam Smith' s projectors wer e hi s innovators , hi s imaginativ e entrepreneurs . Th e on e was thinkin g of th e financia l speculation s o f the Sout h Se a Bubble ; th e other o f the industria l developments o f the secon d hal f of the eighteent h century. Bentham made a very strong intellectual case. To the argument that the usury law prevented prodigalit y h e replied: To prevent our doing mischief to one another, it is but too necessary to put bridles into all our mouths: it is necessary to the tranquillity and very being of society: but that th e tackin g of leading strings upo n th e back s o f grown persons, i n order t o prevent the m doing themselves a mischief is not necessar y either to the bein g or tranquillity o f society , howeve r conduciv e t o it s wel l being, I thin k canno t b e disputed. Such paternal, or, if you please, maternal, care may be a good work, but i certainly is but a work of supererogation.8

And anyway , added Bentham , the prodiga l ca n alway s sel l hi s propert y instead o f borrowing o n it, or run u p debts wit h tradesmen o n which th e interest i s very high . Nor wa s Bentha m impresse d b y the argumen t tha t such laws protect the indigent. Suppose a man is in a position where a loan can save him from great loss, but he has no security to offer. H e can affor d to pay a high rate and no one can afford t o lend to him except at a high rate. It is worth his while to borrow at a high rate. So he judges, who ha s nothin g to hinde r him from judging right; who ha s every motive and every means for forming a right judgment... The legislator who knows nothing, nor can know any thing, of any one of all these circumstances ... comes and says to him: 4It signifies nothing, you shall not have the money: for it would be doing

74 Fro m Adam Smith to Maynard Keynes you a mischief to let you borrow upon such terms.' And this out of prudence and loving kindness! - There may be worse cruelty: but can there be greater folly? 9

A strong intellectual case , but perhaps the doctrinaire Bentha m was less ready than Adam Smith to observe the imperfection of the capital market in underdeveloped eighteent h centur y Britain . One wonders , too, whethe r the problem can be usefully discussed without reference to numbers. Adam Smith's maximum often per cent per annum does not sound usurious to a Canadian i n 1971 ; bu t suppos e w e wer e talkin g about te n pe r cen t pe r month, would Bentham's argument be equally persuasive?

10 Town and country

Book in of the Wealth of Nations, 'On the different Progress of Opulence in different Nations ' i s essentially a n historical essay i n economic develop ment. If one cannot accept his thesis, that the 'natural order of things ... has in al l th e moder n state s o f Europ e been , i n man y respects, entirel y inverted' (360) , one shoul d not write off the boo k altogether . There are , in fact, some very useful and suggestive passages, of which that on the mutual gain in trade between town and country is by no means the least important. The grea t commerc e o f ever y civilize d society , i s tha t carrie d o n betwee n th e inhabitants of the town and those of the country ... The country supplies the town with the means of subsistence, an d the materials of manufacture. The town repays this supply by sending back a part of the manufactured produce to the inhabitants of the country ... The gains ... are mutual and reciprocal, an d the division of labour is in this, as in all other cases, advantageous t o all the differen t person s employe d in the various occupations int o which it is subdivided. The inhabitant s of the country purchase of the town a greater quantity of manufactured goods, with the produce of a muc h smalle r quantity of their own labour , tha n they mus t have employe d ha d they attempte d t o prepar e the m themselves . Th e tow n afford s a marke t for th e surplus produc e o f th e countr y .. . Th e greate r th e numbe r an d revenu e o f th e inhabitants of the town, the more extensive is the market... and the more extensive that market, it is always the more advantageous t o a great number ... Among all the absurd speculations tha t have been propagate d concernin g the balance o f trade, it has neve r bee n pretende d tha t either th e country lose s by its commerce wit h the town, or the town by that with the country which maintains it (356-7).

76 Fro m Adam Smith to Maynard Keynes Recognition of mutual benefit in trade within the nation between tow n and country wa s a step toward s recognitio n o f the mutua l benefit of interna tional trade. Bu t though both partie s gain , they d o not gain equally, an d much of what follows, a s well as what he had alread y writte n abou t th e 'privileges of corporations,' is concerned with the institutions an d policies whereby the towns increase d thei r shar e o f the mutual gain. A Canadia n may well read thi s disquisition on town and country with his mind on the Prairie and the industrialized East ; or on the relations of the 'Third World' and the industrialized Western world. 'The discouragement o f agriculture' (361), or the obstacles to economi c progress i n the country, Adam Smit h attribute d firs t t o the lack o f enter prise of the 'great proprietors.' In the disorderly times which gave birth to those barbarous institutions [feudalism, primogeniture, entail], the great proprietor was sufficiently employe d in defending his ow n territories , o r i n extending his jurisdiction an d authorit y .. . H e ha d n o leisure to attend to the cultivation and improvement of land. Whe n the establish ment of law and order afforded him this leisure, he often wanted the inclination, and almost always the requisite abilities ... To improve land with profit... requires an exact attentio n to smal l savings and small gains, of which a man born t o a grea t fortune, even though naturally frugal, is very seldom capable. The situation of such a person naturally dispose s hi m to attend rather to ornament which it pleases hi s fancy, rathe r than to profi t .. . Th e eleganc e o f his dress , o f his equipage , o f his house, an d househol d furniture, ar e object s whic h from hi s infancy h e has bee n accustomed to hav e som e anxiet y about .. . H e embellishe s perhap s fou r o r five hundred acres in the neighbourhood of his house at ten times the expence which the land i s worth after al l his improvements ; and finds that if he wa s t o improv e his whole estate in the same manner, and he has little taste for any other, he would be a bankrupt before he had finished the tenth part of it (363-4).

'If little improvemen t wa s to be expected from suc h great proprietors , still less was to be hoped for from those who occupied the land under them' (364). Since neithe r slave s nor villeins could expec t t o enjoy th e fruit s of harder wor k o r mor e intelligen t cultivation , ther e wa s n o incentiv e t o improvement. The experienc e o f all ages and nations, I believe, demon strates tha t the work done by slaves, thoug h it appears t o cost only their maintenance, is in the end the dearest o f any. A person who can acquire no property, ca n have no other interes t but to eat as much, and to labour as little as possible' (365). That slave labour persisted on the commercial sugar and tobacco plantations Ada m Smith explained first by 'the pride of man' which makes him 'love to domineer,' and second by the high profits which

Town and country 77 enabled th e owner to 'affor d th e expence of such dear labour' (365). Th e position of the villein or the metayer was not very different. 'It could never, however, be the interest even of this last species of cultivators to lay out, in the further improvement of the land, any part of the little stock which they might save from their own share of the produce, because the lord, who laid out nothing , wa s t o get one-hal f o f whatever i t produced' (367) . Wha t is more the tenant had no security of tenure. In England however tenants had achieved the security that goes with long leases. 'Those laws and customs so favourabl e t o th e yeomanry , hav e perhap s contribute d mor e t o th e present grandeu r o f England , tha n al l their boaste d regulation s o f commerce taken together' (369). An account of the rise of the towns in Europe leads to the crucial theme. Order an d goo d government , and alon g wit h the m th e libert y and securit y of individuals, were, in this manner, established in cities, at a time when the occupiers of lan d in th e countr y were exposed t o ever y sor t o f violence . Bu t me n i n thi s defenceless stat e naturally conten t themselves with thei r necessary subsistence; because to acquire more might only tempt the injustice of their oppressors. On the contrary, when they are secur e of enjoying th e fruit s o f their industry , they naturally exert it to better their condition, and to acquire not only the necessaries, but the conveniences and elegancies of life (379).

The development of the towns had an important impact on the country. First, by affording a great and ready market for the rude produce of the country ... Secondly, the wealth acquired by the inhabitants of cities was frequently employed in purchasing such lands as were to be sold ... Merchants are commonly ambitious of becoming country gentlemen, and when they do, they are generally the best of all improvers .. . Thirdly , and lastly , commerc e and manufacture s introduce d order and good government, and with them, the liberty and security of individuals, among the inhabitants of the country .. . This, though it has been the least observed, is by far th e most important of all their effects (384-5).

We hav e com e t o tak e orde r an d securit y fo r grante d bu t i t i s wel l t o remember the economic importance of'order and good government' in our old countries as well as in the new countries of the developing world. The achievemen t of good government through the overthrow of feudal violence was attributed by Adam Smith to the growth of the urban market. What all the violence of the feudal institutions could never have effected, the silent and insensible operation of foreign commerce and manufactures gradually brought

78 Fro m Adam Smit h to Maynard Keyne s about. These gradually furnished th e great proprietors wit h something for which they could exchange the whole surplus produce of their lands, and which they could consume themselve s withou t sharin g i t eithe r wit h tenant s o r retainers . Al l fo r ourselves, an d nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind. As soon, therefore , as they coul d find a method of consuming the whole value of their rents themselves, the y had no disposition to shar e the m with any other persons . Fo r a pair of diamond buckle s perhaps, or for something as frivolous and useless, they exchanged the maintenance ... of a thousand men for a year, and with it the whole weight and authority which it could give them ... thus for the gratification of the most childish, the meanest, and the most sordicj of all vanities, they gradually bartered away their whole power and authority (389).

A page later he added: The retainer s bein g dismissed , th e grea t proprietor s wer e n o longe r capabl e o f interrupting th e regula r executio n o f justice, o r o f disturbin g th e peac e o f th e country. Having sold their birthright, not like Esau for a mess of pottage in time of hunger an d necessity , bu t i n the wantonnes s o f plenty, fo r trinket s an d baubles , fitter to be the play-things of children than the serious pursuits of men, they became as insignificant as any substantial burgher or tradesmen in a city. A regular government wa s establishe d i n the countr y a s wel l as i n the cit y .. . A revolutio n of the greatest importance to public happiness, was in this manner brought about by two different order s o f people, who had not the least intentio n to serve th e public. T o gratify th e mos t childish vanity was the sol e motiv e of the great proprietors . Th e merchants and artificers , muc h less ridiculous, acted merel y from a view to their own interest , an d i n pursui t o f thei r ow n pedla r principl e o f turnin g a penn y wherever a penny was to be got. Neither of them had either knowledge or foresight of that great revolution which the folly of the one, and the industry of the other, was gradually bringing about (390-92).

So ends this essay in economic determinism.

II

International trad e

The benefits The importatio n o f gold an d silve r is not th e principal , much less th e sol e benefi t which a natio n derive s fro m it s foreig n trade . Betwee n whateve r place s foreig n trade is carried on, they all of them derive two distinct benefits from it. It carries out that surplu s par t o f th e produc e o f thei r lan d an d labou r fo r whic h ther e i s n o demand among them, and brings back in return for it something else for which there is a demand. It gives value to their superfluities, by exchanging them for something else, whic h may satisf y a part o f their wants, and increas e thei r enjoyments. By means o f it , th e narrownes s o f the hom e marke t does no t hinde r the divisio n of labour .. . By opening a more extensive market for whatever part of the produce of their labour may exceed th e home consumption, it encourages them to improve its productive powers, an d to augment its annual produce to the utmost (415).

This exposition of the advantag e o f foreign trad e was very differen t from that o f Ricardo, an d i t was th e Ricardia n theor y tha t becam e orthodox. Adam Smith' s 'heresy' was exposed by John Stuart Mill . Adam Smith's theory of the benefit of foreign trade was that it afforded a n outlet for the surplus produce of a country, and enabled a portion of the capital of the country to replace itsel f with a profit. These expressions sugges t ideas inconsistent with a clear conceptio n o f the phenomena . Th e expressio n surplu s produce , seem s t o imply that a country is under some kind of necessity o f producing the corn o r cloth which it exports; s o that the portion which it does not itself consume, if not wanted

8o Fro m Adam Smith to Maynard Keynes and consumed elsewhere, would either be produced in sheer waste, or, if it were not produced, the corresponding portion of capital would remain idle, and the mass of productions i n th e countr y woul d b e diminishe d b y s o much . Eithe r o f thes e suppositions woul d be entirel y erroneous. Th e countr y produces a n exportabl e article in excess o f its own wants from n o inherent necessity, but as the cheapes t mode of supplying itself with other things. If prevented from exporting this surplus, it would cease to produce it... the labour and capital which had been employed in producing with a view to exportation, would find employment in producing those desirable objects which were previously brought from abroad : or .. . in producing substitutes for them.1

The orthodox exposition of Ricardo and Mill assumed full employment and was concerne d onl y wit h th e rationa l allocatio n o f resource s betwee n industries producin g for the domestic an d export markets . Bu t there are other aspect s o f the impac t o f foreign trade whic h orthodo x theor y ne glected bu t which Adam Smit h properl y noted . Hi s genera l statement , quoted above, may be related to views expressed in the preceding books. I propose t o identif y thre e examples. First , le t me refer once agai n to his discussion of the effect on Scottish agriculture of the opening of the English market (221 -2). The problem was not the static one of re-allocation of given resources, but a highly dynamic almost revolutionary effect on the character and productivity of agriculture. Second, le t me revert to the problem of 'productive an d unproductive' labou r i n Book n . If m y interpretation i s correct, then one may consider th e opening of profitable export markets as leading to a further increase i n 'productive' employment at the expense of 'unproductive' employment. This can, I suppose, be said to be a matter of re-allocation; but it is really very different . Th e choic e i s not whether t o produce in the advanced sector goods for domestic use of goods for export; it i s whether to us e labour for th e productio n o f goods i n the advance d sector, productivel y an d profitably, or whethe r t o continu e t o us e i t in dependent menia l service, in the primitive sector. The real problem is not allocation, nor even full employment , but rather economi c development . Third, le t me refer to the sectio n on the rise of the towns in Book HI . ' A taste for the finer and more improved manufactures, was ... introduced by foreign commerce into countries where no such works were carried on. But when this taste became so general as to occasion a considerable demand , the merchants , i n orde r t o sav e th e expenc e o f carriage , naturall y endeavoured t o establish som e manufactures of the sam e kind in their own country' (380) . N o bette r exampl e ca n b e cite d tha t th e effec t o f th e importation o f oriental porcelai n o n the peasan t potterie s of North Staf -

International trade 81 fordshire. Fro m crud e butte r pot s t o Wedgwoo d dinne r service s i n a generation is surely an example of dynamic development, not static reallocation. Curiously enough John Stuart Mill, after denouncing the Smithian 'vent for surplus ' heresy, discussed certain indirect effects of trade ... which must be counted as benefits of a high order. One is, the tendency of every extension of the market to improve the processes of production. A country which produces for a larger market than its own, can introduce a more extended division of labour, can make greater use of machinery, and is more likely to make inventions and improvements in the processes o f production ... Ther e i s another consideration, principally applicable to an early stage of industrial advancement. A people may be in a quiescent, indolent, uncultivated state ... and they may fail to put forth the whol e of their productive energies for wan t of any sufficien t objec t of desire. The openin g of a foreign trade , by makin g them acquainted wit h new objects ... sometimes works a sort of industrial revolution in a country whose resources were previously underdeveloped for want of energy and ambition in the people.2

The heres y i s not after all so heretical. Onl y since th e obsession wit h static equilibriu m has been succeede d b y a real concern for development have modern writers begun to recognize th e value of this part o f international trade theory, a part which had for so long been treated as crude and fallacious. Professor Allyn Young in his article in the Economic Journal, 3 and Professor J.H . William s in the same Journal,4 wer e amon g the first. Professor Hl a Myint 5 argued tha t 'i n general th e vent-for-surplu s theor y provides a more effective approach tha n the comparative cost s theory to the internationa l trad e o f the underdevelope d countries. ' H e recognize d that this theory does not 'provide an exact fit to all the particular patterns of development,' bu t argue d tha t i t i s mor e relevan t tha n a theor y whic h 'assumes tha t th e resource s o f a countr y ar e give n an d full y employe d before i t enters into international trade.' Professor Myin t was concerned with relatively backward countries; but no countries are 'fully developed,' the mos t highl y developed hav e mor e developmen t ahea d o f the m an d generally have pockets o f backwardness, under-developed regions awaiting development . S o it i s importan t fo r moder n economist s t o conside r more than the effective allocation of given resources and to pay attention to problems of full employmen t and full development. Canadian economists schooled i n the 'staple product' approach ma y be expected t o appreciate this developmen t approach . Foreig n trad e 'gav e a valu e t o thei r superfluities,' i.e. , to those highl y specific natural resources whic h were

82 Fro m Adam Smith to Maynard Keynes much to o abundan t fo r th e need s o f the limite d domesti c market . Th e reasonable expectatio n o f the resulting availability o f sterling exchange to meet th e carryin g charge s o f debt mad e i t possibl e t o borro w i n Grea t Britain, and thus made possible a rate of growth of capital equipment much greater than would have been possible from domestic accumulatio n alone. The stimulus of potential trade to invention and technological advanc e was no les s important . N o stati c mode l i s adequat e t o th e analysi s o f thi s process. Free trade Book iv is, fro m th e point of view of Adam Smith's contemporarie s th e most important part of the whole inquiry, being the detailed indictmen t of mercantilism. T o dea l with it adequately on e would have to discuss th e literature of the mercantilist s an d the economic condition s o f the time. I propose to make two comments only before discussing the positive argument for free trade; the detailed criticism of the negative, restrictive, trade policies of his age I shall ignore. First let me say that the mercantilists were not as stupid as Adam Smith would have you believe. They did not believe 'that wealt h consiste d i n gold an d silver. ' Thoma s Mun, 6 whom Adam Smith took as his example, made it quite clear that there could be too much bullion imported; that price s woul d be driven up by reason thereof , an d exports would decline as the country priced itself ou t of foreign markets ; and that the resulting unfavourable balance of trade would lead to export of the excess bullion . Nevertheless i t was not so misleading to say 'that the great object of political economy [was] to diminish as much as possible th e importation o f foreign good s fo r hom e consumptio n an d t o increas e a s much as possible the exportation of the produce of domestic industry' (418) in order to bring bullion into the country. One does not have to pretend that the mercantilists had achieved a satisfactory analysis of the problem, nor that th e restrictiv e measure s the y too k wer e wise ; bu t shoul d w e no t recognize tha t ther e wa s a real proble m to worr y about? 7 Ma y one no t suppose that distress of the deflation required on occasion for adjustment in the balance of payments was as great, if not greater, than now? Are we as ready as we once were to 'trust with perfect security that the freedom of trade .. . [which ] wil l alway s suppl y u s wit h th e win e whic h w e hav e occasion for ... will always supply us with all the gold and silver which we can afford t o purchase or employ'? (404) The quantity of gold will regulate itself t o the effectua l demand , 'more easily and exactly' tha n most commodities. Tru e enough , bu t wil l i t regulat e itsel f t o th e deman d a t th e existing level of incomes and prices ? I s i t not importan t to examin e the

International trade 83 process b y whic h deman d an d suppl y ar e brough t int o ne w equilibrium positions? Henr y Thornton 8 wa s n o mercantilist , bu t hi s analysis of the process o f deflatio n make s on e mor e sympatheti c t o th e mercantilists ' worries. Al l o f whic h leave s one , however , read y t o acknowledg e th e ineptitude of the restrictive measures to which those legitimate worries led them. The pursuit of economic growth required, perhaps, that the pains of occasional deflation be accepted lest the remedies for pain should stunt the growth of the economy. In economics and in his personal life Adam Smith preferred to rely on the vis medicatrix naturae than on drugs and treatment. In Chapter n of Book iv Adam Smith presented his case against protective dutie s an d prohibitio n o f imports i n general. Suc h restraint s give a monopoly o f the hom e marke t which 'frequentl y give s great encourage ment to that particular specie s o f industry which enjoys it, and frequently turns towards that employment a greater share of both the labour and stock of the society than would otherwise have gone to it... But whether it tends either to increase the general industry of the society, or to give it the most advantageous direction , i s not , perhaps , altogethe r s o evident' (420-1) . The argumen t that follow s is based o n th e economic s o f allocation; de velopment i s forgotten . 'Th e genera l industr y o f th e societ y neve r ca n exceed wha t th e capita l o f th e societ y ca n emplo y .. . No regulatio n of commerce can increase the quantity of industry in any society beyond what its capita l ca n maintain . It ca n onl y divert part o f it into a direction int o which i t migh t not otherwis e hav e gone ' (421) . Ada m Smit h though t it unlikely that this other direction would be an improvement; he relied on the judgment of individual capitalists to employ their capital at the points of the highest profit, and believed that those would be the points of greatest social advantage. Every individua l wh o employ s his capita l in th e suppor t o f domesti c industry , necessarily endeavour s so to direct that industry, that its produce may be of the greatest possibl e value .. . H e generally , indeed, neither intends to promot e the public interest , no r know s ho w muc h he i s promotin g it. .. . B y directin g that industry in such a manner as its produce may be of greatest value, he intends only his own gain, and he is in this, as in many other cases, le d by an invisible hand to promote an end which was no part of his intention. Nor i s it always the worse for society that it was no part of it... I have never known much good done by those who affected t o trade for the public good (422-3).

Adam Smit h woul d not , I think , argu e tha t th e resultan t allocatio n o f resources wa s perfect; he was no doctrinaire. Bu t he had good reason t o

84 Fro m Adam Smith to Maynard Keyne s believe that any interference by the governments of his day was likely to make it worse. The statesman , wh o should attemp t t o direct private peopl e in what manne r the y ought to employ their capitals, would not only load himself with a most unnecessar y attention, but assum e a n authorit y whic h could safel y be trusted, no t only t o n o single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise i t (423). It all goes back to the division of labour. It i s the maxi m of every pruden t maste r o f a family, neve r t o attemp t to mak e a t home what it will cost more t o make tha n to buy. The taylor doe s not attempt t o make hi s own shoes , bu t buy s them of the shoemaker . Th e shoemake r doe s not attempt to make his own clothes, but employs a taylor.... All of them find it for their interest to employ their whole industry in a way in which they have some advantag e over thei r neighbours, an d to purchase .. . whateve r else the y hav e occasio n for . What is prudence in the conduct o f every private family can scarcely b e folly in that of a great kingdom (424). When the advantage is very great the case is obvious. By mean s o f glasses, hotbed s an d hotwalls , ver y goo d grape s ca n b e raise d i n Scotland, and ver y good win e too ca n b e mad e of them at abou t thirt y times th e expence fo r whic h at leas t equall y good ca n b e brough t fro m foreig n countries . Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland? But if there would be a manifest absurdit y i n turning towards an y employment , thirt y time s mor e o f th e capital an d industr y of th e country , tha n woul d b e necessar y t o purchas e fro m foreign countrie s an equal quantity of the commodities wanted, there mus t be an absurdity, though not altogether so glaring, yet exactly of the same kind, in turning towards any such employment a thirtieth, or even a three hundredth part more of either (425). Obiter dicta Let me close this section with some more or less disconnected obiter dicta. First: 'A s defence , however, is of much more importance than opulence the act of navigation is perhaps, the wisest of all the commercial regulations

International trad e 8 5 of England' (431) . Opulence, o r shal l w e sa y industria l development , i s important, a s Adam Smit h knew, for defence. ' A country whose industr y produces a great annua l surplu s o f such manufactures , whic h are usually exported to foreign countries, may carry o n for many years a very expen sive foreign war' (412). The act of navigation, he saw, was not 'favourabl e to foreign commerce , o r to th e growth o f that opulenc e whic h ca n aris e from it' (431). Even from the point of view of defence, som e assessment o f the cost (slower development o f industrial strength) as well as of the benefit (available ship s and seamen) was required . Second: Such taxe s [i.e. , those o n necessaries whethe r excise o r import duties] .. . ar e a curse equal to the barrenness of the earth and the inclemency of the heavens; and yet i t i s in the riches t an d mos t industriou s countries tha t the y have bee n mos t generally imposed. No othe r countries could suppor t s o great a disorder. A s the strongest bodies only can live, and enjoy health , under an unwholesome regimen so the nations only, that... have the greatest natural and acquired advantages, can subsist and prosper under such taxes (433).

The context is the defence of import duties to offset domestic excise duties: but the proposition ha s more general relevance. Third: There may be good policy in retaliations of this kind, when there is a probability that they wil l procure the repea l of the hig h duties or prohibitions complained of. Th e recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods. T o judge whethe r such retaliation s are likel y t o produc e suc h a n effect , doe s not , perhaps, belon g so muc h t o th e scienc e o f a legislato r ... a s t o th e skil l o f that insidious and crafty animal , vulgarly called a statesman or politician ... When there is no probability that any suc h repeal can b e procured, it seems a bad metho d of compensating the injury done to certain classes of our people, to do another injury ourselves, not only to those classes, but to almost all other classes of them (435).

We migh t well take thi s t o hear t i n the presen t decade . Ar e w e no t to o anxious to bargain for reciprocal tariff reductions, which are uncertain, and certain t o b e long delayed, whil e continuing to bea r th e cos t o f our own tariff? Fourth:

86 Fro m Adam Smith to Maynard Keynes To expect , indee d tha t th e freedo m of trade shoul d eve r b e entirel y restore d in Great Britain, is as absurd as to expect tha t an Oceana or Utopia shoul d eve r b e established i n it. No t onl y th e prejudice s o f the public , bu t wha t i s much mor e unconquerable, th e privat e interest s o f man y individual s irresistabl y oppos e i t (437-8). What is, of course, particularly importan t is that the benefits are concen trated o n a relativel y small , wel l organize d group , whil e th e cost s ar e dispersed over the many. We have begun to learn the value of compensation to those injured by the reduction of a tariff (or assistance i n adjustment to the new conditions) not just as a matter of justice but rather as the price which politically mus t be paid to overcome 'th e prejudices of the public' and 4 the private interests' o f the previousl y protected. I f the gai n to th e public from abolitio n or reduction of the tariff i s more than the compensation, or the cost o f the adjustment assistance program , the price is worth paying. Fifth: The Portuguese, it is said, indeed, are better customers for our manufacturers than the French, and should therefore be encouraged in preference to them. As they give us their custom, it is pretended, w e should give them ours. Th e sneakin g arts of underling tradesme n are thu s erecte d int o political maxim s for th e conduc t o f a great empire ; for i t i s th e mos t underlin g tradesman only wh o mak e it a rule t o employ chiefl y thei r own customers . A great trade r purchase s hi s goods always where they are cheapest and best ... By such maxims as these, however , nations have been taught that their interest consists in beggaring all their neighbours (460). Sixth: The wealt h o f a neighbourin g nation however , thoug h dangerou s i n wa r an d politics, is certainly advantageous in trade .. . As a rich man is likely to be a better customer to the industrious people in his neighbourhood, than a poor, so is likewise a ric h natio n .. . Th e manufacturer s of a ric h natio n .. . ma y n o doub t b e very dangerous rivals to those o f their neighbours. This very competition, however, is advantageous to the great body of the people, who profit greatly besides by the good market which the great expence of such a nation affords the m in every other way (461). The emergence of new industrial powers does indeed open new markets for many of our products; but they may sell other products to us at such prices

International trade 87 as mak e continue d productio n a t hom e unprofitable . Effort s t o restric t importation of such products by tariffs, prohibitions, or quotas, deprive us of the advantage of cheapness and probably reduce the advantage to be had from increased exports. Here again is a case for government intervention to compensate, o r to assist in adjustment, so that the public at large may enjoy the potential advantage of this extended trade . Colonial trade Those who are interested in the history of early colonization will find much suggestive materia l in Adam Smith's chapte r 'O f Colonies.' I shall confine myself to some parts of that chapter which illustrate his general attitudes. I have referred earlier to his emphasis on peace, order and good government as factor s i n economi c development . I t i s no t surprisin g the n tha t h e attributed the fact that 'there are no colonies of which the progress has been more rapid than that of the English in North America' (538), to their greater freedom to manage their own affairs an d to the greater security which they derive from democrati c institutions . The absolut e governments of Spain, Portugal and France .. . and the discretionary powers which such governments commonly delegate to all their inferior officers are, on account of the great distance, naturally exercised ther e with more than ordinary violence ... The government of the English colonies is perhaps the only one which, since the world began, could give perfect security to the inhabitants of so very distant a province' (552). The freedom to manage their own affairs was not, o f course , complete . Th e colonie s wer e subjec t t o restriction s i n exporting certain 'enumerated' articles which had to be sent to the market of the mother country, and to th e further restrictio n that they had to use 'British or Plantation ships, of which the owners, and three fourths of the mariners ar e Britis h subjects ' (544 ) fo r th e otherwis e fre e trad e i n th e non-enumerated articles . The y wer e restricted , too , i n som e manufac tures. 'To prohibit a great people, however , from makin g all that they can of ever y part o f thei r own produce , o r fro m employin g their stoc k an d industry in the way that they judge most advantageous to themselves, is a manifest violatio n of the mos t sacred right s of mankind' (549). But, concluded Adam Smith, however unjust, the restrictions on manufacture have 'not hithert o bee n ver y hurtfu l t o th e colonies, ' (549 ) and th e polic y of Great Britain had 'upon the whole, been less illiberal and oppressive than that of any of them' (551). We turn from th e colonies to Europe . 'Th e general advantages which Europe, considered a s one great country, has derived from th e discovery and colonizatio n o f America, consists , first , i n the increas e o f its enjoy-

88 Fro m Adam Smith to Maynard Keynes ments; an d secondly , i n th e augmentatio n of its industry ' (557) . It ha d furnished 4 a variety of commodities which they could not otherwise hav e possessed, some for conveniency and use, some for pleasure, and some for ornament, and thereby contributes to increase their enjoyments' (557). It has opened 'a more extensive market for their surplus produce, and [they] must consequently hav e been encourage d t o increase its quantity' (557). 'Vent for surplus' again! This encouragement to industry might extend to countries which might never have sent a single commodity of their own produce t o Americ a (e.g., Hungar y and Poland), an d eve n t o countrie s which have never received commodities from America but which may have received ' a greate r abundanc e o f othe r commoditie s fro m countrie s o f which the surplus produce had been augmented by means of the American trade. Thi s greater abundanc e .. . mus t necessarily hav e increased thei r enjoyments' (558). Though all Europe gained, each country sought to divert to itself a greater share of the gain than would accrue without interference. In order, however, to obtain this relative advantage in the colony trade, in order to execute the invidious and malignant project of excluding as much as possible other nations from any share in it, England, there are very probably reasons for believing, has not only sacrificed a part of the absolute advantage which she, as well as every other nation, might have derived from tha t trade, but has subjected herself both to an absolute and to a relative disadvantage in almost every other branch of trade (561-2).

After elaborating these disadvantages Adam Smith concluded: If th e manufacture s o f Grea t Britain , however, have bee n advanced , as the y certainly have, by the colony trade, it has not been by means of the monopoly of that trade , bu t i n spite o f the monopol y ... Th e monopol y of the colon y trade, therefore, lik e al l th e othe r mea n an d malignan t expedients o f th e mercantil e system, depresse s the industr y o f all other countries, but chiefl y tha t of the colonies, without in the least increasing, but on the contrary diminishing, that of the country in whose favour it is established (576-7).

The analysi s on which this is based may not be quite convincing: but th e intuitive belief that any one country is more likely to prosper in a generally expanding world, than in one where each seeks benefit through restriction was probably sound.

International trade 89 To foun d a great empire for the sol e purpose of raising up a people of customers, may at first sight appear a project fit only for a nation of shopkeepers. It is, however, a project altogether unfit for a nation of shopkeepers; but extremely fit for a nation whose governmen t i s influence d b y shopkeepers . Suc h statesmen , an d suc h statesmen only , ar e capabl e o f fancyin g tha t the y wil l fin d som e advantag e in employing the bloo d an d treasur e o f their fellow citizens, to found and maintain such an empire. Say to a shopkeeper, Buy me a good estate, and I shall always buy my clothes at your shop, even though I should pay somewhat dearer than what I can have them for at other shops ; an d you will not find him very forward to embrac e your proposal. Bu t should any other person buy you such an estate, the shopkeepe r would be muc h obliged to you r benefactor if he would enjoin you to bu y al l your clothes a t hi s shop . England purchase d fo r som e o f he r subjects , wh o foun d themselves uneas y at home, a great estate in a distant country ... Without pretending, therefore, that they had paid any part, either of the original purchase-money, or of the subsequent expence of improvement, they petitioned the parliament that the cultivators of America might for the future be confined to their shop (579-80).

Here is Adam Smit h th e pamphleteer: perhap s th e derogatory us e of the work 'shopkeeper' ('this truly shopkeeper proposal' ) had a special poin t in appealing to the landed gentry who made up the parliament of his day. The cas e against th e monopol y o f colonial trad e i n Book i v is largel y based o n misallocatio n o f capital, o r resources ; bu t on e mus t remembe r that Adam Smit h saw monopoly a s 'a great enem y to good management ' (147) and individual liberty as the condition of vigorous free enterprise an d imaginative innovation. Having argued that monopoly of the colonial trad e reduced th e benefit s tha t migh t otherwis e hav e bee n enjoyed , h e dre w attention t o the cost incurred in defending the colonies. 'Th e late war was altogether a colony quarrel, and the whole expence of it, in whatever part of the worl d i t ma y have bee n lai d ou t .. . ough t justly t o b e state d t o th e account of the colonies. It amounted t o more than ninety millions sterlin g ... The Spanish war which began in 1739, was principally a colony quarre l ... This whole expence is, in reality, a bounty which has been given in order to support a monopoly' (581). S o he turned t o the possibility o f indepen dence for the colonies; on the eve of American Independence h e had this to say: To propos e tha t Grea t Britai n should voluntarily give up al l authority over he r colonies, and leave them to elect their own magistrates, to enact their own laws, and to mak e peace an d wa r as the y might think proper, woul d be to propos e suc h a

9O Fro m Adam Smit h to Maynard Keyne s measure as never was, and never will be adopted, b y any nation in the world. N o nation ever voluntarily gave up dominion of any province, how troublesome soeve r it might be to govern it, and however small soever th e revenue which it afforded .. . Such sacrifices , thoug h the y migh t frequentl y b e agreeabl e t o th e interest , ar e almost alway s mortifying t o the prid e of every nation, and what is perhaps o f still greater consequence, the y are always contrary to the private interest of the governing part of it, who would thereby be deprived o f the disposal of many places of trust and profit , o f many opportunities o f acquiring wealth and distinctio n .. . I f i t [th e proposal to grant independence] was adopted , however , Grea t Britai n would not only be immediately freed fro m th e whol e annua l expence of the peace establishment of the colonies, but might settle with them such a treaty of commerce as would effectually secur e t o her a free trade, mor e advantageou s to the great body of the people, thoug h less s o to the merchants, tha n the monopoly which she at presen t enjoys. B y thus parting good friends, the natura l affectio n o f the colonie s to th e mother country, which, perhaps, our late dissensions have well nigh extinguished, would quickly revive: It might dispose them not only to respect, for whole centuries together, tha t treaty of commerce whic h they concluded wit h us at parting, but to favour us in war as well as in trade, and, instead of turbulent and factious subjects, to become our most faithful, affectionate , an d generous allies (581-2).

Liberal, and prophetic!

12 Laissez faire

I propose to discuss Adam Smith's case for laissez faire at some length, not just to ensure a fair interpretation of his case, but because misinterpretation of Adam Smith , an d o f th e classica l economist s generally , has le d t o a serious misunderstanding of the modern doctrine o f economic liberalism. This latter is an essential element in the philosophy of the West; and in the competition of ideologies i t is important to understand, and t o clarif y fo r others, the position we seek to defend. All system s eithe r o f preference o r of restraint, therefore , bein g thus completel y taken away, the obvious and simple systems o f natural liberty establishes itsel f of its own accord. Ever y man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capita l into competition wit h those o f any othe r man , or orde r o f men. Th e sovereign is completely discharged fro m a duty, in the attempting to perform which he must always be exposed to innumerable delusions, an d for the prope r perfor mance of which no human wisdom or knowledge could ever be sufficien t .. . Th e sovereign ha s onl y thre e dutie s t o atten d t o .. . first , th e dut y o f protectin g th e society fro m th e violenc e and invasio n of other independen t societies; secondly , the dut y of protecting, a s far a s possible , ever y membe r o f the societ y fro m th e injustice o r oppressio n o f ever y other membe r of it .. . and , thirdly, the dut y of erecting, an d maintainin g certai n publi c work s an d certai n publi c institutions , which it can never be for the interest o f any individual... to erect and maintain .. . the profi t coul d neve r repa y th e expenc e o f an y individua l .. . thoug h i t ma y frequently do much more then repay it to a great society (651).

92 Fro m Adam Smith to Maynard Keynes Adam Smith's plea must first be considered in its historical context. His was not a plea to do nothing, but to destroy the vast complex of regulation and restriction that had grown up. It was a plea for revolutionary refor m and i t was a ple a whic h was base d o n vast historica l knowledg e o f th e ineptitude and corruption of the government of his day. Alfred Marshall put this point effectively i n Industry an d Trade. 'Ada m Smith knew the weakness and corruption of those who were posing as masters of statecraft. His condemnation of officious meddlin g by such men in the affair s o f industry and trade is not indeed limited to the conditions of his age. But he had no means of anticipating the vast increase in the resources o f government and in th e honest y of public officials whic h began in the igt h century. 1 Th e 'agenda' o f government , t o us e Bentham' s phrase , canno t b e properl y determined until the character of the government is specified. There are many who would have you believe that The Wealth of Nations was simply a plea for the removal of all legal and moral restraints upon the anti-social greed of individuals. Of course the plea for liberty has been, on occasion, perverte d int o a plea for what I call 'economic royalism.' But as presented by Adam Smith, and by classical politica l economist s sinc e his time, and as understood by modern economic liberals, the plea for freedom was based o n a belief that the economic welfar e of the people a s a whole would be thereby increased. Th e ends of the socialist an d of the liberal are in larg e par t th e same ; bot h see k economi c welfare . Neithe r ha s a monopoly of the sens e o f justice o r of concern fo r the welfare of people. They differ as to the means to be employed, and as to the relative weight to be attached to the economic and non-economic elements in welfare, of the value, for instance, of freedom. Th e old time socialist cliche, 'productio n for use rather than production for profit,' blinds many to the real characte r of Adam Smith's argument that the public will best be served, that cheapness and plenty will best be promoted, that economic welfare will be most rapidly increased, if enterprising men are free to pursue profit. Adam Smith was not a 'Utopian': his plea was not that all would be well if economic freedom wer e achieved but rather that things would be better if many of the existing restrictions were removed. He was not a doctrinaire. In his Theory of Moral Sentiments he had warned against the doctrinaire, 'the man of system.' The ma n o f syste m i s ap t t o b e ver y wis e i n hi s ow n conceit , and i s ofte n s o enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer th e smallest deviation from it . He goes on to establish it completely, and i n all its parts, without an y regar d either to the great interests, or the strong

Laissez faire 9 3 prejudices whic h may oppos e it : h e seem s t o imagin e tha t h e ca n arrang e the different member s of a grea t societ y wit h a s muc h ease a s th e han d arranges different pieces upon a chess board.2

This may sound like a warning to the doctrinaire planner, but it is equally a warning against the doctrinaire advocate of the system of natural liberty. The case for laissez faire, as argued by Adam Smith and all its honest advocates, depend s o n the assumptio n o f a stable societ y i n which individuals are not simply protected against violence and injustice by the police and the courts o f law, but by the operatio n o f 'sympathy.' The classica l economists too k for granted the existence o f such a society hel d togethe r not by a complex of contractual relations in the pursuit of the self interest of its members, but by a system of ethics, o f 'sympathy,' an d by historica l experience. Th e par t tha t ethica l idea s playe d i n th e syste m o f Adam Smith, and still play in the doctrine of economic liberalism, has been most effectively explore d an d expounde d b y Professo r O.K . Taylo r i n hi s Economics of Liberalism (1955). Of the eighteenth century he said: The new leniency towards individual desire was closely connected with a new faith in th e mora l faculties o f individuals an d i n the goodnes s o f huma n nature . Self centered desires were trusted to promote the general welfare, because reason and the moral sense were trusted to restrain them wherever their indulgence would be inconsistent wit h tha t welfar e .. . Grotiu s once fo r al l founded th e whol e liberal theory of natural rights upon the doctrine that men are endowed with a disinterested love o f societ y .. . Shaftesbury , th e fathe r o f th e schoo l o f Scotc h mora l philosophers that bred Adam Smith, endowed man with an innate 'moral sense' ... and taught that self regarding desires are legitimate, and even virtuous, so long, but only so long, as they are duly controlled and limited by these other propensities ... Finally, Adam Smith himself , befor e writin g The Wealth o f Nations, wrote upon our Moral Sentiments.

Dr Taylor concluded that 'Smith agreed with Shaftesbury that self-centred economic ambitio n i s sociall y beneficen t s o lon g a s i t i s limited , a s i t normally is, by the beneficent dictates of our moral faculties.'3 Having i n min d th e importanc e o f competitio n i n Ada m Smith' s economics it is well to note this passage from his Moral Sentiments: 'In the race for wealth and honours and preferments, he may run as hard as he can, and strain every nerve and every muscle to outstrip all competitors. But if he should justle, o r throw down any of them, the indulgence of the spectators is entirely at an end. It is a violation of fair play.' 4 In the interpreta-

94 Fro m Adam Smith to Maynard Keynes tion of Adam Smith and in understanding economic liberalism it is essential to recognize, as O.H. Taylo r s o clearly demonstrated, that: 'Competition could work as Adam Smith thought it should work only in a society whos e legal system, and whose current and effective standards of business morality, were products of the effective working of the force of sympathy.'5 It is important, particularly as we export our ideas to new countries, t o make explicit the importance of this social, cultural, ethical, legal framework for the effectiveness of economic freedom in achieving economic welfare. It i s not just a general background of law and order tha t Adam Smith envisaged as necessary, give n which laissez faire was the rule. There was much more for his state to do than to provide a night watchman. Professor Robbins gav e a goo d reaso n fo r th e apparentl y 'negativ e emphasi s o f extreme individualism' as a product of its controversial setting. 'In polemical discussion,' he says, 'ther e is a tendency to overemphasis; if you are arguing against fatuous regulations you do not necessarily fee l under any immediate obligations to state all that you would really agree to be desirable functions of government. There are man y obiter dicta, even i n the classical literature , whic h clearly cal l for this interpretation.' 6 Professo r Jacob Viner in a famous essay on 'Adam Smith and Laissez Faire'7 listed the many deviations from that policy which Adam Smith explicitly recommended. Some have been referred to in earlier sections, e.g., the defence of the usur y law s and the navigatio n laws, and the argumen t for regulation of note issue. As time went by, as understanding of the economic proces s and experienc e o f the defect s i n its operatio n accumulated , a s qualifie d trustworthy 'referees ' t o supervis e th e economi c 'game ' becam e mor e plentiful, an d a s th e voic e o f the peopl e becam e mor e influentia l i n th e legislature, new 'rules of the game' were developed in order that the pursuit of profit might be made more fully consisten t with the achievement of the public good. I n a pamphlet, The Positive Policy o f Laissez Faire (1934), Professor Henr y Simon s se t ou t wha t h e believe d t o b e th e necessar y conditions, th e necessar y rule s o f th e game , i f laisse z fair e wa s t o b e acceptable as a social policy. His positive policy involved a very great deal of regulation; but the regulation set the conditions under which men would be free t o pursue profit, it did not direct them in the employment of their resources. Thi s differenc e i n the nature of interference rather than in the amount o f interferenc e constitutes th e essentia l differenc e betwee n th e modern 'liberal ' advocat e o f fre e enterpris e an d th e socialis t interven tionist. May I suggest a hockey analogy. Let us suppose that the aim of the game

Laissezfaire 9 5 is t o establis h whic h o f two team s ha s th e greates t skil l (this assumes , perhaps, more discriminating viewers in the arena and on television tha n is quite realistic) . Withou t an y restraint s th e strongest , an d mos t vicious , team would win; if you disable th e other team you can score at will. Th e general restraint s o n persona l violenc e o f th e crimina l law an d privat e morals make it necessary to use skill rather than violence. But the rules of the game are then further refined and enforced b y the referee, stil l furthe r increasing the importanc e o f skill in achieving victory. S o the economi c game, played with no restraints against violence would lead to the victory of the strong and the vicious. Competition migh t be expected to lead to the survival of the fittest, but this means of course of the fittest to survive. The mild mannere d tiger or th e kindl y lion will not surviv e in the jungle. We want those fittest to serve the public good to survive and this requires the general restraint on violence of law and morals, and the more specific rules of the game developed t o give the edge to the skilful who produce what the public wants, rules to be regularly revised as experience shows possibilities of improvement, and to be effectively enforced . In Book i, Chapter vii, Adam Smith showed how supply tended to 'suit itself t o the effectual demand. From on e point of view this is a matter of 'positive' economi c theory ; it is a statemen t o f what would happen i n a model characterize d b y fre e enterprise , fre e mobility , and fre e competi tion. Bu t i t wa s als o 'normative. ' No t onl y woul d suppl y sui t itsel f t o effectual deman d under these conditions, but it was desirable tha t suppl y should so suit itself, for this meant the appropriate direction of production, production o f the mos t wanted goods. Th e Wealth of Nations i s closel y related to Professor Pigou's Economics o f Welfare (1912) : the interest lies not solely in why prices are what they are, but also in the social function of prices. Professor F.H. Knigh t once said: 'The discussions of value theory give, in connection with natural price, a fair indication of the general nature of the organisation mechanism and process under price competition ... It is in Smith that we find much the clearest view of the organisation process.' In other words the theory of value of Book i is an essential part of the theory of laissez faire. The atmosphere of freedom made for greater productivity; the free marke t promise d a consume r oriente d us e o f tha t productivity . I n Digressions n an d in , I shal l rais e som e question s abou t consume r sovereignty and about the pursuit of wealth.

13

The education of youth

The education o f 'people of some ran k and fortune' shoul d 'naturally ' be financed by th e fees whic h the studen t 'pay s to the master.' 'Wher e th e reward of the master does not arise altogether fro m this natural revenue, i t is still not necessary tha t it should be derived from that general revenue of the society , o f which the collection an d application ar e ... assigned t o the executive power ' (716) . Ther e ar e publi c endowments th e incom e fro m which supplement s the fees. Adam Smith, whose experience o f life i n an endowed Oxfor d (Balliol ) had bee n on e o f almost complet e neglect , de voted man y pages t o th e effec t o f such endowments . 'Hav e they contri buted t o encourag e th e diligenc e an d t o improv e th e abilitie s o f th e teachers? Have they directed the course of education towards objects more useful, both to this individual and to the public, than those to which it would naturally hav e gone o f its own accord? ' (716 ) Th e answer s involve d th e application o f tw o o f hi s fundamenta l principles , th e importanc e o f pecuniary incentive and the importance of freedom of individual choice. I t is the problem of incentive that I propose to discuss. In ever y profession, the exertio n of the greate r par t of those wh o exercis e it, i s always in proportion to the necessity they are under of making that exertion. This necessity is greatest with those to whom the emoluments of their profession are the only source from which they expect their fortune, or even their ordinary revenue ... In orde r to acquir e this fortun e .. . they must, i n the cours e o f a year , execute a certain quantity of work of a known value; and, there the competition is free, th e rivalship o f competitors , who ar e al l endeavourin g to justle one anothe r ou t o f

The education of youth 9 7 employment, obliges ever y ma n to endeavour t o execute hi s work with a certain degree of exactness (716).

In an earlier sectio n on the 'Expence of Justice/ Adam Smith had argued that judges shoul d be paid by the piece rather tha n by salary: 'By not being paid to the judges til l the process was determined, the y [the fees] might be some incitement t o the diligence o f the court .. . Public service s ar e never better performe d tha n when thei r rewar d come s onl y i n consequence o f them bein g performed , an d is proportioned t o the diligenc e employe d i n performing them' (678). So now he argued that the endowments of schools and colleges have necessarily diminished more or less the necessity of application in the teachers ... In some universities the salary makes but a part, an d frequently but a smal l part of the emolument s of the teacher , of which the greater part arises from the honoraries or fees of his pupils. The necessity of application, though always more or less diminished, is not i n this case entirel y taken away. Reputation in his profession is still of some importance to him, and he still has som e dependency upon the affection , gratitud e and favourable repor t of those who have attended upon his instructions, and these favourable sentiments he is likely to gain in no way so well as by deserving them that is, by the abilities and diligence with which he discharges every part of his duty (717).

The referenc e t o th e 'affection ' o f hi s studen t suggest s tha t h e di d understand the reward s othe r tha n pecuniar y and thi s is all the mor e obvious in a passage a few pages later. 'Such is the generosity of the greater part of young men, that, so far from being disposed to neglect or despise the instruction o f their master, provided h e show s som e seriou s intentio n of being of use to them, they are generally inclined to pardon a great deal of incorrectness i n th e performanc e o f hi s duty , an d sometime s eve n t o conceal fro m the public a good deal of gross negligence' (721). Here speak s the good teacher of all ages. Here his experience at Glasgow as student and professor is characterized. The contrast is with the Oxford of his day where 'the greater part of the public professors have, for these many years, given up altogether even the pretence o f teaching' (718). It i s th e interes t o f every ma n t o liv e a s muc h at hi s eas e a s h e can ; an d i f his emoluments are t o be precisely the same , whether h e does, o r does no t perfor m some very laborious duty, it is certainly his interest, at least as interest is vulgarly understood, eithe r to neglec t i t altogether , o r i f he i s subjec t t o som e authority which wil l no t suffe r hi m t o d o this , to perfor m i t i n a s careles s and slovenl y a

98 Fro m Adam Smith to Maynard Keynes manner as that authority will permit... If the authority to which he is subject reside s in the body corporate ... of which he himself is a member, and in which the greate r part of the other member s are, like himself, persons who either are, or ought to be teachers; they are likely to make a common cause, to be all very indulgen t t o one another, and every man consent tha t his neighbour may neglect his duty, provide d he himself is allowed to neglect hi s own (718). Surely this is an unduly cynical and probably erroneous estimate of human nature; it ignores the 'instinct of workmanship' and the desire for recognition o f achievement . On e canno t rel y entirel y o n wha t Alfred Marshal l called 'economi c chivalry'; but nor can one ignore it. In this context one should commen t o n th e contras t betwee n Ada m Smith' s vie w o n th e payment of professors and of the clergy. It i s i n on e sens e consisten t tha t Ada m Smit h shoul d argu e tha t w e should 'brib e th e indolence ' o f th e clergy : bu t whe n h e describe d th e competition of the clergy for fees, he ought to have recognized th e possibility of analogous behaviour by the professor, who might find that entertain ment and excitement paid better than solid disciplined work. Adam Smith had more confidence in the discrimination of the student than in the public spirit o f th e teacher ! Th e relevan t passag e i n The Wealth o f Nations i s quoted from Hume : It ma y naturally be thought, at first sight, that the ecclesiastics belong t o the first class, and that their encouragement, as well as that of lawyers and physicians, may safely b e entruste d t o th e liberalit y o f individuals , wh o ar e attache d t o thei r doctrines .. . Thei r industr y and vigilanc e will, n o doubt, b e whette d b y suc h an additional motive; and their skill in the profession ... must receive daily increase .. . But i f we conside r th e matte r mor e closely , w e shal l find , tha t thi s intereste d diligence of the clergy is what every wise legislator will study to prevent; because in every religio n excep t th e true , i t i s highl y pernicious an d i t ha s eve n a natura l tendency to pervert the true, b y infusin g int o i t a stron g mixtur e of superstition , folly an d delusion . Eac h ghostl y practitioner , i n orde r t o rende r himsel f mor e precious an d sacre d i n the eye s o f his retainers , wil l inspir e them wit h th e mos t violent abhorrence o f all other sects, and continually endeavour, b y some novelty , to excit e th e langui d devotion o f hi s audience . N o regar d wil l b e pai d t o truth , morals, or decency .. . Customers will be drawn to each conventicle by new industry and address in practising on the passions and credulity of the populace. An d in the end, the civil magistrate will find, that he has dearly paid for his pretended frugality , in savin g a fixed establishment for the priests; an d that in reality, the most decen t and advantageous composition , whic h he can make with spiritual guides, is to bribe their indolence, b y assigning stated salarie s to their profession (743).

The education o f youth 9 9 Later i n the chapte r Adam Smit h discusse d th e developmen t o f 'disagreeably rigorou s and unsocial' codes of morals, and suggested 'tw o very easy an d effectual remedies .. . The first of those remedie s i s the stud y of science an d philosophy , whic h th e stat e migh t rende r almos t universa l among al l peoples o f middlin g o r mor e tha n middlin g ran k an d fortune ' (748). The stat e might require som e understandin g o f science from ever y person permitte d t o exercise a liberal profession, o r from ever y candidat e for public office . 'Scienc e is the great antidote to the poison of enthusias m and superstition; and where all the superior ranks of people were secured from it , th e inferio r rank s woul d no t b e muc h expose d t o it ' (748) . Th e second remedy is the frequency and gaiety of public diversions. The state, by encouraging, that is by giving entire liberty to all those who for their own interest would attempt, without scandal or indecency, t o amuse an d divert the people b y painting, poetry, music , dancing; b y al l sort s o f dramati c representation s an d exhibitions , would easily dissipate ... that melancholy and gloomy humour which is almost always the nurse of popular superstition and enthusiasm (748).

This concern wit h the amusement o f the people wa s developed a century later b y W.S . Jevons : b y the n freedo m wa s no t enough , subsid y wa s needed and approved. It wa s no t onl y th e amusemen t o f th e peopl e tha t concerne d Ada m Smith, but also their education . Though the common people cannot... be so well instructed as people of some rank and fortune, the mos t essentia l part s o f education, however , to read , write , and account, ca n be acquired a t so early a period of life, tha t th e greater part even of those wh o ar e t o b e bred t o th e lowes t occupations , hav e tim e to acquir e the m before they can be employed ... For a very small expence the public can facilitate, can encourage , an d ca n eve n impos e upo n th e whol e bod y o f th e people , th e necessity of acquiring these most essential parts of education (737).

Adam Smit h recognized th e bad effec t of the divisio n of labour o n th e minds of individuals, as well as the good effect on their productivity. The ma n whose whole life is spent in performing a few simple operations ... has no occasion to exert his understanding ... and generally becomes as stupid and ignorant as it is possible for a human creature to become. The torpo r of his mind renders him, not only incapable of relishing or bearing a part in any rational conversation, but o f conceiving any generous, noble, or tender sentiment, and consequentl y of

ioo Fro m Adam Smith to Maynard Keynes forming any just judgment concerning man y even of the ordinary dutie s o f privat e life (734). So the sectio n o n th e educatio n o f youth ends wit h an argument for th e social importance of the education of the people. A man without the proper us e of the intellectual faculties of a man, is, if possible , more contemptible than even a coward, and seems to be mutilated and deformed in a still more essential part of the character of human nature. Though the state was to derive n o advantage fro m th e instructio n o f the inferior rank s of people, it woul d still deserve it s attention .. . The state, however, derive s n o inconsiderable advan tage from thei r instruction. The more they are instructed, the less liable they are to the delusions of enthusiasm and superstition ... An instructed and intelligent people besides, ar e alway s more decen t an d orderly tha n an ignorant and stupi d on e .. . They ar e mor e dispose d t o examine , an d mor e capabl e o f seein g through , th e interested complaint s of faction and sedition .. . In free countries, where the safety of government depends very much upon the favourable judgment which the peopl e may form of its conduct, it must surely be of the highest importance that they should not be disposed to judge rashly or capriciously concerning it (740). Professor Harol d Inni s frequently quoted th e admonition , 'pa s de zele': Adam Smith would have approved.

14

The canons of taxation

Before enterin g upo n th e examinatio n o f particula r taxe s Ada m Smit h 'premises th e fou r followin g maxim s wit h regar d t o taxe s i n general, ' maxims that have come to be known as 'canons.' First: 'Th e subject s o f ever y stat e ough t t o contribut e toward s th e government, a s nearl y a s possible , i n proportio n t o thei r respectiv e abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state' (777). We accept the proposition s o far as ability t o pa y goes , bu t w e n o longe r argu e tha t thi s i s consisten t wit h proportional taxation. Clearly the very poor are not able to pay one-tenth of their income; while the rich are able to pay even one-half of their income without hardship . Th e firs t modification , then, i s t o exemp t a certai n portion o f income considered necessar y fo r subsistenc e a t a sociall y ac ceptable leve l and to tax the exces s ove r tha t portion. W e go further, o f course, and tax income at progressively higher rates as income rises above that exempt level. What is the 'just' proportion is a matter of social values, and politica l acceptability , o n whic h difference s o f opinio n canno t b e resolved by intellectual argument. But Adam Smith when he came to deal with particular taxes proposed to confine his observations 't o that inequality which is occasioned b y a particular tax falling unequally even upon that particular sort of private revenue which is affected by it' (777). This kind of inequality i s mor e subjec t t o intellectua l estimatio n an d mos t plan s o f taxation reform ar e concerned t o achiev e 'equity ' (equa l burden on individuals wit h equal incomes) rathe r than 'justice ' (th e relative burde n on individuals with different incomes) . Even equity is not easy to define since

102 Fro m Adam Smith to Maynard Keynes the concept o f income is itself not without ambiguities. And even if equity could b e defined , there woul d remai n th e possibilit y tha t som e inequit y (even some injustice) may be expedient if economic growt h is given a high priority. W e conclude that the first canon doe s not give as much guidanc e as appears on first reading it. Second: Th e ta x whic h eac h individua l is bound t o pa y ough t t o b e certain, an d not arbitrar y .. . The uncertaint y o f taxation encourage s th e insolence an d favours the corruption o f an order of men who are naturally unpopular, even where they are neither insolent no r corrupt... a considerable degre e o f inequality .. . i s no t nea r s o great a n evi l a s a ver y smal l degree of uncertainty' (778). Here i s another case of the conflict of equity and expediency, and a useful warning to those who would add complication to complication in the search for equality or equity. Third: 'Ever y ta x ough t t o be levied a t the time , o r in the manner , i n which is most likely to be convenient fo r the contributor t o pay it' (778). Payroll deductio n o f income ta x conform s t o thi s canon . Onl y whe n th e rates of taxation became high did the convenience of this method becom e obvious. That i t puts some of the cost o f collection o n the employer is too often ignored: this form of collection hide s part of the cost of collection and imposes an additional tax of undetermined amount on the employer. This is not to argue against such collection, but to argue for assessment of the cost and consideration of this assessed cos t when establishing tax policies . Fourth: Every ta x ough t t o b e s o contrive d as bot h t o tak e ou t an d t o kee p ou t o f th e pockets of the peopl e as littl e as possible , over and abov e wha t it brings into the public treasury ... First , the levyin g of it may requir e a great number of officers , whose salaries may eat up the greater part of the produce of the tax ... Secondly, it may obstruct the industry of the people ... While it obliges the people to pay, it may thus diminish, or perhaps destroy, some of the funds which might enable them more easily to do so. Thirdly, by the forfeitures, and other penalties which those unfortunate individual s incu r wh o attemp t unsuccessfully t o evad e th e tax , it ma y frequently ruin them, and thereby put an end to the benefit which the community might have received from th e employment of their capitals ... Fourthly, by subjecting the people t o th e frequen t visit s an d th e odiou s examination o f tax-gathers , it ma y expose the m to muc h unnecessar y trouble, vexation an d oppression; and though vexation is not, strictly speaking, expence it is certainly equivalent to the expence at which every man would be willing to redeem himself from i t (778-9).

Looking back to the first three maxims, each presents some problem under

The canon s of taxation 10 3 this fourth. The searc h for greater equality may involve increased costs of collection s o that on e ma y have t o as k how much i s a little mor e equity worth. Uncertaint y i n tax la w provides employmen t fo r a vas t arm y of accountants an d ta x expert s pai d b y th e bi g taxpayers, particularl y th e corporations. This expense i s a hidden cost of tax collection borne b y the taxpayer: but it also imposes on the government the cost of a public army of experts to assess th e validity of the estimates and arguments of the private armies of experts. The cost of litigation must also be included; and if one is less sympathetic than Adam Smith to 'those who attempt unsuccessfully to evade the tax,' one may surely insist that the cost of litigation to the private parties resulting, not from an attempt to evade, but from the uncertainty of the law , shoul d b e include d i n estimating th e cos t o f collection an d th e burden of taxation.

Digression i Consumer sovereignty

When Adam Smith explained how supply suits itself to effectual demand he was expounding a doctrine o f equilibrium, but he was also expounding an essential ingredien t i n the case for laissez faire. The price system, give n a high degre e o f competition, woul d produc e a n allocatio n o f resources i n accordance wit h the desires and preferences of the consumers, that is of the people. This to Adam Smith appeared acceptabl e becaus e he believed tha t the individual citizen was better able to judge what would contribute to his happiness or welfare than any government. I do not think he would argu e that the resulting allocation wa s the best possible - h e was no doctrinaire. He argued , rather , tha t th e resul t wa s probabl y bette r tha n coul d b e expected from government interference. It was later writers of the marginal utility school wh o pushed the argument further an d maintained that a free market maximize d utilit y s o that th e resul t wa s not just probabl y bette r than woul d be achieved b y intervention , but was the best possible . Thi s difference betwee n the classical and neoclassical economis t i s an example of the danger of reducing a common sense, rough , proposition t o rigorous theory. Wha t F.H. Knigh t said o f Menger and Walra s ma y be sai d with equal force with reference to Adam Smith, who had not heard of marginal utility, and to the neoclassics generally . 'In the more rigorous versions of the theor y ther e i s a n elemen t o f parado x an d unrealis m .. . Th e entir e theory is much more convincing in the loose, common sense formulation of Menger, than in the refined mathematica l version of Jevons and Walras.'1 The common sense of the case for allocation of resources i n response t o consumer demand may be illustrated by a simple parable. Suppose , i n an

Consumer sovereignty 105 Adam Smith type of market, all prices to be at their 'natural' level. Suppose then tha t ther e occurs a sudde n chang e i n consumption habits , suc h a s would result from a widespread adoption of vegetarianism. A large group of people try to buy more vegetables, and are less inclined to buy meat. In the short-run the rates of supply of vegetables and meat are fixed, and the rates of consumption must be adjusted to the given rates of supply. The price of vegetables rise s sharply , that of meat falls sharply . The mor e convinced vegetarians secur e thei r vegetable s a t a price , th e les s convince d veg etarians are deterred fro m thei r new dietary practice b y the high price of vegetables, an d the temptatio n to eat mea t i s made more sever e a s meat becomes temptingl y cheap. Those who do not adopt the change in dietary habit, ar e affected by the change i n relative prices : they buy less vegeta bles, releasing supplies for the ardent vegetarians, and they buy more meat, consuming the supplies released b y the vegetarians. In time the high price of vegetables wil l induce an increase i n vegetable production, and the low price o f mea t wil l induc e a reductio n i n mea t production , til l price s o f vegetables fal l an d prices o f meat rise so as to restore bot h prices to their natural level. Now suppos e tha t th e econom y wa s a 'planned ' on e rathe r tha n a 'market' one. Sensibl e adjustment to such a change in consumption habits would involve , if the plannin g authority tried t o mee t th e wishe s of th e people, a change of plan, a change immediately in the rationing of current supplies and a change in the production plan for the future. Th e change s which would thus be made by authority in a planned economy of this type would in our individualistic model be made without consultation, automatically, through price changes. But the changes would be substantially the same. However, the authority in the planned world might disapprove of the vegetarian craz e an d refus e t o promote the adjustment ; it might itself be composed of fanatical converts and make it difficult fo r those who did not conform t o the ne w practice; or, i t might be little concerned t o meet th e wishes o f the peopl e an d unwillin g to mak e any adjustment . I thin k i t is more useful t o demonstrate thi s similarity between the automatic change s through the operation of the market with those which would be made by a planning authority which tried to give the people what they wanted, than to show tha t th e equilibriu m pattern o f production and consumptio n in th e market economy would be similar to that which such a 'democratic' plan would b e tryin g to establish . Bu t on e ma y sa y tha t an y increas e i n th e production of a particular commodity, when the system was in equilibrium and the conditions of demand unchanged, could only be sold by tempting people to increase their consumption of it by lower prices. The resource s

io6 Fro m Adam Smith to Maynard Keynes used t o increase th e productio n o f this commodit y woul d ear n les s tha n they could in other industries; they would be employed making less wanted commodities and would revert a s soon a s they could to making the more wanted commodities and so earn once again their 'natural' rates of pay. There ar e thos e wh o sa y tha t th e consume r doe s no t kno w wha t h e wants, does not want what he needs, and often does not get what he thinks he i s getting . True , som e consumer s wil l mak e mistakes , bu t s o ma y planning authorities, for such authorities are not necessarily intelligent; nor are they necessarily benevolent. But remember the limited character o f the proposition: the result of free consumer choice is likely to be better than the alternative authoritarian guidance, it may not be the ultimate best. Freedom o f choice is , o r ha s becom e throug h use, desirabl e i n itself: freedom to make mistakes and possibly t o learn from experience seems to many preferabl e t o a n extremel y ordere d life , howeve r wel l ordered . Freedom o f choic e become s fo r th e liberal , on e migh t sa y fo r th e trul y adult, not merel y a means to maximu m satisfaction (o r some reasonabl e approximation thereto) but a desirable end in itself. F. H. Knight had this to say: the classical economists' argument for liberty made it instrumental... on the ground that th e individua l i s a better judge tha n governmen t official s o f the mean s t o hi s happiness. It is not denying weight to this argument to point out that liberty itself is unquestionably a good t o th e individua l ... A n individua l may desir e libert y an d claim a right to i t without contending tha t h e wil l uniformly mak e decisions mor e wisely than they would be made for him ... and just as certainly it can be maintained that th e individua l should [m y italics] make hi s own decision s an d abid e b y thei r consequences.

Perhaps thi s could be summed up by saying that mos t consumers d o not like being pushed around, should not like being pushed around, and do not need to be pushed around if the market works reasonably well. If we are talking about a reasonably goo d solutio n rather tha n the bes t solution one naturally begins to ask whether it cannot be made still better. Adam Smith recognized that the market did not work perfectly. There was a high degree of competition, but elimination of the privileges of corpora tions, reductio n o f monopol y elements , woul d improv e it s operation . There was a fair degre e o f mobility, but eliminatio n of the unnecessaril y long apprenticeship s an d th e hars h regulation s o f th e Settlemen t Law s would improve its operation. Finally he recognized that some public goods must be provided free to the users, financed by taxation, and in addition to

Consumer sovereignty 10 7 those that must be so provided there were others that should perhaps be so provided. Muc h attentio n ha s been give n in the two hundred year s sinc e Adam Smith to ways of making the market operate more effectively, and of determining whethe r i t still operates with a sufficient degre e o f effectiveness to giv e a reasonably goo d an d acceptable result . Muc h of what ha s been done come s unde r th e three categories noted b y Adam Smith : con cern for the degree of competition, the degree of mobility, and the extent of the field of public provision. I would add only one other area of concern; the improvement i n the disseminatio n o f accurate information. Reduction of uncertainty ca n mak e a n important contributio n t o th e greater effective ness of the market. But we are no t concerned here wit h the effectivenes s of the marke t in 'suiting' suppl y t o th e effectua l demand,' bu t t o th e desirabilit y o f it s o suiting itself. We must ask whether the general case for the sovereignty of the individual consumer in the market is subject to qualification. I say of the individual consumer because we shall find that the satisfaction of the wants of consumers a s a group may not be consistent wit h the pursuit of satisfaction of his particular want s by each o f the individuals in that group. I shall explore a few of the issues thus raised, but I shall not attempt to review and evaluate the vast modern literature of welfare economics; I cannot refrain , however, fro m on e comment. Thi s literature criticize s th e validity of the proof that the competitive solution in the market is 'optimal' but gives little help in determining the optimu m and indeed generall y rules out a unique solution. Bu t th e classica l cas e wa s no t based , a s I hav e said , o n th e achievement of an optimum, but of a generally satisfactory solution. Interference with the market should not await elaboration of the conditions for a perfect solution , but should be undertaken whenever there is a high probability of a significan t improvement . Such interventio n would generally be appropriate whe n significant unpaid social costs should be imposed on the producer, o r wher e unrecoupe d benefit s wer e o f suc h magnitud e an d importance that subsidy or public provision would be justified. Bu t always one should be concerned abou t too much interference for too small, and too uncertain, objectives bearing in mind the costs of information necessary t o back u p such interference, the costs of administration, the hig h degree of uncertainty, and the los s of individual freedom on which last a high value should be placed . By wa y o f illustration of the unrecoupe d benefit s (th e 'neighbourhood effects,' o r 'externalities') I offer one example of a rather personal nature. I recently presented a brief to the Ontario Royal Commission on the Publishing Industry in which I asked for provincial support for 'scholarly publica-

io8 Fro m Adam Smith to Maynard Keynes tion.' In presenting this plea I felt i t necessary, for my own conscience, and because I was arguing before Commissioners who were likely to start with a predispositio n towards fre e enterprise , t o explai n th e notio n o f 'unre couped' benefits and to identify thes e benefits in the particular case. I said in part: Economists hav e lon g recognize d tha t ther e ar e som e industrie s wher e privat e production o f a commodit y yields social benefit s surpassing th e purel y persona l satisfactions o f the consume r wh o buy s it . W e refer t o thes e a s neighbourhoo d effects. I suggest that there are such neighbourhood effects in scholarly publication, i) Without scholarship higher education becomes sterile . S o one of the neighbour hood effect s is on the quality of the university education i n the province. 2 ) Works of scholarship become th e basi s of textbooks a t lower level s of education. Ther e can only be a sound Canadian content i n these texts if there is a flow of knowledge about Canada ; an d a flow of Canadian research on world topics contributes to the interpretation of the world outside through Canadian eyes and relevant to Canadian problems. Al l of this gives Canadia n colou r an d enhance d qualit y t o ou r schoo l texts. Add to this the higher quality of the teachers, fro m th e higher quality of the Universities from whic h they graduate, and you have a substantial neighbourhoo d effect o n the quality of primary and secondary education. 3) It is not only textbooks that build on this scholarly foundation. Ask Pierre Berton , for example, how much he depends on the publishe d research o f scholars i n writing his literary books. 4 ) Finally, I have argue d i n a pamphle t on th e Financing o f th e Performing Arts i n Canada that a nation requires heroes and particularly international heroes, i f it is to develop unity, self-confidence an d a sense of identity. We get benefits which cannot be measured and certainly cannot be recovered b y the publisher when a Canadian scholar's boo k achieves international fame. The gold medal for the most beautiful book publishe d in the worl d in 197 0 awarded to the Economic Atlas of Ontario i s important in developing the self-confidence not just of this scholarly community but of the people of this province as a whole. This Atlas could not have been published without a very large subsidy from th e Province. 2 I ende d b y suggestin g that a modes t fun d fo r th e suppor t o f scholarl y publication b e se t up , no t pretendin g t o measur e th e neighbourhoo d benefits nor estimate the optimum contribution, but asking for an amount which my experience in the field indicated was needed if scholarship wa s not to languish. All neighbourhood effects ar e not, of course, beneficial, some are harmful. Conside r th e consumer s of automotiv e transportation. The y ar e re sponsible for noxious noise, their exhaust pollutes the air, and their number

Consumer sovereignty 10 9 creates congestion . T o reduce noise and air pollution in the interest of the people generall y the manufacturer may be required to modify hi s vehicle. This increases th e cost and the price, thereby imposing on the consumer of that form of transportation the cost of reducing the adverse neighbourhood effects. This seems reasonable as long as one does not push it too far. Some noise and pollution is tolerable; one should therefore think not in terms of absolutes an d total elimination, but should balanc e th e marginal improvement i n th e environmen t agains t th e margina l increas e i n cost . A s t o congestion one needs to devise a tax roughly proportional: to road usage so as to reduce usage, reduce congestion, and ration the scarce road facility by price to those who want (or need) the facility most. The gasoline tax comes near to the requirement, though consumption varies with the size and type of engin e a s wel l as wit h mileage. One las t commen t on neighbourhood effects, whethe r positive or negative; some are monetary and measurable, others ar e huma n and immeasurable . There i s a temptation t o trea t th e measurable a s the important: thi s temptation mus t be resisted. One must not hesitate to estimate the importance of the immeasurable items. The concep t o f neighbourhood effect s o r externalitie s i s relevant no t only to the behaviour of the consumer but als o to that of the producer. I shall treat th e proble m of the producer ver y briefly, sinc e m y concern in this digression is with the propriety of free consume r choice, rathe r than with the over-all effectiveness of the free market. The most obvious, and in the present decade th e most discussed, example of unpaid cost i s the fre e disposal of wastes into the air, the water and to some extent on the land. The cost lies in the public expenditure to reduce the waste products to less noxious form; in the destruction of private wealth or reduction of private incomes through the adverse effec t o f such pollution on the productivity of those employed in other occupations; in the effect o n the quality of life for the inhabitants whether it be a reduction of the amenities or an increase in health hazards ; i n the increase d publi c healt h expenditur e necessar y t o counter in part the increased hazard s to health. This concern wit h unpaid costs is not new; A.C. Pigou said most of what was necessary half a century ago in his Economics o f Welfare (1912) . It ha s become a matter of almost fanatical concer n a s th e amoun t of waste produc t fro m ou r enormousl y productive modern industrial centres becomes too great for the capacity of the water and air into which producers hav e been almost free to dispose of waste. Our affluence create s the problem, and our affluence should make it possible t o conquer it . We can reduce the noxious character o f the waste s at a cost. We must then impose on the producers the requirement that they incur th e cost s o f reducing , o r eliminatin g pollution ; an d w e mus t b e

i io Fro m Adam Smith to Maynard Keynes prepared t o se e the cost and prices o f many commodities increased . W e must diver t som e o f the productive powe r no w used t o making goods t o reducing pollution. The resul t wil l be les s produc t now ; but i t may well mean an improvement in the amenities of life now, and may possibly avoid a reduction of productivity in the long run. The danger is in fanaticism. The new bree d o f ecologists an d their admirin g followers ar e to o incline d t o think i n absolute terms ; th e economis t ca n mak e his contribution, a s s o often, through application of the marginal approach. The problem must be dealt wit h in terms of how muc h less pollutio n ca n b e achieve d b y eac h additional extr a expenditur e o n pollutio n control , whethe r i t b e publi c expenditure or private expenditure required by the establishment o f standards. Particularly hopefu l is the growin g interest i n a proposal of Professo r John Dales, that a price be set on the right to pollute.3 If you want land on which to pile up your refuse fro m th e blast furnace, yo u have to buy it, or rent it. Land is scarce an d is privately owned. But you were, at one time, almost completely free t o dispose o f waste in the air or the rivers. Air and water had not yet become scarce, and were generally not privately owned. Now they are scarce and the right to use them should be priced, the public being recognize d a s th e owner s entitle d t o th e ren t fo r thei r use . Bein g scarce thei r use for waste disposal should be rationed. This could be done by administrative regulation; but there is a strong case for using the pric e system. Determine the level of pollution that is tolerable (or if you like the amount of waste disposal that does no t constitute pollution) . Then sell at public auction rights to dispose of given quantities of waste in the air or the water. The right to a unit of pollution would have to be defined as so much of this less noxiou s pollutant or s o muc h less o f that mor e noxiou s one . Rationing by price would mean that continued use of such a form of waste disposal i n any plant would be based o n an assessment o f the cos t o f the alternative of eliminating or reducing the amount of noxious waste to be disposed o f and s o eliminatin g the necessit y o f buying any, o r a s many, rights to pollute. If at any time it was felt that the level of pollution was still too high , fewer rights woul d be offere d an d their pric e woul d rise: additional plants would be induced to reduce their noxious wastes. As with the consumer not al l neighbourhood effect s ar e good, s o with the producer they are not all bad. The classical example is the effect on the productivity of the bee keeper when his neighbour increases hi s acreage of clover. If there is no way of charging the beneficiary, and if the magnitude of the benefi t i s substantial, the tw o forms o f production ma y have to be integrated under one ownership; the farmer must become apiarist. Alterna-

Consumer sovereignty 11 1 lively one ma y consider the feasibility o f subsidizing th e benefacto r an d taxing the beneficiary. This sounds simple until one considers the difficult y of assessing the benefit. A larg e par t o f moder n welfar e economic s i s 'static ' i n character , reflecting th e stati c equilibriu m analysi s o f which i t i s a derivative . Th e conditions o f demand, the nature of peoples' wants, are taken for granted. Now w e mus t look , briefly , a t som e dynami c aspects , no t just a t th e adjustment t o changing wants as in the early part of this digression but at the proces s o f chang e i n thos e wants . W e must , further , conside r th e quality of wants, howeve r unscientific that may be, however persona l the value judgments mad e ma y be. Th e welfar e whic h i s the ultimate goal of our immediate pursuit of wealth must be greater the more intelligent are our wants. 'Livin g intelligently, ' sai d F.H . Knight , 'include s mor e tha n th e intelligent use of means in realizing ends: it is fully as important to select the ends intelligently.' In similar vein Cliffe Leslie emphasized the great importance of studying the kinds of wealth people want. 'New desires for health, decency, knowledge, refinement, and intellectual pleasures, have, in fact, revolutionised production. The antithesis to modern wealth is not so much poverty as a different kind of wealth. The change is more remarkable in the quality than in the quantity.'4 Ruskin, by contrast, thought his generation was producing as much 'illth' as wealth. What of the future? Can we hope for improvement in wants as well as improvement in productivity? Can we, indeed shoul d we, consider means to improve them? Can we be certain of the hig h qualit y o f ou r ow n judgments? Perhap s th e answe r i s tha t w e should see k t o persuad e an d rel y o n the competitio n o f persuaders with different idea s and different values . An exchange of views between Professors Scitovsk y and Baumol illustrates the difficulty. Sai d Scitovsky: Even th e mos t arden t believer s in consumer sovereignty must realise tha t mos t tastes are acquired, that bad tastes are as easy to acquire as good ones, and that the best one can hope for is that by example and imitation the good will prevail over the bad if given an even chance ... [There is a] tendency of producers in an increasing number of fields to pla y saf e an d no t t o ris k imaginativ e innovations i n products, services an d publication s the y pu t o n th e market , but t o rel y instea d on market research int o th e consumer' s unfille d desires . A t it s best , thi s ca n slo w down genuine innovation and progress in the design of products; at its worst, it can lead to a seriou s misreading of the publi c taste and th e impositio n o f a mythical majorit y taste that in fact fe w people share. The automobil e industry, with it s hand on th e consumer's pulse, has for many years diagnosed a chronic yearning for longer and

H2 Fro m Adam Smith to Maynard Keynes wider and more powerful cars; and had it not been for foreign competition we-and they-might never have found out how wrong they were. Similarly, Hollywood used to proclaim twelve as the median age of the movie audiences; and if it had not been for th e succes s o f foreig n film s w e woul d stil l liv e unde r th e shado w o f thi s displeasing thought.5

On this , an d mor e o f th e same , Professo r Baumo l commented: I mus t sharply disagree ... it offers unrestricted licence to the blue noses and those who would impose on myself and others their own standards of good tast e ... it is essential... that the pattern of public intervention be designed very explicitly in terms of the desires of the public ... [We should aim to] permit consumer's sovereignty to operate undistorted, not to distort it.' 6 The real 'blue noses ' propos e t o subsidiz e th e productio n o f goods an d service s wanted at present by too few people t o permit their profitabl e productio n by unaide d free enterprise, no t simpl y from th e selfis h motive o f having others pa y par t o f the cos t o f their pleasures , bu t fro m a belief tha t al l people should have a chance to sample their wares. Even if individual choice is 'best,' it must be choice between known and available alternatives. Let me offer a simple personal example . Recentl y I was invite d ou t t o dinne r an d give n a choic e betwee n a Chines e an d a Western restaurant . I wa s persuade d t o g o to th e Chines e restaurant , although I would not have chosen to do so because I was not familiar with such food. But when persuaded I enjoyed it very much. My range of choice has bee n extended . Music , drama, ballet, ar e the y no t a s unfamilia r to many as Chinese food was to me? But, while a small clientele can provide a specialized restaurant , s o that i t was knowledg e rather tha n availability that limited my choice, a symphony orchestra, a ballet company, an opera, involve great expense and cannot be made available for a few at prices that even th e ric h fe w could afford . I f the y ar e t o b e availabl e the y mus t be subsidized. If , whe n available, i n high quality they ar e no t wanted , no t attended, I hav e n o more to sa y except tha t perhaps eac h generatio n is entitled t o hav e the rang e of choice kep t ope n fo r it . So , i n spite o f my fundamental bia s i n favou r o f fre e consume r choice , I hav e advocate d larger grants to the performing arts t o permit the development o f artisti c excellence an d t o mak e availabl e t o th e publi c a t lo w prices excellen t performances o f both classica l an d moder n works ; alway s rememberin g that the government giving the grants is subject to re-election at the polls.7 This discussion o f welfare economics i s concluded wit h a reference t o Kenneth Boulding' s chapte r o n 'Economic s a s a Mora l Science ' i n Economics a s a Science. H e distinguishe d ther e th e heroi c an d th e

Consumer sovereignty 11 3 economic ethics . H e quote d Wordsworth' s sonne t o n King' s Colleg e Chapel: 'hig h Heave n reject s th e lore of nicely calculate d les s or more.' This sonne t Bouldin g call s th e 'fines t expressio n i n Englis h poetr y o f the heroi c critiqu e o f economics.' I canno t d o justice here t o hi s wis e philosophical treatmen t of this problem; but I cannot refrain from quoting his summing up. My persona l vie w is that , especiall y a t hi s presen t stag e o f development , man requires bot h heroi c an d economi c element s i n hi s institution s in hi s learning processes, an d i n hi s decisio n making , an d th e proble m of maintainin g the m i n proper balance and tension is one of the major problems of maturation, both of the individual person and of societies. Economic man is a clod, heroic man is a fool, but somewhere between the clod and the fool, huma n man, if the expression may be pardoned, steers his tottering way.8

For th e individual to choose the heroi c rathe r tha n th e economic i s one thing; for the government to make such a decision is quite another, for it is other peoples' money that is to be spent heroically. One may hope that the people wil l endorse heroic decisions, one can try to persuade them of the wisdom of the heroic decision, bu t one must recognize tha t ultimately the 'heroism' is theirs. However much the economist may want to persuade the publi c t o adop t th e heroi c decision , h e mus t stil l recogniz e tha t hi s expertise consist s i n assessin g th e economi c cos t o f th e heroi c act . I n honesty he must disclose the cost while still persuading.

Digression 2 The pursuit of wealth

Adam Smit h was concerned wit h the wealt h o f nations an d its increase , with the conditions under which 'the nation will be better or worse supplied with all the necessaries and conveniences fo r which it has occasion' (Ivii). Edwin Cannan, Adam Smith's great modern editor, opened his elementary text, Wealth, wit h thes e words : Th e reall y fundamenta l question s o f economics are why all of us, taken together, ar e as well off - or as ill off, if that way of putting it be preferred - as we are, and why some of us are much better off , an d others muc h worse off than the average.' 1 In spit e o f the literary success of Kenneth Galbraith's book, The Affluent Society (1958), and the brilliant persuasiveness o f Professor Mishan, 21 make no apology for m y continued concern fo r the wealth of nations and for my belief tha t modern economists mus t continue to share the concern of Adam Smith. In spite of the extraordinary plenty of our time in one part of the world, we are still subject to the 'economic s of scarcity' for we have not the capacity t o produce all that we want. We may be foolish to want so much and to want the things we do. We may hope that Galbraith and other modern preachers may conver t thei r fellow citizen s t o a new asceticism an d a new scale of preferences. But as an economist I conceive it to be my job to consider how best to provide for the actual and growing wants of my fellow men. As one member of society, like Galbraith I hope to see more resources poured into education, into the development of the arts, into the beautification of cities, and the preservation of the natural beauty of the country, and all this along with even shorter working hours of labour, less wear and tear on the human

The pursui t of wealth 11 5 tissue, an d les s menta l stres s fo r ou r fello w men . A s evidenc e o f my honesty in saying this I cite th e plea for support fo r scholarly publication included in Digression One, the Report o n the Financing of Higher Education in Canada* b y a commission o f which I was chairman, and a recen t report prepare d a t the request o f the Canada Council on the Financing o f the Performing Arts in Canada: An Essay in Persuasion.4 As an economist I see more hope of an increase in the resources devote d to such noble ends through increasing productivity than through developing asceticism . O f the tw o way s t o th e satisfactio n o f wants, increasin g production or decreasing wants, the former seem s to be the more feasible. No amount of jeering abou t th e 'conventional wisdom' leads m e to doubt this. If expenditure on public goods is to increase, an d particularly on the nobler public goods, then expenditure on private goods must be decreased: if wealth per capita is not growing this means that individuals must agree to reduce their personal individual consumption in order to pay the increased taxes necessar y to pay for the increased provisio n o f public goods . Thi s may requir e greate r power s o f persuasion tha n w e have , an d invit e authoritarian direction: th e price o f the pursuit of these noble aims could be the sacrifice of a measure of individual liberty, and there would probably be increasing marginal sacrifice as the program was extended. But if production pe r capita is increasing, the n increased publi c expenditure is consistent wit h maintained personal expenditure : surel y it is easier to persuade citizen s t o refrain from increasing , o r increasing a s much as they might , thei r persona l consumptio n i n orde r t o permi t th e publi c programs which many of us value highly, than to persuade them to reduce their personal expenditures an d to revise downwar d pattern s o f expenditure that have become customary. Professor Morro w i n a sesquicentennia l lectur e o n th e Wealth o f Nations5 sai d of Adam Smith that he 'was too canny to despise wealth; too wise no t t o recogniz e tha t th e ne w er a o f materia l enterpris e ha d pos sibilities for the advancement an d perfecting of the human species which no other perio d eve r possessed. ' Th e amoun t o f povert y i n th e 'affluen t society' is still so great, an d its effect o n the huma n spirit so depressing , that thi s attitude i s not obsolete . J.M . Keyne s onc e sai d th e economist s were trustees , no t fo r civilization , bu t fo r th e possibilit y o f it. 6 I t i s for others to direct the trustees i n the use of their trust fund; but it is important that the fund b e big enough and growing fast enough to meet the needs of civilization. Surely Adam Smith would have included beauty and the art s under hi s categor y o f 'conveniences. ' W e are bac k wit h the proble m of

116 Fro m Adam Smith to Maynard Keynes consumer sovereignt y bu t wit h a new slan t a s a complacent vie w o f th e adequacy o f our productivity i s added t o a criticism of our scale of preferences. Professor Haberle r was unready to accept the theory of the affluence: he could no t tak e th e los s implie d b y unemploymen t o f four t o five million people lightly, as did Galbraith. H e said : My trouble with this theory is that it is either the expression of a somewhat idealistic personal value judgment (which as far as I can see is hardly share d b y any socia l group except perhaps by a few theologians or moral philosophers) or if it purports to say something about the behaviour and valuations of individuals, it flies in the face of the patent fact that there is not a single class i n American society tha t does no t think i t is grossly underpaid, or at any rate does no t strive strenuously to raise its income.7

Galbraith's personal valu e judgment i s one with which I a m highly sympathetic; but as a liberal democrati c economis t I must be concerned with wants as they are, not as I would have them. And as an honest ma n I must add that my sympathy for the ideal goes along with a quite human realisti c concern to raise my income. My concern fo r the increase o f wealth i s based o n a more fundamental reason tha n th e nee d fo r suc h increas e t o permi t th e developmen t o f a civilized environment. Essentially, it is based on my concern to see poverty reduced, an d ultimatel y eliminated . Again , I se e thi s a s likel y t o b e achieved mor e full y an d mor e quickl y b y increasin g th e produc t t o b e divided than by seeking to change the division of the existing product. I am concerned, too , wit h th e conques t o f poverty, no t onl y i n our so-calle d affluent society , but in the rest of the world. I see more hope for this in the international sprea d o f the technolog y an d managemen t skill s whic h w e develop here for the increase o f our national wealth than in a change in the international distribution of the existing income an d wealth. I hav e mor e confidence in the influence on the developing countrie s o f a strong marke t for their products in the affluen t nation s than in any long-run international altruism. As for the short-run altruism, I see more hope of persuading the citizens of the affluent nation s to increase their aid to the Third World, if the increased contributio n come s fro m increasin g productivit y an d doe s no t require any great reductio n o f the personal expenditure s o f the citizens o r the publi c expenditure o n these thing s which ar e intende d fo r the enjoy ment an d satisfactio n o f thes e sam e citizens , o r o n thos e thing s whic h contribute t o their health and education. Again, it is a matter of persuasio n

The pursui t of wealth 11 7 in relation to international transfers of wealth (those within the same nation are difficult enough ) let me quote from Adam Smith's Moral Sentiments: The most frivolous disaster which could befall himself would occasion a more real disturbance. I f h e wa s t o los e hi s littl e finge r to-morrow , h e woul d no t slee p to-night; but provide d he neve r saw the m h e wil l snor e with th e mos t profoun d security over the ruin of a hundred millions of his brethren, and the destruction of that immense multitude seems plainly a n object less interesting to him, than this paultry misfortune of his own.8

Even immediate viewing of the disaster on television via satellite leaves us still callous. Some year s ag o I suggeste d tha t th e economist , whil e studyin g the behaviour o f individuals in the pursuit of wealth might have considerabl e sympathy with the view expressed by Colonel de Stancy in Hardy's Laodicean tha t 'th e world has not yet learne d the riche s of frugality,' or tha t expressed by Prosper Profond in the Forsyte Saga that 'life's awfully like a lot of monkeys scrambling for empty nuts.'9 As I read now what I said then, I feel that I must remember, and remind my readers, tha t these words are put into the mouths of reasonably affluen t authors . Le t us not mix poverty and frugality. Le t us remember that increased productivity does not necessarily reduce poverty , bu t that the elimination of poverty requires a great increase i n productivity. Concern wit h productivity must not diver t ou r attention from th e need for redistribution; but concern wit h redistribution must no t diver t our attentio n fro m th e nee d fo r increasin g productivity. Where ther e i s a conflict, where ou r redistributiv e measure s ma y affec t adversely productivity, economists must estimate the quantities involved so that decisio n ca n b e mad e o n grounds o f reason rathe r tha n emotio n alone. Gross National Product Concern wit h the pursuit of social wealth suggest s a n obsession with the increase i n Gross Nationa l Product a s currently measured in most countries o f the world. I do not propose to develop a detailed criticis m o f the statistical concep t o r o f th e metho d o f estimation ; but I d o propos e t o suggest some warnings. In the first place, as long as population is increasing we need t o pa y attention t o per captita productio n rathe r than aggregat e production. Concer n tha t th e Gross Nationa l Product shoul d increas e a t least in the same proportion as population increases is basic, whatever the qualifications.

118 Fro m Adam Smith to Maynard Keynes The firs t qualificatio n relates t o leisure . Increasin g productivit y pe r man-hour may lead to the choice of more leisure rather than more goods. In international comparisons, o r i n contemplating the rat e o f growth of our own Gross National Product, w e should remember that the value of leisure has been ignored (necessarily) i n estimating the product. W e should concern ourselves with productivity per man-hour. The shorter work week, the reduction in the number of work weeks in the year as holidays proliferate , the shorte r wor k lif e a s entr y to th e labou r marke t is delayed b y longe r schooling and exit is accelerated by early retirement, al l these have led to the condition where the abundance of things the citizen has is only a little less strikin g than the abundanc e of time at his disposal. Tha t thi s preference for leisure is not quite general, and is to some extent impose d b y the majority through collective bargaining and social pressure, is evidenced by the prevalence of 'moonlighting' and the development o f new careers for the retired. But there remains on this continent 'abundance of time.' Just as abundance of goods has a very different significanc e for welfare according to the components of that abundance, the quality of the goods, so abundance of time may have very different significanc e according t o th e wisdom with which it is used. D r Heckscher discusse d thi s problem very effectively: Leisure time has before this belonged to a small group in society; it has been won at the cos t o f slaver y or, a t best , o f toil an d drudger y b y th e grea t mass. But no w leisure is promised for all. Free time is not in itself leisure ... to describe mere idleness and self indulgence as leisure is to use th e wor d in a questionable sense. Th e classes , whic h in great historical periods maintained learning and manners, which pushed back the fron tiers o f the physica l an d intellectua l world , have made leisure synonymous with freedom an d freedom synonymous with self-discipline and disinterested effort. 10

The proble m is to ensure that the free tim e that we are promised may be transformed int o leisure. Thi s raises man y new problems; not only prob lems of education for leisure but problems of organization of free time. The distribution o f fre e tim e ove r th e lif e spa n raise s question s abou t ou r current retiremen t practices. D r Heckscher aske d whethe r a 'thre e day dosage a t th e week' s en d wil l eventuall y prov e a s usefu l fo r leisur e a s continuance o f the presen t week-en d wit h a free da y adde d somewher e toward the middle of the week.' I once speculated, in a short paper read to the Industrial Relations Research Association, 11 on some of the problems involved if we all want to enjoy our leisure at the same time as others.

The pursuit of wealth 11 9 Real cost Let me next consider the possibility of increasing the net human advantage from production by reducing human cost. Such inquiry is very much in the tradition of the classical economics, from the 'real price' of Adam Smith to the 'rea l cost' o f Alfred Marshall . Neo-classical economic s turne d awa y from thes e consideration s o f huma n cos t a s i t becam e obsesse d wit h problems o f equilibriu m an d allocatio n o f resources. Th e grea t heretic , J.A. Hobson , develope d th e them e o f huma n cost , bu t h e mad e littl e impression and few read hi m these days. 12 Bu t as we become mor e con cerned wit h wealt h tha n wit h equilibrium , with growth tha n wit h stati c models, we should return to a consideration of human cost. Of course, we will b e dealin g wit h quantitie s tha t w e canno t measure , wit h problem s where subjectiv e judgment cannot b e submitte d to objective testing . Yet surely there can be agreement on some general propositions. Whereas John Stuart Mil l in 184 8 doubted whethe r machine s had lightene d the wor k of any human being, it is clear that modern machine industry has reduced and will still further reduce the strain on human muscle. The problem now, and for the next generation, is to reduce the psychological strain. Here a n economis t i s quit e ou t o f hi s depth : bu t i t appear s tha t th e researches o f Elton Mayo and many others have demonstrated that slight changes in the social organization of the factory, or of the office, can lead to great increases i n productivity and decreases in fatigue and mental stress. Mayo's experiment in a Philadelphia textile mill is the classic case.13 Later studies have indicated that one of the serious costs of technological change is that social relationships are destroyed and personal stress results. When more is understood about human behaviour in such situations, this cost can be reduced, opposition to chang e ca n be reduced, an d we can enjo y th e increase in production (or the increase in leisure) that such change makes possible. There are dangers: charlatans are rife, and malignant use can be made of such knowledge to manipulate men as in the Orwellian vision. But to my mind research in this field, and joint study by scholars, business men, and trade unio n leaders, ar e urgently needed. I believ e that not only the success of our economy but the future of liberal society depends largely on our ability to find ways of making efficient productio n consistent with the 'good life. ' I n suppor t o f this point of view let m e quote fro m Professo r Phelps Brown's inaugural lecture at the London School of Economics. There i s reason to believ e tha t ou r nationa l produc t can to-da y be substantiall y increased, without installing any more equipment, if men who are now working only reluctantly an d listlessly , wh o 'couldn' t car e less,' woul d come to wor k willingl y

120 Fro m Adam Smith to Maynard Keynes and with interest. The possibility of such an increase is not a matter of conjecture, but i s established b y known differences betwee n the results obtaine d b y differen t firms in th e sam e trade, or by the sam e group of workers at differen t times . Th e increase does not come from speedin g up, nor even from the workers being willing to put more effort int o the job. It comes about without increased exertion through the liberation of human energies that occurs when inner conflicts are resolved and social frustration s ar e removed . When interest succeed s boredom , an d prid e in achievement takes the place of indifference, when we work with a common purpose instead of at cross purposes, then we get more done in a day without being any more tired at the end of it.14

The productivity thus released ma y of course be used to increase leisure if that be preferred to increased production of goods. Net product This discussio n o f real huma n cost suggest s tha t on e shoul d attemp t t o develop som e indicatio n o f ne t rathe r tha n gros s product . Ther e is , o f course, a figure for the Net National Product regularly published: but this is simply th e Gros s Nationa l Produc t les s depreciatio n o f material capital . Even if one cannot measure it, should one not be sensitive to the possibility that an increase in output may be accompanied by such an increase in real human cost that there is no net advantage, bu t possibly eve n a net loss of advantage. Shoul d on e no t sacrific e some produc t i f there i s reasonabl e expectation tha t th e huma n costs would be s o reduced a s t o mor e tha n compensate for the material loss? If thi s concer n wit h huma n cos t i s dismisse d a s unmeasurabl e an d unrealistic, there ar e other reason s fo r suggesting that the concept o f net product need s extension . I hav e referre d i n Digressio n On e t o 'unpai d costs,' but w e now revert t o that problem by use of the phrase 'negativ e by-products.' Dr Tom luster in the Fiftieth Annual Report of the National Bureau of Economic Research, in the course of an admirable discussion of the 'Measurement of Economic and Social Performance,' put the problem this way: 'No accounting is made for the decline in utility resulting from the unwanted side effects of economic activity - rivers that cannot be used for recreation, paths that are cluttered with disposable bottles, etc.'15 What is perhaps wors e i s tha t th e cos t o f clearin g u p th e negativ e by-product s appears as an item in the Gross Product. If a new industrial developmen t adds one hundred million dollars to the value of the production of wanted goods, but also creates negative by-products which it costs the community twenty-five millio n dollars t o render innocuous , then th e Gross Nationa l

The pursuit of wealth 12 1 Product wil l appear t o have grown by one hundred and twenty-five mill ions. The net product, in a really significan t sens e wil l have increased b y only seventy-five million dollars. This discussion of net product leads me to add a word about the classical concept of'net revenue.' This concept is so named in Ricardo's Principles, Chapter xx vi. If five millions of men could produce as much food and clothing as was necessary for ten millions, food and clothing for five millions would be the net revenue. Would it be of any advantage to the country, that to produce thi s same net revenue, seve n millions o f me n shoul d b e require d t o produc e foo d an d clothin g sufficien t fo r twelve millions ? Th e foo d an d clothin g o f fiv e million s woul d b e stil l th e ne t revenue.

This concern for 'surplus' over and above the necessary subsistenc e of the workers was a very old one. E.S. Furnis s quoted, in his The Position of the Labourer in a System o f Nationalism (1920) , a number of mercantilist writers o n thi s subject . Fo r example , Joh n Seller s (1714) : 'I f th e poo r laborers di d no t rais e muc h more foo d an d manufactur e than wha t did subsist themselves every gentleman must be a laborer an d every idle man must starve.' Adam Smit h assume d tha t wage s woul d b e somewher e clos e t o th e subsistence level , an d tha t th e surplu s abov e th e amoun t necessary fo r subsistence woul d b e enjoye d b y th e landlord s an d capitalists . I n th e chapter o n ren t h e discusse d th e effec t o n th e siz e o f that surplu s of a change from a wheat to a potato diet: 'the same quantity of cultivated land would maintain a much greater number of people, an d the labourers being generally fed with potatoes, a greater surplu s would remain after replacing all the stock an d maintaining all the labour employed in production (160). This 'surplus ' is Karl Marx's 'surplu s value' and the basis of John Stuar t Mill's 'unproductive consumption.' As the standard of living of the workers has risen one may say that they too share, however inequitably, in the surplus, the surplus value, the net revenue, however you name it. It is the size of this net revenue, rather than of the gross product, that really matter s for the comfor t and the civilize d welfare of a nation. Th e difficulty o f measurin g it involve s not onl y th e difficult y o f determining what shoul d be considere d subsistence . Eve n Ricard o an d Mar x recognized a customary or moral element in subsistence, and the improvement in the standard of living of the workers appeared for many decades as a rise in the level of subsistence rather than as a rise in wages above that level. But if

T v we canno t measur e th e produc t neede d fo r subsistenc e an d therefor e cannot measur e net revenue, ther e i s one area of comparison i n modern times where the concept remains relevant. Comparisons of the per capita Gross National Product between affluen t developed nations and developing nations of the Third World are frightening in the magnitud e of the difference . If , however, we could make even rough estimates of the per capita net revenue the contrast would be even more extreme. Let me give an arithmetical example: suppose the per capita GNP i n countr y A to b e $4,000 , an d i n countr y B $500. A pe r capit a production eight times that of the poorer country is sufficiently worrying . But suppose the subsistence of the people in the country A may be thought to requir e $1500 per head , whil e in country B it requires $400 . The wid e difference i n the level of subsistence depends on the customary and moral elements referred t o above , an d partly perhaps on the differen t physica l environment. Given the figures I have assumed, the net revenue per capita in country A is $2500, that in country B is $100: the difference changes fro an advantage of eight times to one of twenty-five times . I neither suggest that this represents any actual case, nor that net revenue can be satisfactorily measured ; I d o argu e tha t th e differenc e i n Gros s Nationa l Produc t grossly understates the real difference i n the material condition of the rich and the poor nations. When you consider also the difference in the hours of work the gap widens still further. The value of any leisure has been ignored; so has the real burden of fatigue.

Digression 3 On competition

The case for laissez faire in Adam Smith depended on the expectation tha t there woul d be activ e competition . Thi s was partly th e product o f stati c analysis: monopoly elements woul d impede th e process b y which supply 'suited itself to effectual demand. ' Competitio n was the conditio n which guaranteed tha t existing resource s would b e appropriately allocate d an d that prices woul d be kept down to existing costs. Moder n elaboration of models o f perfec t competitio n ha s improve d ou r understandin g o f thi s process bu t i t ha s distracte d attentio n fro m th e dynami c vie w o f th e classical politica l economists , wh o were concerne d wit h growth and development. Th e case for competition i n the classical traditio n wa s largely based o n the belief tha t the maintenance o f an atmosphere favourabl e to innovation, enterprise, an d technological advanc e was of paramount concern. I t i s in that vei n that Adam Smit h wrote: 'Monopoly , besides, i s a great enemy to good management , which can never be universally established bu t i n consequenc e o f that fre e an d universa l competitio n whic h forces everybody to have recourse to it for the sake of self defence (147).' It was i n thi s vei n tha t Joh n Stuar t Mil l wrote : T o b e protecte d agains t competition is to be protected i n idleness and mental dullness.M It is in this vein tha t Marshal l stresse d 'enterprise ' rathe r tha n competition . An d Schumpeter, asking what we mean by 'a competitive business' wrote 'what we mea n is a schem e o f motives, decision s an d action s impose d upo n a business firm by the necessit y o f doing things better o r at any rate mor e successfully tha n the fellow next door .. . it is to this situation to which we

124 Fro m Adam Smith to Maynard Keynes trace th e technologica l an d commercia l efficienc y o f competitiv e business.'2 In th e dynami c worl d 'cheapnes s an d plenty ' flow fro m competitiv e innovation i n technology an d fro m accumulation . Schumpete r pu t mos t effectively th e contrast betwee n th e road t o cheapness an d plenty tha t is envisaged i n the static competitive mode l and the alternative road that is suggested by looking at the dynamic world: The problem that is usually being visualised is how capitalism administers existing structures, whereas the relevant problem is how it creates and destroys them ... In capitalist realit y a s distinguishe d from it s textboo k picture, it i s not tha t kin d o f competition which counts, but the competition from th e new commodity, the new technology, the new source of supply, the new type of organization ... competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing forms, but at their foundations and their very lives. This competition is as much more effective tha n the other as a bombardment i s in comparison with forcing a door, and s o much more important that i t becomes a matter of comparative indifferenc e whethe r competition in th e ordinary sense functions mor e or less promptly: the powerful leve r that in the lon run expands output and brings down prices is in any case made of other stuff. 3

Once on e ha s recognize d th e importanc e o f thi s dynami c proces s on e begins to ask how much competition we want, and what kind of competition w e want , i f w e ar e t o continu e t o rel y o n fre e enterpris e an d t o minimize state intervention. One thing is clear, we do not want the condition o f perfect competitio n o f the theorist' s model. Wha t we want is the kind of competition that the classical political economists talked about but did not define. Thei r conception o f the mechanism of the System of Free Enterprise was, ' a s Professo r Lione l Robbin s pu t it , ' a conceptio n o f something mor e roug h an d ready , somethin g muc h mor e dynami c tha n these exquisite laboratory models.' 4 The most useful investigation s of the problem i n ou r generatio n appea r t o m e t o b e thos e b y Professo r J.M . Clark, wh o coined th e phras e 'workabl e competition ' t o describ e th e objective w e seek.5 Essentially h e was concerned with the effec t o f competition in limiting, or eliminating, profit, and with the effect o f this in turn on the process of innovation and accumulation. As competitors adopt your innovations, as competitors expand as you have expanded, the profits, the expectation o f which induced you to innovate and expand, are reduced o r eliminated. This Schumpeter referre d to as the 'perennia l gale of creativ e destruction': Clark referred to it as the process o f 'neutralization.' Some -

On competition 12 5 thing less than and different fro m perfec t competitio n ma y be necessary , Schumpeter argued , t o provid e a degree o f insurance to induc e innovational investmen t where other form s o f protection ar e impossible . 'Per fectly free entry into a new field,' said Schumpeter, 'may make it impossible to enter it at all. The introductio n o f new methods o f production an d new commodities is hardly conceivable wit h perfect - o r perfectly prompt - competitio n fro m the start. And this means that the bulk of what we call economic progress is incompatible with it.'6 So, similarly, J.M. Clark drew attention t o the problem of 'time.' 'The problem is one of the relative speeds .. . of the initiator's gain ... and of the neutralizing process whereb y rivals follow the initiator's lead and destroy his differential advantag e as his action becomes standar d practice .. . If an innovator expects neutralizatio n to be complete before he has recovered the costs of innovation, his incentive vanishes.' The perfectly competitive model is, Professor Clar k argued, one 'fro m whic h competitive progress would be ruled out... either no producer is allowed to make improvements that reduce his costs below those of his rivals, or else the rivals imitate him instantly and eliminate his differential profit... competitiv e neutralizatio n is so perfect that there would be nothing to neutralize.' 7 This is a point of view that requires serious attention: in Schumpeter it is stated, perhaps too strongly an d dogmatically; in Clark it is stated wit h modesty, good judgment, and as a basis for inquiry. The dilemm a is this : w e need long-ru n competitiveness t o promot e innovation and to ensure that the public enjoy th e 'cheapness and plenty' which can be the product of such innovation, yet we need some mitigation of competition i n the short-ru n if innovation and accumulatio n are t o b e induced under a system of free interprise. It is the old dilemma of security and progress: too much security or too little security are alike unfavourable to progress, while many of the real bases of security depend on progress. This digressio n o n competition is intended here t o thro w light on th e classical literatur e about whic h I a m writing. But it is highly relevan t t o modern discussions of policies fo r the control o f monopoly. Where 'neutralization' is too slow, where the gains from past progress are not passed on to the public, and where further progress is not being made, intervention is called for. But the indiscriminate pursuit of all restrictions of competition may inhibit progress. 'Rationa l as distinguishable fro m vindictiv e regula tion by public authority,' as Schumpeter said, 'turns out to be an extremely delicate problem. '8 It is particularly difficult because it is difficult to provide for the courts and administrators 'yardsticks' of workable competition. But if economists hav e difficulty i n supplying them there is also, as Professo r

126 Fro m Adam Smith to Maynard Keynes Adelmann ha s said , a 'merchandising ' problem . Mor e knowledg e an d understanding of the competitiv e proces s i n particular industrie s shoul d help in developing better yardsticks: it should also enable those who wield the clubs to be more effective not only in the selection of the proper victims but also in their punishment. Once again I repeat the admonition: 'pa s de zele.'9

BOOK TW O THE CLASSICA L ERA : MALTHUS AN D RICARD O T O MIL L AN D MARX

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Introductory statemen t

Some of the work of the English Classical Schoo l of Political Economy will be discussed i n this part. I shall confine myself to a few books, which I hope to persuade my readers to read, it is to be hoped wit h greater profit a s a result of my interpretations. I shal l begin with the First Essay o n Population, by T.R. Malthus , and then discus s Henr y Thornton' s Paper Credit o f Great Britain an d th e monetary views of David Ricardo and T.R. Malthus. The Ricardian theory of value and distribution will be approached vi a the Essay on the High Price of Corn e n rout e t o th e Principles. I n J.S . Mill' s Principles o f Political Economy I shal l concentrate mor e o n th e socia l philosoph y tha n o n th e technical positiv e theory . Finally , I shal l discus s certai n ver y limite d aspects of the economics o f Karl Marx; limiting myself to those which seem to me to be important fo r the improvement of 'bourgeois' economics. The true Marxis t wil l no t approv e o f my isolation of the economic s fro m th e total philosophical an d sociologica l system , an d will probably not accep t my interpretation . I a m not writin g for th e Marxist , no r a m I writin g an introduction t o Marxis m fo r th e bourgeois . I a m writin g abou t hi s economics fo r those whom the Marxists would call bourgeois economists , of which number I am one.

I

Malthus and population

I

FACTS AND

FEARS1

We can make only rough estimates of the population of England and Wales before 180 1 when the first census wa s taken, but we probably no w know better wha t was happenin g than did Malthus and the economist s o f that early period . I t seem s tha t th e populatio n ha d remaine d mor e o r les s stationary for several centuries before 1700, with the birth and death rates at about thirty-five per thousand. In the first half of the eighteenth century there was slow growth, from five-and-a-half to six-and-a-half millions, but there was no general recognition of this growth, After 175 0 an era of rapid population growt h se t i n an d wa s recognized . B y 180 0 th e populatio n was nine millions; by 1850 eighteen millions; by 1900, thirty-three millions. The rat e o f growth per decad e reache d si x per cen t i n 1751-61 , ros e t o eighteen per cent in 1811 -21, continued at from twelve to fourteen per cent for the remainder of the century, but fell back to six per cent in 1921-31. At the beginning of the nineteen-thirties i t seemed likely that the rate of growth i n that decad e woul d be barel y tw o per cent ; tha t growt h would cease in the forties and that population would actually decline in the fifties. In 1930 the population was forty millions, in 1941 nearly forty-one millions; the expectation at that time was that population would have fallen by 1971 to thirty-seven millions . There was, however, a resurgence o f population growth, 'th e bab y boom, ' s o tha t th e populatio n i n 197 1 wa s ove r fifty millions. After ou r complete failur e in the thirties t o predict th e reversal o f the

Malthus and population 13 1 population trends, it is not very convincing when we try now to predict the trend of the next few decades. I would hazard a guess that the baby boom is petering out , an d tha t th e possibilit y o f zer o populatio n growt h i n th e countries o f the Western World begins to emerge. Meanwhile in the countries of the Third World, after centurie s o f stationary population , popula tion is growing, and seems likel y to continue for several decade s to grow very rapidly, indeed more rapidly than at any time in the Western World. A population grows , migration apart, when the inflow through births is greater than the outflow through deaths. Before 1700 in England, as I have said, birt h an d deat h rate s wer e abou t 3 5 per thousand . Th e birt h rat e continued at about the same rate until around 1870, but the death rate fell to 20 per.thousand by 1820,14 per thousand in 1910,12 per thousand by 1930. The rapi d increas e in populatio n was therefor e the resul t of declinin g death rates associate d wit h the continuance o f high birth rates. Beginning about 1870 the birth rate began to fall: it was 24 per thousand in 1910,16 per thousand in 1930. Birth and death rates are subject to two influences, the underlying conditions of fertility an d mortality, and the age composition o f the population concerned. A rapidly growing population has a high proportion of women at the child-bearing age and a low proportion of old people whose chance of death is high. The 'gros s reproduction rate,' which is a good indication of the trend of fertility, fell from 2.3 in 1870 to 0.9 in 1935. Fertility had falle n to a point wher e n o further improvemen t in the mortalit y rates (short of achieving general immortality ) could preven t ultimat e decline i n population. For the time being favourable age distribution consequent on the long period of continuous growth, in spite of this decline in fertility, gave a birth rate high enough for continuing, though slower, growth. The ultimate decline presage d b y th e gros s reproductio n rat e o f les s tha n unit y woul d appear only after a couple of decades. When the birth rate again rose in the forties it was a matter of debate as to whether there had been a real reversal of the trend in fertility, or whether the flood of babies was a make up for the forgone babies of the depression an d war years, and a borrowing from th e future resultin g from earlie r marriage . Havin g predicted i n the thirtie s a further decline in fertility, I shall not hazard a further prediction. In the Third Worl d the decline in the death rat e in the last few decades has been spectacular, wit h the importation of modern medicine and public health measures. The birth rate remains high. One may expect ultimately that th e birt h rat e wil l declin e a s i t di d i n th e Wester n World . Bu t th e adjustment o f mores wa s ver y slo w in the West . Ca n one expec t i t to be faster in the Third World?

132 Fro m Adam Smith to Maynard Keynes Changing rates of population growth have been accompanied by a cycle of population fears: from th e fear of under-population, through the fear of over-population, back to the fear of declining population, and on to a new fear of over-population particularly in the Third World. The Mercantilist s feared declining population and wanted larger numbers o f people. The reaso n wa s largely military and political ; the natio n state neede d man-powe r to make it strong and influential. Th e economi c reason was not clearly stated but it is implied in the theory of exploitation expressed by John Bellers in An Essay for Imploying th e Able Poor (1714): 'Labouring people d o raise an d manufactur e above doubl e th e food an d clothing they use themselves,' were this not true 'every gentleman must be a laboure r an d ever y idl e ma n mus t starve.' 2 I t follow s tha t th e mor e 'labouring people,' th e better fo r the gentleman, the better for the state. This may be described as a theory of the most advantageous exploitation. The rapid growth of population after 177 0 was barely recognized before it became a subject of apprehension. From Thomas Robert Malthus, whose First Essay o n Population appeare d i n 1798 , to Joh n Stuar t Mill , whose Principles wer e published in 1848, most economists talked of the danger of over-population. Malthu s did no t se e ho w th e foo d suppl y coul d b e in creased as fast as population was increasing, or seemed likely to increase if there were no restraint. Mil l saw that the food suppl y could be increase d fast enough, but thought it could be done only at greatly increased human cost. How late this fear o f over-population persisted ca n be illustrated by reference to J.M. Keynes's Economic Consequences o f the Peace Treaty (1919): 'Malthus disclosed a Devil. For half a century all serious economical writings held that Devil in clear prospect. For the next half-century he was chained up and out of sight. Now perhaps we have loosed him again. '3 In th e thirtie s recognition o f th e probabl e declin e i n populatio n wa s followed b y a complete reversa l o f population fears. Som e were worried because the y could se e no end to th e declin e shor t o f extinction, just a s Malthus and Mill could see no end to the increase shor t of 'plague, pestilence an d famine , battle , murde r an d sudde n death. ' Som e talke d o f a League of Low Birth Rate Countries, fearing political domination by those countries which continued to produce cannon fodder at a high rate. But the new elemen t i n the fea r wa s relate d t o th e ne w theories o f employment associated especiall y with Lord Keynes . As it came to be recognized that the maintenanc e of high level employment depends o n adequate 'invest ment' to offset the saving that would be associated with the high incomes of full employment , it als o becam e recognize d tha t increase o f population provided on e o f the mos t importan t source s o f demand for ne w capital .

Malthus and population 13 3 Indeed, Professo r Hansen 4 estimate d tha t the growth of population in the 19th century was responsible for 40 per cent of the total capital formation in Western Europ e an d fo r abou t 6 0 per cen t i n the Unite d States . I n hi s presidential addres s t o the American Economi c Associatio n i n 1938, Pro fessor Hanse n said : 'Th e grea t transition , inciden t to a rapid declin e in population growth and its impact upon capital formation and the workability of a system of free enterprise, calls for high scientific adventure along all the points represented b y the social science disciplines.'5 J.R. Hicks, in his Value an d Capital (1939) wondered whethe r the 'whol e industrial revolution o f the las t tw o centurie s ha s been nothin g but a vast secula r boom , largely induced by the unparalleled rise in population.'6 Along with the worr y about th e effec t o f declining rates of population growth, and, a fortiori, o f declining population, o n the prospects fo r high level employment, went a worry about the effect o f changing age distribution o n th e moral e o f th e people . D r Gunna r Myrda l expresse d thes e worries: The shiftin g of the age distribution within the working ages, which will result from the lowerin g of the populatio n trend , wil l come t o hav e a restrictive effec t upo n young people's opportunities for advancement .. . The y wil l los e thei r dynamic interest in working life, society will lose the mental attitude that goes with progress. Interest in security will be substituted for an earlier interest in social advancement. The peculia r bran d o f Socialis m whic h i s ap t t o develo p unde r th e continue d influence of these factors must unfortunately be expected to take on an administrative, bureaucratic , senile character. I t wil l b e bureaucratic administration of the liquidation of a people ... the best, the most dynamic intelligences cannot come to feel a very great interest in the administration of a liquidation. Even one who was a Socialist in politics, who has felt th e pulse of progress in his veins, who has loved free initiativ e and advance, must feel cheerles s before these prospects. He hardly expected this to be the outlook for Socialism. He would even be tempted to defend private capitalism if by that means he could revivify dynamic progress.7

This worr y abou t a 'countr y withou t youth' sound s od d i n the worl d in which the post-war flood of babies has renewed youth. With th e renewa l o f population growt h cam e a renewal o f the fea r of over-population. In the Third World some fear, as Malthus did, approaching famine; others, rather i n the Mil l tradition, fear increasing poverty o r slower escape from povert y and less chance o f achieving a break-through to plenty. On the North American continen t th e new plea for zero population growth is more related to pollution than poverty. An early statement of

134 Fro m Adam Smith to Maynard Keynes the case against population growth came from Professor Josep h Spengler. 8 He argued that an overworked stork is the enemy of the beautiful... because satisfactio n of the demands of the stork absorbs resources which might otherwise have been devote d to satisfyin g th e criteria of beauty and to meeting the requirements of excellence . Population growth entails diversion of resources fro m th e elevation of the peopl e above what has been the common level to mere multiplication of those at or near the common level. A people that worships the stork cannot escape paying the piper ... Agents of production required to support population growth might otherwise have been use d t o improv e the health , education and cultura l attainment of the given self-replacing population ... Population growth not only absorbs resources; it also accelerates their dissipation and intensifies many kinds of scarcity ... Water, long the economist's stock example of a free good, has became scarce .. . This shortag e will b e felt increasingl y as populatio n growth augments both water pollution and water requirements ... [Ruskin ] would probably have found operativ e Gresham's law o f aesthetics i n the continuin g replacement of Arcadian beauty of car dominated, bill-boarded, neon-signed shabbiness.

Spengler's concern fo r beauty was followed by the sudden concern fo r pollution; to some, man seemed no t so much the polluter a s the pollutant . On all of this I make but one comment: perhap s th e enemy is not just th e stork but the Veblenian Devil. We on this continent, could have excellence in Spengler' s sens e wit h the presen t rat e o f population growt h i f we es chewed competitive consumption and conspicuous waste , if we preferred good medicine, good education, good art, and beautiful surroundings to the kind of things we crave: automobiles, highways, jet transport an d war. We could have more people an d less pollution if we were prepared t o pay the cost; that is, to forego much of what we now think essential t o our happiness. W e will not necessarily hav e beauty and less pollutio n if population growth ceases ; we coul d simpl y have mor e o f the sam e ol d things. Th e choice woul d stil l have t o b e mad e an d th e Devi l of ugliness migh t still prevail. The fea r of the employment effects of the declining rates of population growth so prevalent in the thirties seems to have been allayed. Technological change, whic h ha d slowe d dow n i n the thirtie s t o a point wher e th e 4 ' stagnation thesis'' became widely accepted, is now rapid; some fear excessively an d disturbingly rapid. Suc h chang e stimulate s investmen t an d s o reduces the need for the stimulus of population growth . Preparation fo r war took Europe out of the depression o f the thirties: a state of'permanent war'

Malthus and population 13 5 now help s t o maintai n employment , threaten s continue d inflation , an d diverts resource s fro m th e pursui t o f excellence , beaut y an d pollutio n control. But perhap s th e mos t importan t chang e i s a ne w confidenc e i n th e possibility of so managing the economy that high level employment can be achieved i n a perio d o f peac e an d zer o populatio n growth . Ho w wel l founded thi s new confidence is remains to be seen : a s I write, the majo r concern is whether we can achieve satisfactor y levels of employment and at the same time a satisfactory degre e of price stability. II

THE

MALTHUSIAN

P O P U L A T I O NN

THESIS*

The First Essay on Population, published in 1798 was written, as Malthus later explained, 'on the impulse of the occasion, and from the few materials which were then within my reach in a country situation.' It owed 'its origin to a conversation wit h a friend on the subject of Mr Godwin's Essay , o n avarice an d profusio n in th e Enquirer ' (i) . Th e 'friend ' wa s hi s father, Daniel Malthus, a great admirer- almo st worshipper- of Rous seau, and very susceptible t o th e 'perfectibilist ' doctrine s o f Willia m Godwin . Lor d Keynes, in his brilliant biographical essay on Malthus, describes thi s first essay a s 'no t onl y a priori and philosophica l in method, bu t .. . bol d and rhetorical i n styl e wit h muc h bravura o f language and sentiment.' 9 Th e quotations whic h I shal l mak e wil l amply justify this description . In th e Second Essay (1803) Keynes continued, 'political philosophy gives way to political economy , genera l principle s ar e overlai d b y th e inductiv e verifications of a pioneer in sociological history , and the brilliance and high spirits o f a youn g ma n writin g i n th e las t year s o f th e Director y disappear.'10 I t i s th e brillian t pamphle t o f 179 8 rathe r tha n th e heav y treatise of 1803 which I find most worth study; I shall confine myself almost exclusively to it. 'I have read,' wrote Malthus in his first chapter, 'som e of the speculations o n the perfectibility of man and society wit h great pleasure. I hav e been warme d and delighted wit h the enchantin g picture whic h they hold forth. I ardently wish for such happy improvements. But I see great, and to my understanding unconquerable difficulties i n the way to them' (7). The obstacle wa s population pressure. Malthu s also saw little evidence o f the progress towards the perfect rationality that Godwin counted on. * I n the remainder of this chapter page references in the text are to the First Essay on Population, reprinted for the Royal Economic Society in 1926, by A.M. Kelley, in 1965. The pagination in the reprints is that of the original.

136 Fro m Adam Smith to Maynard Keynes I put out of the question, at present, all mere conjectures; tha t is, all suppositions , the probabl e realization of which cannot be inferred upon any just philosophica l grounds. A writer may tell me that he thinks man will ultimately become an ostrich. I cannot properly contradict him. But before he can expect to bring any reasonable person over to his opinion, he ought to shew, that the necks of mankind have been gradually elongating; that the lips have grown harder, and more prominent; that the legs and feet ar e daily altering their shape; and that the hair is beginning to change into stubs of feathers. And till the probability of so wonderful a conversion can be shewn, it is surely lost time and lost eloquence to expatiate on the happiness of man in such a state; to describe his powers, both of running and flying; to paint him in a condition wher e al l narro w luxurie s woul d b e contemned ; wher e h e woul d b e employed only in collecting the necessaries o f life; and where, consequently, eac h man's share of labour would be light, and his portion of leisure ample (10-11).

Malthus mad e tw o 'postulata. ' 'First , tha t foo d i s necessar y t o th e existence of man. Secondly, tha t the passion between th e sexes i s necessary, an d wil l remain nearl y i n its presen t state ' (n) . Godwi n ha d no t questioned th e nee d fo r food, bu t h e ha d 'conjecture d tha t th e passio n between th e sexe s ma y i n time b e extinguished ' (12) . Fo r thi s Malthu s found no evidence, h e therefore assumed that his 'postulata' were granted and declared 'tha t the power of population is indefinitely greater than th e power in the earth to produce subsistence for man' (13). So he introduced his famous 'ratios.' 'Population, when unchecked, increases in a geometrical ratio . Subsistenc e increase s onl y i n a n arithmetica l ratio . A sligh t acquaintance wit h numbers will show the immensity of the first power in comparison of the second' (14). Now sinc e food is necessary 'th e effects of these two unequal power s must be kept equal. This implies a strong and constantly operatin g chec k on population from th e difficult y o f subsistence' (14). I shall revert t o th e ratios whe n examinin g his secon d chapter , bu t firs t I woul d quot e an d criticise a passage whic h presents wha t I can only describe a s his animalvegetable approach to human population. Through the animal and vegetable kingdoms, nature has scattered the seeds of life abroad with the most profuse and liberal hand. She has been comparatively sparing in the room, and the nourishment necessary to rear them. The germs of existence contained i n this spot o f earth, wit h ampl e food, an d ampl e room t o expan d in, would fill millions of worlds in the course of a few thousand years. Necessity, that imperious all-pervading law of nature, restrains them within the prescribed bounds. The rac e of plants, and the race of animals shrink under this great restrictive law

Malthus and population 13 7 And the race of man cannot, by any efforts of reason, escape from it. Among plants and animals its effects ar e waste of seed, sickness , and premature death. Among mankind, miser y and vice. The former , misery , is an absolute necessary consequence o f it . Vic e i s a highl y probabl e consequence , an d w e therefor e se e i t abundantly prevail; but it ought not, perhaps, to be called an absolutely necessary consequence. The ordeal of virtue is to resist all temptation to evil (15-16).

This is, of course, all too simple. The birth rate among rabbits is a matter of fecundity, among men of fertility. Fertility is a matter of social mores and rational choice. In his Second Essay Malthus recognized that fertility might be reduce d b y 'mora l restraint, ' i.e. , b y later marriag e an d continence before marriage . Fertilit y di d ultimately declin e bu t b y deliberat e birt h control rather tha n by 'moral restraint/ To Malthus this was 'vice,' but morals change as well as mores. George Bernard Shaw, in his Intelligent Woman's Guide to Socialism,11 argued for birth control, as ap/s aller. The practical question for the mass of mankind is not whether the population shall be kept down or not, but whether it shall be kept down by preventing the conception of children , or b y bringin g the m into the worl d an d the n slaughterin g the m by abortion, exposure , starvation, neglect, ill-usage, pestilence and famine, battle , murder an d sudde n death . I def y an y bisho p o r cardina l t o choos e th e latte r alternatives. St Paul abhorred marriage but he said: 'Better marry than burn/ Our bishops and cardinals may abhor contraception (so do 1, by the way); but which one of them would not say , when put to it like St Paul: 'Better have no children, by whatever means, than have them and kill them as we are killing them at present.'12

The propaganda for birth control of the 'Neo-Malthusians ' began very early in the nineteenth century. I shall not deal with it here but I suggest that the natur e o f this earl y propagand a ca n bes t b e understoo d b y reading Graham Wallas' s Life o f Francis Place. The difference between the population problem of rabbits and men is not just a matter of the contrast between fecundity and fertility. Rabbits bring mouths but not hands; men bring mouths and hands which serve to increase production. Whether production will increase proportionately, or whether there will be 'diminishing return' to human effort remains to be considered. Rabbits accept the food supply as it is; men use their hands and heads t o increase the food supply. Proper use of the head by improving technology may offset the 'diminishing return' to hands. Rabbits accept whatever food there is; man has customary standards. The attachment to white bread may lead to restriction of births. This Malthus recognized: Th e labourer s of the

138 Fro m Adam Smith to Maynard Keynes south of England are so accustomed to eat fine wheaten bread, that they will suffer themselves to be half-starved, before they will submit to live like Scotch peasants' (132). Finally, rabbits have access to any food there is; for man there arises the problem of employment, and wages, for access to the food that is produced. The problem of unemployment as a cause of poverty was explored in the later writings of Malthus. Malthus turned from th e general statement of the 'ratios' to consider the particular magnitudes involved. In the United States o f America, where the means of subsistence hav e been mor e ample, the manners of the people more pure, and consequently the checks to early marriages fewer, than in any of the modern state s o f Europe, th e population ha s been found to double itself in twenty-five years. This ratio of increase, thoug h short of the utmost power of population, yet as the result of actual experience, w e will take as our rule; and say, That population, when unchecked, goes on doubling itself every twenty-five years, or increases in a geometrical ratio (20-1). What then of food supply? If I allow that by the best possible policy , by breaking up more land, and by great encouragements t o agriculture, th e produce o f this Island ma y be doubled i n the first twenty-five years, I think it will be allowing as much as any person will demand. In the next twenty-five years, it is impossible to suppose tha t the produce coul d be quadrupled. It would be contrary to all our knowledge of the qualities of land. The very utmos t that w e can conceive is , that th e increase i n the secon d twenty-fiv e years might equal the presen t produce! Let u s then take this for our rule, though certainly far beyond the truth; and allow that by great exertion the whole produce of the Island might be increased ever y twenty-five years by a quantity of subsistenc e equal t o wha t i t a t presen t produces . Th e mos t enthusiasti c speculato r canno t suppose a greater increase than this. In a few centuries it would make every acre of land in the Island like a garden. Yet the increase is evidently arithmetical (21-2). Malthus then brought together the effects o f these two ratios: The populatio n of the Island is computed to be about seven millions; and we will suppose th e presen t produc e equa l t o th e suppor t o f tha t number . In th e first twenty-five year s th e populatio n woul d be fourteen millions; and th e food bein g doubled, th e mean s of subsistence woul d b e equal t o thi s increase . In th e nex t twenty-five years the population would be twenty-eight millions; and the means of subsistence onl y equal to the support o f twenty-one millions ... And at the conclu-

Malthus and population 13 9 sion of the first century, the population would be one hundred and twelve millions and the subsistence only equal to the support of thirty-five millions (23-4).

So far h e ha d bee n talkin g o f th e 'Island, ' an d h e di d no t forese e th e immense improvements in transportation tha t would open the granaries of Eastern Europe and then of the North American continent to the people of England. Bu t he wen t o n to appl y th e ratio s t o th e world : 'Takin g th e population o f the world at any number, a thousand million, for instance .. . in two centuries an d a quarter th e population woul d be to the mean s of subsistence a s 512 to 10 ' (25-6). How then is the 'increas e of the human species ... kept commensurate to the increase of the means of subsistence?' The answer: 'by the constant operation of the strong law of necessity actin g as a check upon the greater power' (26). So Malthus examined the 'checks.' Again we start with the plants and animals. 'They are all impelled by a powerful instinct to the increase of their species; an d this instinct is interrupted b y n o reasoning , o r doubt s abou t producin g fo r thei r offspring . Wherever therefore there is liberty, the power of increase is exerted; and the super-abundant effects ar e repressed afterward s by want of room and nourishment, which is common to animals and plants; and among animals, by becoming the prey of others' (27). By contrast, ma n is 'impelled to the increase o f his species by an equally powerful instinct' but reason interrupts his career and asks him whether he may not bring beings into the world for whom he cannot provide the means of subsistence. In a state of equality, this would be the simple question. In the present state of society other considerations occur. Will he not lower his rank in life? Will he not subject himself to greater difficulties than he at present feels? Will he not be obliged to labour harder? and, if he has a large family, wil l his utmost exertions enable him to support them? May he not se e his offspring i n rags and misery, and clamouring for bread that he cannot give them? And may he not b e reduce d to th e gratin g necessity of forfeiting hi s independence, an d o f being obliged to th e sparin g hand of charity for support? These consideration s are calculated to prevent, and certainly do prevent, a very great number in all civilized nations from pursuing the dictates of nature in an early attachment to one woman (27-8).

Malthus believed 'tha t the tendency to a virtuous attachment i s so strong, that there is a constant effort toward s an increase of population' (29). The preventive checks, which he examined in a later chapter were not adequate to preven t the onse t o f the positiv e check s o f 'misery,' or, i f they wer e adequate, they spelt vice.

140 Fro m Adam Smith to Maynard Keynes The general theory of these first two chapters i s summarized in thre e propositions: 'that population cannot increase without the means of subsistence; .. . tha t populatio n doe s invariabl y increase, wher e ther e ar e the means of subsistence;... that the superior power of population canno t be checked, without producing misery or vice' (37). The first is self-evident; the second is contradicted by the population history of our affluent world ; the thir d depends o n a moral judgment on the practice of contraception. Historically, a s I hav e show n above , i t ha s bee n a decline i n mortality rather tha n a n increas e o f subsistenc e tha t ha s cause d population s t o increase. I f a n increas e i n th e income s o f th e poo r (greate r availabl e subsistence) ha s played a part, i t woul d seem t o be , a s note d b y Adam Smith, through a reduction in infant mortality as improved nutrition reinforces medical advance. Having stated hi s general principles, Malthu s proceeded to a 'cursory review' o f 'th e differen t state s i n whic h mankin d have bee n know n t o exist': the 'hunter state,' th e 'shepherd state, ' the 'state of civilized na tions.' The brief sketches of these 'states' in the First Essay are expanded into documented chapters in the Second: but the theme is the same. First, the North Amencan Indians. In all accounts we have of them, and, indeed, of most other savage nations, the women are represented a s much more completely in a state of slavery to the men, than the poor are to the rich in civilized countries .. . and the misery that checks population falls chiefly, as it always must do, upon that part whos e condition is lowest in the scal e o f society. Th e infanc y o f man in th e simplest stat e require s considerabl e attention ; bu t thi s necessar y attentio n th e women cannot give, condemned as they are to the inconveniences an d hardships of frequent change of place, and to the constant and unremitting drudgery of preparing everything for the receptio n o f their tyrannic lords. Thes e exertions, sometime s during pregnancy, or with children at their backs, must occasion frequent miscarriages, and prevent any but the most robust infants from growing to maturity. Add to these hardships of the women, the constant war that prevails among savages .. . May we not then fairly infer from this short review, or rather, from the accounts that may be referred to of nations of hunters: that their population is thin from scarcity of food; tha t it woul d immediately increase i f food wa s i n greater plenty ; and that , putting vice out of the question among savages, miser y is the check that represses the superio r powe r o f population , an d keep s it s effect s equa l t o th e mean s o f subsistence (41-4).

Next, the shepherds. Of this state Malthus admits that less was known than about the savage state and the problem was complicated by migration.

Malthus and population 14 1 Want was the goad that drove the Scythian shepherds from their native haunts, like so many wolves in search of prey. Set in motion by this all-powerful cause, clouds of Barbarians seemed to collect, from all points of the northern hemisphere. Gathering fresh darkness, and terror, as they rolled on, the congregated bodie s a t length obscured th e su n o f Italy, an d san k th e whol e worl d i n universal night . These tremendous effects, so long and so deeply felt throughout the fairest portions of the earth, ma y be traced t o the superior power of population, to the means of subsistence .. . Among these bold and improvident Barbarians, population was probably but little checked, as in modern states, from a fear of future difficulties. A prevailing hope o f bettering thei r conditio n b y chang e o f place; a constant expectatio n o f plunder; a power even, if distressed, of selling their children as slaves, added to the natural carelessness o f the barbaric character, al l conspired to raise a population which remained to be repressed afterward s by famine or war. And so he concluded that 'population was checked, and the actual population kep t equa l t o th e mean s o f subsistence by miser y an d vice .. . Fo r independently o f any vicious custom s tha t migh t have prevailed amongs t them with regard to women, which always operate as checks to population, it must be acknowledged, I think, that the commission of war is vice, and the effec t o f it, misery ; and none ca n doub t th e miser y of want of food' (44-p). Finally, th e civilize d state : th e slo w growth of population 'canno t be traced to a decay in the passion between the sexes' but 4 a foresight of the difficulties attending the rearing of a family, acts as a preventive check; and the actua l distresse s o f som e o f th e lowe r classes , b y whic h the y ar e disabled from giving the proper food and attention to their children, acts as a positiv e chec k t o th e natura l increase o f population' (62-3) . Ho w the preventive check operated in the various ranks of English society is briefly discussed. There are some men, even in the highest rank, who are prevented from marrying by the idea of the expences that they must retrench, and the fancied pleasures that they must depriv e themselves of , o n th e suppositio n o f having a family .. . A man of liberal education, but with an income only just sufficient t o enable him to associat e in the rank of gentlemen, must feel absolutely certain, that if he marries and has a family, h e shal l b e obliged , i f h e mixe s at al l i n society , t o ran k himsel f with moderate farmers, an d th e lowe r class o f tradesmen. The woma n that a man of education would naturally make the object of his choice, would be one brought up in the sam e tastes an d sentiment s wit h himself .. . Can a man consent t o place th e object o f hi s affectio n i n a situatio n s o discordant , probably , to he r taste s an d

142 Fro m Adam Smith to Maynard Keynes inclinations .. . These considerations undoubtedl y prevent a great number in this rank of life fro m followin g the bent of their inclinations to an early attachment... The sons of tradesmen and farmers are exhorted no t to marry, and generally find it necessary to pursue this advice, till they are settled in some business or farm ... The labourer who earns eighteen pence a day, and lives with some degree of comfort as a single man, will hesitate a little before he divides that pittance among four or five, which seems t o b e bu t just sufficien t fo r one. Harder far e and harde r labou r h e would submit to, for the sak e of living with the woman he loves; but he must feel conscious, if he thinks at all, that should he have a large family, an d an y ill luck whatever, no degree of frugality, no possible exertion of his manual strength, could preserve hi m fro m th e heartrendin g sensatio n o f seein g hi s childre n starve , o r forfeiting his independence, and being obliged to the parish for their support... The servants who live in gentlemen's families hav e restraints that ar e ye t stronger t o break through, in venturing upon marriage. They possess the necessaries, and even the comfort s of life, almos t in as great plent y as their masters .. . What are thei r prospects i n marrying ? ... thei r only refuge seem s t o b e a miserabl e al e house , which certainl y offer s n o very enchanting prospects of a happy evenin g t o thei r lives. B y much the greater part, therefore, ... content themselves with remaining single where they are. So Malthus concluded: ... the preventive check to population operates, thoug h with varied force, through all the classe s o f the communit y ... Th e effects , indeed , of these restraint s upo n marriage ar e bu t to o conspicuou s i n th e consequen t vice s tha t ar e produce d i n almost every part of the world: vices, that are continually involving both sexes in inextricable unhappiness (63-70). It was left for Francis Place and the neo-Malthusians to argue that the 'vice' that develops when marriage is delayed is more serious than the 'vice', if it be such , o f tha t practic e o f contraceptio n tha t permit s earl y marriag e without th e individua l disaster o f poverty throug h th e burde n o f many children, and the social disaster of a too rapidly growing population. Strong a s wer e th e preventiv e checks i n the Englan d o f his time, th e positive checks were also in operation. A high mortality among the children of th e urba n poo r wa s wel l recognize d bu t Malthu s remarke d tha t th e condition of the rural poor was not much better. The sons and daughters of peasants will not be found such rosy cherubs in real life, as they are described t o be in romances. It cannot fail to be remarked by those who

Malthus and population 14 3 live much in the country, that the sons of labourers are very apt to be stunted in their growth, and are a long while arriving at maturity. Boys that you would guess to be fourteen o r fifteen, are upon inquiry, frequently found to be eighteen or nineteen. And the lads who drive plough, whic h must certainly b e a healthy exercises , ar e very rarely seen with any appearance of calves to their legs; a circumstance, which can only be attributed to a want either of proper, or of sufficient, nourishment (73).

2 Malthus: the economist *

I

THE

POOR LAWS

To alleviate the distress generated by this urban and rural poverty was the purpose of the 'poor laws.' Malthus examined their effect i n some detail, and his views were very influential for a century. I shall report them rather fully an d make brief critical comments as I report. The key-note is struck immediately: the poor laws of England 'have spread the general evil over a much larger surface' (74) . It i s a 'matter of great surprise ' to many 'that notwithstanding the immense sum that is annually collected fo r the poor in England, there is still so much distress among them. Some think the money must b e embezzled; other s tha t th e church-wardens and overseers consume the greater part of it in dinners. All agree that it somehow or other must be very ill-managed ... But a man who sees a little below the surface of things, would be very much more astonished, if the fac t wer e otherwis e than i t is observed t o be, o r even i f a collection universall y of eighteen shillings on the pound instead o f four, wer e materially to alter it' (74-5). The reason appeared t o Malthus to be that the supply of food was almost completely inelastic and that increased money income would simply drive up prices. Suppose, that by a subscription o f the rich, the eighteen penc e a day which men earn now, was made up five shillings, it might be imagined, perhaps, that they would * I n this chapter pag e reference s i n the text are to the First Essay o n Population, reprin t (Royal Economic Society, 1926 ; A.M. Kelly, 1965)

Malthus: the economist 14 5 then b e abl e t o liv e comfortably, an d hav e a piece o f meat every day fo r their dinners. But this would be a false conclusion. The transfer of three shillings and sixpence a day to every labourer would not increase the quantity of meat in the country. There is not at present enough for all to have a decent share. What then would be the consequence? The competito n among the buyers in the market for meat would rapidly raise the price from sixpenc e or sevenpence, to two or three shillings in the pound; and the commodity would not be divided among many more than it is at present. When an article is scarce, and cannot be distributed to all, he that can show the most valid patent, that is, he that offers most money, becomes the possessor (75-6).

If th e pric e remaine d hig h fo r a lon g enoug h tim e mor e cattl e might , Malthus admitted, be raised and the supply of meat be increased but 'only at the expence of corn, which would be a very disadvantageous exchange; for i t i s wel l know n that th e countr y coul d no t the n suppor t th e sam e population' (76). The aggregat e food supply was more inelastic tha n was the supply of any one item in that aggregate. This argumen t was repeate d i n the Investigation of th e cause of th e present high prices of provisions (iSoo)1 and in the context of inflation had a useful short-run application. I shall discuss the Investigation later. Here, in the Essay, th e argument was 'long-run' and less satisfactory. Eve n in his day the possibility of importation of food increased the elasticity of supply, and th e domesti c suppl y wa s probabl y mor e elastic tha n h e supposed . Later in the chapter Malthus reverted to this theme: It should be remembered always, that there is an essential difference between food, and those wrought commodities, the raw materials of which are in great plenty. A demand for these last will not fail to create them in as great a quantity as they are wanted. Th e deman d for foo d ha s b y n o mean s the sam e creative power. In a country where all the fertile spots have been seized, hig h offers ar e necessary t o encourage the farmer t o lay his dressing on land, from whic h he cannot expect a profitable retur n for som e year s .. . Th e deman d for a n increase d quantit y of subsistence is, with very few exceptions, constant everywhere, yet we see how slowly it is answered in all those countries that have been long occupied (90-1).

To those who believe that 'the increased number of purchasers in every article, would give a spur to productive industry' he replied that 'the spur that these fancied riches would give to population, would more than counterbalance it ' (77) . This is pushing the 'mone y illusion ' rathe r far ! 'The receipt of five shillings a day, instead of eighteen pence, would make every

146 Fro m Adam Smith to Maynard Keynes man fancy himself comparatively rich, and able to indulge himself in many hours or days of leisure. This would give a strong and immediate check to productive industry ; and i n a shor t time , no t onl y th e natio n woul d b e poorer, but the lower classes themselves woul d be much more distressed than when they only received eightee n pence a day' (78). I find this even less convincing than the assumption of inelastic supply . A quarter century of inflation has gone a long way towards shattering the money illusion; and such as it was and still is it is surely a short-run illusion largely irrelevant to the long-run problem of population growth. Malthus returned to the problem of inelastic supply. It may appear strange, but I believe it is true, that I cannot by means of money raise a poo r man , and enabl e hi m t o liv e muc h bette r tha n h e di d before , withou t proportionably depressin g other s i n the sam e class . If I retrenc h th e quantity of food consume d i n my house, an d give hi m what I cu t off , I benefi t hi m without depressing any but myself and family... If I turn up a piece of uncultivated land, and give him the produce, I then benefit both him and all the members of the society .. . But if I only give him money, supposing the produce of the country to remain the same [m y italics], I give him a title to a larger share of that produce tha n formerly, which share he cannot receive without diminishing the shares of others (79-80). Malthus concluded that the poor-laws of England tend to depress the general condition of the poor... Their first obvious tendency is to increase population without increasing the food for its support .. . Secondly , th e quantit y o f provision s consume d i n workhouse s .. . diminishes the share that would otherwise belong to the more industrious and more worthy members (83-4). The Malthusian thesis runs like this: Hard a s i t ma y appea r i n individua l cases dependen t povert y ough t t o b e hel d disgraceful. Suc h a stimulu s seems t o b e absolutel y necessar y t o promot e th e happiness o f the grea t mas s o f mankind .. . I f men are induce d t o marr y from a prospect o f parish provision, with little or no chance of maintaining their families in independence, they are not only unjustly tempted to bring unhappiness and dependence upo n themselves and children, but they are tempted, without knowing it, to injure all in the same class with themselves. A labourer who marries without being

Malthus: the economist 14 7 able to support a family, may in some respects, be considered as an enemy to all his fellow-labourers (85-6).

On the basis of historical evidenc e that the birth rate has been mainly responsive t o sociologica l and cultural influence , and that the suppl y of children does not seem to have been responsive to increases in the incomes of parents, the fear that the poor law, by weakening the preventive check, promoted population growth seems doubtful. Recent efforts by economic historians to establish or refute the hypothesis by empirical evidence have not bee n complete d satisfactorily . Perhap s m y bias i s reveale d b y my readiness t o accep t th e stud y b y Jame s P . Huzell. 2 Comparin g tw o parishes, in one of which the administration of poor relief was lax and in the other was strict, Huzell found the difference in the birth rates insignificant. The differenc e i n infant mortality was very significant. Malthus knew, as Adam Smith had known, that poverty kills infants: but in discussing th e poor-laws he stressed their effect o n the preventive checks rather than on the positive checks. It would be a slander on him to say that he opposed the poor laws because they interfered with the positive check. He did not exult over the effectiveness of the death rate as a curb on population: and when in the Second Essay h e preached mora l restraint h e was pleading for more effective operation of the preventive check in order to save mankind from the misery of the positive check. Perhaps, one should add, every improvement i n mortality , whether i t arise s fro m improve d medicine o f public health, high family incomes, or more adequate relief, calls for adjustment in fertility rates to avoid renewed population explosion. I shall revert to this problem when discussing J.S. Mill's views on population. In concluding this section the Malthusian poor-law program should be noted. Th e progra m is necessaril y on e o f 'palliatives' : th e pressur e of population create s 'a n evil so deep-seated tha t n o human ingenuity can reach it.' First ite m in the program is 'abolition of all the present parish laws .. . th e marke t for labou r woul d then be free , an d those obstacle s removed which, as things are now, often fo r a considerable time prevent the price from risin g according to the demand.' Second item: 'Premium s might be given for turning up fresh land, and all possible encouragements held out to agriculture above manufactures, and to tillage above grazing.' Third item : 'fo r case s o f extreme distress, count y workhouses might be established .. . the fare should be hard ... they should not be considered a s comfortable asylums in all difficulties' (96-9). This general comment on the character of workhouses hardened into the rigid principle of 'less eligibility' which bedeviled poor-law administration in England for a century.

148 Fro m Adam Smith to Maynard Keynes n E F F E C T I V E D E M A N D : T HE Essay A N D T H E Investigation Two year s afte r th e Essay Malthu s publishe d a pamphle t entitle d A n Investigation o f th e Cause of th e Present High Price of Provisions (1800). Lord Keynes, in his biographical essay on Malthus was high in his praise of this pamphlet but, curiously enough, he did not notice that the argument in that par t o f the pamphle t whic h h e quote d i s almos t identica l wit h th e argument of the chapter o n the Poor Laws in the Essay. His comment s are therefor e relevan t t o th e Essay an d th e pamphlet . They ar e interestin g fo r th e contras t the y dre w wit h th e Ricardia n economics, whic h becam e th e classica l orthodoxy . I shal l quot e Lor d Keynes at some length: This pamphle t ha s importanc e bot h i n itsel f an d a s showin g tha t Malthu s wa s already dispose d t o a certai n lin e o f approac h i n handlin g practica l economi c problems which he was to develop later in correspondence with Ricardo, - a method which t o m e i s mos t sympathetic , and , as I think , mor e likel y t o lea d t o righ t conclusions than the alternativ e approach o f Ricardo. Bu t it was Ricardo's mor e fascinating intellectua l construction whic h was victorious , an d Ricard o who , by turning his back so completely on Malthus's ideas, constrained th e subject for a full hundred years in an artificial groove. Accordin g to Malthus's good commo n sens e notion prices and profits are determined by something which he described, though none too clearly, as 'effectiv e demand. ' Ricard o favoured a more rigid approach , went behind 'effective demand ' to the underlying conditions o f money on the one hand an d th e rea l costs and rea l divisio n of the produc t o n the other , conceive d these fundamental factors as automatically working themselves out in a unique and unequivocal way, and looked on Malthus's method as very superficial. But Ricardo in th e cours e o f simplifyin g th e man y successiv e stage s o f hi s highl y abstrac t argument, departed, necessaril y and more than he himself was aware, away fro m the actual facts; whereas Malthus , by taking up the tale much nearer its conclusion, had a firmer hold on what may be expected to happen in the real world. Ricard o is the father of such things as the quantity theory of money and the purchasing power parity o f th e exchanges . Whe n on e ha s painfull y escape d fro m th e intellectua l domination of these pseudo-arithmetical doctrines, one is able, perhaps for the first time for a hundred years, t o comprehend th e real significanc e of the vaguer intuitions of Malthus.3 Other difference s betwee n th e economi c analysi s o f Malthu s an d Ricardo will be discussed later ; all of them stem from Malthus' s realiance on intuition , an d concentratio n o n th e shor t run . Her e I woul d simply

Malthus: the economist 14 9 comment that Malthus had really only proposed a n approach, he did little to develop the analysis suggested by that approach. As Professor Johnson said: 'Th e Investigation contain s a clea r statemen t o f th e principle o f effective demand , it is a long way from a theory o f effective deman d and income determination in the modern sense.'4 I have referred to this pamphlet primarily to introduce Lord Keynes' s comment on Malthus's use of 'effectual demand, ' but a few further comments o n th e pamphlet s shoul d b e made . First , Malthu s attacke d th e problem, not of why prices had risen, but why they had risen higher than the degree of that scarcity would at first sight appear to warrant. He refuted the explanations o f the witch-hunters who sought wicked persons whose action coul d b e considere d th e caus e o f th e distress , speculators , monopolists, an d bankers. As Professor Johnson put it in his introduction to the pamphlet, Malthus saw the rise in prices of provisions as a result of 'transferring o f money income from group s with zero to those wit h unit marginal propensity to consume.' Should one not however qualify thi s by referring t o th e margina l propensity t o consum e provisions'? Professo r Johnson wen t on to say : 'Malthus' s case is , i n fact, th e specia l thoug h interesting one of inflationary taxation-a case not worked on again until the economists o f th e Oxfor d Institut e o f Statistic s applie d th e Keynesia n theory to public finance.' Ill

T H E O V E R - S A V I N G T H E S I S : T H E Essay

A N D T H E Principles

I do not propose t o discuss the chapters i n which Malthus dealt with the 'perfectibilist' speculations of Condorcet and Godwin. It would be unfair to report Malthus' s critica l accoun t withou t examinin g the origina l state ments, an d I d o no t thin k tha t woul d b e particularl y valuabl e fo r my purpose. But one element in the discussion of Godwin is of great interest, viz., discussio n o f the essa y o n 'avaric e and profusion' i n the Enquirer which raised the possibility o f oversaving. Exploration o f this topic continued in correspondence wit h Ricardo (examples of which are quoted in Lord Keynes' s biographica l essay ) an d i n th e Principles o f Political Economy (1820). It is fashionable now to decry the sympathetic treatment of Malthus by Keynes and the attempts by Keynesians to find in Malthus elements o f the Keynesia n analysis . Bu t th e importan t contributio n o f Malthus was to direct attention to the possibility of over-saving. Only when recognized as possible, even though the recognition be intuitive, is analysis undertaken of the conditions under which it may take place. Identification

150 Fro m Adam Smith to Maynard Keynes of th e proble m wa s th e wor k o f Malthus ; analysi s o f th e proble m wa s beyond hi m an d wa s lon g delaye d becaus e th e identificatio n wa s no t accepted. 'Surely,' wrote Lord Keynes, 'i t was a great fault in Ricardo to fail entirel y t o se e any significance in this line of thought. But Malthus' s defect lay in his overlooking entirel y the part played by the rate of interest. Twenty years ago I should have retorted to Malthus that the state of affairs he envisages coul d no t occur unless the rate of interest had first fallen t o zero. Malthus perceived, as often, what was true: bu t it is essential to a complete comprehensio n o f why it is true , t o explai n ho w a n excess of frugality does not bring with it a decline to zero in the rate of interest. 5' It is in Chapter xv of the Essay that Malthus first discussed this problem. Dr Adam Smith has very justly observed, that nations, as well as individuals, grow rich by parsimony, and poor b y profusion; and that, therefore , ever y frugal ma n was a friend, and every spendthrift an enemy to his country ... No observation can be more evidently just. The subject of Mr Godwin's essay is a little similar in its first appearance, but in essence it is as distinct as possible. He considers the mischief of profusion a s an acknowledged truth; and therefore makes his comparison between the avaricious man, and the man who spends his income. But the avaricious man of Mr Godwin is a totally distinct character... from the frugal man of Dr Adam Smith. The frugal ma n in order to make more money, saves from his income, and adds to his capital; and this capital he either employs himself in the maintenance of productive labour, or he lends it to some other person, who will probably employ it in this way ... But the avaricious man of Mr Godwin locks up his wealth in a chest, and sets in motion no labour of any kind (283-4).

Malthus then turned his attention t o the labour market . 'Th e only way that a poo r ma n ha s o f supportin g himsel f i n independence , i s b y th e exertion o f his bodily strengt h .. . It would hardly appear that you benefit him ... by decreasing th e demand for labour' (288). But Godwin may have been intending that the rich should give to the poor 'without exacting a task from them in return' (291). To this Malthus's response was to refer back to the phrase 'i n independence.' Those who were recipients o f the gifts of the rich must consider themselves as under a great obligation to him, and as dependent upon him fo r their support. Th e ric h ma n would feel hi s power, an d th e poo r ma n his dependence .. . In the present state of things ... the man who does a day's work for me, confers as great a n obligation upo n me, as I do upon him. I possess what he

Malthus: the economist 15 1 wants; he possesses what I want. We make an amicable exchange. The poor man walks erect in conscious independence ; and the mind of his employer is not vitiated by the sens e o f power. Three or four hundre d years ago, there wa s undoubtedly much less labour i n England, in proportion t o the population, than at present; but there wa s muc h mor e dependence : an d w e probabl y shoul d no t no w enjo y ou r present degree of civil liberty, if the poor, by the introduction o f manufactures, had not bee n enable d t o giv e somethin g i n exchange fo r th e provision s o f the grea t Lords, instead o f being dependent o n their bounty. Eve n the greatest enemie s of trade an d manufactures, an d I d o not reckon mysel f a very determined friend t o them, must allow tha t whe n they wer e introduced int o England , libert y cam e in their train (291-4). Following Malthu s I hav e straye d fro m th e oversaving theme, bu t he returned to it. If every man who employs the poor, ought to be considered as their enemy ... and if the miser is ... to be preferred to the man who spends his income, it follows, that any number of men who now spend their incomes, might, to the advantage of society, be converted int o misers. Suppos e then , that a hundred thousand persons wh o now employ ten men each were to lock up their wealth from general use, it is evident that a million of working men of different kind s would be completely thrown out of all employment... But Mr Godwin says, that the miser really locks up nothing ... that the miser locks up neither corn, nor oxen, nor dollars, nor houses. Undoubtedly he does not really lock up these articles, but he locks up the power of producing them which is virtually the same (295-7). So in Chapter xv Malthu s began t o worr y ove r a possible deficiency in effectual deman d as earlier i n Chapter v and later i n the Investigation h e had worried about a temporary excess in effectual demand . After th e Napoleoni c wa r th e worr y abou t a deficienc y o f effectua l demand wa s aggravate d b y th e obviou s distres s o f high unemployment. But the Ricardian orthodoxy withstood all his efforts a t persuasion. He and Ricardo were close friends and carried o n an extensive correspondence . Two quotation s wil l illustrate th e majo r differenc e i n their approac h t o economics. Said Ricardo, in 1817: it appears t o m e that one grea t cause o f our differenc e i n opinion on the subjec t which w e hav e s o ofte n discusse d i s tha t yo u hav e alway s i n you r min d th e immediate an d temporar y effects o f particular changes, wherea s I pu t thes e im -

152 Fro m Adam Smith to Maynard Keynes mediate and temporary effects quit e aside, and fix my attention on the permanent state of things which will result from them. Perhaps you estimate these temporary effects too highly, whilst I am too much disposed to undervalue them.6

Malthus might have replied, with Lord Keynes, that in the long run we are all dead, or that those unemployed in the short run were particularly likel y to be dead in the long run. He might also have said that Ricardo should have referred t o the 'permanent state of things' tha t would result, other things being equal, rathe r tha n will resul t whic h implicitl y assume s tha t othe r things will be equal throughout the long period necessary fo r this permanent state to be achieved. He might also have asked how 'permanent' might the lon g ru n resul t b e expecte d t o be . I n fac t h e replie d t o Ricard o a s follows: I certainly am disposed t o refer t o things as they are, as the only way of making one's writings practically useful to society, and I think the only way of being secure from fallin g into the errors of the taylors of Laputa, and by a slight mistake at the outset arrive at a conclusion the most distant from the truth. Besides I think that the progress of society consists of irregular movements, and that to omit the consideration of causes which for eight or ten years will give a great stimulus to production and population, or a great check to them, is to omit the causes o f the wealth and poverty of nations-the grand object of all enquiries in Political Economy.

He went on to note the more specific difference between them. 'You seem to thin k that th e want s and tastes o f mankind are alway s read y fo r th e supply; while I am most decidedly o f the opinion that few things are more difficult tha n to inspire new tastes and wants ... I am quite of opinion that practically th e actual chec k t o produce an d population arise s mor e fro m want of stimulus than from want of power to produce.'7 Effectual demand can be deficient, Say and Ricardo notwithstanding. When Malthu s wrot e hi s Principles of Political Economy (i82o) 8 h e included in its preface a statement of what Dr Oskar Lange has termed the concept of the 'optimum rate of saving.' Adam Smith has stated, that capitals are increased by parsimony, that every frugal man i s a publi c benefactor, an d tha t th e increas e o f wealt h depends upo n th e balance of produce above consumption. That these propositions are true to a great extent i s unquestionable ... Bu t it i s quit e obvious that the y are no t tru e t o a n indefinite extent, and that the principles of saving, pushed to excess, would destroy the motive to production ... The two extremes are obvious; and it follows that there

Malthus: the economist 15 3 must be some intermediate point, though the resources of political economy may not b e abl e t o ascertai n it , where , takin g into consideratio n bot h th e powe r t o produce and the will to consume, the encouragement to the increase of wealth is the greatest.9

I have discussed thi s problem of the 'optimum rate of saving' above (in Book One , chapte r nine) ; furthe r discussio n a t thi s poin t i s therefor e unnecessary. Bu t perhaps one should sa y that Lord Keyne s is reading too much into this preface when he says that 'the whole problem of the balance of Saving and Investment had been posed'10 Implicitly, perhaps; for more explicit recognitio n on e has to go to the last section of the book where he argued that the relief of 'the Distresses of the Labouring Classes since 1815' required a program of public works and of private expenditure by the rich. I shoul d say, that the employment of the poor in roads an d public works, and a tendency amon g landlords an d person s o f propert y t o build , t o improv e an d beautify their grounds, and to employ workmen and menial servants, are the means most within our power, and most directly calculated t o remedy the evil s arising from that disturbance in the balance of product and consumption, which has been occasioned by the sudden conversion of soldiers, sailors, and various other classes which the war employed, into productive labourers.11

Malthus recognized a case of oversaving and proposed increase d invest ment: but as I have said before, his was intuitive common sense rather than adequate analysis. Naturally Lord Keynes was attracted by this approach, for ha d h e no t operate d fro m a simila r intuitiv e commo n sens e i n th e nineteen-twenties befor e his analysis had taken shape in the Treatise an d the General Theory ?

3

The paper pound: Thornton, Ricardo, an d Malthus

The prime object of this chapter is to direct attentio n to the great book by Henry Thornton, Th e Paper Credit of Great Britain (1802): discussion o f the monetary views of Ricardo and Malthus will be brief and will grow out of discussion o f Thornton. I hope that the quality of Thornton's wor k will become obvious as I expound his views, but I would like to quote from two of his modern admirers. First , Professo r Hayek , wh o edited th e moder n reprint of the Paper Credit: 'Although Thornton's merit s have long been overshadowed b y th e greate r fam e o f Ricardo , i t ha s no w com e t o b e recognized tha t in the field of money the main achievement of the classica l period i s du e t o Thornton.' 1 Second , Professo r Schumpeter , wh o de scribed the book as 'an amazing performance' whic h 'anticipated in some points the analytic developments o f a century to come ... as an analyst of money an d credit Ricard o wa s inferior t o Thornton.' Le t m e also quot e Schumpeter on Hayek, and endorse hi s statement: the reprint o f 1939 'is prefaced by an essay by Professor vo n Hayek, the scholarship o f 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.'2 I

THE

C L I M A T E OF O P I N I O N

Fully to understand and appreciate Thornton's book requires knowledge of the historica l context . Le t m e firs t sa y somethin g abou t th e climat e o f opinion, viz. the 'metallist,' laissez faire , approac h t o monetary policy. I have already quoted Adam Smith on the 'avarice and injustice of princes

The paper pound 15 5 and sovereign states' 3 in diminishing the quantity of metal in the coins in terms o f whic h contract s wer e made . Th e creditor s o f th e stat e wer e thereby 'defraude d o f a part o f what wa s due to them.' Perhaps a mor e dramatic statemen t o f thi s purel y 'metallic ' concer n i s foun d i n Joh n Locke's defence o f the standar d a t a time whe n Willia m Lowndes 4 wa s arguing for a temporary devaluation , b y raising th e denominatio n o f the coin rathe r tha n lowering the metal content o f the established denominations. Locke' s Further Considerations concerning Raising th e Value of Money (1695 ) was dedicate d t o Si r John Sommers , Lor d Keepe r o f the Great Seal of England. 'Westminster-hall, ' he said, 'is so great a witness of your lordships unbiassed justice, and steady care to preserve t o every one their right, that the world will not wonder that you should not be for such a lessening of our coin, as will, without any reason, deprive great numbers of blameless me n o f a fift h par t o f thei r estate s beyon d th e relie f o f th e Chancery.'5 The essence of Locke's argument, and the essential element for understanding the context o f the monetar y controvers y o f the Bullionis t er a is contained in the following sentences. Men in their bargains contract not for denominations or sounds, but for the intrinsic value, which is the quantity of silver, by public authority, warranted to be in pieces of suc h denominations; and i t is by havin g a greater quantity of silver, that men thrive an d gro w richer, an d no t b y havin g a greate r numbe r of denominations; which, when they come to have need of their money, will prove but empty sounds, if they do not carry with them the rea l quantity of silver expected. The standard once settled by public authority, the quantity of silver established under the several denominations (I humbly conceive) should not be altered till there were an absolute necessity shown of such a change, which I think can never be. The reaso n why it should no t b e change d is this: because th e publi c authority is guarantee for th e performance of all legal contracts. But men are absolved from th e performance of their legal contracts, if the quantity of silver under settled and legal denomination be altered ... Raising of coin is but a specious word to deceive the unwary. It only gives th e usua l denominations of a greater quantity of silve r to a les s .. . I ask, whether he, that is forced to receive but 320 ounces of silver under the denomination of £100 (for 400 ounces of silver which he lent under the like denomination o £100) will think these 320 ounces of silver, however denominated, worth those 400 ounces he lent?6

As I hav e sai d in discussing Adam Smit h on Money, this concer n fo r metal content di d not mean that economist s o f that ag e believed tha t th e

156 Fro m Adam Smith to Maynard Keynes integrity of the standard gave a guarantee of stability of prices, stability of purchasing power , o r stabilit y o f labour command . Tha t ther e wa s n o consideration o f the inequity of the fulfilment o f contracts b y giving up on repayment o f a loan greate r (o r less) purchasin g powe r (o r labour com mand) than had been received when the loan was made, is explained by the distrust of the honesty of governments and disbelief in their competence t o provide a better money than silver (or gold). There wa s much experienc e on whic h t o bas e thi s judgment. I n Lock e i t is summe d up in a table 7 showing the amount of silver contained in one shilling:

28

Edward i Edward in Edward in Henry v Henry vi Henry v i Henry v i Henry v m Henry vm Henry v m Henry v m Edward v i Edward vi Edward vi 2 Elizabeth 43 Elizabeth 18 27 9 I 4 49 I 34 36 37 3 5 6

264 grains 236 grains 2 13 grains 1 76 grains 143 grains 1 76 grains 142 grains 1 1 8 grains i oo grains 60 grains 40 grains 40 grains 20 grains 88 grains 89 grains 86 grains

And s o it has remaine d fro m th e forty-thir d yea r of Queen Elizabet h to thi s day . W. Lowndes's 69.

Since every reduction in the silver content of the shilling was intended by the prince to reduce the real burden of his debts, currency management seemed to be inevitably currency mismanagement. An automatic metallic standard, established an d defended, seemed to be the best guarantee of a money which would give reasonable equity in the relations of debtors and creditors, and thereby give a sufficient confidenc e for that development of that borrowing and lending on which economic growth largely depended. The attachmen t t o th e gol d standar d was , then , essentiall y a matte r of attachment to the principle of 'laissez-faire' related to a profound disbelief in the honesty, intelligence and efficiency o f government.

The paper pound 15 7 The gold standard was an international standard and in the controversy discussed her e i t i s thi s aspec t whic h i s paramount . Ada m Smit h ha d recognized the problem, but saw no difficulty . A country that has no mines of its own must undoubtedly draw its gold and silver from foreign countries, in the same manner as one that has no vineyards must draw its wines. It does not seem necessary, however, that the attention o f government should be more turned towards the one than towards the other object... We trust with perfect security tha t th e freedom of trade, without any attention o f government, will always supply us with the wine which we have occasion for, and we may trust with equal security tha t i t will always supply us with all the gold and silver which we can afford to purchase ... The quantity of every commodity which human industry can either purchase or produce, naturall y regulates itself in every country according to the effectual demand. 8 The effectua l deman d for the mone y metal, in this context , mus t surely have meant the amount that people wanted to hold at a level of domestic prices, o r at a value of the money metal, which would neither induce an increase i n supply (further importation ) nor a decrease (a drain to foreign countries). It wa s Adam Smith's frien d Davi d Hume who had given the classical exposition of this mechanism of adjustment. In his Essay 'Of the Balance of Trade' he wrote: Suppose four-fifths o f all the money in Great Britain to be annihilated in one night... what would be the consequence? Mus t not the price of all labour and commodities sink in proportion? ... What nation could then dispute with us in any market...? In how little time, therefore, must this bring back the money which we had lost, and raise us to the level of all neighbouring nations, where, after w e have arrived, we immediately lose the advantage of the cheapness o f labour and commodities, and the furthe r flowin g i n o f mone y is stoppe d b y ou r fulnes s an d repletion . Agai n suppose that all the money of Great Britain were multiplied fivefold in a night, must not the contrary follow .. . Now, i t is evident, that the sam e causes which woul correct thes e exorbitan t inequalities , wer e the y t o happe n miraculously , mus t prevent their happening on the common course of nature, and must forever, in all neighbouring nations, preserve money nearly proportionable to the art and industry of each nation.9 The mercantilist's concern for the balance of trade seems in the light of these quotations fro m Adam Smith and David Hume to be misplaced: one

158 Fro m Adam Smith to Maynard Keynes can safely leave alone. Interference is unnecessary, and when undertaken likely to be inept and harmful. But Hume recognized tha t there were short run effect s o f those rising and falling prices whic h were necessary fo r the adjustment to be achieved. In his Essay on 'Money' he said: We find , that , i n ever y kingdom , into whic h mone y begins t o flo w i n greate r abundance tha n formerly , everythin g takes a new face; labour and industry gain life; the merchant becomes more enterprising, the manufacturer more diligent and skilful, and even the farmer follows the plough with greater alacrity and attention... There is always an interval before matters be adjusted t o their new situation; and this interval is as pernicious to industry, when gold and silver are diminishing, as i is advantageous when these metals are increasing. The workman has not the same employment from th e manufacturer and merchant... the former cannot dispose of his corn and cattle, though he must pay the same rent to the landlord. The poverty and beggary, and sloth, which must ensue, are easily foreseen. 10

One wonders whether the mercantilists were not justified in worrying about the 'pernicious' effects i n the 'interval,' or short run, particularly i f there were likel y t o b e a n almos t continuou s serie s o f suc h intervals . I n th e argument between Thornton, Ricardo and Malthus, the cost of the 'pernicious' shor t run effects was underestimated by Ricardo; but perhaps his estimate of the importance of the long run, even secular, maintenanc e of the standar d justified his refusal to consider an y mitigation of those per nicious effects . II

THE HISTORICAL CONTEXT

I do not propose to recount the monetary history of the Napoleonic war but a few relevant facts must be noted. The work of N.S. Silberling published in the Review of Economic Statistics (1923) and in the Quarterly Journal of Economics (1924 ) give s th e detaile d statistica l background. 11 Her e al l I need to say is that by 1790 gold had come to be de facto th e standard, an d that the gold reserve wa s held by the Bank of England. In 1793 there was a run o n the Bank of serious dimensions, a typical 'panic' related t o fear of invasion. Thi s wa s successfull y met b y providin g an alternativ e highl y liquid asset which was accepted b y many who had sought gold. This was a purely 'interna l drain ' an d th e actio n take n b y th e government foreshadowed the suspensions of the Bank Charter of 1857 and 1866. As on those occasions th e drain of gold ceased whe n an alternative liqui d asse t was known to be available in sufficient quantity. In 1797 a new crisis arose: the reserv e o f the Ban k of England fel l fro m aroun d £5 million to £1.2 5

The paper pound 15 9 million. Thi s tim e ther e wa s bot h a n interna l drai n relate d t o renewed invasion panic; and an external drain as French 'hot money' in London was repatriated, an d as the transfer problem involved in financing a European war became difficult. Faced with this drain of gold the government, first by Order in Council and then by Act of Parliament, suspended cash payments by the Bank. Following suspension there was a restoration of confidence at home and a favourable change in the balance of payments. The reserves of the Bank increased an d things went on much as if there were still a solid gold standard. But with the turn of the century pressure develope d o n the foreign exchange market and since the pound was no longer convertible it fell to a discount, by 1801 of some 13 per cent. This was well below the' gold point' which was probably, in those days of war, about 5 per cent below the gold par. Wit h this discoun t o n the exchang e marke t there develope d a premium on gold bullion of about 8 per cent: if one could buy and export gold the 8 per cen t premium plus 5 per cent to cover the cost o f freight, insurance, etc., made it a matter of indifference whether one bought bullion at that premium or a bill of exchange at that discount. The pressure on the exchange cam e from heav y wa r expenditure s i n Europe combine d with unusually heav y importatio n o f corn. I t wa s i n this perio d o f exchange difficulty tha t Thornto n wrot e his Paper Credit. Fro m 180 4 to 180 9 th e exchange rat e staye d withi n the gol d point s an d th e premiu m on gol d therefore was eliminated. From 1809 to the end of the war there was again pressure o n th e exchange : th e discoun t risin g t o 2 0 per cent , an d th e premium on gold to about 1 6 per cent. It wa s in this period that Ricard o wrote his pamphlet on The High Price of Bullion (1810), that the House of Commons Committe e publishe d th e Bullion Report (1810) , tha t Henr y Thornton mad e two speeches tha t were reprinted by Professor Hayek in his editio n o f th e Paper Credit, an d tha t T.R . Malthu s expresse d hi s monetary views in the Edinburgh Review. Before I turn to this literature, small samples of a veritable flood of writing, let me add this. So far as we can now tell, prices rose during this period by 66 per cent from 179010 1801, by a further 1 0 per cent by 1810, and were nearly doubled by the end of the war. This inflation seem s to have caused littl e concern: equit y as I have said above was concerned with metallic equivalence not with equivalent purchasing power . A twent y pe r cen t premiu m on gol d defraude d th e creditor of one-fifth of his due; a hundred per cent rise in prices, halving the 'real' burden of the debt, was scarcely discussed. Suspension of cash payments meant that the automatic monetary system had been replaced by a managed currency. The manager, the Bank of England, di d not recogniz e tha t it s role ha d changed , that i t had a new responsibility. If it had recognized it s new function a s manager, it might

160 Fro m Adam Smith to Maynard Keynes have asked wha t it was expected t o achieve. I suppos e tha t th e answe r would have been that the paper money of the nation should be managed in such a wa y a s t o mak e it behav e a s i f the gol d standar d ha d no t bee n suspended. Deliberat e managemen t should achiev e wha t the automati c mechanism o f fre e convertibilit y o f al l mone y int o gol d woul d hav e achieved. Th e rise in prices would be forgivable, but not the premium on gold: inflation was acceptable, devaluation was anathema. i n Th e Paper Credit of Great Britain * I propose to ignore Thornton's description of the institutions of the English banking system, and quote only such passages as seem to me to be interesting and important in relation t o the development o f monetary theory and monetary policy. First , let me note the passage referrin g to the panic of

1793:

The alarm , the first material one of the kind which had for a long time happened , was extremely great. It does not appear that the Bank of England notes, at that time in circulation , wer e fewe r tha n usual . I t i s certain , however , tha t th e existin g number became, at the period of apprehension, insufficient for giving punctuality to the payments of the metropolis; an d it is not to be doubted, tha t th e insufficienc y must have arisen in some measure, from tha t slowness in the circulation of notes , naturally attending an alarm, which has been just described. Ever y one fearing lest he should not have his notes read y when the day of payment should come, would endeavour t o provide himsel f with them somewhat beforehan d .. . The success of the remedy which the parliament administered, denotes wha t was the nature of the evil. A loa n o f excheque r bill s was directe d t o b e mad e t o a s man y mercantile persons, givin g proper security , a s shoul d apply . It i s a fact , worth y o f seriou s attention, tha t th e failure s abated greatly , and mercantil e credit bega n t o b e re stored, no t at the period whe n the exchequer bills were actually delivered, but at a time antecedent t o that aera. It also deserves notice , that though the failures had originated i n an extraordinary deman d for guineas, it was no t any suppl y of gold which effected the cure (97-8). Generalizing from this experience of 1793 Thornton said That a state of distrust causes a slowness in the circulation of guineas, and that at such a time a greater quantit y of money will be wanted in order t o effect onl y the * Throughou t thi s par t in the pag e reference s i n the text ar e to the reprin t o f The Paper Credit of Great Britain, ed. F.A. Hayek (1939)

The paper pound 16 1 same money payments, is a position whic h scarcely needs to be proved .. . When a season of extraordinary alarm arises ... guineas, it is commonly said, are hoarded... a considerabl e variet y o f persons , countr y bankers , shopkeepers , an d others , augmenting ... that suppl y which it had been customary t o keep by them ... Thus, then, it appears, that the sentiment which Dr Smith leads his readers t o entertain, namely, that there is in every country a certain fixed quantity of paper, supplying the place of gold, which is all that can 'easily circulate' ... is, in a variety of aspects incorrect (99-1 oo). I explaine d above , i n the sectio n on Money in Book i , the reason why Thornton found Adam Smith not only incorrect but misleading. I repeat the key statement because it is crucial to Thornton's argument. Adam Smith's view might 'lead the reader to suppose, that whenever the bank finds itself subject to any great demand for gold ... the cause of the evil is an excess of circulating paper, and the remedy a reduction of bank notes. There is also a danger lest it should be considered, that if the remedy should appear to fail, it can fail only because the reduction is not sufficiently grea t (103). Thornton ha d n o doubt s abou t th e importanc e o f gol d coi n a s th e 'standard' but he said: 'It is perfectly well understood among all commercial men, that gold coin is not an article in which all payments (though it is so promised) are at any time intended really to be made.' The guarantee that 'gol d shal l b e th e standar d t o whic h the valu e o f that pape r shal l conform itself depend s on 'interchange of gold for paper,' or as we would say on convertibility. Thornton was thus led to a consideration o f reserve policy. In order to secure that this interchange shall at all times take place, it is important that, generally speaking, a considerable fun d of gold should be kept in the country, and there is in this kingdom no other depository for it but the Bank of England. This fund shoul d b e a provisio n no t onl y agains t th e commo n an d mor e triflin g fluctuations in the demand for coin, but also against the two following contingencies. First , i t should serve to counteract th e effects o f an unfavourable balance of trade, fo r thi s infallibl y wil l sometime s occur , an d i t i s wha t on e o r mor e ba d harvests cannot fail to cause. It is also desirable, secondly, that the reserve of gold should be sufficient to meet any extraordinary demand at home, though a demand in this quarter, if it should arise from great and sudden fright, may undoubtedly be so unreasonable and indefinite a s to defy al l calculation, If, moreover , alarm should ever happen at a period in which the stock of gold should have been reduced by the other great cause of its reduction, namely, that of a call having been recently made for gol d to discharge a n unfavourable balance o f trade, th e power s of any bank ,

162 Fro m Adam Smith to Maynard Keynes however ample its general provision should have been, may easily be supposed t o prove insufficient for this double purpose (i 11-12). Already it begins to be realized that the primary purpose for holding gold in reserve is for international payments and that the domestic hoarder of gold may have to be satisfied wit h some other liquid asset. If there wer e an adverse balanc e o f trade an d a drain of gold fro m th e reserve, the teaching of Hume and Adam Smith and later of Ricardo would require a reduction in the domestic money supply and a consequent fall in domestic prices. Exports, i t was supposed, woul d be stimulated, import s reduced, and a new favourable balance woul d lead to a restoration o f the reserves. Hume , a s I hav e said , wa s awar e o f a shor t ru n proble m o f depression; Thornto n discusse d this short run problem with great insight and concern. Let me quote part of his argument. That a certain degree of pressure will urge the British merchants in general who buy of the manufacturers, as well as the manufacturers themselves, to sell their goods in order t o raise money ; that it will thus have som e influenc e i n lowering price s a t home; and that the low prices at home may tempt merchants to export their article s in the hope of a better price abroad, i s by no means an unreasonable supposition . But, then, it is to be observed o n the other hand, first, that this more than ordinary eagerness of all our traders to sell, which seems so desirable, is necessarily couple d with a general reluctance to buy, which is exactly proportionate to it... The sales of the manufacturer s are , therefore, suspended ; but though these ar e stopped , hi s daily and weekly payments continue, provided his manufacture proceeds. I n other words, his money is going out while no money is coming in; and this happens at an aera when the general state of credit is such, that he is not only not able to borrow, in order to supply his extraordinary need , but when he is also pressed for a prompter payment than before of all the raw materials of his manufacture .. . To inflict such a pressure on the mercantile world as necessarily cause s an intermission of manufacturing labour, is obviously not the way to increase that exportable produce, by the excess of which, above the imported articles, gold is to be brought into the country. But, secondly, that very diminution in the price of manufactures which is supposed to cause them to be exported, may also, if carried very far, produce a suspension of the labour of those who fabricate them. The masters naturally turn off their hands when they find their article selling exceedingly ill. It is true, that if we could suppos e the diminution of bank paper to produce permanently a diminution in the value of all articles whatsoever, and a diminution as it would then be fair that it should do, on the rat e o f wages also , the encouragemen t t o future manufacture s would b e the same, though there would be a loss on the stock in hand. The tendency, however, of

The paper pound 16 3 a very great and sudden reduction o f the accustomed number of bank notes, is to create a n unusual an d temporary distress , an d a fal l o f price arisin g fro m tha t distress. Bu t a fall arising from temporary distress, will be attended probably with no correspondent fall in the rate of wages; for the fall of price, and the distress, will be understood to be temporary, and the rate of wages, we know, is not so variable as the pric e o f goods . Ther e i s reason , therefore , t o fea r tha t th e unnatura l and extraordinary low price arising from th e sor t o f distress o f which we now speak, would occasion much discouragement of the fabrication of manufactures (i 17-19).

Thornton considered the possibility o f adjustment through a reduction of imports but noted the magnitude of the importation of essential corn, of raw materials required for domestic manufacture , an d of goods for re-export. He also considered the possibility tha t the exporting merchant might 'press the sale of goods .. . at a short credit' while the importing merchant might 'buy at a long credit.' He noted, however , that 4 a very severe pressure is sure to produce a suspension o f manufactures, while it is not sure to cause British merchant s t o obtai n a n extension o f credit fro m foreigners . An d very extraordinary suppressio n o f ban k note s mus t produc e distrus t abroad, through the failures at home, to which it is known abroad to give rise.' H e conclude d tha t 'som e moderat e restrictio n o f th e pape r o f the bank' may be expedient at a time of an unfavourable balance, but 'any very sudden and violent reduction of bank notes must tend, by the convulsion to which it will lead, to prevent gol d coming into the country, rather than to invite it , an d thu s increas e th e dange r o f th e ban k itsel f (122) . Th e mechanism of adjustment was not as frictionless a s some seemed t o suggest, an d the friction was the greater th e bigger the adjustment required. Following what 'seems likely to have been the advice of Dr A. Smith' the Bank of England had erred i n Thornton's view , 'on the side of too much restricting its notes in the late seasons of alarm' (127). In Chapter v Thornton discusse d th e 'Balance of Trade.' He stated the 'general truth' that the exports and imports of a country 'actually proportion themselve s i n som e degre e t o eac h othe r .. . th e balanc e o f trade , therefore .. . canno t continu e fo r a ver y lon g tim e t o b e eithe r highl y favourable, or highly unfavourable to a country.' But there are inevitably short periods of imbalance. But though the value of the commercial exports and imports of a country will have this general tendency to proportion themselves to each other , there will no t fai l occasionally to arise a very great inequality between them. A good or a bad harvest, in particular, will have considerable influence i n producing this temporary differ-

164 Fro m Adam Smith to Maynard Keynes ence. The extra quantity of corn and other articles imported into Great Britain in this and the last year, with a view to supply the deficiency of our own crops, must have amounted in value to so many millions, that it may justly excite surpris e tha t we should have been able, during an expensive war, to provide the means of cancelling our foreign debt so far even as we have done; especially when the peculiar interruptions to our commerce are also considered .. . If the harvest fails, and imports are necessary, in order to supply the deficiency, payment for those import s is almost immediately required: but the means of payment are to be supplied more gradually through the limitation of private expenditure or the encrease of individual industry. Hence a temporary pressure arises at the time of any very unfavourable balance. T o understand how to provide against this pressure, and how to encounter it, is a great part of the wisdom of a commercial state (143).

Again Thornton referred to the Adam Smith prescription for the cure of this imbalance, and the consequent depreciation o f the exchange and rise in the market price o f gold, viz. , 'a diminution in the quantity of paper.' Adam Smith led one to believe that a difference between the mint price and the market price of gold arises from an issue of a greater quantity. Dr Smith also too much countenances an idea, that the excess consist s of paper forced int o circulation; for he terms the proper quantity that pape r whic h wil l 'easil y circulate. ' He , moreover , induce s hi s reade r t o suppose, tha t the excessive issu e is an issue to a more than usual amount. At the time of a very unfavourable balance of trade (an event which Dr Smith leaves totally out o f his consideration), it i s very possible, a s I apprehend , tha t th e exces s o f paper, if such it is to be called, is merely an excess above that very low and reduced quantity to which it is necessary that it should be brought down, in order to prevent the existence of the market price above the mint price of gold [my italics] (150-51).

There followed the classic passage which came to be quoted time after time in the course o f the controversies ove r theory and policy which continued for a hundred and fifty years. The fair statement of the case seems to be this. At the time of a very unfavourable balance (produced , fo r example, through a failure o f the harvest), a country has occasions for large supplies of corn from abroad: but either it has not the means of supplying at the instant a sufficient quantit y of goods in return, or, which is much the more probable case, and the case which I suppose more applicable to England, the goods which the country having the unfavourable balance is able to furnish a s means of cancelling its debt, are not in such demand abroad as to afford the prospect

The paper pound 16 5 of a tempting or even of a tolerable price; and this want of a demand may happen possibly through some political circumstance which has produced, i n a particular quarter, th e temporar y interruption of an established branc h of commerce. Th e country, therefore , whic h has the favourable balance, being, to a certain degree , eager fo r payment , bu t no t i n immediate want of all that suppl y of goods whic h would be necessary to pay the balance, prefers gold as part, at least, of the payment; for gold can always be turned to a more beneficial use than a very great overplus of any other commodity. In order then, to induce the country having the favourable balance to take all its payment in goods, and no part of it gold, it would be requisite not only to prevent goods from being very dear, but even to render them excessively cheap [m y italics]. It would be necessary, therefore , that the bank should not only not encreas e it s paper, but tha t i t should , perhaps , ver y greatly diminish it, i f it would endeavour to prevent gold from going out in part of payment of the unfavourable balance. An d if the bank do this, then there will arise those other questions , which Dr Smith leaves totally out of his consideration; namely, whether the bank, in the attempt to produce this very low price, may not, in a country circumstanced as Great Britain is, so exceedingly distress trade and discourage manufactures as to impair, in the manner already specified , those source s of our returning wealth to which w e mus t chiefly trus t for th e restoratio n o f our balanc e o f trade, an d fo r bringing back the tide of gold into Great Britain. It is also necessary to notice in this place, that the favourable effect whic h a limitation of bank paper produces on the exchange is certainly not instantaneous, and may, probably, only be experienced after som e considerabl e interva l o f time ; i t may , therefore , i n man y cases, b e expected that the exchange will rectify itself before the reduction of bank paper can have any operation (151-2).

So Thornton concluded : it may be the true policy and duty of the bank to permit, for a time, and to a certain extent, the continuance of that unfavourable exchange, which causes gold to leave the country , an d t o b e draw n ou t o f its ow n coffers ; an d i t must , i n tha t case , necessarily encrease it s loans to the sam e extent to which its gold is diminished. The bank, however, ought generally to be provided with a fund of gold so ample, as to enable it to pursue this line of conduct, with safety to itself, through the period of an unfavourable balance; a period, the duration of which may, to a certain degree, be estimated, though disappointment in a second harvest may cause much error in the calculation (153).

Over a century-and-a-quarte r late r th e Macmilla n Committee o n Fi nance and Industry (i93i)12 found it necessary t o argue:

166 Fro m Adam Smith to Maynard Keynes The proper amount of the ultimate reserve cannot be reached as a fixed proportion of the note circulation (which is the usual principle abroad) o r as the excess o f the note circulation over a fixed figure (which is the principl e of the Britis h fiduciary issue). Fo r i t depends on quit e differen t factor s from thos e whic h determine the note issu e .. . W e recommend .. . tha t th e Bank' s norma l holding s o f gold o r it s equivalent in foreign exchange should, in view of the large liability of London as an international banking centre, be larger than they have been in recent years . What we envisage, therefore , is a Bank of England with both increase d resource s an d greater freedom.

It was not long after this that there developed a greater readiness to accept devaluation, o r mor e flexibl e exchang e rates , t o dea l wit h a degre e of imbalance so large and so persistent tha t even the new freedom to use the gold reserve for international purpose s wa s inadequate. It would be misleading to leave Thornton's argument at this point. While he argued that the depreciation o f 1802 was the result of a failure, which he approved, t o deflate to meet th e peculiar exchange pressur e o f the shor t period, h e full y recognize d an d discusse d i n Chapte r vi n th e cas e o f exchange depreciatio n developin g fro m domestic inflation . What is more he recognize d the cumulativ e proces s of expansion . I shal l not quot e Thornton a s fully on this inflationary case as I did on the deflationary one . Let me, however, draw attention to his exposition of'the steps by which an increase o f paper serve s t o lift u p the price of articles (195). ' Then le t me note his discussion of the limit to the increase o f employment with expanding credit: Th e antecedentl y idl e persons t o whom we may suppose th e new capita l to giv e employ, are limite d in number' (236) . Finally le t m e quote a very 'Wicksellian' passage. In orde r t o ascertai n ho w fa r th e desir e o f obtainin g loans a t th e ban k ma y b e expected at any time to be carried, we must enquire into the subject of the quantum of profit likely to be derived from borrowing there under the existing circumstances. This is to be judged of by considering two points: the amount, first of interest to be paid o n th e su m borrowed ; and, secondly , of the mercantil e or othe r gai n t o b e obtained by the employment of the borrowed capital ... We may, therefore, consider the question as turning principally on a comparison of the rate of interest taken at the bank with the current rate of mercantile profit (253),

or as Wicksell would say a comparison betwee n th e 'market' and 'natural' rates. In 180 2 the Ban k was prohibited by law from chargin g more than 5 per cent. This rate, Thornton argued , was too low in the conditions of war. 'The borrower s i n consequence o f that artificial state of things whic h is

The paper pound 16 7 produced b y th e la w against usury , obtai n thei r loan s to o cheap . Tha t which they obtain too cheap they demand in too great quantity. To trust to their [th e Ban k Directors] moderation and forebearance unde r suc h cir cumstances' i s unreasonabl e (255) . No w i t migh t b e though t tha t th e extension of bank loans, by furnishing additiona l capital, would reduce the profit o n it . Bu t Thornto n pointe d ou t tha t afte r th e ris e i n prices th e 'temptation to borrow at five per cent will be exactly the sam e as before (255). He concluded that 'there can be no reason to believe that even the most libera l extensio n o f bank loans will have the smalles t tendenc y t o produce a diminution o f the applications to the bank for discount (256).' Meanwhile, as we shall shortly see, th e Director of the Bank of England felt that they need not worry as long as they lent on good security, did not think the rate of interest was relevant, and were quite sure that their credit policy had no effect on the exchange rate! Thornton's final statement of a sound policy for the Bank followe d thi s discussion of the danger of cumulative inflation: To limit the total amount of paper issued, and to resort for this purpose, whenever the temptation to borrow is strong, to some effectual principl e of restriction; in no case, however, materiall y to diminish the su m in circulation, bu t t o let it vibrate only withi n certain limits ; t o affor d a slo w an d cautiou s extensio n o f it , a s th e general trad e o f th e kingdo m enlarge s itself ; t o allo w o f som e special , thoug h temporary encrease in the event of any extraordinary alarm or difficulty, as the best means of preventing a great demand at home for guineas; and to lean to the side of diminution, in the case of gold going abroad, and of the general exchanges continuing lon g unfavourable ; thi s seem s t o b e th e tru e polic y o f th e director s o f a n institution circumstance d lik e tha t o f the Ban k o f England . T o suffe r eithe r th e solicitations of merchants, or the wishes of government, to determine the measure of the ban k issues , i s unquestionabl y t o adop t a very fals e principl e of conduc t (259).

iv Th e High Price o f Bullion * Renewed depreciation, and depreciation of greater degree, brought a flood of pamphlet literature, generally of very high quality, in the years 1809-11. Of these the mos t famous i s David Ricardo's, The High Price o f Bullion a proof o f th e Depreciation o f Bank Notes. Already in 1809 in a letter to th e Morning Chronicle (Augus t 29) he had made his stand clear. 'Let the Ban k * Throughou t thi s Part page reference s i n the text are to Ricardo's, High Price of Bullion. Reprinted i n Works an d Correspondence o f David Ricardo, ed . Pier o Sraffa (1951) , vol. HI: Pamphlets an d Papers, 1809-1 1

168 Fro m Adam Smith to Maynard Keynes be enjoined by Parliament graduall y to withdraw to the amoun t of 2 or 3 millions of their notes from circulation' the price of gold would then fall to the mint price, exchange s retur n t o par, prices woul d fall, an d cash pay ments could be resumed. 'It would then be evident that all the evils in our currency wer e owing to over-issues o f the Bank, to the dangerous powe r with whic h i t was entruste d o f diminishing at it s wil l the valu e o f ever y monied man's property, and by enhancing the prices of provisions injuring all thos e wit h fixe d income s (21). ' Th e pamphle t o f 181 0 expanded th e argument an d criticized th e dangerou s view s o f Henry Thornton . In my view th e difference s betwee n Ricard o an d Thornton wer e no t base d o n disagreement o n the theor y of money and the exchanges, but on a differ ence i n their estimate s o f the degre e o f deflation necessary t o brin g th e exchanges dow n withi n the gol d points , o f the degre e o f distress whic h would be caused by that deflation, and of the probability that the deprecia tion would be temporary and that in the long run the old standard could be maintained. The argument was obscured by the use of such highly charged words a s 'over-issue, ' 'redundant ' currency , an d 'excessive ' issue . T o Ricardo thes e term s mean t a note issu e i n excess of that whic h rigorou s maintenance of the standard woul d require: to Thornton 'a n excess above that very low and reduced quantit y to which it is necessary tha t it should be brought down , in order t o prevent th e existence abov e th e min t price of gold' was not an excess in the sense of a quantity greater than was socially desirable. Let me quote some of the relevant passages from Ricardo . It appears that the currency of one country can never for any length of time be much more valuable, as far as equal quantities of the precious metals are concerned, than that of another; that excess of currency is but a relative term; that if the circulation of England were 1 0 millions, that of France 5 millions, that of Holland 4 millions, etc., whilst they kept their proportions, though the currency of each country were doubled or trebled, neither country would be conscious of an excess of currency. The pric e o f commodities would everywher e rise, on accoun t of the increas e of currency, bu t ther e would b e n o exportatio n of mone y fro m either . But i f these proportions b e destroyed by Englan d alone doubling her currency , while tha t of France, Holland , etc., continue d as before , we shoul d the n be consciou s o f an excess in our currency , and for the sam e reason the other countries would feel a deficiency in theirs, and part of our excess would be exported till the proportions of ten, five, four, etc., were again established (56-7).

The Bank when required t o convert it s notes int o gold would be forced to restrict it s issue to the amount that was consistent wit h the value of gold

The paper pound 16 9 in the world generally. 'It appears that the temptation to export money in exchange for goods, or what is termed an unfavourable balance of trade, never arises but from a redundant currency' (59). Redundant from the point of view of the standard, yes: but redundant in the view of social policy, not necessarily. So the argument with Thornton begins: Mr Thornton wh o has considered thi s subject very much at large, supposes tha t a very unfavourabl e balance o f trade ma y be occasione d t o thi s country by a bad harvest, and the consequent importation of corn; and that there may be at the same time an unwillingness in the country to which we are indebted to receive our goods in payment; the balance due to the foreign country must therefore be paid out of that part of our currency consisting of coin, and that hence arises th e demand for gold bullion, and it s increased price . H e considers th e Ban k as affording considerabl e accommodation t o th e merchants , b y supplyin g wit h thei r note s th e voi d oc casioned by the exportation o f the specie ... A void of currency, as here supposed , can only be occasioned by the annihilation or limitation of paper currency, and then it would speedily be filled by importations of bullion, which its increased value, in consequence of the diminution of circulation medium, would infallibly attract to the advantageous market. However great the scarcity of corn might be, the exportation of mone y woul d b e limite d b y it s increasin g scarcity . Mone y i s i n suc h genera l demand, and , in th e presen t stat e o f civilization , is s o essentia l t o commercial transactions, that it can never be exported t o excess ; eve n in a war, such as th e present, whe n our army endeavours t o interdic t all commerce with us, the value which th e currenc y woul d bea r fro m it s increasin g scarcit y woul d preven t th e exportation of it from being carried so far as to occasion a void in the circulation. Mr Thornton has not explained to us why any unwillingness should exist in the foreig country to receive our goods in exchange for their corn; and it would be necessary for hi m to show , that i f such a n unwillingness were to exist, we shoul d agree t o indulge it so far as to consent t o part wit h our coin . I f we consent t o give coin in exchange for goods, it must be from choice , no t necessity. W e should not import more good s tha n w e export , unles s w e ha d a redundanc y of currency, which it therefore suit s us t o mak e a par t o f our exports . The exportatio n of the coi n is caused b y it s cheapness, an d i s not th e effect , bu t th e caus e o f an unfavourable balance: we should not export it, if we did not send it to a better market, or if we had any commodity which we could export more profitably. It is a salutary remedy for a redundant currency; and as I have already endeavoured to prove that redundancy or excess is only a relative term (59-61). Surely Thornton had made it clear that the unwillingness to receive our goods wa s a n unwillingnes s at an y bu t a n excessivel y lo w price . An d Ricardo's reference to the endeavours of our enemy to 'interdict all com-

170 Fro m Adam Smith to Maynard Keyne s merce with us' might have been expected t o lead him to wonder how great a fall i n price s woul d b e necessary . On e migh t wonde r to o whethe r th e degree o f unemployment tolerable when fighting an unpopular wa r is not very low. As to the fact of depreciation ther e was no disagreement wit h Thornton: 'the maintenance of our general exchanges, or... the agreement of the Mint price wit h the bullion pric e o f gold .. . seem s t o be the true proof tha t the circulating pape r i s not depreciated.'13 And by 181 0 Thornton was chang ing his tune: the depreciation was then more seriou s and the threat to the long-run standar d greater , so , a s a signator y an d partia l autho r o f th e Bullion Report, an d i n hi s speeche s i n th e Hous e o f Common s o n th e Bullion Report whic h are reprinted in Hayek's edition of the Paper Credit, Thornton joined Ricard o in the defence of the standard. Le t me quote first Ricardo: The extraordinary powers with which they [the Directors of the Bank] are entrusted enable them to regulate at their pleasure the price at which those who are possessed of a particular kind of property called money, shall dispose of it... Today i t is their pleasure tha t £4.10 5 shal l pas s fo r £3.17 5 ioV2d , to-morro w the y ma y degrad e £4.155 to the same value, and in another year £10 may not be worth more ... A debt contracted i n 179 7 may now be paid with 85 per cen t of its amount; and who shal l say that the depreciation will go no further' (95-6).

The Ricardia n remed y was 'that th e Bank shoul d graduall y decreas e the amount of their notes in circulation .. . till the prices of gold and silver shal l be brought down to their Mint price' (94). When this had been done, cas h payments could be resumed. To preven t the evil consequences whic h may attend th e perseveranc e i n this system , w e must kee p ou r eye s steadil y fixed on the repeal of the restriction bill. The only legitimate security which the public can possess agains t the indiscretion of the Bank is to oblige them to pay their notes on demand in specie' (98-9). The change in Thornton's view on policy may well have been induced by his experience o n the Select Committe e of the House o f Commons on the High Price o f Bullion.14 The evidenc e given by the officers o f the Bank of England wa s enoug h t o convinc e anyon e tha t a a currency manage d b y them was unsafe. The y refuse d to admi t that th e 'amoun t of Bank note s issued can operate upon the price of bullion, or the state of the Exchanges ' and state d thei r opinio n 'tha t th e pric e o f Bullio n o r th e stat e o f th e Exchanges, ca n never be a reason for lessening the amount of Bank notes to b e issued. ' M r Whitmore , th e lat e Governor , sai d ' I neve r thin k i t

The paper pound 17 1 necessary t o advert to the price of gold, or to the Exchange, on the days on which we make our advances.' The automatic early warning systems of the drain of reserves unde r convertibility ha d been abandoned , an d the nee d for a n alternative i n personal watchfulnes s was not recognized. The y als o showed complete ignoranc e of the importance of the rate of interest. Th e committee quoted the following extract from the minutes of evidence.'' 'Is it your opinion that the same security would exist against any excess in the issues of the Bank, if the rates o f discount was reduced from £5 to £4 per cent?" Answer - "The security of an excess of issue would be, I conceive, precisely the same" -Mr Pearse. " I concu r in that answer." "If i t were reduced t o £3 per cent" - M r Whitmore. "I conceiv e ther e woul d be no difference, i f our practice remaine d the same as now, of not forcing a note into circulation. " - M r Pearse. " I concu r i n that answer. " ' Lik e goo d bankers the y thought onl y of 'good security,' they had not learnt tha t a s Central Bankers , a s managers o f the mone y system , the y mus t establis h new criteria. If they had understood Thornton they would have known that their loans created the very condition that brought borrowers to them with excellent prospect s o f profit . Th e Wicksellia n cumulativ e process wa s beyond their ken. Suspension o f cas h payment s had 'th e effec t o f committin g into th e hands of the Directors of the Bank of England, to be exercised at their sole discretion, the important charge of supplying the Country with that quantity of circulation mediu m which is exactly proportiona l t o the wants and occasions o f the Public. ' I t ha d appeare d fro m th e evidenc e tha t thes e Directors possesse d 'no distinct an d certain rul e to guide their discretion' and it was the opinion of the Bullion Committee that it was unreasonable to ask them to perform the duty laid on them. The most detailed knowledge of the actual trade of the Country, combined with the profound scienc e in all the principl e of Money and Circulation , would not enable any ma n o r an y se t o f me n t o adjust , an d t o kee p alway s adjusted , th e righ t proportion of circulating medium in a country to the wants of trade ... if the natural system o f currency an d circulatio n [th e metalli c standard] be abandoned , and a discretionary issue of paper money substituted in its stead, it is vain to think that any rules can be advised for the exact exercise of such a discretion.15

Thornton, in his speech in the House of Commons on 7 May, 1811, made a strong statement on the importance of maintaining the standard. 'H e must advert,' he said, 'to the important subject of the standard of our currency. There was great danger of our finally departing from it , if we suffered th e

172 Fro m Adam Smith to Maynard Keynes present depreciation o f our paper to continue.' The government proposa l which he was opposing 'appeared to him to be liable to the construction of laying in some claim to depart from it, if such a measure should hereafter be deemed expedient; for it asserted th e King' s right, at a period whe n the temptation to exercise it was occurring, might naturally execute apprehen sion among the public.'16 The two speeches tha t Thornton mad e have an interest beyon d their polic y polemics . Ther e were made , unobtrusivel y and largely unnoticed, important contributions to monetary theory. In the Paper Credit h e had noted the importance of the distinction between th e market and the natural rates of interest, now in the speech o f May n h e noted a further distinctio n between th e marke t and the 'real ' rat e o f interest. If, for example, a man borrowed of the Bank £1000 in 1800 and paid it back in 1810 ... he paid back that which had become worth less by 20 or 30 per cent than it was worth when he first received it. He would have paid an interest of £50 per annum for the us e o f the money ; but i f from thi s interest wer e deducte d th e £2 0 or £30 per annum which he had gained by the fall in the value of money, he would find that he had borrowed a t 2 or 3 per cent, and not at 5 per cent as he appeared to do.17

In recent years of inflation this concern for the real rate has become highly relevant, and neglect of the concept led to misunderstanding of the situation: high market rates failed to restrict investment, for the 'real' rate was relatively low, and lower than the 'natural' rate. This speech also contained a reference to the importance of the rate of interest in attracting gold from other countries. 'A high rate of interest would arise, and this extra profit on the us e o f gold, which would increase a s its quantity diminished, would contribute to detain it here.' Thus was interest rate policy introduced into the discussion of the 'mechanis m of adjustment.'18 Befor e leaving Thornton perhaps I may revert to another of his important anticipations of later theory. In the Paper Credit he expounded the doctrine of 'forced saving.' It must be admitted, that, provided we assume an excessive issue of paper to lift up , as i t ma y fo r a time , th e cos t o f good s thoug h no t th e pric e o f labour , som e augmentation of stock wil l be the consequence; for the labourer, according to this supposition, ma y be forced by his necessity t o consume fewer articles, though he may exercise the same industry. But this saving, as well as any additional one which may arise from a similar defalcation of the revenue of the unproductive members of the society, will be attended with a proportionate hardshi p and injustice. 19

The paper pound 17 3 The doctrine of forced saving has become old-fashioned and unfamiliar. It can still be very useful. V

RICARDO

AND

MECHANISM

THE R I C A R D I A N

OF ADJUSTMENT

THEORY

OF THE

Jacob Viner, in Canada's Balance of International Indebtedness, 1900-13 (1924), maintained not only that the 'Ricardian' theory of the mechanism of international balance s o f indebtness originate d wit h Henry Thornton, bu t also that 'Ricardo rejected this explanation an d offered one in conflict with it.' This opinion is quoted i n most of the later writers on the subject, e.g. , Professors Angell, Ohlin, Haberler. In spite of the great weight of authority I do not accept the verdict as correct. I was encouraged t o find that in his later book, Studies in International Trade, Viner, after restating his earlier view added, 'i t is arguable that the above accoun t exaggerate s th e differ ence between Ricardo and the other bullionists.'20 The problem is whether Ricardo accepte d th e so-calle d Ricardia n theor y o f th e mechanis m of adjustment a s requiring a fall i n export prices i n the countr y making the transfer. The alternative vie w stresses the transfer of 'purchasing power' and the 'shif t i n demand schedules' a s inducing the receiving country t o buy mor e goods an d services (an d enough more) in the absenc e o f price changes. I am not concerned her e to evaluate the alternative theories; I am concerned only to dispute the interpretation of Ricardo's writings. Thornton ha d explained i n the Paper Credit that 'a t a time of a very unfavourable balanc e (produced , fo r example , throug h a failur e o f th e harvest)' adjustment, in default of plenty of gold for export, would require a drastic fall in export prices. 'In order, then to induce the country having the favourable balance to take all its payment in goods, and no part of it in gold, it would be requisite not only to prevent goods from being dear, but even to render the m excessively cheap. ' Professor Vine r in Canada's Balance 21 quoted this passage from Thornton and then the following comment upon it from Th e High Price of Bullion, to sho w that Ricardo rejected thi s view: 'Mr Thornton has not explained to us why any unwillingness should exist in the foreign country to receive ou r goods for their corn .. . We should not import mor e goods tha n we export unles s w e had a redundancy of currency. The exportation of the coin is caused by its cheapness, and is not the effect, bu t the cause o f an unfavourable balance.' Professor Viner , however, ignored the immediately preceding paragraph in Ricardo's pamphlet, which seems to endorse th e Thornton vie w that prices would fall, though

174 Fro m Adam Smith to Maynard Keynes Ricardo and Thornton obviously disagreed as to whether such a fall was to be deplored an d if possible avoided . 'However great,' said Ricardo in this earlier paragraph, 'th e scarcity of corn might be, the exportation o f money would b e limite d by its increasin g scarcity . Mone y .. . ca n neve r b e exported t o excess ; eve n i n war , suc h a s th e present , whe n ou r enem y endeavors to interdict all commerce with us, the value which the currency would bear from it s increasing scarcity [m y italics] woul d preven t th e exportation o f it being carried s o far a s to occasion a void in the circula tion.' Malthus in his review of Ricardo's pamphlet in the Edinburgh Review22 had, like Professor Vine r later, starte d hi s quotation fro m Ricard o at th e words: 'M r Thornton ha s not explained ... ' He also ignored the previous paragraph, quoted above. He stated Ricardo' s erro r to be that 'of denying the existence of a balance of trade or of payments, not connected wit h some original redundanc y o r deficiency of currency' [italics , mine] . The inno cent wor d original seems to misrepresent Ricardo . It is true that Ricard o had said: 'We should not import more goods than we export unless we had a redundancy o f currency.' Bu t what does redundanc y mean? Does i t not mean mor e tha n woul d circulat e i f the standar d wa s maintained , i.e. , i f exchange rates wer e kept withi n the gold points? Does i t not follow that Ricardo meant that England, the paying country, would not import more goods tha n were exporte d unles s there wa s a failure t o contract th e currency sufficientl y t o maintai n the standar d i n the fac e of such increase d pressure on the exchanges? Viner, commenting on this review by Malthus, said that 'he argued that Ricardo had not shown why the country to which a subsidy wa s grante d shoul d immediatel y demand a t th e sam e price s a greater quantity.' But as I have tried to make clear Ricardo did not say 'at the same prices,' and I must now add that Malthus did not say that he did. The differences in exposition are to be explained by reference to policy rather than to logic. The Thornton approac h seeme d to distract attentio n from the real issue, the standard: if people were able to say that the trouble lay i n th e exceptiona l foreig n trad e situatio n their attentio n woul d b e distracted from the Bank and its duty to regulate the note issue with a view to counteracting such exceptional conditions in foreign trade. The problem was not just academic and the differences wer e not purely intellectual; the political element was of very great importance. The theory was, I maintain, the same: Ricardo, equally with Thornton, accepted th e 'Ricardian' theory of adjustment through price changes. The theor y might surely have been named after Hume!

The paper pound 17 5 vi

P O S T S C R I P T , u s 193 0

This is no place to discuss the monetary events and policies of the United States in 1930. The Great Contradiction 23 by Schwartz and Friedman is a superb critical account. As I read it, however, I felt that Henry Thornto n would have given the advice, tha t thes e author s argu e should have been given i n 1930 . Surel y Thornto n woul d hav e tol d th e u s monetar y au thorities to meet the internal drain by an expansion of the currency, and the external drain by exporting gold rather than by raising the discount rate and precipitating domesti c deflation ; and surel y he would have tol d the m to stop immobilizing their enormous gold reserve by tying it to the volume of the note circulation. W e cannot be certain that suc h policies woul d have cured the international monetar y illness: but we can be reasonably certai n that they would have greatly alleviated it . My reason fo r referring to this episode i s to draw attention t o the incredibl y slo w growth in our understanding of the economic system . We seem to have to rediscover i n each generation some of the ideas that our forefathers had developed .

4

The Ricardian theory of value and distribution

I

THE

CORN

LAW

CONTROVERSY

Just a s Ricardo' s monetar y writing s grew ou t o f th e controvers y ove r monetary polic y s o his theor y of value and distributio n was, in it s first expression, a product of controversy over the Corn Laws. A brief examination of the historical context will show the drastic change in the climate of opinion resulting from three pamphlets; Essay on the Application of Capital t o Land (1815) by Si r Edward West, Observations on the Corn Laws (1814) by T.R. Malthus, and thelnfluence o f the Low Price of Corn on the Profits o f Stock (1815) by David Ricardo. The patter n o f protectio n t o cor n producer s was , i n th e eighteent h century, on e o f hig h duties a s lon g as th e domesti c pric e wa s belo w a certain level , wit h drasti c reductio n i n th e dut y whe n th e pric e brok e through that level. In 179 1 the duty was 245 3d when the price was under 50s, 2s 6d when it was between 505 and 548; and 6d when it was over 545. From 179 5 to 180 0 there wa s suc h scarcit y o f corn tha t th e dutie s wer e waived and even some premiums offered o n importation. Then in 1801, the price of corn fell to 498 6d. There was considerable agitation and an inquiry was demanded. Was 508 still a fair price, a 'remunerative' price? A Committee of the House of Commons recommended higher protection, with 638 as the price below which the high duty would be imposed.l In the debate on their Report, Squir e Wester n sai d th e measure proposed 'wa s mean t to prevent thousands of acres from being deserted b y the plough, to prevent recurrence o f scarcity, an d ultimately to make the price of corn cheap by increasing the supply.' A bad harvest brought the price up to 86s and the

The Ricardian theory of value and distribution 17 7 proposal wa s dropped. Hig h prices continue d an d by 181 3 the price was 1178. In that year another Parliamentary Committee reported unde r pressure fro m th e Iris h wh o wanted freedo m to expor t t o a well protecte d English market. The report talked of the danger of dependence o n foreign supplies, and repeated Western's thesis that extension of domestic agriculture promised lower prices. Parnell, in presenting the Report, argued that if agricultural capital were considerably increased the 'effects on the quantity produced and the expense of production, an d also in lowering prices, will be just the same as when employed in manufactures' where the reduction of cost and prices consequent on larger production is notorious. This plea for 1058 as the 'remunerative ' price below which the hig h duty would have applied was rejected. Agricultur e wa s very prosperous. A s one member said in the debate in the House of Commons: Formerly a farmer thought it a high luxury if he was able to enjoy his ale; but now on entering their houses you are not only treated with a bottle of port, but sometimes even with madeira ... The sons of the agriculturalists are all fine gentlemen, instead of following the plough they are following the hounds; and the daughters, instead of milking the cows are using cosmetics to their hands that they might look delicate while strumming on the harpsichord.

Landlords wer e doing well too; it was generally stated i n Parliament that rents ha d trebled . Th e fea r wa s tha t i f peace returne d th e existin g law would be no obstacle to importation and the consequent low price 'would deprive the growers of it of a fair return for the labour and capital they had applied in extending tillage.' In 181 4 a bountiful harvest and peace nearly ruined the farmers and the plea fo r increase d protectio n becam e insistent . Agai n there wa s a Par liamentary Committee. Considering the recent extension of agricultrue in the United Kingdom, and considering the expenses of cultivation including rent the Committee recommended 8os as the 'remunerative' price, 'though 965 was necessary o n the cold clay, waste, and inferior lands.' No actio n was taken, and by 1815 there was serious distress. But in the debates of that year there was a new tone. The pamphlets of West, Malthus, and Ricardo had ha d effect . On e membe r doubted th e polic y of offering artificia l en couragement to the extended tillage of soils which could be cultivated only at greatly increased expense . 'I f we encourage the indefinite tillage of our worst land s th e presen t remunerativ e pric e wil l soo n b e insufficient. ' Another argued that 'the country ought not to be compelled to pay a high price for bread, that the experiment of cultivating barren lands might be tried.' An Irish member unintentionally gave the case away when he said

178 Fro m Adam Smith to Maynard Keynes that to supply the English market land had been brought under cultivation that wa s s o stubbor n tha t i t require d si x bull s t o dra w th e plough . I f protection wer e not maintained this land could not be left i n cultivation.' The concept o f diminishing return put an end to the expectation o f lower prices through increased domestic production. The inclusion of rent in the estimates o f cost for determination o f the remunerative pric e was at last recognized as improper. This ought not to have required the new argument of Malthu s and Ricardo ; i t shoul d hav e bee n obviou s t o an y studen t o f Adam Smith. How persistent th e error is was evident to me when agricultural economists of the early nineteen-thirties were publishing estimates of the cost of production o f Western Canadia n wheat . They did not includ e 'rent,' for little land was leased, but they did include, improperly, mortgage payments, and a 'fair' return on the purchase price of the land.2

i i M A L T H U S : Observations on the Corn Laws What is usually thought of as the Ricardian theory o f rent is expressed in the pamphlet by Malthus.3 He explained the necessity of recourse to poorer lands to increase the food supply to meet the needs of a growing population, or of recourse to more intensive cultivation of lands now used with diminishing returns to each next increase in the capital applied. Therefore price s of corn might be expected to rise. If under the impression that the high price of raw produce, which occasions rent , is as injuriou s t o th e consume r a s i t i s advantageou s t o th e landlord , a ric h an d improved natio n were determined by law , to lowe r the pric e of produce, till n o surplus in the shape of rent anywhere remained; it would inevitably throw not only all the poor land, but all, except the very best land, out of cultivation ... The price of produce, i n ever y progressive country, must b e just abou t equa l to th e cos t o f production on land of the poorest quality actually in use .. . It is quite obvious that the price cannot be less; or such land would not be cultivated ... It follows, then that the price of raw produce .. . is sold at the natural or necessary price, that is, at the price necessary to obtain the actual amount of produce, although by far the largest part is sold at a price very much above that which is necessary to its production.

He added a few pages later: 'Ther e is no just reason to believe that if the landlords were to give the whole of their rents to their tenants, corn would be more plentiful or cheaper. '4 The effect would be to turn the tenants into 'gentlemen.' With all this Ricardo agreed bu t his approach wa s not identical as will

The Ricardian theory of value and distribution 17 9 appear below . Bu t genera l agreemen t o n th e analysi s di d no t produc e agreement o n policy. Malthus was protectionist. He argued on grounds of security, agreeing with those who feared dependence o n foreign supplies . But partly he was influenced by his dislike (and fear o f the socia l conse quences) o f excessive industrialization . H e ha d sai d i n the First Essay: 'Excessive proportion o f manufacturing is unfavourable to national happiness.' Here Malthus admitted that manufacture s infuse fres h lif e an d activit y int o al l classe s o f th e stat e .. . excit e invention, encourage science and the useful arts , spread intelligence and spirit, inspire taste for conveniences an d comforts among the labouring classes; and, above all, give a new and happier structur e t o society, b y increasing the proportion o f the middle classes, tha t body on which the liberty, public spirit, and good government must mainly depend.5

But this panegyric did not prevent him from worrying lest 'the manufacturing system' be 'carried to excess.' H e doubted whethe r ' a great relativ e increase t o its manufacturing population and relative check to its agricultural population' would contribute to a country's happiness. Malthu s also feared that cheap corn would give a further stimulus to population growth. And, finally, he argued that there was a legitimate vested interest base d on wartime expansion. The increased investment of the landlords and farmers had been necessary to feed the people when foreign supplies were cut off by war, wer e the y no t entitle d t o a period o f protection durin g which the y could recoup this investment before being subjected to the competition of supplies from a Europe at peace? Malthus realized, however , that the high prices owin g to th e necessit y o f cultivating and improvin g more land t o provide for the demands of an increasing population would be an increasing handicap o n manufacture s in the for m o f higher wages. 'Thi s drawbac k may ultimately be so great as to counterbalance thei r present advantages in skill, capital and machinery.'6 Ricardo was prepared t o agree to a few years' protectio n o f the veste d interest: bu t onl y to a clearl y limite d numbe r of years. Commentin g on Malthus, he wrote: He dwells with much stress on the losses of agricultural capital, which the country would sustain, by allowing an unrestricted importation. He laments the loss of that which by the course of events has become of no use to us, and by the employment of which we actually lose. We might just a s fairly hav e been told , whe n the stea m engine, or Mr Arkwrighf s cotton-machine was brought to perfection, that it would

i8o Fro m Adam Smith to Maynard Keynes be wrong to adopt the use of them, because th e value of the old clumsy machinery would be lost to us. That the farmers of the poorer lands would be losers, there can be no doubt, but the public would gain many times the amount of their losses .. . It might, however, be desirable that the farmers, during their current leases, should be protected agains t th e losses which they would undoubtedly suffe r .. . unde r thei r existing monetar y engagements wit h their landlords. Althoug h th e natio n woul d sacrifice much more than the farmers would save even by a temporary high price of corn, it might be just to lay restrictive duties on importation for three or four years , and to declare that, after that period, the trade in corn should be free. 7

So far a s a s 'security ' i s concerned , Ricard o wa s no t receptiv e t o th e protectionist argument. The dangers o f dependence on foreign supply do not admit of being very correctly estimated: they are in some degree matters of opinion and cannot... be reduced to exact calculation. They are generally stated to be two - is t - That in the case of War a combination of the continental powers , or the influence of our principal enemy, might deprive us of our accustomed suppl y Secondly, That when bad seasons occurred abroad , the exporting countries would have, and would exercise, the power of withholding the quantity usually exported to make up their deficient supply.8

Ricardo replie d tha t th e foreigne r woul d becom e dependen t o n u s for a market as we became dependent on him for supply. When we consider the value of even a few weeks consumption of corn in England, no interruption could be given to the export trade, if the continent supplied us with any considerable quantity of corn, without the most extensively ruinous commercial distress - distres s which no sovereign, or combination of sovereigns, would be willing to inflic t o n thei r people; and, if willing, it would b e a measure t o which probably no people would submit. It was the endeavour of Buonaparte to prevent the exportatio n of the ra w produc e of Russia, more than an y othe r cause whic h produced th e astonishin g effort s of the peopl e o f that countr y agains t th e mos t powerful force perhaps ever assembled to subjugate a nation.9

Having discussed th e inconvenience whic h the exporting countrie s woul d have to endure, he turned to the importing country. A great diminution in our usual supply... would be an evil of considerable magnitude; but w e hav e obtaine d a suppl y equa l t o this , eve n whe n th e growt h o f foreign countries was not regulated by the constant demand of our market. We all know the

The Ricardian theory of value and distribution 18 1 prodigious effect s o f a high price i n procuring a supply .. . I t cannot , I think, be doubted, that we should obtain a considerable quantity from thos e countries with which w e wer e no t a t war ; which, wit h th e mos t economica l us e o f ou r ow n produce, and the quantity in store, would enable us to subsist till we had bestowed the necessary capita l and labour on our own land, with a view to future production ... Buonaparte, when he was most hostile to us permitted the exportation of corn to England by licenses, when our prices were high from a bad harvest, even though all other commerce was prohibited.10 As to the secon d dange r Ricardo argued that th e wider the area fro m which supply was drawn, the less the variation in that supply. It has been remarked, in reference to a single country, that if the crops are bad in one district, they are generally productive in another; that if the weather is injurious to on e soil , o r t o on e situation , i t i s beneficia l t o a differen t soi l an d differen t situation; and by this compensating power, Providence ha s bountifully secure d us from th e frequent recurrence o f dearths. I f this remark be just a s applied to one country, how much more strongly may it be applied to all the countries togethe r which compose our world?11 He cited in support of his argument against the reality of the second danger the cas e o f Hollan d 'whic h countr y depend s almos t wholl y on foreig n supply.' The price of corn there had been remarkably steady 'even during the convulsed times which Europe has lately experienced' and this steadiness ha s given convincing proof tha t 'th e effects o f bad season s ar e no t exclusively borne by the importing countries.' The positive case for free trade in corn in Ricardo's pamphlet was based on his argument that the high price of corn would mean low profits of stock. This argument will be explained in the next section. Here I simply say that he believed that the health and continued growth of manufacturing industry depended on a satisfactory level of profits, and that the wealth of the nation depended on that growth. So he ended his pamphlet with a clear call for free trade in corn. To recur, however, to the subject before me, I shall only further observe, that I shall greatly regret that considerations fo r any particular class, are allowed to check the progress of the wealth and population of the country. If the interests of the landlord be o f sufficien t consequence , t o determin e u s no t t o avai l ourselve s o f al l th e benefits which would follow from importing corn at a cheap price, they should also influence us in rejecting all improvements in agriculture, and in the implements of

182 Fro m Adam Smith to Maynard Keynes husbandry; for it is as certain that corn is rendered cheap, rents are lowered, and the ability of the landlord to pay taxes is, for a time at least, as much impaired by such improvements as by the importation of corn. To be consistent, then , let us by the same act arrest improvement, and prohibit importation.12

i n R i c A R D o : Influence o f a Low Price of Corn on the Profit o f Stock (1815) * Ricardo's argument for free trade in corn was not based on the simple and obvious advantag e o f cheapness o f corn a s of all other things, nor on the principle of comparative cos t which he later expounded i n the Principles. His concern wa s rather for the effect o f cheap cor n on the level of profits. His exposition o f the emergence o f rent as cultivation extend s extensivel y and intensively, though superficially similar to the familiar expositions o f the 'Ricardian' theory of rent in modern elementary textbooks, differs fro m it by its different treatmen t of profit. The familiar modern exposition take s the rat e o f profit a s determined i n the economy a s a whole an d supposes that the margin of cultivation will be that on which cost, including normal profit, equal s price . I n Ricardo, as will be seen fro m th e following quotations, profit was said to be determined at the margin of cultivation and profit in the rest of the economy was supposed to adjust to that rate. Let me make Ricardo's position clear before discussing it further. In the first settling of a country rich in fertile land, and which may be had by any one who chooses to take it, the whole produce, after deducting the outgoings belonging to cultivation, will be the profit s o f capital, and wil l belong to the owne r of such capital, without any deduction whatever for rent. Thus, if the capital employed by an individual on such land were of the value of two hundre d quarters of wheat, of which half consisted o f fixed capital, suc h as buildings, implements , etc. , an d the othe r hal f o f circulating capital - if , afte r replacing the fixed and circulating capital, the value of the remaining produce were one hundre d quarters of wheat, or o f equal value with on e hundre d quarters of wheat, the net profit to the owner of capital would be fifty per cent, or one hundred profit on two hundred capital.'l

This rat e of profit might continu e a s lon g a s equall y fertil e an d well situated land was available. The rate might rise if wages fell or if there were * Throughou t par t i n pag e reference s in th e tex t ar e t o Works an d Correspondence of David Ricardo, ed. Piero Sraffa. Vo l iv, Pamphlets and Papers, 1815-1823

The Ricardian theory of value and distribution 18 3 improvements i n technology, bu t Ricard o proceede d o n th e simplifyin g assumption tha t there would be no 'improvements' and that the real value of labour would 'continue uniformly the same.' He then noted that the rate of profit in agriculture mus t als o be th e rol e in manufacture, o r trade : if there were differences capita l would be transferred i n pursuit of the higher rates. The argument then proceeded: After al l the fertile land in the immediat e neighbourhood of the first settlers were cultivated, if capital and population increased , mor e food would be required, and it could only be procured from lan d not so advantageously situated. Supposing then the land to be equally fertile, the necessity o f employing more labourers, horses , etc., to carry the produce fro m the place wher e it was grown to the place where it was to be consumed , althoug h no alteratio n wer e to tak e plac e in the wage s of labour, would make it necessary tha t more capital should be permanently employed to obtain the same produce. Suppose this addition to be of the value often quarters of wheat, the whole capital employed on the new land would be two hundred and ten, to obtain the same return as on the old; and, consequently, the profits of stock would fall from fifty to forty-three per cent, or ninety on two hundred and ten. On the land first cultivated, th e return would be the sam e as before, namely fifty per cent, o r on e hundre d quarters o f wheat; but , the genera l profit s o f stoc k bein g regulated b y th e profit s mad e o n th e leas t profitabl e employment o f capita l i n agriculture, a division of the one hundred quarters would take place, forty-three per cent, or eighty-six quarters, would constitute the profit of stock, and seven per cent, or fourteen quarters , woul d constitut e rent . An d tha t suc h a division must take place is evident, when we consider that the owner of the capital of the value of two hundred and ten quarters of wheat would obtain precisely the same profit, whether he cultivated the distant land, or paid the first settler fourteen quarters for rent. In this stage, the profit s i n all capital employed in trade would fal l t o forty-three pe r cent (i 3-14).

Following referenc e t o a third extension wit h the profit down to thirtysix pe r cent , Ricard o state d hi s genera l conclusion . 'Thu s b y bringin g successively lan d o f a wors e quality , o r les s favourabl y situated , int o cultivation, rent would rise on the land previously cultivated, an d precisely in the same degree profit s would fall; and if the smallness o f profits do not check accumulation , ther e are hardly any limits to the rise of rent, and the fall o f profit' (14) . As Ricard o pursue d the argumen t he asserted that th e price o f cor n wa s no t jus t on e determinan t o f profit ; i t wa s th e sole determinant. 'Profits of stock fall only, because land equally wel l adapted to produc e foo d canno t b e procure d .. . If , therefore , i n the progres s o f

184 Fro m Adam Smith to Maynard Keynes countries i n wealth an d population, ne w portions o f fertile lan d could b e added to such countries with every increase o f capital, profits would never fall, no r rent s rise' (18) . A fe w pages late r h e said : 'Genera l profit s on capital, can only be raised by a fall in the exchangeable valu e of food' (22). Such a fall can, h e argued, onl y arise fro m a fall in wages, from improve ment in agriculture ('or in the implements of husbandry'), or from importa tion from countries tha t can produce cor n cheaper than we can. On th e wa y t o thi s conclusio n Ricard o devote d tw o paragraph s t o exposition o f a theory o f exchange value . 'Th e price o f corn, an d o f all other raw produce, has been invariably observed to rise as a nation becam e wealthy, an d was obliged t o have recours e t o poorer land s .. . very littl e consideration will convince us, that such is the effect whic h would naturally b e expecte d t o tak e plac e unde r suc h circumstances ' (19) . Thi s i s a matter o f history: hi s argument i s based o n a strong analyti c propositio n supported b y a weak historical prediction . Th e analysis is essentially tha t of Adam Smith: involving not a simple labour theory of equilibrium value at a given time, but a theory o f changes in relative values over long periods of time as the relativ e difficult y o f their productio n (simplifie d into relativ e labour cost) changes. Let me quote Ricardo's exposition: The exchangeable value of all commodities, rises as the difficulties o f their production increase . If then new difficultie s occu r in the productio n of corn, from mor e labour being necessary, whilst no more labour is required to produce gold, silver, cloth, linen, etc., the exchangeable value of corn will necessarily rise, as compared with those things. On the contrary , facilities in the production of corn, or of any other commodity of whatever kind, which shall afford th e same produce with less labour, wil l lowe r it s exchangeabl e value . Thu s w e se e tha t improvement s in agriculture, or i n the implement s of husbandry, lower the exchangeabl e valu e of corn; improvements in the machiner y connected with the manufacture of cotton, lower the exchangeable value of cotton goods; and improvements in mining, or th discovery of new and more abundant mines of the precious metals, lower the value of gold and silver , or, whic h is the sam e thing, raise th e pric e o f all other commodities. Wherever competition can have its full effect , an d the production of the commodity be not limited by nature, as is the case with some wines, the difficulty of facility o f their production wil l ultimately regulate their exchangeable value. The sole effect the n of the progress o f wealth on prices, independently of all improvements, either in agriculture or manufactures, appears to be to raise the price of raw produce and of labour, leaving all other commodities at their original prices, and to lower general profits in consequence of the general rise of wages (19-20).

The conclusion of this analysis of the effect o f the progress o f wealth on

The Ricardian theory of value and distribution 18 5 the assumption tha t there are no improvements i n agriculture, become s a prediction o f a historical tren d b y virtu e of a footnote t o thi s paragrap h which read s as follows: 'Th e causes, which rende r th e acquisitio n o f an additional quantit y o f corn mor e difficult are , in progressive countries , i n constant operation, whilst marke d improvement s i n agriculture, or in the implements of husbandry are of less frequent occurrence.' Had they really been s o infrequent a s t o b e negligible ? Di d they reall y appea r likel y t o continue to be negligible? The case for free importation of food would be no less strong if improvement at home were great: the amount imported would be less. Ricardo recognized tha t his proposition abou t profit would not be readily admitted by those who ascribe to the extensio n of commerce, and discovery of new markets, where our commodities can be sold dearer, and foreign commodities ca n b e bough t cheaper , th e progres s of profits .. . Nothing is more common than to hear it asserted, tha t profits o n agriculture no more regulate the profits o f commerce , tha n tha t th e profit s o f commerc e regulate th e profit s i n agriculture. It is contended tha t they alternately take the lead; and, if the profits of commerce rise , which it is sai d they do, whe n new market s are discovered , the profits of agriculture will also rise; for it is admitted, that if they did not do so, capital would be withdrawn from the land to be employed in the more profitable trade. But if the principles respecting the progress of rent be correct, it is evident that, with the same population and capital , whils t none of the agricultur e capital i s withdrawn from th e cultivation of the land , agricultural profits canno t rise, nor can ren t fall; either the n i t mus t be contende d whic h is a t varianc e with al l the principle s of political economy , that th e profit s o n commercia l capital will rise considerably, whilst th e profit s o n agricultura l capital suffe r n o alteration, or that, under such circumstances, the profits on commerce will not rise (23-24).

In a footnote he then explained 'tha t we cannot abando n the use of it [the marginal land]; for it is the condition on which we obtain the food necessary for ou r population , an d th e deman d fo r foo d i s b y th e suppositio n no t diminished - bu t who would consent t o use it if he could mak e greater profits elsewhere?' (24) Surely th e argumen t throughout th e pamphle t i s vitiated b y a n undue simplicity. In his model there is but one output of agriculture, corn: there is also but one input, corn a s seed, as fodder for cattle t o pull the plough, as food fo r th e workers ; an d the deman d fo r cor n i s perfectly inelastic . S o there nee d b e n o referenc e t o prices : th e margi n of cultivatio n ca n b e determined b y the number of people t o be fed without reference to prices; the rat e o f profi t involve s a rati o o f input , quarters o f corn , t o output ,

186 Fro m Adam Smith to Maynard Keynes quarters of corn, wit h no reference to prices. Professor Schumpete r com menting on this analysis said: Under his implicit assumptions an d in the particular sense in which the terms of the propositions are to be understood, thi s is not only true, but undeniably true, in fact trivially, so. Profits could not possibly depend upon anything else, since everything else is 'given,' that is frozen. It is an excellent theory that can never be refuted and lacks nothin g save sense . Th e habi t o f applyin g result s o f this characte r t o th e solution of practical problem s we shall call the Ricardian Vice.13 The vic e was not, an d is not, confine d to Ricardo and the Ricardians, as Schumpeter knew well. It is a vice to which we all are susceptible . In an earlier section I have referred to Ricardo's obsession wit h the long run an d contraste d i t wit h Malthus' s recognitio n o f th e long-ru n significance o f the shor t run . Ricardo admitte d tha t the discovery o f new markets o r ne w machiner y affected profit s i n th e shor t ru n bu t h e wa s concerned onl y with the ordinary or long-run level of profit. He did not deny that the first discoverer of a new and better market may, for a time, before competition operates, obtain unusual profits. He may either sell the commodities he exports at a higher price than those who are ignorant of the new market, or he may purchase th e commodities importe d a t a cheaper price . Whils t he, or a few more exclusively follow this trade, their profits will be above the level of general profits. But it is of the general rate of profit that we are speaking, and not of the profits of a few individuals ; an d I canno t doub t that , i n proportio n a s suc h trad e shal l b e generally known and followed , ther e will be suc h a fall i n the pric e of the foreig n commodity in the importin g country, in consequence o f its increased abundance, and th e greater facilit y wit h which it is procured, tha t its sale wil l afford onl y the common rate of profits - tha t so far from th e high profits obtained by the few who first engaged in the new trade elevating the general rate of profits - those profits will themselves sin k to th e ordinar y level. Th e effect s ar e precisel y simila r to thos e which follow fro m th e us e o f improved machinery at home. Whilst the us e of the machine is confined t o one, or a very few manufacturers, they may obtain unusual profits, because they are enabled to sell their commodities at a price much above the cost of production -but as soon as the machine becomes general to the whole trade, the price of the commodities will sink to the actual cost of production, leaving only the usual and ordinary profits (24-5). There i s one further passag e which I wish to quote from thi s pamphlet before making a final effort a t interpretation based on some reference to the later Principles. Thi s passag e i s concerne d wit h th e gain s fro m trade .

The Ricardian theory of value and distribution 18 7 Though the expansion of commerce may not raise profits it will increase the provision of 'necessaries and luxuries.' There ar e two ways in which a country may be benefited by trade - on e by the increase of the general rate of profits, which , according to my opinion, can never take place but in consequence o f cheap food, which is beneficial only to those who derive a revenue from the employment of their capital, either as farmers, manufac turers, merchants, or capitalists, lending their money at interest - the other by the abundance of commodities, and by a fall in their exchangeable value, in which the whole communit y participate .. . I t i s i n thi s latte r mod e only that nation s ar e benefited by the extension of commerce, by the division of labour in manufactures, and by the discovery of machinery - they all augment the amount of commodities, and contribute very much to the ease and happiness of mankind; but they have no effect o n the rate of profits, becaus e the y do not augment the produce compared with the cos t o f production on the land , and it is impossible that all other profit s should rise whilst the profits on land are either stationary, or retrograde (25).

Before leavin g thi s pamphle t ther e ar e tw o areas of discussion t o b e opened up. The first is relatively obvious. I have said that modern expositions of rent theory assume the rate of profit in the economy to be given. By contrast, Ricard o argued that the rate of profit in the economy was determined by the rate of agriculture. However wrong he was in this, surely he would hav e bee n wron g to tak e th e rat e of profit a s given . T o d o s o is appropriate only when dealing with a small industry the expansion of which will have a n insignifican t effect o n the deman d for capita l an d othe r re sources. In Ricardo's day agriculture, corn production, wa s surely too big an industry to be able to ignore the effect of its expansion on the demand for capital. The problem is necessarily on e of general equilibrium: one should not take the rate of profit either as given, or as determined in agriculture. In the model of the pamphlet wages are corn and in those days no doubt the proportion o f wages spent on bread wa s very high. If one extends th e notion of wage goods from cor n alone to the wide variety of goods in fact consumed b y th e workers , th e Ricardia n thesi s abou t profit s i s foun d inadequate; but his plea for free trade in food remains strong. In his model, production of corn minus wage cost in corn leaves a surplus in corn which is divided between landlords and capitalists as rent and profit. Profit, it should be noted, means here the whole income of the capitalists, not profit as we would define it, neither 'normal ' profit nor 'windfall' profit. As recourse is had to poorer or less favourably situated lan d the share of rent increase s and of profits decreases. The quantity of profit, quarters of corn, can then be shown as a percentage o f the capital input , all corn. Now suppose tha t

188 Fro m Adam Smith to Maynard Keynes the wag e cost i s reduced b y agricultura l improvemen t o r importation o f cheap food, profit will increase, as a quantity and as a rate. Next, suppos e industrial improvement increases the national product and lowers the cost of othe r wag e goods . Productio n increase s bu t i t i s n o longe r easil y quantified for it consists of many things, not just corn. Suppos e real wages to be unchanged, but their real cost to have been reduced, then wages as a proportion of production per man must have fallen. The surplus must then have increased absolutely, and as a proportion of product per man. Nothing has happened that would increase rent, therefore the full impac t of the improvement i s on profits. I n al l of this there i s no need t o establis h th e actual quantity of the surplus, or the actual proportion o f the product pe r man accruing as surplus. Such quantification is strictly impossible. But the proposition tha t the quantity and the proportion wil l increase unde r thes e conditions is independent of the ability to measure by how much they will increase. Of course the higher profits may induce a greater competition for workers and wages may rise; the increased surplu s would then be share d between labour and capital. It is very unlikely that labour would absorb all the gain and that profits would not rise. Finally suppose tha t the improved technology lowers the cost of non-wage goods. If the effect i s on luxuries it would follow from thi s revised Ricardia n mode l a s from hi s original on e that profits as a proportion of the production per man would be unchanged, but the standard of comfort of the capitalists woul d rise. If the effect i s on machinery, the effect wil l depend on whether it is machinery related to the production o f wage goods o r to non-wage goods. Let m e emphasize on e unfamiliar elemen t i n this approach . I hav e no t talke d abou t profit s pe r cent, for the simplicit y of the one product model has been supersede d b y the complexity of the multiproduct model. I have reverted to the notion of 'surplus' which Adam Smith applied in the section where he speculated on the effect of the acceptance o f a rice or a potato standard instead of a white bread standard. I am anticipating the treatment of profit in the Principles, and th e treatmen t o f 'surplu s value ' i n Kar l Mar x whic h wa s derive d from it . i v R I C A R D O ' S Principles (1817)* Profit continued In the preface to the Principles Ricardo said: 'In different stages of society the proportions o f the whole produce of the earth which will be allotted to * Throughou t part in page references in the text are to the Works an d Correspondence o f David Ricardo, ed. Piero Sraffa. Vol . i, On the Principles o f Political Economy and Taxation (1962) . This is a reprint of the third edition of 1821

The Ricardian theory o f value and distribution 18 9 each of these classes, under th e name s o f rent, profit, and wages, will be essentially different; depending mainl y on the actual fertility of the soil, on the accumulation of capital and population, and on the skill, ingenuity, and instruments employe d in agriculture. To determine the laws which regulate this distribution is the principal proble m i n Political Economy' (5). Notice that th e proble m i s her e state d a s on e o f proportional distribution ; no t wages per head, capital per cent, and rent per acre; nor the real income, and the standard of living based on it, of the three classes of people or of typical individual members o f those classes. At the end of Chapter i Ricardo reverted to this proble m bu t change d from proportional distribution to 'real value' of the share. He did not notice that hi s two criteria of distribution wer e not necessarily consistent . Th e passage to which I refer runs as follows: It is not by the absolute quantit y of produce obtaine d b y either class, tha t we can correctly judg e o f the rat e o f profit, ren t and wages, bu t by the quantity of labour required t o obtain tha t produce . B y improvements t o machinery and agriculture, the whole produc e ma y be doubled, thes e thre e wil l bear th e sam e proportions t o one another , an d neithe r coul d b e sai d t o hav e relativel y varied . Bu t i f wage s partook no t o f the whol e o f this increase; if they, instea d o f being doubled, wer e only increase d one-half ; i f rent , instea d o f bein g doubled , wer e onl y increase d three-fourths, and the remaining increase wen t to profit, it would, I apprehend, be correct for me to say, that rent and wages had fallen, while profits had risen ... We might find, for example, that though the absolute quantity of commodities had been doubled, the y wer e th e produc e o f precisely the forme r quantity of labour .. . Of every hundred hats, coats, and quarters of corn produced if the labourers had before 2 the landlords 2 and the capitalists 5

5 5 0 100

And if, after these commodities were doubled in quantity, of every 10 0 the labourers ha d only 2 the landlords 2 and the capitalists 5

2 2 6

100 In that case I should say, that wages and rent had fallen, and profits risen; though in consequence of the abundance of commodities the quantity paid to the labourer and

190 Fro m Adam Smith to Maynard Keynes landlord woul d hav e increase d in th e proportio n o f 2 5 to 44 . Wage s ar e t o b e estimated by their real value, viz., by the quantity of labour and capital employed in producing them (64-5).

Surely this is an extraordinary concept, wages said to be falling when real wages have nearly doubled! And surely it is a concept to which he did not adhere consistently when he talked about profits per cent. But, finally, this concept i s clearly inconsistent wit h his early concept o f proportional dis tribution except in the limited case where the number of workers remain s the same . Edwin Cannan in his Theories of Production and Distribution14 made this point clear. If there were more workers the aggregate amount of 'real value' would increase. Suppos e with 1000 workers, 25 per cent of the product goes as wages, one may say, in Ricardian terms, 250 units of real value (i.e., labour value) goes as wages. Now let there be 2000 workers, but the proportiona l distributio n b e unchanged , 2 5 per cen t o f th e produc t would go as wages, and 500 units of real value. Wages would be unchanged under one criterion, they are higher under the other. Consistency require s one to change the criterion to 'real value per worker.' Cannan made fun of this; rea l valu e pe r worke r make s som e sens e bu t 'profi t pe r worker ' seemed to him to be nonsense. Yet is it? This is the Ricardian line that was developed b y Karl Marx. In a theory of exploitation 'profit per worker' in terms of 'real value' becomes the number of hours that the workers devote to th e productio n o f surplu s value . Th e concer n i s wit h th e degre e o f exploitation: to Marx it was largely irrelevant how the surplus was divided between the capitalist and the landlord, they were lumped together as the 'bourgeoisie.' On value I shall not discuss Ricardo's treatment of Adam Smith's propositions abou t 'real price ' an d it s measurement . Suffice i t to sa y tha t I believ e h e misunderstood and misrepresented Adam Smith. The first few sections of the Principles rea d i n conjunction with my interpretatio n o f Adam Smit h in Part i abov e wil l mak e m y positio n clear : furthe r discussio n woul d b e unnecessarily repetitious. Ricardo's own theory of value is not intelligible without considering the questions that he was asking, and the meanings that he attached to the word value. At first he appears simply to be extending Adam Smith's proposition about relative exchange value in the 'nation of hunters' to the economy of his day:'' 'It is natural that what is usually the produce of two days', or two hours', labour should be worth double of what is usually the produce of one

The Ricardia n theory of value and distribution 191 day's, o r on e hour's , labour. " Tha t thi s i s really th e foundatio n o f the exchangeable valu e of all things, except those that cannot be increased by human industry , i s a doctrin e o f th e utmos t importanc e i n politica l economy' (13) . The proble m appear s t o be the determinatio n o f relativ e exchange value at a given time. It might be said to be a first approximation subject to the qualifications of the later sections of the chapter. Bu t there is more concer n for changes i n the relationship over time than fo r equilib rium. The problem s o f equilibrium valu e o r price ar e dealt wit h later, i n Chapter iv , 'O n Natural an d Market Price.' That chapter deal t primarily with th e 'accidenta l an d temporar y variations ' o f price , whil e 'makin g labour th e foundation of the valu e of commodities.' Bu t it dealt wit h the allocation o f resources i n response ultimatel y to consume r deman d and immediately to prospects of profit. It is then the desire which every capitalist has, of diverting his funds from a less to a more profitable employment, that prevents the market price of commodities from continuing for any length of time much above, or much below their natural price. It is this competition which so adjusts the exchangeable value of commodities, that after paying the wages of the labour necessary to their production, and all other expenses required to put the capital employed in its original state of efficiency, the remaining value o r overplus, will in each trad e b e i n proportion to th e valu e of the capita l employed. I n th e yt h chapte r o f th e Wealt h o f Nations, al l tha t concern s thi s question is most ably treated (91).

So we arrive with Ricardo, as with Adam Smith, at a 'cost of production' theory of equilibrium price. If we examine further th e concept o f value in chapter on e we find that Ricardo wa s talking much of the time about 'absolute ' value rather tha n 'relative' value. 'Two commodities vary in relative value, and we wish to know i n which the variatio n ha s reall y take n place ' (17) . Thi s migh t be supposed t o mean simpl y that we want to know whether a change i n the relative value of A and B was th e result of changes in technology affecting A or B. But from what is said in other places it would appear that the 'value' of A is conceived t o be intrinsic: absolute not relative. In dealing above with profits I have referred to his view that the rates of profit, ren t and wages, should b e judged 'b y th e quantit y of labour require d t o obtai n tha t pro duce:' and, later, 'wages are to be estimated by their real value.' This latter is, I take it, simply a restatement of the former statement. If we then turn to the chapter on 'Value and Riches' (Chapte r xx) we read: 'The labour of a million men in manufactures, will always produce the same value, but will

192 Fro m Adam Smith to Maynard Keynes not always produce th e sam e riches ' (273) . Value is then a quality which labour bestows on commodities; there can be more value in the aggregate if more people are put to work, there will be no more value if the productivity of workers is increased . The wealt h of a country ma y be increased i n two ways: it may be increase d b y employing a greater portion of revenue in the maintenance of productive labour which will not only add to the quantity, but to the value of the mass of commodities; or i t ma y b e increased , without employin g any additiona l quantity of labour, by making the same quantity more productive - whic h will add to the abundance, but not to the value of commodities (278).

This is a far cry from th e modern theory of value; it is concerned wit h an absolute valu e of individual commodities which can b e added t o giv e an aggregate value. The problem for Ricardo was one of quantification not of equilibrium: an d i t wa s quantificatio n for hi s theor y o f distribution , fo r measurement of the shares of the three orders of society. Whether th e purpos e b e explanatio n o f relative exchang e value , o r measurement of absolute value, there were some qualifications to be made. Ricardo, like Adam Smith, recognized tha t labour was not homogeneous. 'I must not be supposed to be inattentive to the different qualities of labour, and the difficulty o f comparing an hour's or a day's labour, in one employment, with the same duration of labour in another' (20). Adam Smith had passed thi s of f with a referenc e t o th e 'higglin g of the market' : Ricard o added that the 'scale once formed is liable to little variation' (20). In view of the use mad e of the concep t of absolute value it is surprising t o find him arguing here: 'As the inquiry to which I wish to draw the reader's attention, relates to the effect o f variations in the relative value of commodities, and not in their absolute value, it will be of little importance to examine into the comparative degrees o f estimation in which the differen t kind s of human labour ar e held ' (21-2) . Wha t then ar e w e to sa y abou t progressiv e im provement in the quality of labour: does it add to value, or only to riches? The second qualification relates to the different proportions of'machinery an d othe r fixe d o r durabl e capital ' employe d pe r ma n i n differen t employments. That the labour necessary for the production of a commodity included all the indirect labour employed in producing the raw materials and the machinery was clear, and was expounded in some detail in section in, 'Economy in the use of labour never fails to reduce the relative value of a commodity, whether the saving be in the labour necessary to the manufacture of the commodity itself, or in that necessary to the formation of the

The Ricardian theory of value and distribution 19 3 capital, by the aid of which it is produced' (26). The general proposition is acceptable, but his argument went further. The reduction in value would be in the sam e proportion a s the reduction i n labour costs; the newly estab lished exchange value s would be governed b y the newly established rela tive labour costs. But if in two industries, the product of one requires twice the quantity of labour as the product o f the other, an d if the first industry involves a hig h proportio n o f indirec t labou r throug h th e us e o f muc h machinery an d th e othe r a hig h proportio n o f direc t labour , wil l thei r products exchange i n the proportion o f two to one, and would a reduction often per cent in the labour cost of each of them leave their relative values unchanged? Ricardo's answe r was, of course, no . On account then of the different degree s of durability of their capitals, or, which is the sam e thing , o n accoun t o f th e tim e whic h mus t elaps e befor e on e se t o f commodities ca n b e brough t t o market , the y wil l b e valuable , no t exactl y i n proportion to the quantity of labour bestowed on them - the y will not be as two to one, but something more, to compensate for the greater length of time which must elapse before the most valuable can be brought to market (34).

Only if all manufactures 'employed fixed capital of the sam e value and of the sam e durability ' (32) , o r a s Mar x woul d late r pu t it , i f the 'organi c composition of capital' is uniform in all industries, will equilibrium prices in the market be proportional t o labour costs. Ricardo ha d argue d i n section ii i that n o change i n wages coul d affec t values. Thi s mean t chang e i n the genera l leve l o f wages, change s i n the scale of estimation of different skill s having been ruled out . No alteratio n in the wage s of labour could produce any alteratio n in the relative values of these commodities: for suppose them to rise, no greater quantity of labour would be required in any of these occupations, but it would be paid for at a higher price, an d th e sam e reason s whic h shoul d mak e th e hunte r an d fisherma n en deavour to raise the value of their game and fish, would cause the owner of the mine to raise the valu e of his gold ... The relativ e value of game, fish, and gold, would continue unaltered. Wages might rise twenty per cent, and profits consequently fall in a greate r o r les s proportion , withou t occasionin g th e leas t alteratio n i n th e relative value of these commodities (28-9).

When difference s i n th e 'organi c compositio n o f capital, ' o r i n 'labou r intensity,' if that phras e b e substituted, wer e considered this proposition had to be modified.

194 Fro m Adam Smith to Maynard Keynes The degree of alteration i n the relative value of goods, o n account o f rise or fall in labour, woul d depend o n th e proportio n whic h fixed capital bor e t o th e whol e capital employed. All commodities which are produced by very valuable machinery ... o r which require a great length of time before they can be brought to market, would fall in relative value, while all those which were chiefly produced by labour, or which would speedily be brought to market would rise in relative value' (35).

But havin g note d thi s modificatio n of hi s origina l propositio n Ricard o argued that the degree of modification was minor, that the first approximation was still useful. This cause of variation of commodities is comparatively slight in its effect . With such a rise o f wages a s shoul d occasio n a fal l o f one pe r cen t i n profits, good s produced under the circumstances I have supposed, vary in relative value only one per cent... The greatest effect s whic h could be produced o n the relative prices of these goods from a rise of wages, could not exceed 6 or 7 per cent... Not so with the other great cause of the variation in the value of commodities, namely, the increase or diminution in the quantity of labour necessary to produce them (36).

If the introduction of differing proportio n o f capital employe d require d modification of the theory o f relative exchange value , what did it do to the other uses to which the value concept was to be put? First, the estimation of the distribution of income in terms of real value required a unit of value that was independent of the changes in distribution which it was to measure. If value was affected by changes i n wages, it was not a satisfactory measur e for this purpose. But if the variation from this point of view was minor, one might decid e t o us e i t non e th e less . Secondly , th e modificatio n o f th e simple labour theory affected the problem of selecting a measure of changing real value through time. The problem at first seemed to be one of findin a commodity which had not changed, and was not likely to change, in real value, that is in the amount of labour required to produce it. Ricardo coul d not find one but his analysis in the Principles used a pound sterling assumed to be so stable in real value. But here too the modification caused trouble. If we suppose .. . the sam e quantity of labour to be always required t o obtain th e same quantity of gold, still gold would not be a perfect measure of value, by which we could accurately ascertain the variations in all other things, because it would not be produced with precisely the same combinations of fixed and circulating capita ... nor with fixed capital of the same durability; nor would it require precisely the

The Ricardia n theory of value and distribution 195 same lengt h of time before it could b e brough t to market . It woul d be a perfect measure of value for all things produced under the same circumstances precisely as itself, but for no others (44-5).

Again Ricardo argue d tha t 'th e effect o n relative price s o f things from a variation in profits, is comparatively slight ' (45). If we suppose then that the production o f gold requires a n unvarying amount of labour to produce it , 'we shal l posses s as near a s an approximation t o a standard measur e o f value as can be theoretically conceived' (45). On rent I shal l no t go over agai n th e familia r Ricardia n theor y o f rent sinc e th e general position was made clear in discussing the Corn Law pamphlet. But I want to discuss one aspect of his examination o f the effect of agricultural improvement on rent: namely, his readiness t o work with one assumption as to the nature of the improvement without examining the difference that would be made by choosing a different one; and his readiness to accept, on inadequate evidence , o r o n n o evidenc e a t all , th e probabilit y tha t hi s chosen assumption for the model represented th e most probable condition of the real world. In chapter two he introduced his arithmetical example by saying: 'If, by the introduction of the turnip husbandry, or by the use of a more invigorating manure, I can obtain the same produce with less capital, and without disturbing the difference between the productive powers of the successive portion s o f capital, I shal l lowe r rent ' (81) . Th e arithmetica l example follows: If, fo r example, the successiv e portions of capital yielded 100, 90, 80, 70; whilst I employed these four portions, my rent would be 60, or the difference between 70 and 10 0 = 30 whils 70 and 9 0 = 20 woul 70 and 8 0 = 1 0 34 60 34

t the produce 10 d be 9 08

0 0 0 70 0

and while I employed these portions, the rent would remain the same, although the produce of each should have an equal augmentation. If instead of 100,90,80,70, the produce should be increased to 125 , 115 , 105 , 95, the ren t would stil l be 60, or th e difference between

196 Fro m Adam Smith to Maynard Keynes 95 and 12 5 = 30 whils t the produce 12 95 and 11 5 = 20 woul d be increased 11 95 and 10 5 = 1 0 t o 44 0 10 60 44

5 5 5 95 0

But with such an increase of produce, without an increase of demand, there could be n o motiv e for employin g so muc h capital on th e land ; one portio n woul d be withdrawn, and consequently the last portion of capital would yield 105 instead of 95, and rent would fall to 30 (81-2).

His assumptio n o f equa l absolut e addition s t o th e produc e o f eac h portion had advantages for simple arithmetical illustration . It is surprising, however, to find Ricardo in Chapter twenty-two arguing that this assumption is a realistic one. 'Improvement s in agriculture, and in the division of labour, are common to all land; they increase the absolute quantity of raw produce obtained from each, but probably do not much disturb the relative proportions whic h befor e existe d betwee n them ' (412-13) . I f on e goe s through the arithmetical processes of Ricardo one can show a much greater fall i n rent b y supposin g tha t th e improvemen t i s more effectiv e on th e poorer land, or on the later portions of capital, than on the better land, or on the earlier portions of capital; and one can show rent rising if one assumes that the improvement widens rather than narrows the differential betwee n the good and the poor land, and between the productivity of the earlier and later applications of capital. And if one is concerned wit h aggregate rent in the society on e can again get different result s accordin g to one's assumptions about the relative amounts of the various grades of land. The rent on the good depends on its differential quality; but the amount of the aggregate rent of landlords depends on whether the high rent is obtained from a large or small area. On wages The natura l price of labour i s that price which is necessary to enable th e labourers, one with another, to subsist and perpetuate thei r race, without either increase o r diminution' (93). When the market price is higher than this natural price 'the condition of the labourer is flourishing and happy ... he has it in his power to command a greater proportion of the necessarie s and enjoyment s o f life , an d therefor e t o rea r a health y an d numerou s family' (94). The resulting increase in population, the increase in the supply of labour, will make 'wages again fall to their natural price, and indeed from

The Ricardia n theory of value and distribution 197 a reactio n sometime s fa r belo w it ' (94) . Bu t thi s gloom y pictur e wa s somewhat modified . 'Notwithstanding the tendency o f wages to conform to their natura l rate, the market rate may, in an improving society, for an indefinite period be constantly above it' (94-5). Further, Ricardo explained that the standard s of living, or of subsistence, o n which that natural price was based was not absolutely fixed and constant. It varies at different time s in the same country, and very materially differs i n different countries . It essentiall y depends on the habits and customs o f the people. A n English labourer woul d consider hi s wages under their natural rate, as too scanty to support a family, if they enabled him to purchase no other food than potatoes, and to live in no better habitation than a mud cabin; yet these moderate demands of nature are often deeme d sufficient i n countries where "man's life is cheap," and his wants easily satisfied (96-7).

Ricardo, like Adam Smith before him and Karl Marx after him , is surely wrong in concentrating on the process by which wages tend to the conventional level of subsistence, rather than on the process by which the level of subsistence, to whic h the y tend , become s mor e comfortable , mor e ade quate. Ricardo , lik e Malthu s an d Joh n Stuart Mill , di d contribut e on e suggestion. If the market price stayed above the natural price long enough the workers migh t develop suc h a 'taste for comforts and enjoyments' a s might lea d the m t o hav e fewe r rathe r tha n mor e children . Th e worker s 'should be stimulated by all legal means in their exertions to procure them [i.e., suc h comforts] . Ther e canno t b e a bette r securit y agains t a superabundant population' (100). But Ricardo expected wages to fall in the natural advanc e o f societ y 'fo r th e suppl y o f labourers wil l continue t o increase a t th e sam e rate , whils t the deman d for them will increase a t a slower rate' (101), that is, the supply of capital will increase at a slower rate. So we ar e bac k t o th e tendenc y o f the marke t rat e t o approximat e th e natural rate , we are back t o the pessimisti c expectatio n tha t populatio n increase wil l b e excessive , an d w e hav e turne d awa y fro m th e earlie r proposition tha t a n 'improvin g society ' promise d marke t wage s 'fo r a n indefinite period .. . constantly above' the natural rate (94-5). Chapter v ends with a thoroughly Malthusian attack on the poor laws: It is a truth which admits not a doubt, that the comforts and well-being of the poor cannot be permanently secured without some regard on their part, or, som e effor t on the part of the legislature, to regulate the increase of their numbers, and to render less frequent amon g them, early and improvident marriages. The operatio n of the

198 Fro m Adam Smith to Maynard Keynes system of poor laws has been directly contrary to this. They have rendered restraint superfluous, and have invited imprudence, by offering i t a portion of the wages of prudence and industry ... No scheme for the amendment of the poor laws merits the least attention, which has not their abolition for its ultimate object (107).

On profit I find Chapter v i 'On Profits' difficult , an d struggling with it unrewarding. Adam Smith had argued that high wages meant low profits; but, as I have argued above, he recognized the 'economy of high wages,' recognized that if productivity rose faster than wages high-priced labour might be cheap , and recognize d tha t i n a rapidl y developin g economy , lik e th e Nort h America of his day, high wages and high profits went together. Ricardo's argument tha t hig h wage s spel t lo w profit s wa s firs t develope d i n th e pamphlet on the Corn Laws. This I have discussed above. Here I only note two points . First , h e did , i n th e Principles exten d hi s concep t o f wagegoods beyond corn, but he argued that this made no difference. 'M y object has been to simplify th e subject, and I have therefore mad e no allowanc e for th e increasing price of other necessaries, beside s food of the labourer ; an increase which would be the consequence of the increased valu e of the raw material s fro m whic h the y ar e made , an d whic h woul d o f cours e further increas e wages, and lower profits' (122). Adam Smith had consi dered the possibility that decreasing cost of manufactures might more than offset th e increasin g cos t o f ra w materials ; Ricard o ignore d this . Eve n Ricardo recognize d th e possibilit y o f improvement in the productio n o f corn and other raw produce; but in this proposition that 'a rise in wages ... would invariably lower profits,' it was not made clear that it was based on the assumption tha t ther e woul d be no improvement. H e noted tha t thi s 'gravitation' o f profit s i s 'happil y checke d a t repeate d interval s b y th e improvements i n machinery , connecte d wit h th e productio n o f neces saries, as well as by discoveries in the science of agriculture' (120). But he saw these happ y checks as temporary breaks in an inevitable downward trend of profits. The second point that I would note is concerned with 'accumulation.' In his arithmetica l example s Ricard o pushe d th e calculatio n t o th e poin t where there would be lef t 'nothin g whatever for profit.' Bu t he then said 'long before this state of prices was become permanent, there would be no motive for accumulation; for no one accumulates bu t with a view to make his accumulatio n productive, an d i t i s onl y whe n s o employe d tha t i t operates on profits. Without a motive there could be no accumulation, and consequently suc h a state of prices never could take place ... Their motive

The Ricardian theory of value and distribution 19 9 for accumulatio n wil l diminish with ever y diminutio n o f profit, an d wil l cease altogethe r whe n thei r profit s are s o low as no t t o affor d the m a n adequate compensatio n fo r thei r trouble , an d th e ris k whic h the y mus t necessarily encounte r i n employing their capital productively' (122). Concern for an adequate rat e of accumulation i n the interest of the nation as a whole, no t least of the workers, i s the reason for his plea for free trade in food, and his fear of declining profit. Ricardo returne d t o this subjec t o f 'accumulation' i n chapter xxi . He rejected th e thesi s o f Adam Smit h that th e increase of stock woul d raise wages and lower profits. This would be but a 'temporary rise proceedin g from increase d fund s befor e the population i s increased' (289). Ricardo's criticism wen t beyon d thi s t o recogniz e th e expansio n o f the marke t in which the capitalists compete. To dismiss the temporary effects, when the time required fo r a population t o respond wa s s o great an d when furthe r increases i n stoc k kep t puttin g farthe r awa y th e dat e whe n populatio n growth would catch u p with accumulation, was characteristic o f Ricardo with his obsession with the long run. But surely Adam Smith had neglected the dynamics of expanding market and an increasing productivity. Ricardo in pursuit of his thesis that only rising wages, resulting from increased cos t of foo d necessar y t o fee d th e increase d populatio n induce d b y th e in creased deman d for labour, coul d lower profits, rejected th e Adam Smith thesis of'mutual competition' and in the process introduced the Say thesis. 'Mr Sa y has , however , mos t satisfactoril y shewn , tha t ther e i s n o amount o f capita l whic h ma y no t b e employe d i n a country , becaus e demand is only limited by production' (290). In the context o f criticism of Adam Smith this may appear misplaced, for had he not preached th e virtue of parsimony? But Ricardo's friend Malthus was talking of the possibilit y of over-saving and many others were tainted by this heresy. The orthodo x view, later name d Say' s Law, i s developed i n this chapter o f Ricardo a s follows: No man produces, but with a view to consume, or sell, and he never sells, but with an intention to purchase some other commodity, which may be immediately useful to him , or whic h may contribut e t o futur e production . B y producing, then, h e necessarily becomes either the consumer of his own goods, or the purchaser and consumer of the goods of some other person. It is not to be supposed that he should, for an y lengt h of time , b e ill-informe d o f th e commoditie s which he ca n mos t advantageously produce , t o attai n the objec t whic h he ha s i n view, namely the possession of other goods; and, therefore, it is not probable that he will continually produce a commodit y for whic h there i s no deman d ... Production s are always

200 Fro m Adam Smith to Maynard Keynes bought b y productions, or by services , mone y is only the mediu m by which the exchange i s effected. To o muc h of a particular commodity may be produced, of which there may be such a glut in the market, as not to repay the capital expended on it; but this cannot be the case with respect to all commodities (291-2).

I hav e already quote d fro m the Malthus-Ricard o letters, let me add one more quotation from a letter by Malthus (16 July 1821) which highlights the essential characteristic of Ricardian thought, viz., its concentration o n the ultimate equilibrium and its lack of concern for the short run, or the serie s of short runs that lie along the path to that ultimate goal. 'But you yourself allow tha t a grea t temporar y saving , commencin g whe n profit s wer e sufficient t o encourage it, might occasion such a division of the produce a s would leave no motive to a further increase of production. And if a state of things i n whic h fo r a tim e ther e i s n o motiv e t o a furthe r increas e o f production be not properly denominated a stagnation, I do not know what it can b e called ; particularl y a s thi s stagnatio n mus t inevitably thro w th e rising generation out of employment.15 On machinery Chapter xxxi, 'On Machinery,' was first introduced into the Principles in the third edition (1821) . In it Ricardo argue d tha t h e had been i n error in supposing that the 'application of machinery to any branch of production, as should have the effec t o f saving labour, was a general good' with only some temporary inconveniences a s capital an d labour were moved fro m one employmen t to another . H e ha d though t the clas s o f labourers wa s 'equally benefitted by the use of machinery as they would have the means of buying more commodities with the sam e money wages, and I thought that no reduction of wages would take place' (387). He later came to believe that 'the substitution of machinery for human labour, is often very injurious to the interest s o f the clas s of labourers' (388) . H e added: 'Th e opinio n entertained b y the labourin g class, tha t th e employmen t of machinery is frequently detrimenta l t o their interests, is not founded on prejudice and error, bu t i s conformable to th e correc t principle s of political economy ' (392). The new worry about the effect of the introduction of machinery derived partly, perhaps , fro m a n increase d concer n fo r th e rea l distres s whic h underlay what he called th e 'temporar y inconvenience.' A succession o f such shift s i n employment might mean a succession o f temporary inconveniences involving whole decades of distress. Perhaps Malthus was beginning to force him to pay attention to the short run; short in the sense that it

The Ricardian theory of value and distribution 20 1 was shorte r tha n th e tim e withi n which equilibriu m woul d be achieved , long i n years a s the ol d equilibrium positio n wa s changed t o a new one before th e ol d was achieved . S o far a s th e worr y wa s mor e tha n thi s i t involved contradiction of Say's law, which he had defended earlier. In his arithmetical example, half of the 'wage fund' having been spent on machinery, half the labour before employed would become 'redundant. ' But what of the principle that there can be no 'general glut'? Surely the impossibility of genera l glu t carrie d wit h i t the assumptio n tha t ful l employmen t wa s assured i n the long run. To alleviate the redundancy Ricard o looked to the landlords and capitalists to employ more menial servants. 'As the labourers are interested i n the demand for labour, they must naturally desire that as much of the revenue as possible b e diverted fro m luxuries to be expende d in support of menial servants' (393) . Surely a backward step, the reverse of development, a ste p tha t Ada m Smit h woul d deplore , bu t tha t Malthu s would accept i n a phase of over-saving. The arithmetic of his argument ran as follows. A capitalist, we will suppose employs a capital of £20,000 ... £7000 of this capital is invested in fixed capital... the remaining £i3,000 is employed as circulating capita in suppor t o f labour .. . profit s ar e 1 0 per cent , an d consequentl y th e capitalisti c capital is every year put int o its original state of efficiency, an d yield s a profit o f £2000. Each year the capitalist begins his operations by having food and necessaries in his possession o f the value of £13,000, all of which he sells in the course of the year to his own workmen for that su m of money, and, during the same period, h e pays them the like amount of money for wages ... Suppose now, that the following year the capitalist employ s half his men in constructing a machine ... During that year he would pay the su m of £13,000 in wages as usual, and would sell food and necessaries t o the same amount to his workmen; but what would be the case th e following year ? .. . The machin e would be worth £7500, and the food and neces saries £750 0 .. . Afte r deductin g [hi s profi t o f £2000 ] h e woul d hav e n o greate r circulating capital than£5500 with which to carry on his subsequent operations;... his means of employing labour would be reduced in the proportion of 13,000 to 5500, and, consequentl y al l th e labou r whic h was befor e employe d by £7500, woul d become redundant (388-9).

This indicate s th e nature of Ricardo's analytical weakness, indee d the weakness of the classical writer s generally. The 'wage fund' approach , the treatment, that is, of the demand for labour as depending on the availabl e circulating capital, was concerned with the immediate financing problem, and ignore d th e 'derived ' characte r o f th e deman d (derive d fro m th e

202 Fro m Adam Smith to Maynard Keynes expectation of revenue from the sale of the product) and the joint character of the demand (the fund being spent on all the factors not just on one, and not o n al l the factor s i n one give n 'mix') . Perhap s w e are to o read y t o assume that a flexible credit system will permit the financing of any venture where the expected demand, and the expected profit, is reasonably certain. But they were too ready to accept the rigidity of the wage fund. They might have remembered tha t the production o f machinery went on from yea r to year, that worker s wer e employe d i n producing it, an d that savin g mad e this production and employment possible; they might even have wondered, with Malthus , whether savin g in th e absenc e o f enoug h productio n o f machinery might not cause unemployment. Having develope d hi s case tha t th e introductio n o f machinery migh t cause distress, Ricardo then proceeded to argue that it should nevertheles s be encouraged. ' I hav e been supposin g that improved machinery is suddenly discovere d an d extensivel y used ; bu t th e trut h i s tha t thes e dis coveries are gradual, and rather operate in determining the employment of the capital which is saved and accumulated, rather than in diverting capital from it s actua l employment ' (395) . Surel y h e ha d bee n analysin g a n ab stract case which had little relevance to the actual conditions of the progressive economy of his day. As Schumpete r said: 'h e obviously underrated th e effect s o f th e increas e i n productiv e powe r tha t mechanize d capitalism would display, and of the expansion of output that would result therefrom - s o that ''distress and poverty" looms larger in his text than it should in a realistic picture.' Schumpeter went on to say that this was due not to 'defective technique' but to 'lack of imagination.' 'He never realized that the essential fac t abou t capitalist "machinery " is that it does what, quantitatively and qualitatively, could not be done at all without it, or, to put i t differently , tha t i t "replaces " workme n wh o hav e neve r bee n born.' 16 The proble m of the effec t o f increasing mechanization and increasin g productivity on the poor has not been completely resolved. Kgo u argued that it is possible bu t highly unlikely that what increases the wealth of the nation will make the poor poorer. I would add that it is highly unlikely that the poo r ca n b e mad e less poor excep t throug h such a n increas e i n the wealth of the nation as a whole: it is a necessary condition if not a certain cause. I t then appears to be the duty of the state, a s Ricardo argued, not only 'no t t o discourage ' th e employmen t of machiner y bu t activel y t o encourage it . It should also be the duty of the state to alleviate the distres s during period s o f adjustment . (Adjustment assistance i n th e proces s o f technological change as in the process of tariff adjustment, is important as

The Ricardian theory of value and distribution 203 reducing opposition t o change th e distres s o f which is concentrated an d immediate an d th e benefit s o f whic h ar e diffuse d an d lon g run. ) I f th e long-run benefit s are distribute d in a way tha t the communit y feels inequitable, the State has the further duty of redistribution by taxation. Finally if the 'human cost' of mechanization, and the social strain of rapid change, are felt t o be higher than the increase i n welfare from increase d materia l wealth, then the duty to encourage mechanization may need to be qualified. In this last case, however, those who make the decision to slow down the process of mechanization an d technological advanc e should make serious efforts t o estimat e th e los s o f material wealt h involve d an d the relativ e importance for welfare of the reduction in human cost and the reduction in the supply of material goods and services. I shal l rever t t o thi s proble m o f 'machinery ' whe n discussin g Mill' s Principles an d Marx's Capital. On foreign trade In Chapte r vi i o f the Principles Ricard o lai d th e basi s o f the theor y o f international trade, and of international values, that was to be developed by Mill and Marshall. The first element was the introduction of the distinction between domestic and foreign trade based on the assumption in the former of perfect, or very high, immobility of these factors. In on e and the sam e country, profits ar e generally speaking, always on the same level; or differ onl y as the employment of capital may be more or less secure. It is not so between different countries . If the profits of capital employed in Yorkshire, should exceed those of capital employed in London, capital would speedily move from London to Yorkshire ... but if... wages should rise and profits fall, it would not follow tha t capital and population would necessarily move from Englan d to Holland , or Spain, or Russia (134).

The secon d elemen t wa s th e recognitio n tha t trad e coul d b e profitable between tw o countries eve n though one of them could produc e al l commodities a t les s cos t tha n th e other , a s lon g a s th e on e ha d a greate r comparative advantag e i n producing some of those commoditie s tha n in producing others. Torrens in the Economists Refuted (1808 ) had alread y developed th e theory an d in Schumpeter's phras e 'baptize d it.' Ricard o expounded i t effectivel y fo r a two-produc t - two-countr y mode l i n a familiar passage which still deserves quotation . England may be so circumstanced, that to produce the cloth may require the labour

204 Fro m Adam Smith to Maynard Keynes of 100 men for one year; and if she attempted to make the wine, it might require the labour o f 12 0 men for th e same time .. . T o produc e the win e in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time. It would therefore be advantageous for he r to export win e in exchange for cloth .. . Though sh e could make the cloth with the labour of 90 men, she would import it from a country where it required the labour of 100 men to produce it, because it would be advantageous to her rathe r to emplo y her capita l in the productio n of wine, for whic h she could obtain more cloth from England , than she could produce by diverting a portion of her capital from the cultivation of vines to the making of cloth. Thus England would give the produce of the labour of 100 men, for the produce of the labour of 80 (135).

Reverting to the difference between domesti c an d foreign trade, Ricard o remarked that 'the labour of 100 Englishmen cannot be given for that of 80 Englishmen, bu t th e produc e o f 10 0 Englishme n ma y b e give n fo r th e produce of 80 Portugese.' This is 'easily accounted for, by considering the difficulty with which capital moves from one country to another... and the activity with which it invariably passes from one province to another in the same country' (135-6). There remained the problem of the determination of the relative values of wine and cloth i n the two countries. Trad e would be advantageous t o each a t an y rate o f exchange between English cloth an d Portugese win e lying between the limits of one day's production of cloth for 9/8 and 5/6 of a day's productio n of wine. Ricardo recognized tha t 'th e sam e rule which regulates th e relativ e valu e of the commoditie s i n one country, doe s not regulate th e valu e of the commoditie s exchange d betwee n tw o o r mor e countries' (133) . He did not develop a n alternative rule; it was left t o Mill and Marshal l t o develo p th e theor y o f 'reciproca l demand ' an d s o t o determine the terms of trade an d the extent to which the one or the othe r country benefitted fro m th e exchange. How difficul t i t was for Ricardo to move from a cost to a demand theory i s partly explained b y his failure to distinguish between demand as functionally related to price and demand as a quantit y actuall y purchased . Hi s confusio n appears i n this statement : 'The demand for a commodity cannot be said to increase, if no additional quantity of it be purchase d or consumed ; and yet , unde r suc h circumstances, its money value may rise' (382). Conclusion There is, of course, muc h more in the Principles. I have neglected entirel y the many chapters on taxation. I do not propose to add to my discussion of

The Ricardian theory of value and distribution 205 Ricardo's monetar y theory as developed in his pamphlet, The High Price of Gold Bullion, any discussion of the monetary chapters in the Principles. I would, however, mention the proposal in his pamphlet, Proposals for an Economical and Secure Currency (1816 ) that the Bank of England should be required t o pay 'i n coined gol d .. . a t the Min t standard an d price .. . instead of the delivery of guineas.' He added that the quantity to be bought or sold 'should never be less than twenty ounces.'17 This proposal showed full recognition of the fact that the gold reserve was really held for meeting international payments rather than for providing coin for the pockets of the people at home - to meet external not internal drains. It was more than a century before this proposal was accepted by England. I conclud e thi s discussio n o f the Principles wit h some comment s on Ricardo's method and approach from Schumpeter's brilliant assessment in his History o f Economic Analysis. They are important not only as helping to understand Ricardo's work, but as preparing for the ensuing discussion of Mill and Marx. Ricardo, said Schumpeter, was not a 'utilitarian.' This is not because of his having had another philosophy but because that busy and positive min d ha d n o philosoph y a t al l .. . Similarly,»h e ha d no t a n inadequate sociology, but none at all; there were certain economic problems that fascinated his powerful intellect but the sociological framework he took for granted - no matter of reproach this, but simpl y a matter of the divisio n of labor. Given its nature, his theory would not have been improved by being caparisoned sociologically ... But of course this applies only to his theory, it does not apply to his recommendations. In these w e d o mis s insight into th e motiv e powers o f the socia l proces s and , in addition, historical sense.

There follows a footnote of great importance. I do not think that Ricardo ever did much historical reading. But this is not what I mean. Th e troubl e wit h him is akin to troubl e I have , i n this respect , wit h my American students , wh o hav e plent y o f historica l materia l pushed dow n their throats. But it is to no purpose. They lack the historical sense that no amount of factual study can give. That is why it is so much easier to make theorists o f them than economists.18

Of his use of theory I have spoken above, and there too I quoted Schumpeter on the 'Ricardian Vice.'

5

John Stuart Mill, general characteristics1

Though Mill had bee n raised i n the Ricardia n tradition, his Principles o f Political Economy is in the tradition of Adam Smith (and Malthus) rather than of Ricardo. Th e titl e suggests this : Principles o f Political Economy with Some of Their Applications to Social Philosophy. The Preface to the first edition elaborated th e point made in the title. Of Adam Smith's work Mill said: The most characteristic quality ... is that it invariably associates the principles with their applications. This of itself implies a much wider range of ideas and topics, than are included in Political Economy, considered as a branch of abstract speculation. For practica l purposes, Politica l Econom y is inseparably intertwined with many other branches of social philosophy . Excep t o n matters of mere detail, ther e ar e perhaps no practical questions, even among those which approach neares t t o the character o f purel y economica l questions , whic h admi t o f bein g decide d o n economical premises alone. And it is because Adam Smith never loses sight of this truth; because, in his applications of Political Economy, he perpetually appeals to other and often far larger considerations than pure Political Economy affords - that he gives that well-grounded feeling of command over the principles of the subject for purposes of practice.2 But Mill felt that advances in 'Political Economy, properly s o called,' and in 'the philosophy of society' had rendered the Wealth of Nations 'i n man y parts obsolete.' So he decided t o attempt to 'combine his [Adam Smith's] practical mod e of treating his subject with the increased knowledg e since

John Stuart Mill 207 acquired of its theory' and to 'exhibit the economical phenomena of society in the relation i n which they stan d to the best social idea s o f the presen t time.' While Mill wanted to make his treatise 'more than a mere exposition of the abstract doctrine s o f Political Economy,' he intended that 'suc h an exposition shoul d be found in it.'3 The Principles is, then, the product of a Ricardian economist wh o was also, in the judgment of F.Y. Edgeworth , 'pre-eminent in general philosophy,' in which respect he, and he alone, was 'comparable to Adam Smith.'4 I T H E Autobiography* I have not written biographies o f the economists whos e work I have so far discussed, and I do not intend to depart from this practice and tell the story of Mill' s life , bu t som e extract s fro m hi s Autobiography ma y hel p t o understand the 'general character' of the Principles wit h its blend of logical analysis an d socia l philosophy , b y indicatin g the conflictin g intellectual influences which affected his development. I pass over the inhuman education i n the classic s of the earlies t year s t o com e t o hi s earl y trainin g in political economy at the age of thirteen. He [his father, James Mill] took me through a complete course of political economy ... Though Ricardo's work was already in print, no deductive treatise embodying his doctrines in a manner fit for learners, had yet appeared. My father, therefore, commenced instructing me in the science by a sort of lectures, which he delivered to me in our walks. He expounded each day a portion of the subject, and I gave him next day a written account o f it, which he made me re-write over and over again until it was clear, precise, an d tolerably complete. In this way I went through the whole extent of the science .. . After this I read Ricardo, giving an account daily of what I read ... On Money, as the most intricate part of the subject, he made me read in the same manner Ricardo's admirable pamphlets, written during what was called the Bullion controversy; to these succeeded Adam Smith; and in this reading it was one of my father's main objects to make me apply to Smith's more superficial view of political economy, the superior lights of Ricardo, and detect what was fallacious in Smith's arguments or erroneous in any of his conclusions (23-4).

This trainin g in Ricardian economics wa s soo n supplemente d by furthe r indoctrination as he came under the influence of Jeremy Bentham. * Throughou t part i page references i n the tex t ar e t o th e editio n of the Autobiography in the World's Classics, edited by H.J. Laski (1924)

208 Fro m Adam Smith to Maynard Keynes When John Stuart Mill began to read law with John Austin his father put into hi s hand s 'Bentham' s principa l speculations , a s interprete d t o th e Continent, an d indee d t o al l th e world , b y Dumont , i n th e Trait e d e Legislation' (53-4). This was a 'turning point' in his mental history. My previou s educatio n ha d been , i n a certai n sense , alread y a course o f Benthamism. The Benthamic standar d of 'the greatest happiness' was that which I had always been taugh t t o apply .. . Ye t in the first pages of Bentham i t burst upo n m e with al l the forc e o f novelty. Wha t thu s impresse d m e was th e chapte r i n which Bentham passe d judgmen t o n th e commo n mode s o f reasonin g i n morals an d legislation, deduce d fro m phrase s lik e 'la w of nature,' 'righ t reason,' 'th e mora l sense,' 'natura l rectitude, ' an d the like , and characterize d the m as dogmatism in disguise, imposing its sentiments upon others under cover of sounding expressions , which conve y n o reaso n fo r th e sentiment , bu t se t u p th e sentimen t a s it s own reason ... When I laid down the last volume of the Traite, I had become a differen t being .. . I now had opinions; a creed, a doctrine, a philosophy; in one among the best sense s of the word, a religion; the inculcation and diffusion o f which could b e made the principal outward purpose o f a life. (53-57) The indoctrinatio n appeared complete , an d the disciple seeme d read y t o join the society of his contemporaries. He gathered around him at the age of 16 a smal l grou p o f youn g me n an d name d th e grou p th e 'Utilitaria n Society.' He thus came in contact 'with several young men at that time less advanced than myself, among whom, as they professed the same opinions, I was for some time a sort of leader' (68). The next few years were devoted, in hi s ow n words , to 'youthfu l propagandism ' (73) , mainl y through th e Westminster Review, and t o continue d stud y i n a grou p o f youn g men developing out of the early group of the Utilitarian Society. These youn g men became the first propagators of what was afterwards called 'Philosophi c Radicalism.' Their mode o f reasoning wa s not characterized b y Benthamism in any sens e which ha s relation to Bentham as a chief or guide, but rather by a combination of Bentham's point o f view wit h that o f the moder n politica l economy, and wit h the Hartleia n metaphysics. Malthus' s population principl e was quite as much a banner, and point of union among us, as any opinion speciall y belongin g to Bentham ... In politics, an almost unbounde d confidenc e in the efficienc y o f two things : representative gov ernment, an d complet e freedo m o f discussio n .. . Thes e variou s opinion s wer e seized on with youthful fanaticis m by the littl e knot of young men of whom I wa s one (88-91).

John Stuart Mill 209 Mill said that at this time it would not be far from the truth to describe him as a 'mer e reasoning machine ' (92) . His father's teachin g 'tende d to the undervaluing of feeling,' and the group of young men found all their most cherished opinion s constantl y attacke d o n the groun d of feeling. 'Utilit y was denounce d a s col d calculation ; political econom y a s hard-hearted ; anti-population doctrines a s repulsive to the natural feelings of mankind.' They retorted by the word sentimentality. 'Although we were generally in the right... the effect wa s that the cultivation of feeling (except the feeling of public and private duty) was not in much esteem among us' (93-4). This group of young men used to mee t tw o mornings a week for study. They worked throug h th e elde r Mill' s Elements, Ricardo' s Principles an d Bailey's Dissertation o n Value. Fro m thes e discussion s emanate d th e essays whic h were published a s Essays on Some Unsettled Questions of Political Economy, one of which, that on method, will be discussed below. At the age of twenty-three there was a 'crisis' in Mill's 'mental history.' He experienced a condition o f profound dejection when he realized tha t if 'all the changes in institutions and opinions' to which he had been looking forward were to be achieved immediately the result would not be for him 'a great joy and happiness' (113). His recovery from this dejection was related to new influences: Wordsworth, Coleridge through the mediation of Frederick Mauric e and John Sterling , Carlyle , Comte, and the S t Simonians. The account of his progress from 'sense' to 'sensibility' is to me a fascinating one : I recommen d the chapte r i n th e Autobiography i n whic h i t i s described no t only to those who want to understand the history of thought but to modern would-be political economists. Mill did not turn his back on 'sense': ' I neve r turne d recrean t t o intellectua l culture , o r cease d t o consider th e power and practice o f analysis as an essential conditio n both of individual and social improvement' (121). But he argued that 'the habit of analysis has a tendency t o wear away the feelings' (116) . Analysis, then, needed t o be corrected 'b y joining other kind s of cultivation with it. The maintenance o f a du e balanc e amon g th e facultie s no w seeme d .. . o f primary importance' (121-2). The statemen t o f hi s politica l positio n a t thi s stag e i n hi s caree r i s relevant to the understanding of his Principles. In politics, though I no longer accepted the doctrine of the Essay on Government [by hi s fathe r Jame s Mill ] a s a scientifi c theory ; though I cease d t o conside r representative democracy as an absolute principle, and regarded it as a matter of time, place, and circumstance; though I now looked upon th e choice of political institutions a s a mora l an d educationa l question, more tha n on e o f materia l in-

210 Fro m Adam Smith to Maynard Keynes terests, thinking that it ought to be decided mainly by the consideration, what great improvement in life and culture stand s nex t in order for the people concerned, as the conditio n o f thei r furthe r progress , an d wha t institution s ar e mos t likel y t o promote that (144-5).

But his practical political cree d was little altered. I wa s as much as ever a Radical an d a Democrat fo r Europe, and especially for England. I thought the predominance o f the aristocratic classes, the noble and the rich, in the English constitution , a n evil worth an y struggle t o get rid of ... as the great demoralizin g agency in the countr y .. . I thought, that whil e the higher and richer classes hel d the power of government, the instruction and improvement of the mass of the people wer e contrary to the self-interest of those classes .. . Bu t if democracy obtaine d a large , an d perhap s th e principa l share , i n th e governin g power, it would become th e interest of the opulent classes to promote thei r educa tion, in order to ward off really mischievous errors, and especially thos e that would lead to unjust violations of property (145-6).

He hoped that the 'higher classes migh t be made to see that they had more to fear from the poor when uneducated, than when educated.' In what he called the 'third period' of his mental development th e major influence was Harriet Taylor, whom he later married . Our opinion s were far more heretica l than mine had been i n the days of my most extreme Benthamism. In those days I had seen little further tha n the ol d school of political economist s int o the possibilitie s of fundamenta l improvemen t in socia l arrangements. Private property, as now understood, and inheritance, appeared t o me, a s t o them , th e dernier mo t o f legislation : an d I looke d n o furthe r tha n t o mitigating th e inequalitie s consequen t o n thes e institutions , b y gettin g ri d o f primogeniture and entails. The notion that it was possible t o go further than this in removing the injustice - for injustice it is, whether admitting of complete remedy or not - involve d in the fact tha t som e ar e born t o riches an d the vast majorit y t o poverty, I then reckoned chimerical, and only hoped that by universal education, leading to voluntary restraint on population, the portion of the poor might be made more tolerable. I n short I was a democrat, bu t not the least of a Socialist... While we repudiated with the greatest energ y that tyranny of society ove r the individual which most Socialistic systems are supposed to involve, we yet looked forward to a time when a society will no longer be divided into the idle and the industrious; when the rule that they who do not work shall not eat, will be applied not to paupers only, but impartiall y t o all ; whe n th e divisio n o f th e produc e o f labour , instea d o f

John Stuart Mill 2ii depending... on the accident of birth, will be made by concert, on an acknowledged principle o f justice; an d whe n i t wil l n o longe r eithe r be , o r b e though t to be , impossible for human beings to exert themselves strenuously in procuring benefits which are not to be exclusively their own ... The socia l problem of the future w e considered t o b e ho w t o unit e th e greates t individua l liberty o f action , wit h a common ownership in the raw materials of the globe, and an equal participation of all in the benefits of combined labour (195-7).

These opinions were promulgated in the Principles, Mill said, less clearl y an d fully i n the first edition, rather mor e s o in the second , and quite unequivocally in the third .. . I n th e first edition the difficultie s o f socialism were stated so strongly, that the tone was on the whole that of opposition to it. In the year or two that followed, much time was given to the best Socialisti c writer s on the Continent, and to meditation and discussion o n the whole range of topics involve d in the controversy : and the result was that most of what had been written on the subject in the first edition was cancelled, and replaced by arguments and reflections which represent a more advanced opinion (198-9).

I conclud e thi s sectio n wit h Mill's accoun t o f the influenc e of Harrie t Taylor on his Principles, not from any special interest in that extraordinar y relationship, but because of the light it throws on the nature of his book. The first of my books in which her shar e was conspicuous was the 'Principle s of Political Economy ' .. . Th e chapte r o f the Politica l Econom y whic h ha s ha d a greater influence on opinion than all the rest, that on the Probable Futurit y of the Labouring Classes is entirely due to her ... the statement and discussion of the two opposite theorie s respectin g th e prope r conditio n o f the labourin g classes , wa s wholly an exposition of her thoughts ... The purel y scientific par t of the Political Economy I did not learn from her; but it was chiefly he r influence that gave to the book that general tone by which it is distinguished from al l previous expositions of Political Econom y that had any pretension t o being scientific. This tone consiste d chiefly i n makin g the prope r distinctio n betwee n th e law s o f th e Productio n o f Wealth, which are real laws of nature ... and the modes of its Distribution which, subject to certain condition s depen d on human will. The common run of political economist confuse these together ... ascribing necessity to things dependent on the unchangeable conditions of our earthly existence, and to those which, being but the necessary consequence s o f particular social arrangements, are merely coextensiv e with these: given certain institutions and customs, wages, profits, and rent will be determined b y certai n causes ; bu t thi s clas s o f politica l economist s dro p th e

212 Fro m Adam Smith to Maynard Keynes indispensable presupposition , an d argu e tha t thes e cause s must , by a n inherent necessity, against which no human means can avail, determine the shares which fall ... to labourers, capitalists, and landlords. The 'Principles of Political Economy ' yielded t o non e of its predecessors i n aiming at the scientifi c appreciation o f th e action of these causes, under the conditions which they presuppose; bu t i t set an example o f not treatin g these condition s a s final. The economi c generalization s which depend , no t o n th e necessitie s o f nature but o n thos e combine d with the existing arrangements of society, it deals with only as provisional, and as liable to be much altered by the progress of social improvement (207-10).

Mill learnt, as the Autobiography make s clear, that he needed more than the technical economi c analysi s of Ricardo, an d a study of his work may lead modern students of Political Econom y t o a fuller recognitio n o f their need for something more than logical analysis, model building, and simulation exercises. There is, as I have said in my foreword, an element of art in the science, a role for imagination, judgment and intuition. But if there is an element of art in the science economic policy-making is an art. It involves much more than prescribing, on the basis of scientific analysis, a particular action with a view to achieving a stated end. There must be a readiness t o act i n spite o f that incomplet e knowledg e which makes th e resul t o f th e action uncertain. Since most policies have indirect as well as direct effects , it is the business o f the political economis t t o determine as carefully and fully a s h e ca n thes e indirec t effects , an d t o weig h i n th e balanc e th e expected and wanted direct effects plus the probable favourable, minus the probable unfavourable indirect effects. Th e indirect effects ar e frequently unrecognized, or underestimated, by the politicians and the public who are blinded by the immediate, and obvious, and wanted, result. The proble m o f prescription i s frequently further complicated b y th e desire of the public to promote two, or more, ends without recognition of their conflict; to make such conflict clear, so that the public may be faced with the necessity of choice between them, is an important function of the economist. Bu t perhap s a mor e importan t functio n o f th e politica l economist i s to make explicit the implicit but unrecognized value s of the community o f which he i s a member, values which he is likely to share . This function John Stuart Mill performed more fully than most; study of his work ma y lead mor e o f us t o recogniz e th e value s implici t in our polic y statements, and to attempt to develop similar recognition on the part of the public. Politica l Econom y i n the classica l traditio n comprehende d mor e than economi c analysis ; som e o f it s inadequacie s i n analysi s ma y b e forgiven when we consider th e total contribution it made.

John Stuart Mill 213 II

MILL ON

METHOD*

I propos e firs t t o examin e Mill' s essa y 'O n th e Definitio n of Politica l Economy an d on the Method o f Investigation Prope r to It.' This was the fifth essa y i n hi s Essays o n Some Unsettled Questions o f Political Economy: i t wa s writte n abou t 1830 , firs t publishe d i n the Londo n an d Westminster Review in 1836, and published with the other essays in 1844. First, let me quote a few sentences concerne d wit h definition, and then let me quote more extensively an d discuss more fully what he had to say about method. The 'vulga r notion o f the nature an d object o f Political Economy' was that it taught 'in what manner a nation may be made rich.' This notion was 'in some degree countenance d b y the title and arrangement whic h Adam Smith gav e t o hi s invaluabl e work . A systemati c treatis e o n Politica l Economy, h e chose t o call An Inquiry into the Nature an d Causes of th e Wealth of Nations.' Thi s 'vulgar ' definitio n comprises 'idea s of science and art." These two ideas differ from one another as the understanding does from the will, or as the indicative mood in grammar differs from the imperative mood. The language of science is , This is , or, This i s not .. . The language of art is, Do this, or, Avoid that. Scienc e take s cognizanc e o f a phenomenon an d endeavour s t o discover it s law; art proposes t o itself an end, and looks out for means t o effect i t (312).

In contrast t o the vulgar notion Mill presented th e following: What i s now commonly understood b y the term 'Politica l Economy ' .. . doe s no t treat of the whole of man's nature ... It is concerned with him solely as a being who desires to possess wealth, and who is capable of judging of the comparative efficac y of means for obtaining that end. It predicts only such of the phenomena of the social state as take place in consequence of the pursuit of wealth. It makes entire abstraction of every other human passion or motive; except those which may be regarded as perpetually antagonizing principles to the desire of wealth, namely aversion to labour, an d desire o f th e present enjoyment o f costly indulgences [m y italics] . These i t takes , t o a certai n extent , int o it s calculations , becaus e thes e d o no t merely, lik e other desires , occasionall y conflic t wit h the pursui t o f wealth, bu t accompany it always as a drag or impediment, and are therefore inseparably mixed * Reference s in the text throughout part n are to Essays in Economics and Society, ed. Lord Robbins, being vol. iv of the Collected Works

214 Fro m Adam Smith to Maynard Keynes up i n the consideratio n of it. Politica l Econom y consider s mankin d as occupie d solely in acquiring and consuming wealth ... [Their actions ] though many of them are really the result of a plurality of motives, are considered b y Political Econom y as flowing solely from the desire of wealth. The science then proceeds to investigate the laws which govern these several operations, under the supposition that man is a being who is determined, by the necessity of his nature, to prefer a greater portio n of wealth to a smaller in all cases, without any other exception than that constituted by th e tw o counter-motives already specified [m y italics]. No t tha t an y politica l economist wa s ever s o absurd as to suppos e tha t mankind are really thus consti tuted, but because thi s is the mode in which science mus t necessarily procee d .. . [He treats] the main and acknowledged end as if it were the sole end ... The political economist inquires, what are the actions which would be produced by this desire, if ... it were unimpeded by any other. In this way a nearer approximation is obtained than would otherwise be practicable ... This approximation is then to be corrected by making proper allowance for the effects of any impulses of a different description (321-3). Given thi s definitio n o f th e natur e o f th e scienc e a s 'abstract, ' th e 'method of investigation proper to it' was obviously a priori. It reasons , and , as w e contend, mus t necessarily reason , fro m assumptions , no t from facts. It is built upon hypotheses, strictly analogous to those which, under the name of definitions, ar e the foundations of the other abstrac t sciences . Geometr y presupposes a n arbitrar y definitio n o f a lin e .. . Jus t i n th e sam e manne r doe s Political Econom y presuppos e a n arbitrar y definitio n o f a man , as a bein g wh o invariably doe s tha t by which he may obtain th e greatest amoun t of necessaries , conveniences, an d luxuries , wit h th e smalles t quantit y o f labou r an d physica l self-denial with which they can be obtained in the existing state of knowledge (326). Mill regrette d tha t thi s 'definitio n o f man i s not formall y prefixed to an y work o n Politica l Economy,' for i f it were, 'i t woul d be less i n danger of being forgotten.' Politica l Economy 'reason s from assumed premises, ' its conclusions therefor e ar e 'onl y true , a s the commo n phrase goes , in the abstract', that is , they ar e only true under certain suppositions , i n which none but general causes - causes common to the whole class of cases under consideration - ar e take n int o account. ' Mill , therefore , warne d th e economist t o b e 'o n hi s guar d no t t o ascrib e t o conclusion s whic h ar e grounded upon an hypothesis a different kin d of certainty from tha t which really belongs to them. They would be true without qualifications only in a case which is purely imaginary' (326).

John Stuart Mill 215 All of this is very sound comment on the character and limitation of what we would now call 'pure theory,' what Mill referred to in the preface to the Principles a s 'pur e political economy.' But Mill asserted that the a priori method wa s no t onl y a legitimat e metho d bu t wa s 'th e onl y legitimat e method fo r th e stud y o f economic s an d socia l phenomena ' (327) . 'It i s vain,' h e said , 't o hop e tha t trut h ca n b e arrive d at , eithe r i n Politica l Economy or in any other department of the social science, while we look at the facts in the concrete, clothe d i n all the complexity with which nature has surrounded them, and endeavour to elicit a general law by a process of induction' (329) . Yet he urged th e political economis t t o stud y the facts. 'Although .. . a philosophe r b e convince d tha t n o general truth s ca n be attained in the affairs of nations by the a posteriori road, it does not the less behove hi m .. . t o sif t an d scrutiniz e the detail s o f every specifi c experi ment. Without this, he may be an excellent professor of abstract scienc e [but] he must rest contented to take no share in practical politics; to have no opinion, o r t o hol d i t with extrem e modesty , o n th e application s whic h should be made of his doctrines t o existing circumstances' (333) . Before writing the Principles, Mil l wrote his Logic \ he again discusse d the proble m o f method , bu t thi s tim e h e wa s concerne d wit h the socia l sciences i n general rathe r tha n with political econom y i n particular. Th e approach remaine d substantiall y th e same : 'Th e conclusion s o f theor y cannot be trusted, unless confirmed by observation; nor those of observation, unles s the y ca n b e affiliate d t o a theory.' 5 I n th e Logic h e showed more recognition o f the valu e of observation; bu t i t wa s fo r th e genera l science o f society, concerne d wit h the law s of the developmen t of social institutions, that the 'inverse deductive, or historical method' was recommended. In this area of study he saw that historical study was necessary not only for verification, but for suggestions of hypotheses. 'While, ' he wrote, 'it is an imperative rule never to introduce any generalisation from history into the social science unless sufficient ground s can be pointed out for it in human nature, I do not think any one will contend that it would have been possible, settin g ou t fro m th e principle s o f huma n nature an d fro m th e general circumstances o f the position of our species, t o determine a priori the orde r i n which human development mus t take plac e an d t o predict , consequently, the general facts of history.'6 But for political economy th e method remained deductive, 'reasoning from .. . one law of human nature, and fro m th e principa l outwar d circumstance s (whethe r universa l o r confined to particular states of society). '7 One should not take too seriously what people sa y about method; what they do is often ver y different. I n the Principles Mill decided to follow th e

216 Fro m Adam Smith to Maynard Keynes example o f Ada m Smit h i n associatin g 'th e principle s wit h thei r applications.'8 That Mill was wise in choosing to go beyond the bounds of the abstract scienc e ca n scarcely b e doubted. H e should, perhaps, have been readie r t o distinguis h thos e proposition s whic h wer e precis e bu t limited in application b y the natur e of the assumption s fro m whic h they were deduced, fro m thos e propositions whic h were less precise bu t were relevant to the real society, not to the unreal model. He should also have been more confident, and more venturesome, in his study of the actual . Mill recognized tha t in society 'custom ' was a determinant o f income distribution alon g with 'competition. ' Bu t he had no t ye t perceive d th e possibility of the 'scientific' study of custom: 'only through the principle of competition,' he said, 'has political economy any pretension to the character of a science.'9 Recognition of the modifying influence of custom was, he knew, essential. To escap e error, we ought in applying the conclusions of political economy to the actual affairs of life, to consider not only what will happen supposing the maximum of competition, but how far the result will be affecte d i f competition falls shor t of the maximum.' 10 Bu t he gave no estimate o f how fa r shor t o f th e maximu m competition di d fal l an d n o estimate of how much the resul t wa s affected. No r di d he se e that pure political economy might be able to deal with problems of monopoly and of limited competition . Ye t h e di d anticipat e th e result s o f suc h moder n theory when he argued with reference to retail trade that 'whe n competition does exist, it often, instead of lowering prices, merely divides the gains of th e hig h pric e amon g a greate r numbe r of dealers. ' Similarly : 'Al l professional remuneration is regulated by custom. The fees of physicians, surgeons, and barristers, th e charges o f attorneys, ar e nearly invariable . Not certainl y for want of abundant competition in these professions, bu t because the competition operates by diminishing each competitor's chance of fees, not by lowering the fees themselves.'11 Curiously enoug h Mill said little abou t anothe r sourc e o f divergence between 'th e law s of th e scienc e an d th e fact s of life' arisin g from th e unreality of the concept of the economic man. Professor Edgeworth questioned, i n hi s articl e i n Palgrave' s Dictionary o f Political Economy, whether Mill could consistently retain his view of the deductive character of the scienc e a s he began to 'doub t th e universalit y of the principl e of self-interest.' This doubt was reflected in the chapter on communism in the Principles, where Mill said: 'Mankind are capable of afar greater amount of public spirit than the present age is accustomed to suppose possible.'12 But his eulogy of peasant proprietorship , and for that matter of co-operativ e factories, wa s base d o n th e expectatio n o f increased productivit y fro m

John Stuart Mill 217 more direct pecuniary incentive to produce, as it would become the interest of the workers 'to do the utmost, instead of the least possible, in exchange for thei r remuneration.' 13 The principl e of self-interest might not b e universal, but i t was recognized to be very powerful. Lik e Alfred Marshall, Mill seems to have been read y to take advantage of the stronges t rather than the highest motives in order to get things done. In spit e o f the insistenc e o n th e a priori character o f the scienc e of economics, the complementary insistence on observation of concrete facts opened th e way to a more general attac k o n problems of society throug h historical and statistical studies ; and indeed Mill did not restrict himself to explanations that could be derived a priori. Though he was not prepared to consider his broader inquiries as 'scientific,' he appears to have been quite confident in the reliability of his explanations, predictions, and judgments in the broader field. What I find missing is a recognition of the dependence of many of his policy prescriptions on the choice of ends. There is, in the last pages of the Logic, a brief discussion o f the 'Logic of Practice or Art; including Morality and Policy.' He there stated very properly: 'A scientific observer or reasoner, merely as such, is not an adviser fo r practice. His part is only to show that certain consequences follo w from certain causes, and tha t t o obtai n certai n ends , certai n mean s ar e th e mos t effectual . Whether the ends themselves are such as ought to be pursued... it is no part of his business as a cultivator of science to decide, and science alone will never qualify him for the decision.'14 If we combine this statement with his statements on the nature of the science one might suppose that Mill would specify th e en d befor e prescribin g policy . Muc h o f th e bes t writin g in Principles i s relevant to the choice of ends, though there appears to be no recognition of the dependence o f his policy prescriptions upo n this choice. Curiously enough this failure to discuss the choice of ends is explained in part by his definition of the 'science, ' and some of the inadequacy o f the 'abstract science' for purposes of explanation and prediction is related t o the neglect of the problems of the choice of ends made by the people who are being studied. I propose to elaborate this proposition because I believe it to have contemporary significance. The antagonizing principles The definition of 'political economy' quoted abov e specified the end: 'the pursuit of wealth.' But two 'perpetually antagonizing principles ... namely aversion t o labou r an d desir e o f th e presen t enjoymen t o f costl y in dulgences' were noted. Here we have a problem of competing ends: more wealth or more leisure, mor e wealth or more current income . These an-

218 Fro m Adam Smith to Maynard Keynes tagonistic principles raised questions not only of how real man does behave as contraste d wit h ho w economi c ma n would behave , bu t fo r Mil l they raised question s o f how real man should behave . S o in my discussion o f Mill's views on method i s blended discussio n o f his social philosophy, o f his values . Predictio n require s knowledg e o f th e generall y hel d values: Mill's predictions and prescriptions o f policy will reflect in some degree his personal values. Let me illustrate with reference to the 'pursuit of wealth.' In England , it is not th e desir e o f wealth that need s t o be taught, but th e us e of wealth, and appreciation of the objects of desire which wealth cannot purchase .. . Every real improvement in the character of the English, whether it consist in giving them highe r aspirations, o r onl y a juster estimat e o f th e valu e o f thei r presen t objects o f desire, mus t necessarily moderat e th e ardou r of their devotion t o th e pursuit of wealth.15

The first two editions had put this even more strongly, referring to 'the all engrossing torment o f their industrialism.' 16 'Th e desirable medium, ' h e went on to argue, 'is one which mankind have not often known how to hit: when they labour, to do it with all their might, and especially with all their mind; but to devote to labour, for mere pecuniary gain, fewer hours in the day, fewe r day s i n th e year , an d fewe r year s o f life.' 17 Thi s i s goo d preaching of values; and is highly relevant to the 'art' of political economy, but it also illustrates the need to determine what values are held in order to predict, that is, for the purpose of the science. To treat the problem as one of defining the supply function of labour does not change it from a problem of values. What Mill thought of as the purely scientific part of economics ha d only predictive value as long as the specifie d end was in fact the choice o f the people studied . If the chosen end is other than that specified not only is the prescription necessaril y different , bu t thi s other en d becomes on e of the factors o n which the prediction o f the effec t o f proposed actio n mus t be based. This relation between the science and the art can be illustrated by a homely example: John Doe is in Toronto on e morning and wants to be in Montreal by evening. He has chosen his end; knowledge of the timetables for air and railwa y travel , of the stat e of the weathe r and of the roads , enables hi m to selec t th e mean s of getting to Montreal : suc h knowledg e constitutes hi s science. Bu t suppose th e proble m reall y t o be that o f the scientist in predicting where John Doe (or a thousand like him) will be on a particular night. Knowledge of the timetables (the science relevan t to the

John Stuart Mill 21 9 simpler question ) i s not enough: th e scientis t must know what end John Doe has chosen, whether to stay in Toronto, t o go to Montreal, or to go to Windsor. Consider next the other 'antagonizing ' principle, 'desir e of the present enjoyment o f costly indulgences. ' M y first comment is that this involves confusion betwee n 'wealth ' and 'income.' Surely the motive assumed for the abstrac t scienc e i s no t th e maximu m accumulation o f wealt h wit h consumption limite d t o 'productiv e consumption, ' s o that eve n th e few luxuries of the poor come under scrutiny as doubtfully proper . 'Consump tion even of productive labourers is not all of its productive consumption... What they consume in keeping up or improving their health, strength, and capacities o f work, o r i n rearing othe r productiv e labourer s t o succee d them, is productive consumption . Bu t consumption on pleasures o r luxuries, whethe r b y th e idl e o r b y th e industriou s .. . mus t b e reckone d unproductive; with a reservation perhaps o f a certain quantu m of enjoy ment which may be classed among necessaries, since anything short of it would no t b e consisten t wit h the greates t efficienc y o f labour.'18 I f consumption wer e assume d t o b e s o limited the abstrac t scienc e woul d be easier, but Mill does not pretend that it either is, or ought to be, so limited. It would be a great error to regret the large proportion of the annual produce, which in a n opulent country goes to suppl y unproductive consumption. It woul d be t o lament tha t th e communit y has s o muc h t o spar e fro m it s necessities , fo r it s pleasures and for all higher uses. This portion of the produce is the fund from which all the wants of the community, other than that of mere living, are provided for .. . That so great surplus should be available for such purposes ... can only be a subject of congratulation.'19

What then of the antagonizing principle? Mill the preacher was offende d by the 'costl y indulgences': what is to be regretted i s not the siz e of the surplus availabl e fo r unproductiv e consumptio n bu t th e 'prodigiou s in equality with which this surplus is distributed, the little worth of the objects to which the greater part of it is devoted, and the large share which falls to the lot of persons wh o render n o equivalent servic e i n return.'20 For th e abstract scienc e th e problem is to establish a supply function fo r savings which emerges from these values, the choices, of the people. Fo r the art a conflict of ends has emerged: is the wealth pursued worth pursuing, would it be worth pursuing if it were more equally divided? Mill returned t o this theme in the chapter on the 'Stationary State':

220 Fro m Adam Smith to Maynard Keynes those who do not accept the present very early stage of human improvement as ultimate type, may be excused fo r being comparatively indifferen t t o the kind economical progress which excites the congratulations of ordinary politicians; t mere increase o f production an d accumulatio n .. . I kno w not wh y it should b e matter of congratulation that persons who are already richer than any one needs be, shoul d have doubled thei r means of consuming things which give little o r pleasure except as representative of wealth ... It is only in the backward countri of the world that increased production is still an important object ... 21

His unkind reference to the Americans in the ist edition of the Principl was a dramatic condemnation of the motive 'assumed' for the science a i of the Malthusian sin of the people. 'They have the six points of Chartisi and they have no poverty: and all that these advantages d o for them is th the life of the whole of one sex is devoted to dollar-hunting, and of the oth to breeding dollar-hunters.' 22 This is preaching, but success in preaching different se t of values would change the data of the science. The scienti l study of the values of the community is, therefore, I reiterate, a major pa of political economy i n the wide sense as distinct fro m politica l econo n conceived a s an abstract science ; assessmen t o f values is, therefore, n evant to the determination of means, as well as to the choice of ends. Tl choice o f means require s predictio n o f the effec t o f any propose d acti < (prediction that requires a knowledge of the values held by the commu ity); th e choic e o f end s require s a n assessmen t o f th e cos t (wha t foregone) of any proposed action . Knowledg e of values is required for tl science; skill in the science i s required for realization of the values. Ill

M E AN S AN D EN DS *

So far ends and means have been treated a s independent of each other. B the mean s ma y become partiall y end s i n themselves. O f modern write r Professor Fran k Knight has dealt most effectively wit h this problem in h Ethics of Competition. 2* When we consider that productive activity takes up the larger part of the wak i lives of the great mass of mankind, it is surely not to be assumed without investig tion or inquiry that production is a means only, a necessary evil, a sacrifice made f the sake of some good entirely outside the production process. W e are impelled * I n the remainder of this chapter page references in the text are to the Principles ofPoliticc Economy, Collected Works, volumes n and in

John Stuart Mill 221 look for ends in the economic process itself, other than the mere consumption of the produce, and to give thoughtful consideration to the possibilities of participation in economic activit y a s a spher e o f self-expressio n an d creativ e achievemen t .. . Economists an d publicist s ar e comin g to realiz e ho w largel y th e efficienc y o f business and industry is the result of this appeal to intrinsic interest in action; how feeble, in spite of the old economics, is the motivation of mere appetite or cupidity; and ho w muc h the drivin g powe r o f ou r economi c lif e depend s on makin g an d keeping th e gam e interesting . A rapidl y growin g literatur e o n 'incentive ' i s a witness to this awakening.

That Mill was not unaware of this interplay of means and ends is shown in the chapte r o n th e 'Stationar y State ' wher e h e argue d tha t increase d production was a matter of minor importance because it meant consuming more thing s tha t giv e littl e o r n o pleasure , bu t als o argued : 'Tha t th e energies o f mankin d shoul d b e kep t i n employmen t by th e struggl e fo r riches, as they were formerly by the struggle of war, until the better minds succeed i n educating th e other s int o better things , is undoubtedly mor e desirable than that they should rust and stagnate' (n, 754). If on e consider s tha t th e mean s b y whic h the y suppl y thei r materia l wants mould the character o f the people whos e wants are to be met, one must ask whether the means most effective i n the supply of their existing wants may mould people into more or less desirable patterns. To Ruskin it appeared that there was a premium on the less desirable characteristics, for success in the business world seemed to depend on these. 'In a community regulated b y th e la w o f deman d an d suppl y bu t protecte d fro m ope n violence,' Ruskin said, 'the persons who become rich are, generally speaking, industrious, resolute, proud, covetous, prompt, methodical, sensible, unimaginative, insensitive and ignorant. The persons who remain poor are the entirely foolish, the entirely wise, the idle, the reckless, the humble, the thoughtful, th e dull, the imaginative, the sensitive, the well-informed, the improvident, the irregularly and impulsively wicked, the clumsy knave, the open thief , th e entirel y merciful , just an d godl y person. ' On e ma y no t accept thi s condemnation , bu t on e mus t recognize tha t th e effec t o f the process on the people is relevant to the choice of the kind of process. R.H. Tawney's Sickness of an Acquisitive Society 24 raise d this problem again. Another case where means and ends became tangled related to the value placed o n libert y a s a n end . I n th e Principles this wa s discusse d i n th e chapter on Property where he asked which of the two systems, communism or competitiv e capitalism , wa s 'consisten t wit h th e greates t amoun t of human liberty and spontaneity' (i, 208). The fluctuation in his assessmen t

222 Fro m Adam Smith to Maynard Keynes of th e desirabilit y o f communis m involved conflic t o f end s mor e tha n uncertainty as to the efficacy of means. 'After the means of subsistence ar e assured,' h e said , 'th e nex t i n strengt h o f the persona l want s of human beings is liberty ...' (i, 208). But the schemes which he discussed seemed to involve renouncing 'liberty for the sake of equality' (i, 209). He recognized that the 'restraint s of Communism would be freedom in comparison with the present condition of the majority of the human race' (i, 209), and urged his readers t o 'compar e Communism at its best, wit h the regime of individual property, no t a s i t is but a s it might be made' (i , 207) . It wa s no t enough for communism to promise 'greater personal an d mental freedom than is now enjoyed by those who have not enough of either to deserve the name' (i, 209); nor was it acceptable to denounce the restriction on freedom under socialism while accepting the restrictions on freedom of the existing society. The title of Hayek's book, The Road t o Serfdom (1944) , suggests that it is a road from freedom! But was it? Perhaps we should re-examine the degree of freedom i n our modern society in the light of Mill's criticism of hi s England . 'Th e generalit y o f labourers .. . hav e a s littl e choic e o f occupation or freedom of locomotion, are practically as dependent on fixed rules an d o n the wil l of others, a s they could be o n an y syste m short of actual slavery ...' (i, 209). With this should be read those splendid pages at the beginnin g of his chapter o n the 'Probabl e Futurity o f the Labourin g Classes,' where he discussed 'th e two conflicting theorie s respectin g th e social position desirable for manual labourers,' the 'theory of dependence and protection, ' an d th e 'theor y o f sel f dependence. ' Libert y implie d independence. There were those who were arguing for a paternal relationship between the rich and the poor, 'affectionat e tutelag e on the one side, respectful an d gratefu l deferenc e o n th e other ' (n , 759) . 'Spaniel-lik e servility' was the phrase W.T. Thornton used . To those Mil l pointed out that 'all privileged and powerful classes, a s such, have used their power in the interes t o f thei r ow n selfishness , an d hav e indulge d thei r self importance in despising, and not in lovingly caring for, those who were, in their estimation, degraded , b y bein g under the necessit y o f working for their benefit' (n , 760). H e made it clear that even if the 'superio r classe s could be sufficiently improve d to govern in the tutelary manner supposed, the inferior classe s woul d be too much improved to be so governed .. . Of the working men, at least in the more advanced countries of Europe, it may be pronounced certain, that the patriarchal or paternal system of government is one to which they will not again be subject' (n, 760-1).25 Liberty, spontaneity, equality, productivity, all must be considered by the political economist and to them Mill added the preservation of natural

John Stuart Mill 223 beauty. His plea in the chapter on the 'Stationary State' is still worthy of consideration and , indeed , i s highly relevant t o ou r curren t discontent : 'solitude in the presence o f natural beauty an d grandeur, is the cradle of thoughts an d aspirations whic h are not only good for the individual, bu t which society could ill do without' (n, 756). There is little satisfaction, he said, in contemplating a world 'with nothing left to the spontaneous activity of nature ... [with] every flowery waste or natural pasture ploughed up, all quadrupeds o r birds which are not domesticated fo r man's use extermi nated as his rivals for food ..., and scarcely a place left where a wild shrub or flower could grow without being eradicated a s a weed in the nam e of improved agriculture' (n, 756). Mill feared that the earth migh t lose tha t 'great portion of its pleasantness which it owes to things that the unlimited increase o f wealth and population would extirpate fro m it' (n, 756). Thi s became the theme of George Gissing's novelDemos (1886). At the opening of the novel , Stanbur y Hill, 'remot e but tw o hours' wal k from a region blasted with mine and factory and furnace, shelters with its western slope a fair green valley, a land of meadows and orchard, untouched by poisonous breath.' In Chapter vn, John Eldon, havin g been deprive d of his inheritance, look s ou t o n a differen t scene : 'buildin g o f various kinds was in progress i n the heart o f the vale; a great massiv e chimney was rising to completion, and about it stood a number of sheds. Beyond was to be seen the commencement of a street of small houses, promising infinite ugliness in a little space ... in truth, the benighted valley was waking up and donning the true nineteenth-century livery.' But a turn of fortune puts Eldon back in the position of owner and all is changed. 'It is springtime, and the valley of Wanley is bursting into green and flowery life, peacefully glad as if the foot of Demos had never come that way. Incredible tha t the fumes of furnaces ever desecrate d tha t fleece-sow n sk y o f tenderes t blue , tha t hammer s clanged an d engine s roare d wher e no w th e thrus h utter s hi s son g s o joyously. Hubert Eldon has been as good as his word. In all the valley no trace is left of what was called New Wanley.' Whether we consider this a case of competing ends, wealth or beauty, or whether we consider beaut y part of the wealth which is to be maximized, the problems raise d ar e still relevant. I t would be wrong to argue that all beauty mus t be preserve d a t an y cost; but growt h in the gross nationa l product requires t o be related t o growth in the net national product in the special sens e develope d i n m y Digressio n o n 'Th e Pursui t o f Wealth. ' Offsetting th e increase i n goods an d services there ma y be a consequen t destruction of natural beauty. There then arise the issues I discussed in my Digression on 'Consumer Sovereignty.' Who is to value the loss of beauty;

224 Fro m Adam Smith to Maynard Keynes who is to bear the cost of its preservation? Mil l might rely on the improvement in the character of the people a s promising that the consumer would opt for beauty i n considerable quantities . Bu t he wa s no t s o wedded t o democracy tha t h e woul d leav e th e issu e t o consume r choice , o r s o I deduce fro m a commen t o n educatio n i n hi s Autobiography. Referrin g there to his essay on 'Corporation and Church Property,' he said: 'I urged strenuously the importance of having a provision for education, not dependent upon the mere demand of the market, that is on the knowledge and discernment of average parents, but calculated t o establish and keep up a higher standard of instruction than is likely to be spontaneously demande d by the buyers of the article.' 26 In the Essay itsel f h e wrote: 'W e deem it important tha t individual s should hav e i t i n their powe r t o enabl e goo d schooling, goo d writing , good preaching , o r an y othe r cours e o f goo d instruction, to be carried o n for a certain number of years a t a pecuniary loss. By that time, if the people are intelligent, and the government wisely constituted, the institution will probably be capable of supporting itself, or the government will be willing to adopt all that is good in it... For, that the people can see what is for their good, when it has long been shown them, is commonly true; that they can foresee it - seldom.' 27 IV

MILL AND

SOCIAL

CHANGE

Pure political economists not only assumed an 'economic man,' they also took fo r grante d th e existin g socia l institution s an d generall y faile d t o specify th e relevan t aspects . Becaus e the y base d thei r analysi s o n th e unvarying characte r o f thes e institutions , the y hav e bee n suppose d t o accept them as permanent, indeed as part of the external order of nature. Joan Robinson , i n An Essay o n Marxian Economics (1963 ) mad e this supposition, sayin g that the bourgeois economis t faile d to see the institutions o f capitalism a s a 'passin g phase i n the transitio n fro m th e feudal economy o f the pas t t o th e socialis t econom y o f the future. ' A simila r charge wa s mad e against th e classica l economist s b y th e writer s of th e Historical School and Mill was their butt. Yet clearly Mill did not consider the social and economic institutions of the England of his day as universal, permanent or even desirable. Nor did he think of the only possible change as purification of those institutions by elimination of the continuing element of feudalism and by the achievement of free trade. Mill mad e a clea r distinctio n betwee n certai n part s o f the Principles which he believed to have general validity and other parts, like the laws of distribution, which were related to particular institutions.

John Stuart Mill 225 The distribution of wealth, therefore, depends on the laws and customs of society. The rules by which it is determined are what the opinions and feelings of the ruling portion of the community make them, and are very different i n different age s and countries; and might be still more different, if mankind so chose. The opinions and feelings o f mankind, doubtless, are no t a matter of chance. The y ar e the conse quences of the fundamental laws of human nature, combined with the existing state of knowledge and experience, and the existing condition of social institutions and intellectual and moral culture. But the laws of the generation of human opinions are not within our present subject... We have here to consider, not the causes, but the consequences, of the rules according to which wealth may be distributed. Those, at least, are as little arbitrary, and have as much the character o f physical laws, as the laws of production. Huma n beings can control their own acts, but not the consequences o f their acts, either to themselve s or to others . Societ y can subjec t th e distribution of wealth to whatever rules it thinks best: but what practical results will flow from the operation of these rules, must be discovered, like any other physical or mental truths, by observation and reasoning (i, 200).

In all of this the relativity of the theory of distribution and its dependenc e on particula r institutions , whic h ar e subjec t t o change , ar e clearl y em phasized. It i s when we consider th e 'law s of the generation o f human opinions ' that th e differenc e wit h Mar x show s up ; thoug h eve n her e i t is easy t o oversimplify. Mil l appear s t o b e th e 'idealist, ' th e 'Utopian ' i n Marx' s language. Yet Mill clearly recognize d som e sort of necessity in the history of institutions. H e sa w the growin g strength o f the workin g class as th e instrument of change; and he saw that the organization of the working class was takin g plac e i n response t o industria l change , congregatio n i n factories, communicatio n throug h newspapers , an d mobilit y throug h rail ways. In hi s essay, Th e Claims of Labour, he said : 'Whil e some , by the physical and moral circumstances whic h they saw around them, were made to feel tha t th e conditio n o f the labouring clas s ought t o be attended to , others were made to see that it would be attended to, whether they wished to be blind to it or not.'28 But if Mill recognized th e 'necessity' in this shif t of power, he probably still felt that the opinions that would be acceptable , the mode s o f conduct tha t i t would be thought fit to adopt, would be the result o f rational evaluation. 'Huma n affairs,' h e said in his review of De Tocqueville,29 'ar e not entirely governed by mechanical laws, nor men' s characters wholl y an d irrevocabl y forme d b y thei r situatio n i n life . Economical an d social change, though among the greatest, are not the only forces which shape the course of our species; ideas are not always the mere

226 Fro m Adam Smith to Maynard Keynes signs and effects o f social circumstances, they are themselves a power in history.' The law s o f th e generatio n o f huma n opinions, ' h e said , 'ar e no t within our present subject ' (i, 200). That he was ready to restrict himself in this way in the Principles is, perhaps, explained b y his estimate of the rate of future change . Whil e Marx and Engels, writin g in the sam e year , sa w social revolutio n jus t aroun d th e corner , Mil l wa s confiden t tha t 'th e political economis t fo r a considerable tim e to come , wil l be chiefl y con cerned with the conditions of existence and progress belonging to a society founded o n privat e propert y an d individua l competition ' (n , 214) . I n a sense that 'considerable time' has not yet elapsed. But i f Mill looked forwar d to the continue d 'existence ' of the society , founded on private property, he was not complacent. He was highly critical of contemporary societ y an d was concerned wit h the possibility o f 'progress.' 'The object to be principally aimed at in the present stage of human improvement is not the subversion of the system of individual property, but the improvemen t o f it, an d the ful l participatio n o f every membe r of the community in its benefits' (i, 214). His views are put forcibly in the chapte r on communism (not, it need hardl y be said, th e Marxia n variety o f communism, but certain forms of'Utopian socialism'). If, therefore, the choice were to be made between Communism with all its chances, and the present state of society with all its sufferings and injustices; if the institution of private property necessarily carried with it as a consequence, that the produce of labour should be apportioned as we now see it, almost in inverse ratio to the labour - th e largest portions to those wh o have never worked at all, the next largest to those whose work is almost nominal, and so in descending scale, the remuneration dwindling as the work grows harder and more disagreeable, until the most fatiguing and exhausting bodily labour cannot count with certainty on being able to earn even the necessaries of life; if this or Communism were the alternative, all the difficulties , great or small , of Communism would be as dust in the balance. Bu t .. . w e must compare Communism at its best, with the regime of individual property, not as it is, but as it might be made. The principle of private property has never yet had a fair trial i n an y country ; and les s so , perhaps , i n thi s country than i n som e other s (1,207).

Before leaving this subject let me emphasize the present importanc e of the requirement that we compare 'Communis m at its best, with the regime of individual property, not as it is, but as it might be.' Too often in emotional discussion we are asked to compare a 'planned society' as it might be under

John Stuart Mill 227 ideal conditions with an unplanned society operating at its worst; or alternatively to compare a perfectly working ideal model of a competitive fre e enterprise societ y wit h som e actua l planne d societ y whic h is operating ineffectively an d wastefully. Le t us compare idea l with ideal, an d reality with reality, and let us try to see reality as it really is.

6

Mill's Principles*

While Mill the Preacher might doubt the importance of increasing produc tion except i n 'the backward countries, ' Mill the political economis t wa s more realistic and put the problem of production, the causes of productivity and of increasing productivity, at the forefront o f his study. Perhaps this was related to his expectation o f continued population increase: increasing accumulation and increasing productivity would be necessary even if no further improvemen t in standard s of livin g wer e desired ; an d whatever improvement in the condition of the poor might be achieved by redistribution with a stationary population, the existing standard could not be maintained wit h increasing population without such increase i n productivity. The preache r wa s contemplatin g th e Stationar y State , th e politica l economist wa s concerne d wit h the practica l problem s o f contemporary society. Increase in the productivity of labour, and accumulation of capital were recognized a s urgent necessities. The y remai n urgently necessary, and modern economists in developing countries, backward or advanced , particularly in countries where population is once again increasing rapidly, do well to reconsider Mill's treatment if only to stimulate them to develop a modern theory of production. I THE D E G R E E OF P R O D U C T I V E N E S S OF PRODUCTIVE AGENTS

Chapter vn of Book i is devoted t o a consideration o f the 'causes' of the * Throughou t thi s chapte r pag e reference s i n th e tex t ar e t o th e Principles of Political Economy in the Collected Works, vols. n and HI

John Stuart Mill 229 differences i n productivity at differen t time s and in different places : it is well worth study for its propositions ar e now largely ignored or taken for granted without recognition. I propose t o quote a little fro m eac h o f his sections on the five causes which he identifies. First, 'natural advantages.' These are , a s he says, the 'most evident,' and littl e nee d b e quote d fro m thi s section . O f th e natura l advantage s 'fertility o f the soil is one of the principal... A favourable climate is even more important than a rich soil ' (i, 101) . It is not only in agriculture that climate is crucial: 'the superiority of the woven fabrics of Southern Europe over those of England in the richness and clearness of many of their colours is ascribed to the superior quality of the atmosphere, for which neither the knowledge of chemists nor the skill of dyers has been able to provide, in our hazy and damp climate, a complete equivalent' (i, 101). Another part of the influence o f climate consists in lessening the physical requirements of the producers. In hot regions, mankind can exist in comfort with less perfect housing, less clothing; fuel, that absolute necessary o f life in cold climates, they can almost dispense with, except for industrial uses ... Much therefore of the labour elsewhere expended to procure the mere necessaries o f life, not being required, more remains disposabl e for it s higher uses and its enjoyments; if the character o f the inhabitants doe s no t rather induc e the m t o us e u p thes e advantage s i n overpopulation, o r i n the indulgence of repose (i, 101-2). Second: 'greater energy of labour.' Individuals, or nations, do not differ s o much in the efforts they are able and willing to make under strong immediate incentives, as in their capacity of present exertion for a distant object; and in the thoroughness of their application to work on ordinary occasions. Som e amount of these qualitie s i s a necessary conditio n o f any great improvement among mankind. To civilize a savage, he must be inspired with new wants an d desires , eve n i f no t o f a ver y elevate d kind , provide d tha t thei r gratification can be a motive to a steady and regular bodily and mental exertion... In England, it is not the desire of wealth that needs to be taught, but the use of wealth, and appreciatio n o f the object s o f desire whic h wealth canno t purchase , o r fo r attaining which it is not required. Every real improvement in the character o f the English, whethe r i t consis t i n givin g them highe r aspirations , o r onl y a juster estimate of the value of their present objects of desire, must necessarily moderat e the ardour of their devotion to the pursuit of wealth (i, 103-5).

230 Fro m Adam Smith to Maynard Keynes Third, 'superio r skill and knowledge.' That the productiveness o f the labour of a people is limited by their knowledge of the arts of life, is self evident; and that any progress in those arts , any improved application of the objects or powers of nature to industrial uses, enables the same quantity of labour to raise a greater produce' (i, 106). I shall revert to this 'cause' when discussing Mill's treatment o f investment in human capital. He did not recognize tha t the increase i n knowledge also required investmen t in research: the development of technology from science was not yet seen as a field o f investmen t comparabl e t o investmen t i n fixe d capital , and , o f course, the incredible acceleration o f scientific achievement as advanced technology is placed at the disposal of the pure experimental scientist could not be foreseen in 1848. But Mill did devote a section of his last chapter on the limits of the province of government to a plea for provision for scientific research an d for the maintenance of a 'learned class.' Th e cultivatio n of speculative knowledge, though one of the most useful of all employments, is a service rendered to the community collectively, no t individually, and one consequently, for which it is,prima facie, reasonable that the community collectively should pay' (n, 968). Fourth, th e superiorit y o f intelligence an d trustworthiness i n the community generally. The importance of 'knowledge' as a cause of increasing wealth had been generally recognized. A thing not yet so well understood and recognized, is the economical value of the general diffusion o f intelligence among the people. The number of persons fitted t o direct an d superinten d an y industrial enterprise, or even to execute any process which cannot be reduced almost to an affair o f memory and routine, is always far short o f th e demand ; a s i s eviden t from th e enormou s difference betwee n the salaries paid to such persons, and the wages of ordinary labour. The deficienc y of practical good sense, whic h renders the majorit y o f the labouring class suc h bad calculators - whic h makes, for instance, their domestic economy so improvident, lax, an d irregular - mus t disqualify the m for any but a low grade o f intelligent labour, an d rende r their industr y fa r les s productiv e than with equa l energy it otherwise might be. The importance, even in this limited aspect, of popular education, is well worthy of the attention of politicians, especially in England (i, 107-8).

The moral qualities of the labourers were seen to be fully a s important to the efficiency an d worth of their labour, as the intellectual. Independently o f the effect s o f intemperance upon their bodily and menta l facul -

Mill's Principles 23 1 ties, and of flighty, unsteady habits upon the energy and continuity of their work ... it is well worthy o f meditation, ho w muc h of the aggregat e effec t o f their labou r depends o n their trustworthiness. All the labour now expended i n watching that they fulfi l thei r engagement , o r in verifying that the y have fulfille d it , i s so much withdrawn fro m th e rea l business o f production , t o b e devote d t o a subsidiar y function rendere d needfu l not by the necessity o f things, but by the dishonesty of men... The advantage to mankind of being able to trust one another, penetrates into every crevice and cranny of huma> life: the economical is perhaps the smallest part of it, yet even this is incalculable. T o consider only the most obvious part of the waste o f wealt h occasione d t o societ y b y huma n improbity; there i s i n al l rich communities a predatory population, who live by pillaging or overreaching other people; thei r number s canno t b e authenticall y ascertained , bu t o n th e lowes t estimate, in a country like England, it is very large. The support of these persons is a direct burthe n o n the nationa l industry . The police , an d the whol e apparatus of punishment, an d o f crimina l an d partl y o f civi l justice, ar e a secon d burthe n rendered necessary by the first. The exorbitantly-paid profession of lawyers, so far as thei r wor k i s no t create d b y defect s i n the law , o f their ow n contriving , ar e required and supported principally by the dishonesty of mankind. As the standard of integrity in a community rises higher , all these expenses becom e less. But this positive saving would be far out-weighed by the immense increase in the produce of all kinds of labour, and saving of time and expenditure, which would be obtained if the labourers honestly performed what they undertake (i, 109-10).

Fifth, superio r security. As in Adam Smith peace, order and good govern ment were seen as necessary conditions of high productivity. Among the secondar y cause s whic h determine th e productiveness o f productiv e agents, the most important is Security. By security I mean the completeness of the protection which society afford s to its members. This consists o f protection by the government, and protection against the government. The latter is the more important. Where a person know n to possess anythin g worth taking away, can expec t nothing but t o have it torn fro m him , with every circumstance o f tyrannical violence, by the agents of a rapacious government, it is not likely that many will exert themselves t o produc e muc h mor e tha n necessaries . Thi s i s the acknowledge d explanation of the poverty of many fertile tracts of Asia, which were once prosperous and populous (1,112).

Mill went on to note that much o f the security in modern nations was the effect of manners and opinion rather than law.

232 Fro m Adam Smith to Maynard Keynes In England the people ar e tolerably well protected, both by institutions and manners, agains t th e agent s o f government; but, for the securit y the y enjo y agains t other evil-doers, they are very little indebted to their institutions. The laws cannot be said to afford protectio n to property, when they afford i t only at such a cost as renders submissio n to injur y i n genera l th e bette r calculation . Th e securit y of property in England is owing (except as regards open violence) to opinion, and the fear of exposure, much more than to the direct operation of the law and the courts of justice (i, 114).

Mill followed this discussion o f security o f property b y reflections o n th e effect of the legal system on incentives t o produce: The efficiency of industry may be expected to be great, in proportion as the fruits of industry are insured to the person exerting it: and that all social arrangements are conducive to useful exertion , according a s they provide that the reward of every one for his labour shall be proportioned a s much as possible to the benefit which it produces. Al l law s or usage s whic h favour on e clas s o r sor t o f person s t o th e disadvantage of others; which chain up the efforts o f any part of the community in pursuit of their own good, or stand between those efforts an d their natural fruits are (independently of all other grounds of condemnation) violations of the funda mental principles of economical policy ; tending to make the aggregate productive powers of the community productive in a less degree than they would otherwise be (i, 114-15) -

In this last section, and to some extent in earlier sections, the rigid distinction Mill had made in his Preliminary Remarks (i, 21) becomes, properly, blurred. Th e effec t o f changin g an d changeabl e huma n institution s o n productivity as well as on the distribution of that product becomes evident. Indeed i n assessin g th e wisdo m o f choosin g alternativ e institutions , if choice i s possible, Mil l was concerned wit h the effec t o n productivity as well as on distribution. The omissio n o f th e quantit y an d qualit y o f th e rea l capita l o f th e community as one of the factors determining the degree of productiveness of labour is surprising. It is particularly surprising when one considers hi s treatment o f investmen t i n huma n capital . H e recognize d tha t capita l provided 'shelter , protection, tools and materials' a s well as food for the workers. But he seems to have assumed that the required quantity of these was directly proportional to the number of workers employed: no recognition yet of the principle of substitution. And he seems to ignore improvement in the quality of the tools. Adam Smith had written about machine s

Mill's Principles 23 3 which facilitate and abridge labour: surel y Mill should have paid attentio n to the accumulation o f more and better machinery, more and better real capital, a s a major influenc e on productivity. Instea d h e emphasized in creasing capita l a s attracting more and more of the unproductive workers into productiv e industr y an d providin g the m wit h th e usua l tool s an d materials. II

INVESTMENT IN HUMAN CAPITAL

One important element in Mill's economics is his emphasis on investment in human beings. After a century of neglect this has come to the fore as a result of the immens e investment in education require d in backward and advanced countries alike. In discussing 'Labour as an Agent of Production' Mill devoted one section to 'labour of which the subject is human beings' (i, 40). Much of this labour is' incurred from other motive s than to obtain such ultimate return, and, for most purposes of political economy, need not be taken int o accoun t a s expense s o f production' (i , 41) . Bu t technica l o r industrial education i s generally 'undergon e for the sake of the greater o r more valuable produce thereby attained' and should therefore be treated as 'part o f what the produc e cost s to society ' (i , 41) . Similarl y 'th e labou r employed in keeping up productive powers; in preventing them from being destroyed o r weakene d b y acciden t o r disease, ' thoug h no t generall y employed by the individual patients fro m 'economica l motives,' must be considered 'a s part of the advance by which society effect s it s productive operations' (i, 41). There follows a section on the labour of the inventor and the savant . Again the differenc e betwee n th e individua l an d th e socia l aspect i s noted: 'thes e materia l fruits, thoug h the result , are seldo m the direct purpos e o f th e pursuit s of savant s .. . Bu t whe n (a s i n political economy one should always be prepared to do) we shift ou r point of view, and consider not individual results, intellectual speculation must be looked upon a s a mos t influentia l par t o f the productiv e labour of societ y .. . ' d,43). Mill recurred t o thi s theme in the chapte r o n 'Unproductiv e Labour ' where h e discusse d 'utilitie s fixe d an d embodie d i n human beings.' H e would have preferred, he said, to 'regard all labour as productive which is employed i n creatin g permanen t utilities , whethe r embodie d i n human beings, o r i n an y othe r animat e o r inanimat e objects ' (i , 48) . Bu t h e accepted th e usag e whic h limite d th e ter m t o labou r which produce d 'utilities embodied in material objects' (i , 49). He then broke through this limitation to include as productive, 'labour expended in the acquisition of

234 Fro m Adam Smith to Maynard Keynes manufacturing skil l ... not in virtue of the skill itself, but of the manufactured products created by the skill' (i, 49). The emphasis is on the 'investment' aspec t o f som e par t o f education ; i f the labou r o f th e teache r i s classed a s 'unproductive ' thi s i s no t 'derogatory, ' bu t i n classin g i t a s 'productive' it s contributio n t o increasin g futur e productivity i s recog nized. That part of educating expense is essentially par t of the 'accumulation' which was so urgently required. In the struggle for free elementary and secondary education the decisive arguments wer e political an d philosophical: tha t democrac y implie d the right o f its citizen s t o educatio n an d tha t democracy , i f it were t o work satisfactorily, required that its citizens be educated. That better education was important in the maintenance of British industrial leadership, soo n to be challenged by Germany and the United States, was recognized, but no effort wa s mad e t o estimat e th e nationa l valu e o f improved education . Quantitative analysi s o n an y scal e wa s no t t o develo p til l th e secon d quarter o f th e nineteent h century , an d it s applicatio n t o th e retur n o n investment i n huma n capita l wa s a featur e o f th e thir d quarter . The n quantitative analysi s had becom e possibl e an d fashionable, so the argu ment for greatly increased expenditure on education, particularly on higher education, was supported by economic argument as to the rate of return on such investment. As long as the amount was relatively smal l the politica l and human e aspect wa s paramount: an y economi c advantag e was , i n a sense, costless. Bu t in the fifties an d sixties the amount of expenditure on education increased drastically. A changed age-composition following the baby boom , a ne w democrati c driv e t o ope n opportunitie s fo r highe r education to all citizens, and a new concern for the supply of highly trained scientists and engineers, stimulated but not caused by 'sputnik,' combined to increase the demand for increased expenditure. This demand was supported by arguments as to the expected rate of return from such investment compared to the rate expected o n investments in fixed capital whether in the public or private sector. This is not the place to examine this literature: there was probably some exaggeration in the early estimates, bu t in later years there was too muc h importance attached t o th e valu e of any such estimates. Though it is no longer proper to ignore the economic effects and to treat education as a 'consumer's good,' it is equally improper to ignore the consumer aspect and to consider the rate of return on the total expenditure as the criterion for decisions on such expenditure. It is not only wrong, it is dangerous; it may produce pressure to sacrifice the 'consumer' aspect s of educatio n which ar e o f great importance in developing the qualit y o f people an d improvin g the quality of life i n favour o f those aspects which

Mill's Principles 23 5 seem to promise materia l advance . W e should hesitat e t o apply to a fre e democracy the criteria which would be appropriate in a slave state. Curiously enough the enormous increas e i n medical expenditure of the same period wa s not supporte d a s likely to increase productivity . Here , rightly, the consumer aspec t was treated as paramount. Bu t if one reject s the economic criterion of productivity entirely for medicine, and largely for education, on e should not fail to recognize the incidental effect on productivity. In both cases there is something like a 'widow's cruse,' the more you take, the more there is to take.1 Ill

CAPITAL AND DEVELOPMENT

In the neo-classical economic s th e theory of production was essentially a theory of allocation o f resources, of the 'right' proportions o f factors in the production o f the 'right ' things ('right' interpreted wit h reference to leas t cost and conformity to demand). In the Keynesian economics th e concer n was with full employment of resources. In the classical economics, as in the new economic s o f growt h an d development , th e ful l employmen t an d proper allocation o f given resources took secon d place to a concern for the development of new resources. This is perhaps clearer in Adam Smith than in Mill, but I believe tha t Mill' s continued us e of the distinction betwee n productive and unproductive labour indicates a continued concern for the liquidation of the primitive sector of the economy in which menial servants were maintaine d i n idlenes s o n a mor e o r les s feuda l basis , an d fo r th e development o f 'industry,' the advanced secto r of the economy i n which workers, wel l equipped, wel l managed, well disciplined, would probably be employe d a t wage s considerabl y highe r tha n thos e prevailin g i n th e primitive sector. I have discussed thi s concept o f unproductive labour and the related theor y o f development in Book One. Tw o quotations may be justifiable repetition. 'W e are more industrious than our forefathers,' sai d Adam Smith , 'becaus e i n th e presen t time s th e fund s destine d fo r th e maintenance of industry are much greater i n proportion t o those which are likely to be employed in the maintenance of idleness than they were two or three centuries ago.' And Malthus: 'Three or four hundred years ago, there was undoubtedly much less labour in England in proportion to the population, tha n a t present ; bu t ther e wa s muc h mor e dependence ; an d w e probably shoul d no t no w enjo y ou r presen t degre e o f civil liberty, if the poor, by the introduction o f manufactures, had not been enable d t o give something i n exchange fo r th e provision s o f the grea t Lords , instea d o f being dependent upon their bounty.' The idle, be it noted, were not unem-

236 Fro m Adam Smith to Maynard Keynes ployed; the problem was to absorb them into 'industry' where they would be more productive. Much o f th e difficult y o f interpretin g or accepting , th e proposition s about capital in Mill may be reduced i f it is recognized tha t these chapters are concerned wit h 'development.' As Professor Hl a Myint put i t in his Theories o f Economic Welfare 22w e should not read 'ou r latter-day preoccupation with the "allocative" problem into the classics through the distorting spectacles provided by the General Equilibrium economists of the Marginal Utility School . I t i s time we learned t o cur e ourselve s o f thi s theoretical anthropomorphis m and to approach the classical economists in the context o f thei r intellectua l climate. ' I t i s i n thi s contex t tha t th e chapters in Mill on capital must be read, not as discussion of the economie s of round-about production, nor eve n of the employmen t problems risin g from a n imbalanc e o f savin g an d investment ; bu t a s discussio n o f th e development o f 'industry ' a t th e expens e o f th e pre-industrial , quasi feudal, secto r of the economy, as the idle-employed are recruited int o the ranks of the industrious, as many come to be employed in the productiv e labour 'who m we shall suppose t o have been only half employed an d half fed'(i, 56). While continuing the theme of development a s being a process of expanding the number of productive labourers, Mill added a discussion of the distinction between productive and unproductive consumption. What productive labourers consume in keeping up or improving their health, strength, and capacities of work, or in rearing other productive labourers to succeed them , is productive consumption. Bu t consumptio n on pleasure s o r luxuries , whether by th e idl e o r b y th e industrious, since production is neither its object nor is in any way advanced by it must be reckoned unproductive: with a reservation perhaps of a certain quantum of enjoyment whic h may be classe d amon g necessaries, sinc e anythin g short o f it would not be consistent with the greatest efficiency o f labour (i, 52).

From thi s discussion o f unproductive consumption there develope d th e proposition tha t ther e i s a more important distinctio n tha n that betwee n productive an d unproductiv e labour , 'namely , betwee n labou r fo r th e supply o f productive, an d for th e suppl y of unproductive, consumption ' (i, 53) . I f th e forme r wer e suspended , 'th e countr y a t th e en d o f th e twelvemonth would have been entirel y impoverished' ; if the latter wer e suspended, 'th e sources o f production woul d be unimpaired' (i, 54). Mill went on to say that it would be a great error to regret the 'large proportion of

Mill's Principles 237 the annual produce, which in an opulent country goes to supply unproductive consumption. It would be to lament that the community has so much to spare from its necessities for its pleasures and for all higher uses' (i, 54). It is surprising that he did not here note that this fund available for unproductive consumptio n i s th e basi s fo r tha t proces s o f accumulatio n which provides fo r a spira l o f economic development . H e underestimate d th e effect o n human productivity o f better living and he underestimated th e magnitude o f th e necessar y increas e i n fixe d capital . H e wa s righ t in directing attention to the 'fund from which all the wants of the community, other tha n that o f mere living , are provide d for ' (i , 54) ; he wa s right to continue Ricardo's concer n for 'net product,' and to parallel Marx's concern for surplus value; he was right because he was concerned with growth. Thrift wa s important, but Mill recognized 'tha t to increase capital there is another way besides consuming less, namely, to produce more... whatever increases th e productiv e powe r o f labour, create s a n additiona l fund t o make saving s from, an d enable s capita l t o be enlarge d no t onl y without additional privation, bu t concurrentl y with an increase o f personal consumption' (i , 70) . I n thes e circumstance s 'abstinence ' i s a rathe r od d description of the basis for capital accumulation. In Chapter iv, 'Of Capital,' there is a specific reference to 'productive' labourers whic h encourage s m e to insist o n the 'development ' aspect of Mill's treatment of capital. In a sort of parable, a hardware manufacturer is supposed to give up his intention to use part of the proceeds from the sale of his iro n good s 't o maintai n a pac k o f hounds , o r a n establishmen t o f servants,' instea d h e 'employ s i t i n hi s business , payin g it i n wage s t o additional workpeople.' Alternatively Mill supposes the manufacturer had intended to buy plate or jewels but diverted a large sum 'from buying plate and jewels to employing productive [m y italics] labourers, whom we shall suppose to have been previously, like the Irish peasantry, only half employed and half fed' (i, 56). He was not concerned here with the competition of this hardware manufacturer bidding for a greater share of a given labour force; no r wa s h e concerne d wit h re-employment o f some o f the unemployed; it was rather that some of the 'idle,' employed as "unproductive " labour, woul d be recruited int o the rank s of the 'industrious. ' Industria l development i s thus promoted. Wha t one misse s is consideration o f the alternative use of such savings to buy capital goods to increase th e productivity of the productive labourers . Indeed i n Chapter vi Mill expressed hi s fear that expenditure on capital goods might divert funds from the employment o f labour. 'Al l increas e o f fixed capital, whe n taking place a t th e expense o f circulating, mus t be, a t leas t temporarily , prejudicia l t o th e

238 Fro m Adam Smith to Maynard Keynes interests of the labourers' (i , 93-4). From this proposition he argued, with Ricardo, tha t 'al l attempt s t o mak e out tha t th e labourin g classe s a s a collective bod y cannot suffer temporaril y by the introduction o f machinery , or by the sinking of capital in permanent improvements, are ... necessarily fallacious' (i , 96). But he argued that 'a s things are actually trans acted' improvements are not 'often, if ever, injurious, even temporarily, to the labouring classes in the aggregate.' This was because improvements are 'seldom or never made by withdrawing circulating capital from actua l production, but are made by the employment of the annual increase' (i, 97). The ultimate benefit was not in doubt but 'this does not discharge governments fro m th e obligatio n o f alleviating, an d i f possible preventing , th e evils of which this source of ultimate benefit is or may be productive to an existing generation' (i, 99). So accumulation of fixed capital seems to take second plac e t o absorption o f the unproductive workers into productiv e industry. Following the general discussion of capital in chapter four come the four 'fundamental propositions respecting capital' of chapter five. First proposition. 'Industry is limited by capital' (i, 63). There cannot, Mill argued, be more persons employe d in productive labour than can be supplie d wit h wage goods, materials, and instruments. The proportions are clearly supposed t o b e fixed . H e adde d tw o qualifications . First, whil e limited by capital industr y does no t alway s come up to that limit : 'capita l may be temporarily unemployed ... or there may not be as many labourers obtain able as the capital would maintain or employ' (i, 65). Second, there is no 'assignable limit' t o th e increas e o f employment from ever y increas e in capital. This proposition require d t o be 'dwel t on' because i t was 'very much opposed to common doctrines.' There was a commonly held opinion 'that the unproductive expenditure of the rich is necessary to the employment o f th e poor. ' B y wa y o f refutin g thi s opinio n Mil l examined th e extreme case. Suppose that every capitalist came to be of opinion that not being more meritorious than a well-conducted labourer, he ought not to fare better; and accordingly laid by, from conscientious motives, the surplus of his profits ... how is the increased capital to find employment? Who is to buy the goods which it will produce? There are no longer customers even for those which were produced before. The goods, therefore (it is said), will remain unsold ... But this is seeing only half of the matter ... when these classe s turn their income into capital they do not thereby annihilat e their power of consumption; they do but transfer it from themselve s to the labourer to whom they give employment.

Mill's Principles 239 If th e increase d deman d fo r labou r increase s employmen t i n industry, production o f necessarie s fo r th e ne w worker s replace s productio n o f luxuries 'and supplies exactly the amount of employment which has been lost.' If the number employed does not increase, wages will and labourer s will becom e consumer s o f luxuries . 'Th e increase d accumulatio n an d increased production , might , rigorousl y speaking , continue , unti l ever y labourer ha d ever y indulgenc e o f wealth, consisten t wit h continuin g to work . . . Every addition to capital gives to labour either additional employ ment, or additional remuneration' (i , 67). Once agai n we notice that employment in the production of real capital in place of luxuries is ignored. The secon d proposition : 'Capita l is the result of saving' (i , 68). There can b e n o increas e i n capita l i f the ne t produc e o f productive labou r i s dissipated i n unproductiv e consumption . Clearl y increas e o f capita l re quires either less wage goods used to support unproductive labour, or less luxury goods consumed by the rich. But, as I noted above, Mill recognized that ther e wa s anothe r wa y to increas e capita l beside s consumin g less, namely 'to produce more' (i, 70). The third proposition. 'Al l capital is consumed' (i, 70). The things consumed, and the persons consuming, are different. There is in the on case, a wearing out of tools, a destruction of material, and a quantity of material, and a quantity of food an d clothing supplied to labourers, which they destroy by use : in the other case , there is ... a destruction , of wines , equipages and furniture . . In the spending, this first stage is also the final stage; that particular amount of the produce of labour has disappeared, and there is nothing left; while on the contrary, the saving person, during the whole time that the destruction was going on, has had labourers at work repairing it; who are ultimately found t o have replaced, with an increase, th e equivalen t of wha t ha s bee n consume d .. . A savin g onc e mad e becomes a fun d t o maintai n a correspondin g number o f labourer s i n perpetuit y (1,71).

It follows that 'saving enriches and spending impoverishes, the community . . .that society at large is richer by what it expends in maintaining and aiding productive labour , bu t poore r b y wha t i t consume s i n it s enjoyments' (i, 72). It is recognized that part of the consumption related to saving is the wearing out of tools and the using up of material and seed. But the emphasis is on the 'perpetual fund' fo r the employment of productive labour. Here, as throughout the discussion of capital, the importance of accumulation of real capital is scarcely noted: the emphasis is the increase in employment of

240 Fro m Adam Smith to Maynard Keynes productive labourers, rather than the increase in the productivity of those labourers as they come to be better equipped. The fourt h proposition : 'Deman d for commodities is not a demand for labour' (i , 78) . Edgeworth 3 calle d thi s th e 'locu s vexatissimus ' o f economics. Much of the difficulty of interpretation arises , I believe, from a failure to recognize the dynamic, development, context. Mill's contemporary Cairnes saw that this 'fourth proposition' was simply 'a different mod e of statin g th e thir d fundamenta l theorem. ' I n hi s ver y interestin g an d valuable 'Note s o n th e Principle s o f Politica l Economy ' (n , 1042-3 ) Cairnes presented a n alternative formulation . In short to establish the doctrine that 'demand for commodities is not demand for labour' - i.e . does not benefit the labouring classes - al l that is needed is the two assumptions i. that he who profits by (i.e. enjoys) wealth is he who consumes it, and 2. that productive labourers consume saved wealth, while wealth unproductively spent is consumed wholly by the unproductive consumers.

Cairnes then illustrated his argument by a reductio ad absurdum: 'i f it be equally for the benefit of the poorer classes whether I consume my wealth unproductively or set aside a portion in the form of wages or alms for their direct consumption , the n o n wha t groun d ca n th e polic y b e justified o f taking my money from m e to support paupers?' That Cairnes ha d understood Mill' s intention is indicated by the adaptation o f this passage fro m Cairnes in the sixth edition of the Principles (i , 84). This fourth proposition ca n be considered a s Mill's version of the Adam Smith, Ricardo, Say, doctrine of the virtue of thrift, an d his answer to the Malthus, Sismondi, fear of oversaving. It can be read simply as referring to the problem of employment and unemployment; but if employment is taken to mean 'productive' employment then the problem at issue becomes on e of development. Let me quote a few passages from Mill. 'I apprehend, that if by demand for labour be meant the demand by which wages are raised, or the numbe r of labourers i n employment be increased , deman d for com modities does no t constitute deman d for labour. I conceive tha t a person who buys commodities an d consumes the m himself, doe s n o good t o the labouring classes; an d that it is only by what he abstains from consuming, and expends in direct payments to labourers in exchange for labour, that he benefits th e labourin g classes , o r add s anythin g t o th e amoun t o f thei r employment' (i, 80). Again there i s a parable; a consumer contemplatin g 'hiring journeymen bricklayer s t o buil d a house , o r excavator s t o di g artificial lakes ... or, instead of this, he may expend the same value in velvet

Mill's Principles 24 1 and lace.' I n th e first case he employ s labourers , i n the secon d cas e he merely decide s i n what sor t o f work labourers , wh o would be employe d anyway, will in fact be employed. Th e proposition come s dow n to this: if there is capital to employ labourers there will always be a demand for their product, but, however great the demand for their product, they cannot be employed if there is not capital t o hire them. Again the concern i s for the employment of productive labourers . Surel y Mill should have considere d the difference between employing men to build an artificial lake and to build new productiv e equipment . Luxur y spendin g o n direc t employment , whether of bricklayers and excavators, or on menial servants, is not the way to long-ru n improvemen t o f th e workin g class . Wha t wa s neede d wa s increased productivity , resultin g fro m accumulatio n o f real capital . Mil l had good reason to say that 'a person does good to labourers, not by what he consumes on himself, but solely by what he does not consume' (83). But the real poin t wa s not that h e would then 'expen d it on wages,' but tha t resources woul d the n b e directe d t o producin g machiner y rathe r tha n velvet. IV POPULATION

AND

PRODUCTION

The problems of population crop up throughout the Principles. Th e study of production becomes a study of the race between production and population. Failure to win the race did not to Mill mean that the positive checks, plague, pestilence an d famine, woul d come int o play, but rathe r that his hopes of improvement in the condition of the mass of the people would be unfulfilled. I n the chapter on the 'La w of the Increase o f Labour' he held that 'It is a very low estimate of the capacity of increase, if we only assume, that i n a good sanitar y conditio n o f the people, each generatio n ma y be double th e numbe r o f th e generatio n whic h precede d it ' (i , 155) . Tha t population doe s no t increas e a t tha t pac e i s not 'throug h a providential adaptation o f th e fecundit y o f th e huma n specie s t o th e exigencie s o f society' (i , 155 ) bu t throug h 'pruden t o r conscientiou s self-restraint ' (i, 157). An 'acceleration of the rate [of population increase] very speedily follows an y diminutio n o f th e motive s t o restraint ' (i , 159) . Thu s th e problem of the masses is posed: 'Unless , either by their general improvement in intellectual and moral culture, or at least by raising their habitual standard of comfortable living, they can be taught to make a better us e of favourable circumstances , nothin g permanent ca n be done for them; th e most promising schemes en d only in having a more numerous, but no t a

242 Fro m Adam Smith to Maynard Keynes happier people' (i, 159). The problem is here posed a s an individual one; in Chapter xm it is posed a s a social one. Ever since the great mechanical inventions of Watt, Arkwright, and their contemporaries, the return to labour has probably increased as fast as the population; and would have outstripped it, if that very augmentation of return had not called forth an additional portion of the inherent power of multiplication in the human species .. . Nothing could have prevented a general deterioration in the condition o f the human race, were it not that population has in fact been restrained. Had it been restraine d still more, and the same improvements taken place, there would have been a larger dividend than there now is, for the nation or the species a t large. The new ground wrung from natur e by the improvement s would not hav e bee n al l used u p in the support of mere numbers' (i, 189-90).

In Book i i there i s further discussion o f the prospects for prudence. I n his discussio n o f communism Mill appeared les s afrai d o f the populatio n effect tha n was Malthus: there woul d be provided 'motive s to restraint... Communism i s precisel y th e stat e o f thing s i n whic h opinio n migh t b e expected t o declare itsel f with greatest intensit y against this kind of selfish intemperance ... Opinion could not fail to reprobate, an d if reprobation di d not suffice , t o repress b y penalties o f some description , thi s or any othe r culpable self-indulgenc e at th e expens e o f the community ' (i , 206) . This sounds mor e lik e Orwell's bad drea m o f 198 4 than th e sentiment s o f the author o f the essa y O n Liberty! Again the 'motive s for restraint' ar e th e primary concern: 'N o remedies for low wages have the smallest chance of being efficacious , whic h d o no t operat e o n an d throug h th e mind s an d habits of the people' (i , 366) . Education migh t help. 'I f th e opinio n wer e once generall y establishe d amon g th e labourin g clas s tha t thei r welfar e required a due regulation o f the number s of families, the respectabl e an d well-conducted of the body would conform to the prescription ...' (i, 372). But a more important influence woul d follow th e admission of women 'to the sam e rights of citizenship with men' (i, 372). In commentin g on hardhearted Malthusianis m he had said: as if it were not a thousand times more hard-hearted to tell human beings that they may, than that they may not, call into existence swarms of creatures who are sure to be miserable and most likely to be depraved; and forgetting that the conduct, which it is reckoned so cruel to disapprov ,, is a degrading slavery to a brute instinct in one of the persons concerned, and most commonly, in the other, helpless submission to a revolting abuse of power' (i, 352).

Mill's Principles 24 3 And later he said: It i s seldo m b y th e choic e o f th e wif e tha t familie s ar e to o numerous ; o n he r devolves (alon g wit h al l th e physica l sufferin g an d a t leas t a ful l shar e o f th e privations) the whole of the intolerable domestic drudgery resulting from the excess ... Among the barbarisms which law and morals have not yet ceased to sanction, the most disgustin g surel y is, that any huma n be'ng shoul d b e permitted t o consider himself as having a right to the person of another (i, 372). To educatio n an d a change i n the statu s o f women mus t be added , Mil l argued, a dramatic improvement in the condition of the poor. Th e minor improvement resultin g from th e repeal o f the Cor n Law s he did not con sider important . 'Thing s whic h onl y affec t the m a ver y little, mak e no permanent impressio n upo n their habits an d requirements, an d they soo n slide back int o their former state. To produce permanent advantage, the temporary caus e operatin g upo n them must be sufficien t t o make a great change i n thei r conditio n .. . O f case s i n point , th e mos t remarkabl e i s France after the Revolution' (i, 342). He recurred t o this point in Chapter xii. To r th e purpos e therefor e o f alterin g th e habit s o f th e labourin g people, ther e i s need o f a twofold action , directe d simultaneousl y upo n their intelligence and their poverty. An effective nationa l education of the children of the labouring class, i s the first thing needful: and, coincidentl y with this , a syste m o f measure s whic h shal l (a s th e Revolutio n di d i n France) extinguis h extreme povert y for one whol e generation ' (i , 374) . 'Unless comfort can be made as habitual to a whole generation as indigence is now, nothing is accomplished; and feeble half-measure s d o but fritte r away resources .. . ' (i, 378). All of this is highly relevant to the problem of the modern world; I propose to underline only one point. With reference to the poorer countrie s with high fertility one may well ask whether external aid, like poor relief i n nineteenth-century England , ma y simply postpon e the necessary adjustmen t in the birth rate, ma y be 'frittere d away, ' mere numbers rather tha n happiness resulting . On e may also wonde r whethe r Mill had the answer for his day and for ours. He saw that relief (or aid) must be on a massive scal e t o permit th e dawn of hope. I f this is correct, as I believe i t to be, w e should concentrate ou r 'aid ' o n a few countries, an d those countries must be chosen as most nearly ready for massive improvement. This 'hard-hearte d Malthusianism' would be hard to practise. Th e choice of those to be aided would be heart-breaking; and there is the danger that thos e no t chosen woul d in exasperation an d frustration do injury t o themselves and us.

244 Fro m Adam Smith to Maynard Keyne s v DISTRIBUTION : INSTITUTION S Book two of the Principles is on 'Distribution.' It consists often chapters concerned with institutions o r social systems and six chapters on economic analysis, on wages, profits, and rent. Of the early chapters I have alread y had much to say. The first chapter, 'O f Property,' with its examination of 'communism,' I have discusse d i n the contex t o f conflicting values ; the chapter 'O f Competition an d Custom,' in the context of a priori method; and the chapter on 'Peasant Proprietorship' in the context o f discussion of economic man and pecuniary incentives: I propose in this part to add a little to the examination of these institutional chapters , an d in the next part t o examine the analytical chapters. In the two chapters 'O f Property' the origin, utility, and proper limita tion o f individua l property right s ar e discussed . O f th e origi n h e said : 'Private property, a s an institution, di d not owe its origin t o any of those considerations of utility, which plead ['s o strongly' he had said in 1848] for the maintenance of it when established. Enoug h is known of rude ages ... to show, tha t tribunal s (whic h always precede laws ) wer e originall y estab lished, no t t o determin e rights , bu t t o repres s violence , an d terminat e quarrels .. . by confirming, to those who already possesse d it, even wha t was not the fruit of personal exertion, a guarantee was incidentally given to them and others that they would be protected in what was so' (i, 201). If this was th e origi n what was the late r developmen t o f the concep t o f private property? The principle of private property has never yet had a fair trial in any country ... The laws o f propert y hav e neve r ye t conforme d t o th e principle s o n whic h th e justification o f private property rests . They hav e mad e propert y o f things which never ought to be property, and absolute property where only a qualified property ought to exist... they have purposely fostered inequalities, and prevented all from starting fair i n the race . Tha t al l should indeed start o n perfectl y equal terms, is inconsistent wit h any la w of property; but i f as much pains as has been take n t o aggravate the inequality of chances ... had been taken to temper that inequality ... if the tendency of legislation had been to favour the diffusion instead of the concentration, of wealth ... the principle of private property would have been found to have no necessar y connectio n wit h th e physica l an d socia l evil s whic h almos t al l Socialist writers assume to be inseparable from it (i, 207-8).

He conclude d that , 't o judge o f the final destination o f the institutio n of property, we must suppose everything rectified, which causes the institution

Mill's Principles 245 to wor k i n a manne r oppose d t o tha t equitabl e principle , o f proportio n between remuneration and exertion, on which in every vindication of it that will bear the light, it is assumed to be grounded' (i, 208). In th e secon d chapte r Mil l followe d u p th e conclusio n o f th e first , namely that privat e propert y wa s likely to endure for a considerable tim e and that improvement rathe r than 'subversion' of the institution shoul d be the aim for the time being. First there is a modification of the simple plea for 'the right of producers to what they themselves have produced,' the right to the whole product of labour as preached by the Ricardian Socialists. The answe r to this is, that the labour of manufacture i s only one of the conditions which must combine for the production o f the commodity. The labou r cannot be carried o n withou t materials and machinery , nor withou t a stoc k o f necessaries provided i n advance, t o maintai n the labourer s during the production . All these things are th e fruit s o f previous labour. If the labourer s were possessed o f them, they would not need to divide the produce with any one; but while they have them not, an equivalent must be given to those who have, both for the antecedent labour, and fo r th e abstinenc e b y whic h the produc e o f tha t labour , instea d o f being expended on indulgences, has been reserved for this use ... While it is true that the labourers are at a disadvantage compared with those whose predecessors saved, it is also true that the labourers are far better off than if those predecessors had no t saved (i, 215-16).

This is followed by a reminder that competition 'is not necessarily a cause of misery and degradation. I f the labourers compet e fo r employment, the capitalist on their part compete for labour, to the full extent of the circulating capital of the country.' High wages are 'as much a product of competition as low wages. The remuneration o f labour is as much the result of the law of competition in the United States, as it is in Europe, and much more completely s o than in England' (i, 216). The right of property, Mill argued, included 'the freedom of acquiring by contract. The right of each to what he has produced, implies a right to what has bee n produce d b y others, i f obtained b y their free consent ; sinc e th e producers must either have given it from good will, or exchanged it for what they esteemed an equivalent, and to prevent the m from doing so would be to infringe thei r right of property i n the produc t of their own industry' (i, 217). He further argued the validity of prescription. 'Even when the acquisition was wrongful, the dispossession, after a generation has elapsed of the probably bonafide possessors , b y the reviva l of a claim which had long

246 Fro m Adam Smith to Maynard Keynes been dormant, would generally be a greater injustice , and almost always a greater private and public mischief, than leaving the original wrong without atonement' (i, 217). The institutio n of property implies the right of bequest, but not the right of inheritance ' (i , 218) . Thu s wer e h e framin g a cod e o f law h e woul d 'restrict, no t wha t anyon e migh t bequeath bu t wha t anyon e shoul d b e permitted to acquire by bequest o r inheritance. Each perso n should have the power to dispose by will of his or her whole property; but not to lavish it in enrichin g som e on e individual , beyon d a certai n maximu m .. . Th e inequalities of property which arise from unequa l industry, frugality, per severance, talents, and to a certain extent even opportunities, are inseparable from th e principle of private property ... but I see nothing objectionable in fixing a limit t o wha t one ma y acquire by mere favour o f others ' (i, 225) . Mil l realized tha t a law limiting the righ t to accep t bequest s (o r gifts) coul d no t be passed, an d if passed would be evaded, a s long as th e prevailing opinion is 'that the best thing which can be done for objects of affection i s to heap on them to satiety those intrinsically worthless thing s on which large fortunes ar e mostl y expended ' (i , 225) . If the restrictio n could be made effective 'ther e would be a great multiplication of persons in easy circumstances, wit h the advantage of leisure, an d all the real enjoy ments which wealth can give, except those of vanity,' and 'a large portio n of the accumulations of successful industry would probably be diverted t o public uses' (i, 225). He cited the example of the United States, but what he said her e mus t be qualifie d b y wha t he sai d earlie r o n the evil s o f 'per petuity'; bequests fo r specifi c publi c use s shoul d b e 'subjec t t o th e perpetual revision (after a certain interval has elapsed) o f a fitting authority' (i, 223). On this point see the earlier reference to his essay on 'Corporation and Church Property.' He there argued for the experimental, innovative, function of the private foundation, believing that successful private experiments for a few would lead to public provision for many. This remains a very sound doctrine: as government provides services that have previously been supported privately, the private citizens and foundations should seek new fields of experiment and innovation, developing new services which will in turn be taken over by government, or abandoned as mistakes. Mill conclude d hi s chapter s o n propert y b y considerin g th e specia l problems of property i n land. H e recognized tha t 'thoug h land is not th e produce o f labour , mos t o f it s valuabl e qualitie s are ' an d tha t h e wh o undertakes improvement s 'mus t hav e a sufficien t perio d befor e hi m in which to profit b y them; and he is in no way so sure of having always as sufficient perio d as when his tenure is perpetual' (i, 227). This justification of property inland is only valid, he then said, 'in so far as the proprietor of

Mill's Principles 247 land is its improver' (i, 228). In England , Mil l argued, the proprietor wa s 'not unfrequently an improver. But it cannot be said that he is generally so' (i, 228). And proprietors had failed to 'hold out inducements to the farmers to do what they will not or cannot do themselves' (i, 229). If the conditions which render property i n land economically justifiable were 'insufficientl y realized' in England, i n 'Ireland these conditions ar e not complied wit h at all' (i, 229). In such conditions propert y i n land 'ceases to be defensible .. . When private property in land is not expedient, it is unjust' (i, 230). But Mill acknowledged th e right of prescription s o that the landlords shoul d not be 'dispossessed without receiving its pecuniary value, or an annual income equal to what they derived from it' (i, 230-1). The proble m i s reall y on e o f combinin g adequate incentiv e to larg e investments in long-term improvements and to intelligent industry in farming th e improve d land . Afte r a n elaborat e examinatio n of peasan t pro prietorship i n many countries o f Europe, Mil l conclude d 'tha t n o othe r existing stat e o f agricultural econom y ha s s o beneficial an effec t o n th e industry, the intelligence, the frugality and the prudence of the population, nor tends on the whole so much to discourage a n improvident increase o f their numbers ; and tha t n o existin g state , therefore , i s o n th e whol e s o favourable to both their moral and physical welfare' (i , 295-6). He recog nized the dange r of undue subdivision; but hi s stress o n the incentiv e to good farming led to him ignore the importance of long-run investment on a scale impossible for small holders. In his chapter on Cottiers Mill described th e condition of the Irish tenant whom he found to be in a condition suc h 'that he can scarcely b e better o r worse off by any act of his own. If he were industrious or prudent, nobody but hi s landlor d woul d gain ; i f h e i s laz y o r intemperate , i t i s a t hi s landlord's expense ' (i , 319) . The povert y an d backwardness o f the Iris h was popularl y attributed b y th e Englis h to ' a peculia r indulenc e and insouciance i n th e Celti c race. ' But , sai d Mill , 'wha t rac e woul d no t b e indolent and insouciant when things are s o arranged, that they derive no advantage from forethough t or exertion ... No labourers wor k harder, in England an d America , tha n th e Irish ; bu t no t unde r a cottie r system ' (i, 319) . Th e proposal s fo r remedyin g thi s situatio n wer e presente d i n Chapter x; but events were moving rapidly, and terribly, in Ireland so that successive edition s reflect changing conditions and ideas. vi D I S T R I B U T I O N : A N A L Y S I S An importan t feature of these chapter s i s the fac t tha t they precede th e chapters o n pricin g in Boo k HI . It i s tru e that Mil l sai d tha t h e ha d no t

248 Fro m Adam Smith to Maynard Keynes 'escaped the necessity o f anticipating some small portion of the theory of Value, especially a s to the value of labour and land' (n, 455), but, at the end of Book m, the chapte r o n 'Distribution as Affected by Exchange' was devoted to the thesis that distribution is not affected b y exchange. 'Wages depend on the ratio between population and capital, and would do so if all the capita l i n the worl d were th e propert y o f one association , o r i f th e capitalists amon g whom it is shared maintained each an establishment fo r the production o f every article consume d in the community, exchange of commodities having no existence' (n, 695). Similarly, on rent: 'Exchange, and money, therefore, make no difference in the law of rent' (11, 698). And on profits: 'Wages and Rent being thus regulated b y the sam e principle s when paid in money, as they would be if apportioned in kind, it follows that Profits are so likewise. For the surplus, after replacing wages and paying rent, constitutes Profits' (n, 698). The verdict of Alfred Marshall is found in his Appendix j: By putting his main theory of wages before his account of supply and demand, he cut himself off from the chance of treating that theory in a satisfactory way ... The fact is that the theories of Distribution and Exchange are so intimately connected as to be little more than two sides of the same problem ... If Mill had recognized this great truth he would not have been drawn on to appear to substitute, as he did in his second Book, the statement of the problem of wages for its solution: but he would have combined the description and analysis in his second Book, with the short but profound study of the causes that govern the distribution of the national dividend, given in his fourth book. 4

It wa s perhap s th e mos t importan t contributio n o f th e neo-classica l economists tha t the y envisage d th e pricin g of final goods an d agent s of production a s simultaneously determined. This vision of general equilib rium was of much greater importance tha n the new understanding of the relation of utility to value. One should add that it was, however, a product of that new emphasis on demand. Having in mind Marshall's assessmen t o f the profundit y of Book iv , perhaps one should remember the limitations, a s well as the value, of the new pricing theory: Mil l ignored the importance of the pricing process i n the theory of distribution but his successors were too readily content with a static solution. Mill may have been unsatisfactory in his explanation of why factor price s wer e what they were , but he had brilliant insight s int o th e probable tren d of change. And his successors were too ready to accept a theory of the pricing of factors as a theory (not just a part of a theory) of

Mill's Principles 24 9 distribution ignoring the really exciting problems of why particular people had particular factor s fo r sale a t these prices, and how the conditions of demand for and supply of the factors change, thus changing the equilibrium prices of productive goods and services. The chapters o n wages are essentially Malthusian . 'Wages depend on the demand and supply of labour in other words, on population and capital' (i» 337) - O n deman d nothing is added t o th e doctrin e o f the chapter s o n capital and there is no reference to his developing doubts as to the validity of the simple 'wage fund.' H e did, however, not e that 'capita l which the owner does not employ in purchasing labour, but keeps idle in his hands, is the same thing to the labourers, for the time being, as if it did not exist.' He admitted tha t i t i s 'no t absolutel y impossibl e tha t on e o f thes e fit s o f briskness or stagnation should affect al l occupations at the same time' so that wages in general might rise or fall, but he dismissed these episodes as 'temporary fluctuations : th e capita l no w lyin g idle wil l next yea r b e i n active employment... Nothing can permanently alter general wages except an increase o r a diminution of capital itsel f (always meaning by the term, the funds of all sorts, devoted to the payment of labour) compared with the quantity of labour offering itself to be hired' (i, 338-9). It is the supply of labour which engaged most of Mill's attention. Let me cite some of his dicta; though there will be some duplication with part four, I thin k i t i s justified a s emphasizin g th e reiterativ e Malthusia n 'beat. ' 'When, by improvements in agriculture, th e repea l o f the cor n laws , o r other such causes, the necessaries of the labourers are cheapened, and they are enabled , wit h th e sam e wages , t o comman d greater comfort s than before. Wages will not fall immediately ... but they will fall at last... unless during thi s interva l o f prosperit y th e standar d o f comfor t regarde d a s indispensable b y th e class , i s permanentl y raised ' (i , 341-2) . Thi s qualification, unless the 'standard of comfort... is raised,' leads to discussion o f th e check s t o populatio n growt h an d th e contras t betwee n th e agricultural and industrial sectors. 'If the growth of the towns, and of the capital ther e employe d .. . did not also absor b a great par t o f the annual addition to the rural population, there seems no reason in the present habits of the people why they should not fall into as miserable a condition as the Irish previous to 1846 ; and if the marke t for our manufactures should ... cease to expand at the rapid rate of the last fifty years, there is no certainty that thi s fat e i s no t reserve d fo r us. ' Thi s calamit y h e hope d migh t be averted a s the 'grea t and growing intelligence o f the factory population' induced 'an adaptation of their habits to their circumstances' (i, 351). In Chapte r xn Mil l examined a number of 'remedies for low wages' :

250 Fro m Adam Smith to Maynard Keynes legal minimum wages, allowances in aid of wages, allotment gardens. The chapter ends with the statement previously quoted. 'N o remedies for low wages have the smallest chance of being efficacious whic h do not operat e on and through the minds and habits of the people.' In chapter xm remedies that do so operate are explored. There must be a change in opinion: 'what is practised a s prudence is still not regarded as a duty.' Let the idea 'become general among the labourin g class, tha t th e competitio n o f too great numbers was the special cause of their poverty; so that every labourer looked (with Sismondi) upon every other who had more than the number of children which the circumstances of society allowed to each, as doing him wrong' (i , 371) . Th e influenc e o f the wome n coul d b e counte d on , h e thought, to foster this change of opinion: 'it is seldom by the choice of the wife tha t familie s ar e to o numerous ' (i , 374) . To promot e the chang e of opinion Mill proposed: 'a n effective nationa l education o f the children of the labouring class .. . and a system of measures which shall... extinguish extreme poverty for one whole generation' (i, 374). This led to discussion of 'foreign and home colonization.' In the 184 8 edition he recommended a 'grant of public money, sufficien t t o remove at once an d establish i n the colonies, a considerable fraction o f the youthful agricultura l population'; he also advocated bringing into cultivation the common land and establishing on it a class o f peasant proprietors ' (i , 376-7) . H e adde d tha t thes e measures should be on a large scale. 'Smal l means do not merely produce small effects, they produce no effect a t all' (i, 378). Comfort must be made as 'habitua l as indigence is now.' By 1865 he thought these measures no longer urgent. 'The extraordinary cheapening of the means of transport... and th e knowledg e which nearly al l classes of the peopl e hav e no w acquired ... of the condition of the labour market in remote parts of the world, have opened up spontaneous emigration from these islands ... Emigration, instead of an occasional vent , is becoming a steady outlet for superfluous numbers.' Add to this the 'flus h o f prosperity occasioned b y free trade. ' Overcrowded England had in 1865 a 'temporary breathing time, capable of being employed in accomplishing those mora l and intellectua l improve ments ... which would render impossible any relapse into the over-peopled state'(1,378). Before leavin g the subjec t o f wages somethin g shoul d b e sai d abou t Mill's views on the role of trade unions. In his chapter on 'differences of wages' he argued that the power to raise wages in any trade was based on the ability to' restrict the number of competitors.' Such restriction operates to the detriment of the excluded in a 'cruel manner': 'entrenching around a particular spo t agains t the inroad s of over-population , and makin g th e wages o f th e clas s depen d upo n thei r ow n rat e o f increase , instea d o f

Mill's Principles 25 1

depending o n that o f a more reckless and improvident class than themselves' may seem to work an injustice; but the injustice 'disappears' when it is recognized that free entry would have 'no permanent effect' other than to reduce the wages of all to the same low level (i, 397-8). In 186 9 Mill wrote a paper on Thornton on Labour and Its Claims ' in which he admitted that the wage fund wa s not determined as rigidly as he had held. The bearing of this on the problem of trade unions is developed in the following extract from that essay. But though the population principle and its consequences are in no way touched by anything tha t M r Thornton ha s advanced , i n another of its bearing s th e labou r question, considered as one of the mere economics, assumes a materially changed aspect. The doctrine hitherto taught by all or most economists (including myself), which denied it to be possible tha t trade combinations can raise wages, or which limited their operation in that respect to the somewhat earlier attainment of a rise which th e competition of the market would have produce d withou t them - thi s doctrine is deprived of its scientific foundation, and must be thrown aside. The right and wrong of the proceedings of Trades' Union s becomes a common question of prudence and socia l duty , not on e whic h is peremptorily decided b y unbendin g necessities of political economy.5

I conclude this discussion of Mill on unionism by referring forward to Book v, Chapter x. He there admitted 'a limited power of obtaining by combination an increase of general wages at the expense of profit,' but considere d that th e 'limit s o f the powe r are narrow ' (11 , 920) . He denounce d thos e 'aristocratic' unions which were 'hedging themselves in against competition, and protecting their own wages by shutting out others from access to their employment' (n, 931). He insisted that it is 'an indispensible condition of toleratin g combinations , that the y shoul d be voluntary ' (n , 933) . He considered mischievous the opposition to piece work and the insistence on equal pay for all workers of a given grade: mischievous because 'they place the energeti c an d th e idle , th e skilfu l an d th e incompetent , on a level ' (n, 934). But he argued the right to free association. Though combinations to keep up wages are seldom effectual... the right of making the attempt is one which cannot be refused to any portion of the working population without grea t injustice , o r withou t the probabilit y o f fatally misleadin g them respecting the circumstances which determine their condition. So long as combinations to raise wages were prohibited by law, the law appeared to the operatives to be the real cause of the low wages ... (n, 931-2).

252 Fro m Adam Smith to Maynard Keynes What Mill did not perceive was the change in the status of the worker which strong unions might achieve: condition s o f employment other than wages became a matter of contract, an d the development of a 'grievance procedure' gav e protectio n agains t management , especiall y agains t th e pett y tyranny of the lower levels. Perception of this change would have led to a very different chapter on the 'Probable Futurity of the Working Class' from that actually written. There remai n the chapters o n profit and rent; of these I shall say little. That on profit continues the tradition of treating profits as the income of the capitalist, noticin g tha t i t consists o f several differen t elements , ye t no t recognizing any need to treat the remuneration of these different element s separately. It is essentially a restatement o f the Ricardian theory with one important development. Where Ricardo said profits depend on wages, Mill said they 'depend on the cost of labour" (i, 413). The cost of labour to the capitalist depend s o n its efficiency ; i t is 'frequentl y a t its highest wher e wages are lowest.' This i s an important qualification, not only because i t emphasizes the productivity of labour (reviving ideas that Adam Smith had presented i n his chapter o n wages) but because i t breaks down the Ricardian doctrines that profit could only be increased by increased efficiency in agriculture. The chapter o n 'rent' is strictly Ricardian: it expounds the theory and defends i t from critic s such as Carey. I have only one comment to make, that i s to compar e Mill' s Ricardia n stati c treatmen t o f the effec t o f improved transportatio n wit h the dynami c view of Adam Smith . Mil l saw such improvements as 'trenching on the monopoly of the land nearest to the place s wher e larg e number s o f consumer s ar e assembled ' (i , 476) . Compare with this Adam Smith on the effect of good roads on the counties near t o London : 'thei r rent s hav e risen , an d their cultivatio n ha s bee n improved.'6 VII VALUE

In Book in on Exchange, Mill devoted eight chapters to 'value,' Chapters i-vi an d xv-xvi . H e state d hi s belief i n the crucia l importanc e o f th e theory o f value and hi s confidence in the qualit y of the accepte d theor y which he intended to expound. 'Almost every speculation respecting the economical interests of a society, thus constituted [i.e. a market economy] implies some theory of Value: the smallest error on that subject infects with corresponding error all other conclusions; and anything vague or misty in our conception o f it creates confusio n and uncertainty in everything else.

Mill's Principles 25 3 Happily there is nothing in the laws of Value which remains for the present or any future write r to clear up; the theory of the subject is complete: th e only difficulty .. . is that of so stating it as to solve by anticipation the chief perplexities which occur in applying it' (n, 456). This was a very injudicious claim. Professor Schumpete r commentin g on the state of the scienc e just befor e Worl d Wa r i , i n hi s prefac e o f D r Zeuthen' s Problems o f Monopoly, ha d this to say: There was a belief that the great work had been done - a belief very similar to that expressed by Mill in that famous passage ... In a sense this attitude was both right and fruitful. Grea t work had undoubtedly been done, and it was certainly necessary to bend to the task of defending, expoundin g and applying it. Yet there was some danger o f petrifactio n ahead , an d th e almos t immediat e ris e o f anti-theoreti c schools of thought... is the proof that Theory was about to pay the penalty for that air of finality whic h was beginning to get on the nerves of the rising generation in very much the same way as it did in the case of Mill.7

It was a claim that reads strangely in the light of the 'neo-classical' theory which soo n emerge d a s victo r (albei t a relativel y considerat e an d co operative victor) in the 'war of the methods.' Because there has been some misunderstanding as to the nature of the advance made from Mill to Jevons, and consequently some misunderstanding of Mill, I propose to state very briefly what I consider to have been the real improvement s mad e b y th e neo-classicists . Th e ne w analysi s o f marginal utility seems to me to be the least important element; the solution of the parado x o f water an d diamond s was academicall y interestin g but little was added to the understanding of the role of demand in the process of exchange. Th e essentia l notion of elasticity o f demand, present i n Adam Smith, was clarified i n Mill and only waited to be christened by Marshall. The notion of'consumers' sovereignty,' again without the name, was basic to the economic s o f Mill, as of Adam Smith: and it might well be argued that this general notion of appropriate economi c organization makes more sense than the precision of the demonstrations of the conditions for maximizing utility, having in mind the fact tha t the utility for any individual is unmeasurable and that interpersonal comparisons are strictly impossible. Edgeworth's verdic t o n Mill' s performance , i n hi s articl e i n Palgrave' s Dictionary o f Political Economy, is just: 'Th e general theory of demand and supply seems to be stated by Mill as clearly as is possible without the aid of mathematical apparatus.' If utility analysis added little to the general

254 Fro m Adam Smith to Maynard Keynes theory of demand, the utility theorists di d make very important advances. Perhaps th e mos t important advance s lay i n the clea r recognitio n o f the simultaneous pricing of goods and factors of production, and of the generality of the notion of 'variable proportions' leadin g to elucidation o f the role of substitution . Closel y relate d wa s th e developmen t o f th e concep t o f 'alternative opportunity' as the basis of cost. Much of the confusion o f the classics in dealing with capital appears to me to have been compounded by the capita l theor y o f Jevon s an d Bohm-Bawerk , but th e wa y ou t wa s demonstrated b y Walra s when he treate d th e pricin g of the service s o f people and durable goods as essentially the same and went on to discuss the pricing o f the durabl e good s a s th e source s o f those services . Perhap s equally importan t with these specifi c advances la y the advanc e toward s more precisio n i n th e specificatio n of models wit h the promis e of more rigorous theory and with the clearer obligation to recognize the difficulty of using such theory in understanding the real economic process, in diagnosing its ills and in prescribing remedies. Leaving these broad generalizations I want to examine in detail some aspects of Mill's treatment of value. First, utility. 'The utility of a thing in the estimation of the purchaser, is the extreme limit of its exchange value' (n, 462). To illustrat e Mill quoted D e Quincy who argued that i n ninetynine case s ou t o f a hundre d the 'elemen t u , o r intrinsi c utility, will be perfectly inoperative. ' A cas e wher e u i s operativ e i s the n described , namely, th e purchas e o f a musica l snuf f bo x o n a steamboa t o n Lak e Superior. The exampl e is quite misleading if the object is to understand a competitive market. The specia l case is of one person buying one indivisible good from one person who owns the only available unit for sale, it being impossible to produce more. If Mill had gone on to a case where there were many buyers, not all equally intense in their desire for the particular good, he might have recognized th e importance of tempting the marginal buyer whose purchase would exhaust the supply. To have seen the importance of the utilit y to th e margina l buyer shoul d no t hav e bee n difficul t whe n so much attention was paid to the cost of the marginal producer. It would not have been a very great step to the case where the buyers might buy more than on e unit each: s o that attentio n woul d be directe d t o th e marginal purchase rathe r tha n the margina l purchaser. A furthe r ste p woul d then have been easy, to the case of divisible goods, so that the question would not be how many but how much. But these steps were not taken; the role of utility an d th e concep t o f marginal utility were lef t fo r Jevons , Menger , Marshall, and Walras to elucidate. What was more serious than the neglect of utility was the failure finally

Mill's Principles 25 5 to clarify the ambiguity in the use of the term, demand. Mill defined demand as 'the quantity demanded,' a quantity which he said 'varies according to the value' (n, 466). 'If the thing is cheap, there is usually a demand for more of it than when it is dear. Th e demand , therefore, partly depend s o n th e value. But it was before laid down that value depends on the demand. From this condition how shall we extricate ourselves? How solve the paradox, of two things, each depending upon the other?' (n, 466) What follows on the 'equation of supply and demand' is in the tradition of Adam Smith, and is still acceptable. But the paradox remains until it is recognized that demand has been given two different meanings . An increase of demand may mean more bought becaus e th e pric e ha s fallen , o r ma y mean that habit s an d preferences hav e so changed that more will be bought at the old price and that at any other price more would be bought now than would have been bought. When geometry an d algebra wer e put to use, an d demand curve s and deman d function s becam e familiar , th e confusio n shoul d hav e bee n eliminated but in literary economics i t persisted. H.D . Henderson i n Supply and Demand8 felt it necessary to warn against the ambiguity and clarify the issue. As late as 193 1 the articl e on Demand in the Encyclopaedeia of the Social Sciences whil e statin g th e 'scientifi c usage ' t o b e t o us e th e phrase 'change in demand' to refer to the case where 'there is a change in sales without a change in price,' and that the reaction to a change in price should be called a change in sales, or purchases, added 'this distinction in terminology i s not always carefully observed.' Perhaps it would be more correct to say that this usage is not quite generally accepted. In the chapter on 'Cos t o f Production i n its relatio n t o Value' th e proble m agai n arise s with reference to supply . 'The value of things which can be increased i n quantity at pleasure, does not depend ... upon demand and supply; on the contrary, demand and supply depend upon it' (n, 475). There is the same necessity t o distinguis h change s i n th e quantit y actuall y supplie d an d changes i n the suppl y function, a s to distinguish changes i n the quantity actually purchase d an d change s i n th e deman d function . Bu t scientifi c usage i s no t symmetrica l i n thes e tw o cases : a n increas e o f suppl y i s generally taken to mean an increase in the quantity actually supplied and available; if it is the supply function that is changing it must be so stated. Chapter i n o n 'Cos t o f Productio n i n Relatio n t o Value ' doe s no t improve on Adam Smith or Ricardo. 'Demand and supply always rush to an equilibrium, bu t th e conditio n o f stable equilibriu m is whe n thing s ex change fo r eac h othe r accordin g t o thei r cos t o f production, or , i n th e expression we have used, when things are at their Natural Value' (n, 476). Demand must always equal supply; but supply will in the long run be that

256 Fro m Adam Smith to Maynard Keynes which will all sell at a price equal to the cost of production - or, it would be better to say, at the 'expenses' of production. In Chapter iv we come to the 'Ultimate Analysis of Cost of Production.' Here w e are back to Ricardo. 'The value of commodities, therefore, depends principally (we shall presently see whether it depends solely) on the quantity of labour required for their production ' (n , 477) . Fo r a n explanatio n o f th e determinatio n o f relative exchange valu e at any one time and place, th e ultimate analysi s should tak e on e behin d th e expense s o f productio n t o th e alternativ e opportunity cost, not to the quantity of labour but to the other things that labour could have produced if it had not been used to produce this one. But this notion of real cost was still in the future; an d Mill, like Ricardo, was concerned wit h changes i n value over time. He quoted Ricard o a t som e length on the effect o f an improvement 'abridging labour in any one of the various processe s throug h which th e ra w cotto n mus t pas s befor e th e manufactured stockings come to the market... the stockings would inevitably fall in value, and command less of other things' (n, 478). He then said that 'Ricard o expresses himself as i f quantity o f labour .. . wer e the onl y thing o n whic h it s valu e depended ' (n , 479) . Now Mil l agreed tha t th e quantity o f labou r wa s th e principa l determinant , bu t note d tw o qualifications. First, h e notice d tha t change s i n th e relativ e wage s o f different classe s of labour woul d affec t th e value s o f their products . 'I n considering, however, the causes ofvariations i n value, quantity of labour is th e thin g o f chie f importanc e .. . variation s o f wage s .. . ar e usuall y general, an d have n o considerable effec t o n value' (n , 481). The secon d qualification relate d t o th e effec t o f profits. H e note d tha t wher e profit s varied from employment to employment there would be the same effect a s was produced by differences in wages. But he added that even when there is n o differenc e i n profits betwee n employments a change i n the rat e of profit wil l affec t commoditie s differently accordin g to th e lengt h of time over whic h the labou r i s spread . Thi s i s a restatemen t o f the Ricardia n proposition tha t value s varied wit h labou r cos t onl y i f what Marx later called the organi c composition of capital were the sam e in all industries. Mill did not add the Ricardian calculation that the margin of error resulting from ignoring this qualification was probably no more than 7 per cent. There remain two chapters whic h call for brief comment: first chapter xv, 'O f a Measure of Value.' Mill there discussed the difficulty o f measuring 'cost ' an d ended th e chapte r wit h an attempt to resolve som e of the confusion in the literature. The idea of a Measure of Value must not be confounded with the idea of a regulator, or determining principle, of value. When it is said by Ricardo and others, that the

Mill's Principles 257 value of a thing is regulated by quantity of labour, they do not mean the quantity of labour for which the thing will exchange, but the quantity required for producing it. This, the y mea n t o affirm , determine s it s valu e .. . Bu t whe n Adam Smit h and Malthus say that labour is a measure of value, they do not mean the labour by which the thing was or can be made, but the quantity of labour which it will exchange for, or purchase; in other words the value of the thing estimated in labour. And they do not mea n that thi s regulates th e genera l exchang e valu e of the thing , or ha s any effect o n determining what that value shall be, but only ascertains wha t it is ... T o confound thes e tw o ideas, woul d be much the same as to overlook th e distinction between the thermometer and the fire (11, 581).

The confusion is removed; but the use to which the 'measure' is to be put is not left clear. Mill seems to reject its use as a measure of changing cost over time, without whic h it is of no interest. Adam Smith knew that at any given time money was the best measure. Chapter xv i o n 'Som e Peculia r Case s o f Value' deal t firs t wit h joint supply. His case of coke and gas added nothing to the effective treatment of beef an d hide s i n Adam Smith . Bu t his formulatio n provided a theore m which prove d importan t whe n h e turne d t o th e theor y o f internationa l values. 'When , therefore, tw o or mor e commoditie s hav e a joint cos t of production, their natural values ... are those which will create a demand for each, i n th e rati o o f th e quantitie s i n whic h the y ar e sen t fort h b y th e productive process ' (n , 584) . Hi s secon d 'peculia r case' als o concerne d 'demand, no t a s a n occasiona l disturbe r o f value , bu t a s a permanen t regulator o f it, conjoined with , or supplementary to, cos t of production." The cas e i s whea t an d oat s wher e som e lan d i s bette r adapte d t o th e cultivation o f the one and some to that of the other. 'Thei r relative valu e must be in proportion to the cost on that quality of land, whatever it may be, on which the comparative deman d for the two grains requires tha t both of them should be grown' (n, 585). Cost i s still 'labour'; alternative opportunity is involved, but not as 'cost.' VIII

THE THEORY

OF

MONEY

Mill, like Adam Smith, opened th e discussion of money by examining the inconvenience of barter. He noted the convenience of a 'common language of pounds, shillings, and pence' in comparing values, and the convenienc e of keeping by them for making purchases som e commodity 'which besides being divisibl e an d generall y desired , doe s no t deteriorat e b y keeping. ' Coined gol d cam e t o fulfi l thes e purposes ; i n doing s o mone y i s sai d t o facilitate but not to affect th e process o f exchange and the determination of

258 Fro m Adam Smith to Maynard Keynes values, o r prices . Ther e cannot, ' h e said , 'b e intrinsicall y a mor e insignificant thing , in the econom y o f society, than money; except i n the character o f a contrivance fo r sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order. Th e introduction of money does not interfere with the operatio n of any of the Laws of Value laid down in the preceding chapters' (n, 506). There follo w a numbe r o f chapters o n monetar y theory , an d monetar y policy, which indicate tha t h e knew that th e 'machinery ' ver y easily got out o f order, s o that mone y was i n fact fa r fro m 'insignificant. ' I d o no t propose to examine these chapters in detail but I assert that they wear well. They nee d t o be read, however , wit h patience; a n initial dogmatic state ment is later qualified. Hi s assertion o f the 'quantity theory,' for instance, is followed by qualifications which 'under a complex syste m of credit like that existin g in England , rende r th e propositio n a n extremel y incorrec t expression o f the fact ' (n , 516) . Professo r Schumpete r ha s sai d o f thes e chapters that 'they contain some of Mill's best work. [They display] indeed some contradictions, hesitations , an d unassimilated compromises .. . bu t even thes e wer e no t unmixe d evil s sinc e the y brough t out , i n strang e contrast t o Mill's own belief in the finality of his teaching, th e unfinishe d state o f th e analysi s o f tha t time , an d thu s indicated line s fo r furthe r research to follow.'9 'The value or purchasing power of money depends, in the first instance, on demand and supply' (n, 509). The supply 'is all the money in circulation at the time ... the demand for money consists of all goods offered for sale.' Though money had been recognized as the thing people select to keep by them, Mill did not see that demand for money might be properly considered to b e th e amoun t whic h peopl e decid e t o 'kee p b y them ' an d tha t thi s amount is a variable depending, like the demand for any commodity, on its value. The Cambridge equation10 is still to come; the Fisher equation is the symbolic expressio n o f the Mil l doctrine . Mill , following Hume , argue d that an increase i n the money supply would raise prices i n a certain rati o and 'that this ratio would be precisely that in which the quantity of money had increased' (n, 511), which is to say that the elasticity of demand in the Cambridge sense is unity. This he added is a property 'peculiar to money.' Nothing is here said about the short period effects, the stimulating effect of rising prices an d the depressing effects o f falling prices, whic h Hume had noted. Mil l nex t introduce d velocity , rapidit y wa s th e curren t term ,

Mill's Principles 25 9 'efficiency' th e term he proposed. In the other usage of demand changes in velocity, o r efficiency, woul d later appea r a s changes i n 'liquidity preference.' In the chapter o n the influence of credit on prices, Mill discussed th e possibility o f a general speculativ e increase in prices even i n the absence of any expansion of credit, by virtue of an increased rapidity of circulation: in a time of speculative activity 'peopl e keep little money by them but haste n to la y i t ou t i n som e temptin g adventur e a s soo n a s possibl e afte r the y receive it ' (n, 541). So Mill did at last relate velocity an d liquidity preference. 'That an increase o f the quantity of money raises prices , an d a diminution lower s them , i s th e mos t elementary propositio n i n th e theor y o f currency .. . In any state of things, however, excep t th e simple and primitive one which we have supposed, th e proposition i s only true other things being the same: and what those other thing s are, whic h must be the same, we are not yet ready to pronounce' (n, 514). Two qualifications were made immediately: first 'whatever may be the quantity of money in the country, only tha t par t o f i t wil l affec t prices , whic h goe s int o th e marke t fo r commodities an d i s ther e actuall y exchange d agains t goods ' (n , 515) . Second, 'i f ther e be , a t an y time , a n increas e i n the numbe r o f mone y transactions, a thing continually liabl e t o happe n fro m difference s in the activity of speculation .. . an increase i n the currency which is only proportional to this increase o f transactions, an d is of no longer duration, has no tendency t o rais e prices ' (n , 515) . Mil l the n adde d tha t man y othe r qualifications remain to be pointed out , s o many as to render th e proposi tion of the quantity theory 'a n extremely incorrect expressio n o f the fact ' (ii, 5i6). Following the pattern of the general theory of value Mill next discussed the 'ultimate regulation' of the value of money, namely, cost of production. He di d recognize tha t th e perio d o f time necessar y fo r cost t o exer t it s influence throug h supply was a very long one because o f the durability of the commodit y an d the siz e o f the existin g stock. But he was misleading when he said 'even if this small annual supply were stopt entirely, it would require many years to reduce the quantity so much as to make any material difference i n prices' (n, 521). Compare wit h this Adam Smith and Gustav Cassel o n th e relativ e gol d supply . Mill' s propositio n woul d b e neare r correct if there wer e n o growth anywher e in the world ; to present i t as a general proposition i n an era of growth was surely seriously misleading. Chapters on 'Credit as a Substitute for Money' and on the 'Influence of Credit on Prices' led to one on 'Excess of Supply' in which the heresies of

260 Fro m Adam Smith to Maynard Keynes Malthus, Chalmers an d Sismondi were dealt with . 'D r Chalmers .. . inculcates o n capitalist s th e practic e o f mora l restrain t i n referenc e t o th e pursuit o f gain ; whil e Sismond i deprecate s machinery , an d th e variou s inventions which increase productive power ' (n, 571). Malthus, h e might have added, deprecate d undu e 'parsimony.' Mill's response was the clas sical one that supply creates its own demand. H e added a refutation of the more 'plausible' argument that the desire to consume might be deficient. If it were, he argued, the motive to produce would be weakened. Bu t suppose there are persons who produce and accumulate from mer e habit; not because the y have any object in growing richer, or desire to add in any respect t o their consumption, but from vi s inertiae .. . Wha t do these person s d o with their savings ? They invest them productively; that is, expend them in employing labour ... they make over the surplu s of it for the general benefit o f the labourin g class. No w wil l that class also not know what to do with it? Are we to suppose that they too have their wants perfectl y satisfied, and g o on labourin g from mer e habit ? Unti l this i s th e case; until the working classes hav e also reached the point of satiety - there will be no want of demand for the produce o f capital, howeve r rapidly it may accumulate (11,573-4).

There can be, he recognized, a temporary glu t in a 'commercial crisis.' But i t is a great erro r t o suppose , wit h Sismondi , that a commercial crisi s i s the effect of a general excess of production. It is simply the consequence o f an excess of speculative purchases. It is not a gradual advent of low prices, bu t a sudden recoil from price s extravagantly high: its immediate cause is a contraction o f credit, and the remedy is, not a diminution of supply, but the restoration of confidence .. . In no manner does thi s phenomenon answer to the descriptio n whic h these celebrate d economists have given of the evil of over production. The permanent decline in the circumstances of producers for want of markets, which those writers contemplate, is a conceptio n t o whic h the natur e of a commercial crisis give s no suppor t (n , 574-5).

He then gave credit t o his father and to the 'judicious' J.B. Say for having 'placed thi s most importan t poin t i n it s tru e light ' (n , 576) . Howeve r inadequate th e theory , on e may perhaps sa y that it s expansionist rathe r than restrictive characte r made the apparent victor y ove r heres y sociall y important a t the time. The pat h forward was to exploration o f a means of supplementing a deficient effective demand rather tha n eliminating excess supply.

Mill's Principles 26 1 IX

INTERNATIONAL

TRADE

On the chapters o n international trade the judgment is almost universally favourable, th e developmen t o f the relationshi p betwee n reciproca l de mand an d th e commodit y term s o f trade bein g considered b y Professo r Viner to constitute 'his chief claim to originality in the field of economics.' This favourable judgment is related to his performance in the static sphere; it is only in recent year s tha t th e dynami c aspect o f his trade theor y ha s been revived. When Mill denounced the fallacy of Adam Smith's 'vent for surplus' approach to the benefit of foreign trade, 'tha t it afforded a n outlet for th e surplu s produce o f a country' (n , 592), he turned hi s back o n the development aspects of the problem of unproductive labour, and argued on the level of the static theorists. A new concern for the economics of growth has brought new appreciation of the Adam Smith approach. I have already discussed thi s problem in Book one, and I noted there the contributions of Professors Allyn Young, J.H. Williams, and Hla Myint. I have nothing to add here. In m y chapter on Ricardo I dre w attentio n t o his development o f the doctrine o f 'comparative advantage' an d noted tha t it was lef t fo r Mill to develop the theor y of international values . Thi s highl y original analysis deserves som e furthe r notice . The theor y ha d bee n state d i n one o f his earlier Essays o n Some Unsettled Questions an d i n th e Principles h e quoted part of the exposition there given as providing the best introduction to hi s final view o f the subject . In hi s arithmetica l exampl e 1 0 yard s of broadcloth cos t i n Englan d a s muc h labou r a s 1 5 yard s o f line n and i n Germany as much as 20 yards of linen. 'When eac h countr y produced bot h commodities for itsel f 1 0 yards of cloth ex changed fo r 1 5 yards of linen in England, and fo r 2 0 in Germany . They wil l no w exchange for the same number of yards of linen in both. For what number? If for 1 5 yards, England will be just as sh e was, an d Germany will gain all. If for 20 yards, Germany will be as before and England will derive the whole of the benefit . I f for any number intermediate between 15 and 20, the advantage will be shared' (n, 597).

Mill then supposed that , by the higgling of the market, the rate of exchange was 1 0 yards of cloth for 1 7 yards of linen. Now the demand for a commodity varies according to the price and so one must ask how much cloth will be in demand in Germany at the price o f 10 yards of cloth. He supposed thi s quantity to be 1000 times 10 yards. He then turned his attention to England and suppose d that the demand for linen would be 100 0 times 17 yards. At

262 Fro m Adam Smith to Maynard Keynes that exchang e rate , unde r thos e condition s o f demand 'th e linen whic h England require s will exactly pay for the quantity o f cloth which, on th e same terms of interchange, Germany requires. The demand on each side is precisely sufficien t t o carry of f th e supply on the other.' (n, 597-8). After arithmetical example s base d o n differen t assumptions a s t o th e amoun t demanded i n each country a t the various rate s of exchange Mill stated the general principle a s follows. It ma y b e considered , therefore , a s established , tha t whe n tw o countrie s trad e together in two commodities, the exchange value of these commodities relatively to each other will adjust itself to the inclinations and circumstances o f the consumers on both sides, in such a manner that the quantities required by each country, of the articles which it imports from it s neighbours, shall be exactly sufficient t o pay fo r one another (11, 598-99).

He then asked how two countries would be affected by an increase in the productivity of labour in one of them. How would the gain be shared? This led him into a consideration of the 'extensibility' (or as we would put it the elasticity) of demand. If the elasticity wer e unity, he argued that Englan d (the importer) would gain the sam e advantag e a s Germany (the exporte r whose efficiency ha d been increased). If the demand were elastic England would no t hav e th e ful l benefi t of the improvement , i f the deman d wer e inelastic England would enjoy a greater advantage than Germany. This led him t o a consideratio n o f the probabilit y o f the deman d bein g elastic o r inelastic. When th e commodit y is one i n general request, an d th e fal l i n its pric e brings it within reac h o f a much larger class o f incomes than before, the deman d is ofte n increased in greater ratio than the fall of price, and a larger sum of money is on the whole expended in the article . Such was the cas e wit h coffe e .. . and suc h would probably b e th e cas e wit h sugar , wine an d a large class of commodities, which, though no t necessaries , ar e largel y consumed , an d i n whic h man y consumers indulge when the articles are cheap and economize when they are dear. But it more frequently happen s that when a commodity falls i n price, less money is spent in it than before ... the third of our three cases is the most probable; and an improvement in a n exportabl e product i s likel y t o b e a s beneficia l (i f not mor e beneficial ) t o foreign countries as to the country where the article is produced (n, 607).

The theory of international values, is put to use in Chapter xxv to refut e the mercantilis t misconception s abou t foreig n competition, an d particu larly the supposed unfairness of competition from low-wage countries.

s Principles 26 3 Since low wages are not a cause of low prices in the country itself, so neither do they cause it to offer it s commodities i n foreign markets at a lower price. It is quite true that if the cost of labour is lower in America than in England, America could sell her cottons t o Cuba at a lower price than England, an d still gain as high a profit as the English manufacturer. But it is not with the profit of the English manufacturer that the American cotton spinne r will make his comparison: it is with the profits of other American capitalists . Thes e enjoy, in common with himself, the benefi t o f a low cost of labour, and have accordingly a high rate of profit. This high profit the cotto n spinner must also have: he will not content himself with the English profit (n, 692). X

THE

D Y N A M I C S OF B O O K IV

The firs t three Book s wer e concerne d wit h th e 'Static s o f the Subject. ' They have only put u s i n possession o f the economica l law s of a stationar y an d unchanging society. W e have still to consider the economical condition of mankind as liable to change, and indeed (in the more advanced portions of the race, and in all regions to which their influence reaches ) a s a t all times undergoing progressive change . W e have to consider what their changes are, what are their laws, and what their ultimate tendencies, thereb y addin g a theory o f motion to our theory of equilibrium - th e Dynamics of political economy to the Statics' (n , 705).

One change, 'about which there can be no dispute' and which 'continues with littl e interruptio n fro m yea r t o year ' i s progress i n wealth, 'a n ad vancement of what is called material prosperity.' Mill proceeded to discuss the rapidl y increasin g knowledge of the 'propertie s an d law s of physical objects,' and the increasing rapidity with which this new physical knowledge is 'converted by practical ingenuity int o physical power' (he noted how the electromagnetic telegraph 'sprang into existence but a few years after th e establishment o f the scientifi c theor y which i t realizes and exemplifies') . This progressiv e applicatio n o f scienc e t o productio n require d ne w and higher type s o f skille d workers , bu t h e argue d tha t ther e ha d bee n n o difficulty i n 'finding or forming, i n a sufficient number of the working hands of the community , th e skil l requisit e for executing the most delicate pro cesses of the application of science to practical uses' (n, 706) . Next t o th e progres s o f scienc e an d technolog y Mil l pu t increase d security of person and property. The people are 'in each generation better protected against the violence and rapacity of one another' and against 'the arbitrary exercis e of the power of government.' Taxation become s 'les s oppressive and arbitrary.' Wars are usually confine d 't o those distant and

264 Fro m Adam Smith to Maynard Keynes outlying possessions i n which it comes into contact wit h savages.' Of this increased security one of the 'most unfailing effects is a great increase both of production and accumulation. Industry and frugality cannot exist, where there is not a preponderant probabilit y that those who labour and spare will be permitted to enjoy' (n , 706-7). To security add increasing capacity for co-operation, improvin g 'business capacity. ' Th e developmen t o f joint stock companie s an d o f co-operativ e association s gav e promis e o f th e performance o f works which 'n o person o r smal l number of persons ar e rich enough to accomplish' (n, 708). This expected improvemen t in technology, increas e i n security , an d 'mor e skilfu l employmen t of th e join t stock principle ' promise d a grea t increas e i n production . Bu t wha t o f population? Mill did not fear that population would 'overpass the increas e of production, ' h e doubte d whethe r i t woul d kee p pac e wit h it . H e re mained worried , however , abou t th e rat e o f populatio n increas e i n th e poorest sectio n of society. 'It , however, is quite possible that there might be .. . a great increase o f aggregate wealth , and even, in some respects, a better distribution of it; that not only the rich might grow richer, but many of the poor migh t grow rich, that the intermediat e classes migh t become more numerou s and powerful , an d th e mean s of enjoyable existence b e more widel y diffused, whil e yet th e grea t clas s at the base of the whol e might increase in numbers only, and not in comfort or civilisation' (n, 709). This comes nearer to sound prophecy than the 'immiserization' prophecy of Karl Marx. Mill proceeded , i n th e nex t fou r chapters , t o analys e th e effec t o f progress o n prices an d on distribution. I n Chapter n there is the familiar contrast between industry and agriculture: in the latter there is a 'conflict of the two antagonistic agencies, increase of population, and improvement of agricultural skill. ' O f mor e interest , I think , ar e hi s discussio n o f th e extension of the market internationally and his defence of speculators. As commerc e extends, and th e ignoran t attempt s to restrain it by tariff s becom e obsolete, commodities tend more and more to be produced in the places in which their productio n can b e carrie d o n a t th e leas t expens e of labour and capita l to mankind. A s civilisatio n spreads , and securit y of person and propert y becomes established, in parts of the world which have not hitherto had that advantage, the productive capabilities of those places are called into fuller activity , for the benefi t of their own inhabitants and of foreigners (n, 711).

Free Trad e i s rate d a s a 'mor e activ e sourc e o f cheapness ' tha n th e extension o f scienc e an d th e industria l arts! At th e en d o f thi s chapter comes hi s defence o f the speculator , tha t unpopula r and misunderstoo d

Mill's Principles 265 character. Hi s defence i s essentially tha t they provide for their own profi t the service that Joseph provide d in Egypt when he bought and stored cor n in the seven fat years an d sold an d fed the people i n the seve n lean years. Speculation prove s profitabl e whe n a pric e ris e i s foreseen. Thei r pur chases make the price begin to rise sooner tha n it otherwise would do, thus spreading the privation of the consumers ove r a longer period, bu t mitigating it at the time of its greatest height ; evidently to the general advantage.' If they have foreseen correctly the y make a profit. The operations, therefore, of speculative dealers are useful to the public whenever profitable to themselves; and though they are sometimes injurious to the public, by heightening th e fluctuation s whic h thei r mor e usua l offic e i s t o alleviate , ye t whenever thi s happen s the speculator s are th e greates t losers. The interest , in short, of the speculators as a body, coincides with the interest of the public ... the best way to promote the one is to leave them to pursue the other in perfect freedo m

(11,71

Perhaps some interference with this perfect freedom, some regulation, may be required : bu t i t shoul d b e undertake n wit h ful l understandin g of th e possible constructiv e functio n of speculation . Perhap s th e manipulatio n that is attributed to the speculator i s a problem of monopoly rather than of speculation/?^ se. There follows a discussion of the influence of 'progress' on the distribution of income. This is in the manner of Ricardo. It discusses in succession cases where population is increasing and capital stationary, capital increasing and population stationary, population and capital increasing but the arts of productio n stationary , th e art s progressiv e wit h capita l an d labou r stationary, an d finally all three element s progressive . Hi s summin g up is Ricardian an d Malthusia n i n it s pessimism ; th e relativel y optimisti c dynamism of his Chapter i seems forgotten. The economica l progres s o f a societ y constitute d o f landlords , capitalists , an d labourers, tends to the progressive enrichment of the landlord class; while the cost of th e labourer' s subsistenc e tend s o n th e whol e t o increase , an d profit s t o fall . Agricultural improvements are a counteracting force .. . [but] the increase of population tends to transfer all the benefits derived from agricultural improvement to the landlords alone ( n , 73 1 -2) .

With thi s tendenc y fo r rent s t o ris e goe s a 'tendenc y o f profit s t o a minimum' which is discussed i n Chapters i v and v . In his examination of the influence s determining the minimu m rate Mil l mad e a distinctio n of

266 Fro m Adam Smith to Maynard Keynes great importance which was largely ignored in the English literature befor e Keynes: he asked what was the lowest rat e tha t wil l induc e the peopl e o f tha t countr y an d tim e t o accumulat e savings an d t o emplo y those saving s productively. Thi s minimu m rate o f profi t varies according to circumstances. It depends on two elements. One is the strength of the effective desire of accumulation ... this element chiefly affects the inclination to save. The other element, which affects not so much the willingness to save as the disposition t o emplo y saving s productively, is th e degre e o f securit y o f capita l engaged in industrial operations (11, 736).

He went on to argue that the minimum rate was diminishing as a result of 'the kind of social progress characteristic o f our present civilisation,' and that in opulent countries profits are habitually near to the minimum. But he noted variou s influence s which prevented profit s falling to the minimum. The firs t o f these, 'wast e o f capital i n periods o f over-trading an d vas t speculation,' I find unconvincing. The second , improvement s i n production, is surely the crucial element. He distinguished, however, the effect of improvement in the wage-good industries and in the luxury industries. All inventions which cheapen any of the things consumed by the labourers, unless their requirements are raised in an equivalent degree, in time lower money wages: and by doing so, enable a greater capital to be accumulated and employed, before profits fal l back to what they were previously .. . The cheapening of lace or velvet has no effect i n diminishing the cost of labour; and no mode can be pointed out in which i t can rais e th e rat e o f profit .. . It , however , produces a n effec t whic h is virtually equivalent ; it lowers , or tend s to lower , the minimu m itsel f .. . All improvements, therefore, in the production of almost any commodity, tend in some degree to widen the interval which has to be passed before arriving at the stationary state (n, 743).

Where this chapter differ s fro m Chapte r i is in the treatment o f improvement as episodic, delaying the arrival of the stationary state, rather than as a process, steadil y accelerating , whic h postpones i t indefinitely. For pre diction the doctrine of Chapter i is more important than that of this chapter. The thir d influence , importation o f cheap necessaries , i s really just one form of 'improvement.' The distinction is again made between wage goods and luxuries; but Mill noted also the effect o f the importation of the means of production o f wage goods. 'Chea p iron has, in a certain measure , th e same effect o n profits .. . as cheap corn , becaus e chea p iron makes cheap tools fo r agricultur e and chea p machiner y for clothing' (n , 744) . Finall y

Mill's Principles 267 Mill added 'emigratio n of capital' a s a fourth counter-force checking th e downward tendency o f profits. What I hav e referred t o as the optimistic dynamism of Chapter i gave way, after these Ricardian-type chapters, t o a consideration of the inevitability of the 'stationary state.' I should not call this 'pessimistic' for to Mill the prospect o f the stationary stat e was not 'unpleasing and discouraging' as i t ha d appeare d t o economist s o f the 'las t tw o generations ' wh o had identified 'al l that is economically desirabl e wit h the progressive state. ' I have alread y discusse d thi s chapte r an d mus t refrai n from furthe r comment. It raised question s of values. Let me simply repeat tw o quotations, 'it is only in the backward countries of the world that increased productio n is still an important object'; and 'solitude in the presence of natural beauty and grandeur, is the cradle of thoughts and aspirations which are not only good for the individual, but which society could ill do without.' The final chapter of Book iv is 'On the Probable Futurity of the Working Class.' The first section o n the 'theory of dependence and protection' is a landmark i n social though t and socia l development . The value s involved have bee n discusse d abov e bu t som e furthe r commen t seem s justified. 'Modern nation s wil l have t o lear n th e lesson , tha t th e well-bein g of the people must exist b y mean s o f the justice and self-government .. . o f the individual citizens ... The prospect of the future depend s on the degree in which they can be made rational beings' (n, 763). The importance of education, including adult education, the 'penny press,' and the manifold provision fo r collectiv e discussio n o f publi c issues , take s o n a ne w aspect . 'Improved intelligence ' Mil l agai n note d i s a n importan t element i n th e control of population which was urgently necessary, and this led him once more to consider the position of women. The sam e reasons which make it no longer necessary that the poor should depend on the rich , mak e it equally unnecessary that women shoul d depend on men; and the least which justice requires is that law and custom shoul d not enforce depen dence .. . by ordaining that a woman, who does not happen to have a provision by inheritance, shal l hav e scarcel y any mean s ope n to he r o f gainin g a livelihood , except a s a wife o r mother. Le t wome n who prefer tha t occupation, adopt it ; but that ther e shoul d b e n o option .. . for the grea t majorit y o f women, except i n the humbler departments of life, is a flagrant socia l injustice (n, 765).

But Mill was concerned wit h expediency as well as justice, he foresaw one of the consequences o f the 'industria l and social independence of women' as a 'great diminution of the evil of over-population.' I do not propose to discuss the study of co-operative associations which

268 Fro m Adam Smith to Maynard Keynes Mill included in this chapter. As prophecy of the 'futurit y o f the labourin g classes' i t wa s no t fulfilled . I do , however , wan t t o quot e par t o f th e comment on competition which concludes hi s discussion o f co-operation . 'Instead of looking upon competition a s the baneful and anti-social principle which it is held to be by the generality of Socialists, I conceive that.. . every restriction o f it is an evil, an d every extension o f it, eve n if for th e time injuriousl y affectin g som e clas s o f labourers, i s alway s an ultimat e good. To be protected against competition is to be protected i n idleness, in mental dullness; t o be saved fro m th e necessity o f being as active an d as intelligent as other people' (n, 795). One may contrast with this his comment on the chapter on the stationary state: 'I am not charmed with the ideal of life held out by those who think that the normal state of human beings is that of struggling to get on, that the trampling, crushing, elbowing, and treading on each other's heels .. . are the most desirable lo t of humankind' (n, 754). But even there he added that the struggle for riches might be necessary t o avoid rus t an d stagnation . I t wa s to the distan t future , whe n 'th e bette r minds succeed in educating the others unto better things' that Mill assigned the end of competition. XI

OF THE

F U N C T I O N S OF

GOVERNMENT

The 'agenda ' o f governmen t change wit h change s i n th e natur e o f th e economy, and with changes in the character (particularl y the honesty and efficiency) o f the government. We do not look at the English prescriptio n for 184 8 as likely to be satisfactory for the England of 1974, nor do we look for a single prescription appropriate for all countries in 1974. But examination of Mill's writing on the 'influence of government,' on the 'economical effects' o f th e manne r in which governments carr y o n thei r 'necessary ' functions, an d on the proper extensio n o f their optiona l functions , is not just a matter for the economic historian. As in other part s o f the inquiry, questions are raised that still demand answers, and insight may be stimulated to the ponnt where answers relevant to our own time may be found. But the answers depend on much more than 'economical' effects. Libert y and democracy ar e a t issue: 'Impatient reformers, thinkin g it easier an d shorter t o ge t possessio n o f th e governmen t tha n o f th e intellect s an d dispositions of the public, are under a constant temptatio n to stretc h the province of government beyond due bounds ... and so many rash proposal s are made by sincere lovers of improvement, for attempting, by compulsory regulation, the attainment of objects which can only be effectually o r only usefully compasse d b y opinion s an d discussion .. . (n, 799). The itc h t o

Mill's Principles 269 interfere, t o impose one's will on others, migh t seem to need restraining, but Mill had no narrow concept of the function of government: 'the admitted functions of government embrace a much wider field than can easily be included withi n th e ring-fenc e o f an y restrictiv e definition , and .. . i t i s hardly possibl e t o fin d an y groun d o f justification commo n t o the m all , except th e comprehensiv e on e o f genera l expediency ; no r t o limi t th e interference o f governmen t b y an y universa l rule , sav e th e simpl e an d vague one , tha t i t shoul d neve r be admitte d bu t whe n the cas e o f expediency is strong' (n, 803-4). In Book i Mill had emphasized the economic importance of security of person an d property , an d i n Boo k n h e ha d argue d tha t th e right s of property wer e no t absolute . H e returne d t o thes e matter s i n Boo k v . 'Insecurity o f perso n an d propert y .. . means , no t onl y tha t labou r and frugality ar e not the road to acquisition, but that violence is' (n, 880). But there i s als o th e ver y suggestiv e qualification: 4a certai n degre e o f insecurity, in som e combination s o f circumstances, ha s goo d a s wel l as ba d effects, b y makin g energy and practica l abilit y the condition s of safety. Insecurity paralyzes, only when it is such in nature and in degree, that no energy o f whic h mankin d in genera l ar e capable , afford s an y tolerabl e means of self-protection.' (n, 881). The 'optional' functions of government are treated in two chapters; one deals with those 'grounde d on erroneous theories,' the other discusses in general th e 'ground s an d limit s of th e laissez-fair e or non-interference principle.' In the former I would note his discussion of Protectionism, 'the most notable' of the false theories. But the 'infan t industry ' plea is recognized: the superiorit y of one country over another in a branch of production, often arises only from havin g begun it sooner. There may be no inherent advantage on one part or disadvantage on th e other , but onl y a present superiority o f acquired skill an d experience. A countr y whic h ha s thi s skil l an d experienc e yet t o acquire , ma y in other respects be better adapted to the production than those which were earlier in the field : an d besides , it i s a just remar k o f M r Rae , that nothin g ha s a greater tendency to promote improvements in any branch of production, than its trial under a new set of conditions. But it cannot be expected that individuals should, at their own risk, or rather to their certain loss, introduce a new manufacture, and bear th burthen of carrying it on until the producers have been educated up to the leve l of those with whom the processes are traditional (n, 918-9).

But if infants are to be protected, they must grow up to compete freely with

270 Fro m Adam Smith to Maynard Keynes the world: the domestic producers shoul d never 'be allowed t o expect tha t it [protection] will be continued t o them beyond the time necessary fo r a fair trial of what they are capable of accomplishing.' The limit s o f th e provinc e o f governmen t Mil l discussed i n th e las t chapter of the book. First notice the plea for 'privacy': 'there is a part of the life of every person wh o has come to years of discretion, withi n which the individuality o f that perso n ough t t o reig n uncontrolle d .. . Ther e is , o r ought to be, some space in human existence thus entrenched around , and sacred fro m authoritativ e intrusion ...' (n, 938). Second, notic e his worry that ever y increas e o f the function s 'devolving o n the governmen t is an increase o f its power, bot h in the form o f authority, an d still more, in the indirect form of influence.' (n, 939). The danger of such power, no less in a democracy tha n in any other for m o f government, makes i t necessary t o develop 'powerfu l defences , i n order t o maintain that originalit y o f mind and individualit y of character , whic h ar e th e onl y sourc e o f an y rea l progress' (n, 940). Third, notic e his recognition o f the danger of overloading: 'Ever y additional function undertaken by the government, is a fres h occupation impose d upo n a bod y alread y overcharge d wit h duties ' (n , 940). Fourth , 'Th e busines s o f lif e i s a n essentia l par t o f th e practica l education of a people ... Instruction is only one of the desiderata o f mental improvement; another, almos t a s indispensable, i s a vigorous exercis e of active energies ... A people among whom there is no habit of spontaneous action for a collective interest - who look habitually to their government to command o r promp t the m i n all matters o f joint concer n .. . hav e thei r faculties onl y hal f developed. ' Finall y Mil l proceeded t o discus s som e cases of appropriate intereference . Publi c provision of elementary educa tion was defended, but a monopoly of that provision denounced: ' A government which can mould the opinions and sentiments of the people fro m their yout h upwards , ca n d o wit h the m whateve r i t pleases ' (n , 950) . Support of research wa s one of his important items of government policy: It i s highl y desirable , therefore , that there shoul d be a mod e o f insuring to th e public the services of scientific discoverer s ... The fellowships of the Universities are a n institutio n excellently adapte d fo r suc h a purpose ; bu t ar e hardl y every applied t o it , bein g bestowed, a t th e best , a s a rewar d for pas t proficiency , i n committing to memory what has been done by others, and not as the salary of future labours in the advancement of knowledge ... The most effectual plan ... seems to be that of conferring Professorships, with duties of instruction attached to them. The occupation of teaching a branch of knowledge, at least in its higher departments, is a help rather than an impediment to the systemati c cultivation of the subjec t itself.

Mill's Principles 27 1 The dutie s o f a professorshi p almos t alway s leav e muc h tim e fo r origina l re searches; and the greatest advances which have been made in the various sciences, both moral and physical, have originated with those wh o were public teachers of them ...(11,969).

A generous statemen t thi s from a servant o f the East India Company who was developin g furthe r th e economics o f the stockbroker Ricard o - but Adam Smith and T.R. Malthu s had been professors .

7

Karl Marx

In my introductory remarks to Book Two I have said that I propose to limit my discussion o f the work of Karl Marx to those aspects which seem to me to be important for the improvement of 'bourgeois' economics. Perhap s I may rephrase this, in view of the context of this chapter, and say, important in understandin g the developmen t o f th e classica l literatur e o f politica l economy. I shal l confine m y study to tw o of his works, Th e Communist Manifesto (1848 ) and volum e i o f Capital (1867). As always , my hope is that I shall persuade my readers to read these books, and that I shall enable them to read with greater ease an d fuller understanding and, in particular, with more recognition of their relevance to the 'classical' tradition. I The

Communist Manifesto *

The essenc e o f the Communist Manifesto i s in the first of its four parts . Here Mar x and Engel s presente d a brilliant sketch o f the emergenc e o f capitalism, a descriptio n o f som e characteristic s o f contemporar y capitalism, an d a n analysi s of the apparen t tren d o f change leadin g to a prophecy, base d o n projectio n o f those trends , o f inevitable, an d early , collapse. Befor e presentin g a summar y of hi s argument , with generou s quotation an d runnin g comment, I wan t t o mak e a rathe r paradoxica l comment on the general nature of his essay, contrasting the judgment of an historian and an economist. * Throughou t this part page references in the text are to the Penguin edition of The Communist Manifesto, wit h an introduction by A.J.P. Taylor (1967)

Karl Marx 273 AJ.P. Taylor i n his introduction to The Communist Manifesto oargue d that 'Marx lacked the historical spirit even by nineteenth century standard s and still more by ours.' The true historian must be aware of the inadequacy of his data. Even a t th e presen t time , whe n thousand s o f traine d expert s ar e engaged i n assembling and analysing the statistics of economic life, experts and governments have only the vaguest idea what has happened and no firm idea of what is likely to happen ... In Marx's lifetime true history was beginning. He was not interested in it. It offered scepticism , where he wanted certainty. It destroyed the foundations of all systems when he had perfected the final system ... It was a misfortune tha t Marx matured before the historical idea had reshaped men's habits of thought. He was to show himself later a historical researcher o f the first order, and a truly historical approach might have freed hi m from the rigid frame of dialectical materialism (12).

But i f Marx seemed t o the historian to lack th e 'historica l spirit' an d the scepticism which that might have developed, th e economist must say that he di d hav e historica l sens e an d throug h thi s ha d a quit e remarkabl e 'vision.' Hi s contribution t o th e developmen t o f economics throug h this historical visio n la y i n insistence tha t economi c institutions , capitalis t institutions, no t onl y were changin g but tha t th e influence s causing that change were endogenous, not exogenous. A dose of scepticism such as true history migh t have develope d woul d hav e mad e hi m les s certai n i n his prophecies (an d therefore quite useless a s a revolutionary leader) but the vision wa s an important contributio n t o bourgeoi s politica l econom y b y providing ne w understandin g o f th e elemen t o f determinis m i n socia l change, and new stimulus to the disinterested stud y of such change. No t that this was all new: I have referred to the element of determinism in John Stuart Mill, but the impact of Marx was of a different order. The historian' s unhistorical Marx is the economist's pionee r of the Historical School . 'The history of all hitherto existing society i s the history of class struggles' (79) . Thi s simplisti c assertio n i s th e natura l introductio n t o th e analysis of Part i in which the development of class antagonism is described and explained , an d i n whic h th e victor y o f th e emergin g proletaria t i s predicted. 'Th e epoch o f the bourgeoisi e .. . ha s simplifie d the clas s antagonisms. Society as a whole is more and more splitting up into two great hostile camps , int o tw o grea t classe s directl y facin g eac h other : Bourgeoisie and Proletariat' (80). How natural was this view of England in 1848 may be recognized by those who have read Disraeli's novel Sybil, with its identification of the 'tw o nations.' Nor wa s Marx alone in recognizing

274 Fro m Adam Smith to Maynard Keynes influences tha t wer e makin g for greate r solidarity . Mil l had recognize d some degre e o f 'necessity ' i n th e developmen t o f economi c an d socia l institutions and saw the growing strength of the working class as an instrument of change. H e further saw that the organization o f the working class was takin g plac e i n respons e t o industria l change , congregatio n i n factories, improve d communicatio n throug h chea p newspapers , increase d mobility through railways. In the essay , Th e Claims of Labour, 1 h e said : 'While some .. . were made to feel that the condition o f labour ought t o be attended to, others wer e made to see that it would be attended t o whether they wished to be blind or not.' Compare with this the end of Part i of The Manifesto: The advance of industry, whose involuntary promoter is the bourgeoisie, replace s the isolatio n of the labourers, due to competition, by the revolutionary combination, due to association. The development of Modern Industry, therefore, cuts from under it s feet th e ver y foundation o n which the bourgeoisie produces an d appropriates products. What the bourgeoisie produces, therefore, above all , is its own grave diggers. Its fall and the victory of the proletariat are equally inevitable (93-4).

What Mill vaguely foresaw, and what Marx could not admit even if he saw its possibility, was the rise of the class of skilled workers to the ranks of the middle class; the achievement of great gains (if not 'victory') in a maturing capitalism throug h the agenc y o f trade union s and parliamentar y action ; and the emergence of partial socialization i n a 'mixed' capitalist economy. But it is not the predictions and their inadequacy that interest me. It is the suggestive account o f the emergence and development of capitalist enter prises. First: th e emergenc e o f capitalism as th e opportunitie s fo r individual profit created a pressure within the restrictive institution of feudalism that could not be contained. The discovery of America, the rounding of the Cape, opened up fresh ground for the bourgeoisie. The East-India n and Chinese markets, the colonization of America, trade with the colonies, the increase in the means of exchange and in commodities generally, gave to commerce, to navigation , to industry, an impulse never before known, and thereby, to the revolutionary element in the tottering feudal society , a rapid development. The feuda l syste m of industry, under which industrial produc tion wa s monopolize d by close d guilds , no w n o longe r sufficed fo r th e growin g wants of the new markets ... Meantime the markets kept ever growing, the demand ever rising. Even manufacture n o longer sufficed. Thereupon , steam and machin-

Karl Marx 275 ery revolutionize d industrial production. The plac e of manufacture wa s taken by the giant, Modern Industry, the place of the industrial middle class, by industrial millionaires, the leaders of whole industrial armies, the modern bourgeois (80-1).

Second: le t m e not e th e 'political ' paragraph . 'Eac h ste p i n th e de velopment of the bourgeoisie was accompanied by a corresponding political advanc e .. . th e bourgeoisi e ha s a t last , sinc e th e establishmen t o f Modern Industr y an d o f th e worl d market , conquere d fo r itself , i n th e modern representativ e State , exclusive politica l sway . The executiv e o f the modern State is but a committee for managing the common affairs of the bourgeoisie' (82) . Thi s wa s a fa r cr y fro m th e idealis t concep t o f th e common good and the 'metaphysical State' that, 'sailing high in the clouds and exempt from and above human struggles and group interest, worships at th e shrin e o f tha t Commo n Good. ' Schumpeter , i n hi s essa y o n th e 'Communist Manifesto in Sociology and Economics,' to which I shall make several references, wen t on to say that economists o f all times have been blinded b y thes e concepts . So , thoug h h e rejecte d a s 'unrealistic ' th e description o f the state as simply a 'committee for managing the common affairs o f the whole bourgeoisie,' Schumpeter argued that Marx was 'th e founder o f modern political science , even thoug h not a single on e of his propositions shoul d stand the test of further research.' 21 think this is not only a fair verdict , but i t illustrates my concern t o identif y th e impac t of Marxian ideas on those who reject many of his theses. Third: Mar x discussed the 'revolutionary ' rol e of the bourgeoisie. T o Schumpeter this recognition of the revolutionar y role was of first importance. The revolutio n in question is a 'constant revolutionizing of production,' creation that spells the obsolescence an d consequent destruction of any industrial structure of productio n tha t exist s a t an y moment ; capitalism i s a process , stationar y capitalism would beacontradictio in adjecto. But this process does not simply exist in increase of capital - let alone increase of capital by saving - as the classics had it. It does not consist in adding mailcoaches to the existing stock of mailcoaches, but in their elimination by railroads.3

This was an important advanc e fro m Ricardia n economics, an d one that should have had more impact on the neo-classical economic s o f the next half century. In my Digression Three, 'On Competition,' there is an example of its current relevance. But Marx was not primarily concerned with the economic revolution, but rather with the consequent revolutionizin g of the

276 Fro m Adam Smith to Maynard Keynes social and political structure: let him speak for himself. 'Th e bourgeoisie, wherever it has got the upper hand, has put an end to all feudal, patriarchal, idyllic relations. I t ha s pitilessly tor n asunde r th e motle y feuda l ties tha t bound ma n t o hi s "natura l superiors, " an d ha s lef t remainin g n o othe r nexus between man and man than naked self-interest , tha n "callou s cash payment"' (82). How like Carlyle wit h his social nostalgia; how different from Malthu s who saw independence a s a product o f the free market! T o Marx the new 'freedom' wa s just a new form of 'slavery,' wage slavery . 'The bourgeoisie ha s strippe d o f its halo ever y occupatio n hithert o hon oured and looked up to with reverent awe . It has converted the physician , the lawyer , th e priest , th e poet , the ma n of science, into its paid wage labourers' (82) . Their wages, or salaries as they are now called, have turned out to be generally very generous and the salaried statu s has not turned out to be demeaning. As a professor I am not ashame d t o receive wage s (or salary) fo r m y services ; I hav e no t worke d wit h an y les s energ y an d enthusiasm because of my status as a wage (or salary) earner; and my social relations hav e neve r suffere d bu t hav e depende d o n th e qualit y o f my service an d the character of my behaviour, rathe r tha n o n my status as a wage earner . The bourgeoisie cannot exist without constantly revolutionizing the instruments of production, an d thereb y th e relation s o f production , an d wit h the m th e whol e relations of society. Conservation of the old modes of production in unaltered form, was, on the contrary, the first condition of existence for all earlier industrial classes. Constant revolutionizing of product, uninterrupted disturbance of all social conditions, everlasting uncertainty and agitation distinguish the bourgeois epoch from all earlier ones. All fixed, fast-frozen relations, with their train of ancient an d vener able prejudice s and opinion s are swep t away, all new-formed ones becom e antiquated befor e the y ca n ossify . Al l tha t i s soli d melt s into air , al l that i s hol y is profaned, and man is at last compelled to face with sober senses, his real conditions of life, and his relations with his kind (83).

One feature of this 'revolution' was the new 'cosmopolitan character.' 'All ol d establishe d nationa l industries have bee n destroye d o r ar e dail y bein g destroyed. They are dislodged by new industries whose introduction becomes a life and death questio n fo r all civilized nations, b y industries that no longer wor k up indigenous raw material, but ra w material drawn from th e remotes t zones; industries whose products are consume d not onl y at hom e but i n every quarter of the globe' (83-4).

Karl Marx 27 7 In this process the 'most barbarian nations ' ar e drawn int o 'civilization. ' Another featur e of this revolution wa s the subjection o f the country to the rule of the towns. 'It has created enormous cities, has greatly increased th e urban populatio n a s compare d wit h th e rural , an d ha s thu s rescued a considerable part of the population from th e idiocy of rural life' (m y italics ) (84). The value judgment i n this comment, which can be characterized as that of a 'city slicker,' may have had serious long-run effects on communist strategy throug h urban proletarian neglec t o f the peasants. Fourth: I must quote part of what Schumpeter referre d t o as a panegyric upon bourgeois achievemen t that has no equal in economic literature ... No reputabl e 'bourgeois ' economis t o f that or any other tim e - certainl y not A. Smith or J.S. Mil l -ever said as much as this. Observe, i n particular, the emphasis on the creative rol e of the business class tha t the majority o f the most 'bourgeois' economists s o persistentl y overlooke d .. . Neve r ha s a brie f bee n compose d o n behalf of the business class from so profound and so wide a comprehension of what its achievement is and of what it means to humanity. 4

I quote the 'panegyric' in full. The bourgeoisie , durin g its rul e of scarce on e hundre d years , ha s create d mor e massive and more colossal productiv e forces than have all preceding generations together. Subjection of Nature's forces to man, machinery, application of chemistry t o industr y an d agriculture , steam-navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalization of rivers, whole populations conjured out of the ground - what earlier century had even a presentiment that such productive forces slumbered in the lap of social labour? (85)

Fifth: the continued development o f this productivity was coming to be inhibited b y the ver y institution s tha t ha d mad e i t possible. At a n earlie r stage 'feuda l relation s of property becam e no longer compatibl e wit h the already develope d productiv e forces : the y became s o many fetters. The y had to be burst asunder; they were burst asunder' (85). A similar process was seen to be in operation. Modern bourgeoi s societ y wit h it s relation s o f production , o f exchang e an d o f property, a societ y tha t ha s conjure d u p suc h giganti c means of production an d exchange, is like the sorcerer , wh o i s no longer able to control the power s of the nether worl d whom he ha s calle d u p b y hi s spells . For man y a decade pas t th e history o f industr y an d commerc e i s bu t th e histor y o f th e revol t o f moder n

278 Fro m Adam Smith to Maynard Keynes productive force s agains t moder n condition s o f production agains t th e propert y relations that are the conditions for the existence of the bourgeoisie and of its rule. It is enough to mention the commercial crises that by their periodical return put on its trial, each time more threateningly, the existence of the entire bourgeois society. In these crises a great part not only of the existing products, but also of the previously created productive forces, are periodically destroyed. In these crises there breaks out an epidemic that, in all earlier epochs, would have seemed an absurdity - the epidemic of over-production. Society suddenly finds itself put back into a state of momentary barbarism; it appears as if a famine, a universal war of devastation had cut off the supply of every means of subsistence; industry and commerce seem to be destroyed; and why? Because ther e i s too muc h civilization, too muc h means of subsistence, too muc h industry, too muc h commerce. Th e productiv e forces .. . have become too powerful for these conditions, by which they are fettered (85-6).

Sixth, we come to the proletariat. 'No t only has the bourgeoisie forge d the weapons tha t bring death t o itself; it has also called into existence the men who are to wield thos e weapons - th e modern workin g class - the proletarians .. . a class of labourers who live only so long as they find work, and who find work only so long as their labour increases capital' (87). The deterioration of the condition of the class, the process of 'immiserization' is then described. Owing to the extensive use of machinery and to division of labour, the work of the proletarians has lost all individual character, and, consequently, all charm for the workman. He becomes an appendage of the machine, and it is only the most simple, most monotonous, and most easily acquired knack that is required of him. Hence, the cost of production of a workman is restricted, almost entirely to the means of subsistence that he requires for his maintenance, and for the propagation of his race ... In proportion as the use of machinery ... increases, in the same proportion the burden o f toil also increases, whethe r by prolongation of the workin g hours, by increase of the work exacted in a given time or by increased speed of the machinery ... Masses of labourers, crowded into the factory, are organized like soldiers. As privates o f the industria l army they ar e place d unde r the comman d of a perfect hierachy of officers an d sergeants. Not onl y are they slaves of the bourgeois class, and of the bourgeois State; they are daily and hourly enslaved by the machine, by the overlooker, and , above all, by the individual bourgeois manufacturer himself. The mor e openly this despotism proclaim s gain to be its end and aim, the mor e petty, th e mor e hatefu l and th e mor e embitterin g it i s .. . Th e les s the skil l and exertion of strength implied in the manual labour ... the more is the labour of men superseded by that of women... No sooner is the exploitation of the manufacturers,

Karl Marx 27 9 so far, at an end, that he receives hi s wages in cash, than he is set upon by the other portions o f th e bourgeois , th e landlord , th e shopkeeper , th e pawnbroker , etc . (87-8).

The proletariat thus grows in number, an d suffers increasing hardship, but it become s concentrate d i n greater masses , it s strengt h grows , an d i t feels tha t strength more . Th e variou s interest s an d conditions o f life withi n the rank s of the proletariat are more and more equalized, in proportion a s machinery obliterates all distinctions of labour, an d nearly everywhere reduce d wage s t o the same level.. . The worker s begi n t o form combinations (Trade s Unions ) against the bourgeois ; they clu b togethe r i n order t o kee p u p th e rat e o f wage s .. . No w an d the n th e workers are victorious, bu t only for a time. The rea l fruit of their battles lies, not in the immediate result, but in the ever expanding union of the workers. This union is helped o n by the improve d mean s o f communication tha t ar e created b y moder n industry ... The organization of the proletarians into a class, and consequently into a political party, i s continually being upset agai n by the competition between th e workers themselves. Bu t it ever rises up again, stronger, firmer, mightier... Further ... entir e section s of the ruling class are, b y the advance o f industry, precipitate d into th e proletaria t .. . Thes e als o suppl y th e proletaria t wit h fres h element s o f enlightenment an d progres s .. . Finall y .. . a smal l section o f the rulin g class cut s itself adrift, and joins the revolutionary class (89-91).

There follow brief reference s t o the 'lower middle class' and the 'dangerous class.' The former are 'reactionary for they try to roll back the wheel of history' (91) ; the latter are often 'th e bribed tool of reactionary intrigue ' (92). So we come to the climax: The modern labourer... instead of rising with the progress of industry, sinks deeper and deepe r belo w th e condition s o f existenc e o f hi s ow n class . H e become s a pauper, an d pauperis m develop s mor e rapidl y tha n populatio n an d wealth . An d here it becomes evident , that the bourgeoisie is unfit any longer to be the ruling class in society .. . It is unfit t o rule because i t is incompetent to assure an existence to its slave within his slavery ... Society ca n no longer live under this bourgeoisie .. . its existence i s n o longe r compatibl e wit h societ y .. . Th e developmen t o f Moder n Industry, therefore , cut s fro m unde r its fee t th e ver y foundation s on whic h th e bourgeoisie produces and appropriates products. What the bourgeoisie, therefore, produces, abov e all , is it s own grave-diggers. It s fal l an d th e victor y o f the pro letariat are equally inevitable (93-4).

280 Fro m Adam Smith to Maynard Keynes For m y particula r purpos e Par t n o f th e Manifesto i s no t o f grea t importance as it is concerned with the problem of party policy, and with the defence of the program against certain aspersions o r misconceptions. Th e policy ma y b e summe d u p i n a singl e statement : 'Abolitio n o f privat e property' (96). But this requires explanation . It i s private property i n the means of production tha t i s to be abolished an d the misconception tha t it means al l private propert y i s corrected i n a few paragraphs tha t ca n b e considered a s much as social criticism as policy explanation . We Communists have been reproache d wit h th e desir e o f abolishing the right of personally acquiring property as the fruit o f a man's own labour, which property is alleged to be the ground work of all personal freedom, activity and independence. Hard-won, sel f acquired, self earne d property . Do you mean the propert y of the petty artisa n and of the smal l peasant ... ? Ther e i s no nee d t o abolis h that : th e development of industry has to a great extent destroyed it , and is still destroying it daily (96).

What is to be abolished is 'capital, i.e. that kind of property which exploits wage labour.' Let m e note briefl y the other objection s urge d agains t the Communist program and Marx's replies. 'It has been objected tha t upon the abolition of private propert y al l work will cease, and universal lazines s wil l overtake us. According to this, bourgeois societ y ough t long ago to have gone to the dogs through sheer idleness, for those o f its members who work, acquir e nothing, an d thos e wh o acquir e anything , do no t work ' (99) . The n th e family: But yo u Communists would introduce communit y of women, screams th e whol e bourgeoisie i n chorus . Th e bourgeoisi e see s i n hi s wif e a mer e instrumen t of production. H e hear s tha t th e instrument s of productio n ar e t o b e exploite d in common, and, naturally, can come to no other conclusion than that the lot of being common to all will likewise fall to the women. He has not even a suspicion that the real point aimed at is to do away with the statu s of women as mere instruments of production ... The Communists have no need to introduce community of women; it has existed almost from time immemorial. Our bourgeois, not content wit h having the wive s an d daughter s o f their proletarian s a t thei r disposal , no t t o spea k o f common prostitutes , tak e th e greates t pleasur e i n seducin g each others ' wive s (101).

There followed th e assertio n tha t 'th e workin g men have n o country .. .

Karl Marx 28 1 National differences an d antagonisms between peoples are daily more and more vanishing, owing to the development o f the bourgeoisie, to freedom of commerce, to the world market, to uniformity in the mode of production and in the conditions o f life corresponding thereto . Th e supremac y of the proletariat will cause them to vanish still further.' Thi s was wishful thinking, and unfulfilled prophecy . It woul d hav e bee n t o descen d t o 'Utopian ' thinkin g t o discus s th e institutions of the new society that was inevitably emerging, but one point is made . 'Th e proletaria t wil l us e it s politica l supremac y t o wrest , b y degrees, al l capital from th e bourgeoisie, t o centraliz e al l instruments of production in the hands of the State, i.e., of the proletariat organized as the ruling class; and t o increase the total o f productive forces a s rapidly a s possible' [m y italics ] (104) . Thi s las t statement , rea d alon g wit h th e 'panegyric' quoted above shows how well Marx recognized the importance of expanding productivity. Great as productivity had become it was inadequate t o provid e a n acceptabl e standar d o f livin g t o al l whe n equall y distributed. The well-being of the workers depended on increasing productivity unde r th e ne w institutions, no t just o n providing mor e equitable , more nearly equal, distribution. There follows a list often measure s that Communists might seek as intermediate aims. I shall not list them here, but simply commen t tha t the y soun d ver y conservativ e today , an d mos t of them woul d no t hav e shocke d Joh n Stuar t Mill . The y wer e described , however, as 'despotic inroads on the right of property' (104). Part i n o f the Manifesto discusse s th e competin g socialist ideologies . For my purposes its importance is that it underlines the importance of the awareness of some historical necessity. One does not have to be a dogmatic determinist, t o accep t th e broa d propositio n tha t on e canno t ignor e th e forces of history when one is trying to influence the result of those forces . So i t i s th e criticis m o f thes e socialis t program s a s unhistorica l tha t I propose t o illustrate . 'I n thi s wa y arose feuda l Socialism: hal f lamentation, half lampoon; half echo of the past, half menace of the future; at times by it s bitter, witt y and incisiv e criticism, strikin g the bourgeoisi e t o th e very heart's core; but always ludricous in its effect, through total incapacity t o comprehend th e march of modern history' (106 , m y italics). Nex t Petty-Bourgeois Socialism: This form of Socialism aspires either to restoring the old means of production and of exchange ... or to cramping the modern means of production and exchange within the framework of the old property relations ... it is both reactionary and Utopian. Its last word s are: corporate guilds for manufacture; patriarcha l relations in agricul-

282 Fro m Adam Smith to Maynard Keynes ture. Ultimately , whe n stubborn historical facts ha d disperse d al l intoxicating effects of self-deception, this form of Socialism ended in a miserable fit of the blues' (109, my italics).

Finally 'Critical-Utopian Socialism,' Saint-Simon, Fourier , Owen , et al.: 'Historical action is to yield to their personal inventive action, historicall y created condition s o f emancipatio n t o fantasti c ones , an d th e gradua l spontaneous organizatio n of the proletariat t o a n organization of societ y specially contrive d b y thes e inventors . Futur e histor y resolve s itsel f i n their eyes, into the propaganda and the practical carrying out of their social plans .. . The y stil l drea m o f experimenta l realizatio n o f thei r socia l Utopias, o f founding isolated 'phalansteres, ' of establishing 'Hom e Colonies,' o f setting up a 'Little Icaria' - duo-decim o edition s o f the New Jerusalem (115-17, my italics). A two-page last part discusses the political tactics of the Communists in the Europe of that day. It ends with the resounding call 'Working men of all countries, unite ' an d immediatel y befor e tha t th e 'treacherou s phrase, ' which a s Schumpete r said , 'sound s s o wrong in the ligh t of more recen t developments,'5 namely that in a revolution the 'proletarians have nothing to lose but their chains.' II

THE P R E F A C E S TO

Capital*

In the author's preface to the first edition Marx explained 'wh y England is used as the chief illustration in the development of my theoretical ideas. ' It is becaus e fo r a stud y o f the capitalis t mod e o f productio n th e 'classi c ground i s England. ' H e wa s concerne d t o analys e the law s of capitalis t production 'workin g with iron necessity toward s inevitabl e results. Th e country tha t i s mor e develope d industriall y only show s t o th e les s de veloped, the image of its own future .. . where capitalist productio n is fully naturalised amon g the German s .. . the conditio n i s much worse tha n in England because the counterpoise of the Factory Acts is wanting.' In other spheres in Germany and in the continent of Europe generally the condition is worse, the worker s 'suffer no t only from th e development of capitalist production but also from the incompleteness of that development. Alongside of modern evils, a whole series of inherited evils oppress us' (13). There follows a eulogy of English government investigators that almost matches the panegyric on capitalism of the Manifesto. * Pag e references throughout the remainder of this chapter are to the Modern Library Edition of Capital

Karl Marx 283 The socia l statistics of Germany and the rest of continental Western Europe are, in comparison wit h those of England, wretchedly compiled .. . We should be appalled at the stat e o f things at home, if, as in England, our governments and parliaments appointed periodicall y commission s of enquiry into economic conditions ; if these commissions were armed with the same plenary powers to get at the truth; if it was possible t o find for this purpose me n as competent, a s free fro m partisanshi p an d respect of persons as are the English factor y inspectors , her medical reporter s on public health , he r commissioner s o f enquiry int o th e exploitatio n o f women an d children, into housing and food. (14). On the next page he talked of bias in the social sciences: In th e domai n of Political Economy , fre e scientifi c enquir y meets no t merel y the same enemies as in all other domains. The peculia r nature of the material it deals with, summons as foes into the field of battle the most violent, mean and malignant passions of the human breast, the Furie s of private interest . Th e Englis h Estab lished Church, e.g., will more readily pardon a n attack o n 38 of its 39 articles tha n on 1/3 9 of its income (15). Of course political economists must strive constantly to be aware of their biases: but perhaps one might have as much confidence in them as in those officers eulogize d above. In th e prefac e t o th e secon d editio n Mar x discusse d th e chang e i n English politica l econom y a s th e 'clas s struggle , practicall y a s wel l a s theoretically, took on more and more outspoken forms,' and 'sounded the knell of scientific bourgeois economy.' Thereafter 'in place of disinterested enquirers ther e wer e hire d prize-fighters ; i n plac e o f genuin e scientific research, the bad conscience and the evil intent of apologetic .. . Men who still claime d som e scientifi c standing ... trie d t o harmonis e the Politica l Economy of capital with the claims , no longer to be ignored, of the proletariat. Hence a shallow syncretism, of which John Stuart Mill is the best representative' (19). Now for the predictions: first, that of 1867. In England the process of social disintegratio n i s palpable. Whe n it has reached a certain point, it must react on the continent. There it will take a form more brutal or more humane, according t o th e degre e o f the developmen t o f the workin g clas s itself. Apar t fro m highe r motives , therefore , thei r ow n mos t importan t interest s dictate to the classes that are for the nonce the ruling ones, the removal of all legally removable hindrances to the free development of the working class. For this reason

284 Fro m Adam Smith to Maynard Keynes ... I have given so large a space in this volume to the history .. . o f English factor y legislation. One nation can and should learn from others . And even when a society has got upon the right track for the discovery of the natural laws of its development - an d it is the ultimate aim of this work, to lay bare the economic law of motion of modern societ y - i t can neither clea r by bold leaps , no r remove b y legal enact ments, the obstacles offere d by the successive phase s o f its normal developments . But it can shorten and lessen the birth-pangs' (15). Nearly twent y year s later , Frederic k Engel s i n hi s prefac e t o th e firs t English translatio n o f Capital sai d tha t afte r a life-lon g stud y o f th e economic histor y and condition o f England, Marx had come to the conclu sion tha t 'a t leas t i n Europe , Englan d i s th e onl y countr y wher e th e inevitable social revolution might be effected entirel y by peaceful and legal means' (32). One last reference to the prefaces may be made to indicate the continu ing belief that the early collapse o f capitalism might be expected, an d that the recurrent crises would provide the immediate cause of collapse. I n the preface to the second edition in 1873, Marx wrote: The contradiction s inheren t in the movemen t of capitalist societ y impres s them selves upon the practica l bourgeois mos t strikingl y in the changes of the periodi c cycle, throug h which moder n industr y runs, an d whos e crownin g poin t i s th e universal crisis. That crisis is once again approaching ... and by the universality of its theatre and the intensity of its action it will drum dialectics int o the heads of the mushroom upstarts of the new, holy, Prusso-German Empire (26). Similarly Engels in the preface of 1886: The decennia l cycle of stagnation, prosperity , over-production , an d crises , eve r recurrent from 182 5 to 1867, seems indeed to have run its course; but only to land us in th e sloug h of despond o f a permanent and chronic depression. The sighe d for period of prosperity will not come ... Meanwhile, each succeeding winter brings up afresh th e grea t question , 'wha t t o d o wit h th e unemploye d .. . w e ca n almos t calculate th e momen t when the unemployed, losing patience, wil l take their own fate into their own hands.' (131). Ill

THELABOURTHEORYOFVALUE

Before explorin g th e labou r theor y o f valu e a s expounde d b y Mar x in volume i o f Capital, I wan t t o sa y somethin g about th e relatio n o f his

Karl Marx 28 5 exposition to those o f Adam Smith and Ricardo. The Marxia n theory can be better understood if it is read in the context of the classical theory of the previous hundred years; along with a basic similarity with Adam Smith and Ricardo, there are important differences whic h can only be understood in the light of the different objective s o f the three economists. Adam Smith was concerned wit h the 'wealt h of nations.' So far as this depended o n productivit y pe r man-hou r h e wa s intereste d i n changin g man-time price or , as he called it , 'rea l price.' His problem was to find a measure of the changing amount of labour (man-time) required to produce particular commodities at different time s and in different pieces . 'Cheap ness,' i.e. , lowe r rea l price s o f goods, spel t 'plenty. ' S o far a s h e wa s concerned wit h allocatio n o f scarc e resource s h e wa s intereste d i n th e behaviour o f the market , in th e 'natura l price' an d i n the wa y i n which supply 'suited' itself to consumer demand. A labour theory of natural price, a labou r theor y o f exchange valu e i n th e sens e i n whic h th e moder n bourgeois economis t use s that term, he dismissed a s applicable onl y to a 'nation of hunters,' i.e. to a simple one input model. David Ricardo wa s less ready to dismiss the labour theor y o f value as irrelevant t o the actua l marke t process; bu t h e did recognize tha t i t gave only a first approximation to th e determinatio n o f equilibrium exchange values. The difference s i n the length of the period of production, or in the proportion of men to machines, between different industries meant that the equilibrium exchang e value s o f thei r product s woul d no t b e precisel y proportional t o th e quantit y o f labou r require d t o produc e them . Th e divergence, however, he thought would be slight, hence the description of his theory as a 93 per cent labour theory. So far as Ricardo was concerned with allocation o f resources and indeed with the determination o f prices in the market, he endorsed Adam Smith's Chapter vii. His major concern was different. H e wa s searchin g fo r a means of quantifying th e share s of th e three classes betwee n whom the wealth of the country was divided. Th e same difficulties tha t made the labour theory inadequate as an explanation of relative exchange value, or normal price, limite d the usefulness o f any one good as a measure of the real value of, i.e., of the labour embodied in, any other good, to those other goods which were produced under the same conditions o f capita l us e a s th e one . Wha t i s speciall y relevan t t o th e understanding o f the relatio n o f the Ricardia n t o th e Marxia n theory is , first, his use of the concept 'absolute ' value. When the relative exchang e value of two goods change Ricardo wanted to be able to say what has been the change in their absolute values. The second point of relevance is the use of the term 'real value,' i.e., absolute value, to measure changes in distribu-

286 Fro m Adam Smith to Maynard Keynes tive shares. The thir d point of special relevanc e i s the argument that th e same amount of labour always creates the same amount of 'value,' though, of course, it may come to create more 'riches.' It is a very slight transition from thi s Ricardia n theor y t o tha t o f Kar l Marx ; indee d Professo r Schumpeter say s bluntly , 'hi s [Marx's ] theor y o f value i s the Ricardia n one.'6 Marx was not interested in the theory of value as related to the understanding of the capitalist market in the process of allocating resources an d rationing consumers. His concern was to demonstrate, or to describe, the process o f exploitation, the process b y which a class o f men who did not work, the bourgeoisie, were able to command part of the labour, or part of the product of the labour, of those who did, the proletariat. In writing about Adam Smith I have said that this way of thinking of the 'labour command' of income rather than of its 'purchasing power' was familiar in mercantilist literature and came naturally to the classical economists, an d so to Marx. Now th e labou r theor y o f value whic h purporte d t o explai n th e marke t process had been given by some an ethical twist. Values should conform to the labour theory; only so would the 'right' of men to the 'whole produce of their labour ' b e assured . Th e 'Ricardia n Socialists, ' Bray , Hodgkin , Thompson, etc., had preached thi s doctrine. The Marxian variant was to consider the 'right' not of the individual worker to the whole produce of his labour, bu t th e righ t of th e workin g class t o th e whol e produc t o f their labour, so that any part of that product enjoyed by the bourgeoisie could be properly designate d as 'exploitation. ' This statemen t shoul d be qualifie d by sayin g that Mar x did not argu e in terms of 'rights'; his argument was presented a s objectiv e descriptio n o f th e proces s b y whic h on e clas s commanded a large part o f the labour of the other. Bu t the description i s highly charged with an emotional concern for the injustice of exploitation as a violatio n of the righ t to th e whol e produce. It i s in the ligh t of this objective, to demonstrate and describe the process of exploitation, that one must accept his definition of value; and recognize his simplifying assumption, for the purpose of the description of the aggregate process of exploitation in volume i, that the 'organi c composition of capital' is uniform i n all industries. That equilibrium prices diverge from values he noted in a letter to Engel s while writing the first volume, noted i n an obscure footnot e in volume i (p. 244), and developed in the little read volume in. If his objective had been to explain the current working of the capitalist commodity markets thi s insistenc e o n th e labou r theor y o f valu e an d th e complicate d adjustment to make it square with the facts would be unacceptable. But his objective was quite different. H e was, as I have said, interested i n describ-

Karl Marx 287 ing the process of exploitation, and in demonstrating how this process was leading inevitabl y t o th e destructio n o f th e institution s whic h mad e i t possible, to the overthrow of capitalism. Marx opened hi s discussion o f value by recognizing that commoditie s satisfy human wants, have utility, are 'use values.' But looking at the act of exchange, rathe r than that of consumption, he argued that exchange wa s 'characterized by a total abstraction from use value' (44). Of course, to the trader the characteristic that matters is the ability to exchange commodities for more money than he gave for them; but an underlying condition is that the commodities are so useful to the consumers that money will be paid for them. Marx may make this 'total abstraction' but the market does not. 'I f then we leave out of consideration the use-value of commodities, they have only on e commo n propert y left , tha t o f bein g product s o f labour ' (44) . There follows a further abstraction. Commodities are not to be regarded as the products of particular kinds of labour, that of 'the joiner, the mason, the spinner, o r an y othe r definit e kin d of productive labour ' bu t o f 'huma n labour in the abstract' (45). Each commodity represents then a 'congelation of huma n labou r .. . huma n labou r ha s bee n embodie d i n them . Whe n looked at as crystals of this social substance, common to them all, they are - Values ' (45) . Notic e tha t thi s i s no t a n explanatio n o f how value is determined; i t is a definition. 'If w e abstrac t fro m thei r us e valu e ther e remains their Value as defined above ' (45, my italics). Much confusion can be avoided if this definition be fully recognized . Even for the purpose of definition certai n amplification, of the sort that would b e necessar y i f the objec t wer e explanation o f exchange values , was necessary . Th e amoun t of labour mus t be that 'sociall y necessary. ' Without thi s qualificatio n a commodit y migh t b e expecte d t o b e more valuable the more idle and more unskilled the labourers. The labou r time socially necessary is that required to produce an article under the normal conditions of production, and with the average degree of skill and intensity prevalent a t th e time . The introductio n of powe r looms into England probably reduced by one half the labour required to weave a given quantity of yarn into cloth. The hand-loom weavers ... continued to require the same time as before; but for all that, the product of one hour of their labour represented after th e change only half an hour's social labour. (46)

Though 'total abstraction' of utility had been made, utility came back in as the meaning of socially necessary was amplified. 'Nothin g can have value, without being an object o f utility. If the thin g is useless, s o is the labou r

288 Fro m Adam Smith to Maynard Keyne s contained i n it; the labour does not count a s labour, and therefore create s no value' (48) . Late r whe n discussin g Exchange , Mar x reverte d t o this : 'labour spent upon them counts effectively, onl y in so far as it is spent in a form that is useful for others' (97). And again : Suppose that every piece of linen in the market contains no more labour-time than is socially necessary ... If the market cannot stomach the whole quantity at the normal price o f two shilling s a yard , this prove s tha t to o grea t a proportio n o f the tota l labour of the community has bee n expended in the form o f weaving. The effec t i s the sam e a s i f each individua l weave r ha d expende d mor e labour-tim e upon hi s particular product than is socially necessary (120).

Amplification als o led to the problem, whic h Adam Smit h and Ricardo had raised, as to the summation of different kind s and qualities of labour. Skilled labou r counts onl y a s simpl e labour intensified , o r rather , a s multiplied simple labour, a given quantity of skilled labour being considered equal to a greater quantity of simple labour. Experience shows that this reduction is constantly being made ... The differen t proportion s in which different sort s of labour are reduced to unskilled labour as their standard, are established b y a social process that goes on behind the backs of the producers and consequently appear to be fixed by custom (51-2).

This takes u s no further than di d Adam Smith' s 'higglin g of the market. ' Having noted the problem Marx decided t o ignore it: 'for simplicity's sak e we shal l henceforth accoun t ever y kin d of labour t o b e unskilled, simple labour' (52). For a theory of exchange thi s would be unacceptable: fo r his theory of exploitation it is justified. Since value is embodied labour it follows, that 'however then productive power may vary, the same labour, exercised durin g equal periods o f time, always yields equal amounts of value. But it will yield, during equal period s of time, different quantitie s of values in use; more if the productive power rise, fewer, if it fall' (53-4). This is a Ricardian proposition; it plays its part in his and in Marx's analysis in focusing attention on the labour command rather than the purchasing power, or the utility, of class incomes . Value as embodied labou r i s an absolute amount ; but i t is the relativ e value of any two commodities that shows up in the exchange valu e of the market. (Mar x assumed , fo r th e tim e being, tha t th e equivalenc e i n exchange of, say , i coat or 20 yards of linen reflected the equivalence o f the labour embodie d i n tha t amoun t o f eac h o f thes e commodities. ) 'Rea l

Karl Marx 289 changes i n the magnitud e of value are neither unequivocally nor exhaustively reflected in their relative expression, that is, in the equation expressing the magnitude of relative value. The relative value of a commodity may vary, althoug h it s value remains constant . It s relativ e valu e may remain constant, although its value varies' (63). Marx stated four cases: i) 'Let the value o f th e line n vary , tha t o f th e coa t remainin g constant. If , say , in consequence o f the exhaustion of flax-growing soil, the labour time necessary for the production of the linen be doubled, the value of the linen will also b e doubled. Instea d o f the equation , 2 0 yards of linen = i coat , we would hav e 2 0 yards o f linen = 2 coats' (62) . 2) His secon d cas e i s that where th e valu e o f line n remain s constan t bu t tha t o f th e coat , a s a consequence of a 'poor crop of wool,' doubles: in this case 20 yards of linen = l /2 coat . 3) 'Let the quantities of labour time respectively necessary fo r the productio n o f the linen and the coat var y simultaneously in the sam e direction and in the same proportion. In this case 20 yards of linen continue equal t o i coat , howeve r muc h thei r value s ma y hav e altered ' (63) . 4) Finally, he noted that the labour time necessary, and therefore the value of these commodities may vary in the same direction but at unequal rates, or in opposite directions. From this discussion of the relative exchange value of two commodities Marx proceeded t o the case of many commodities, noted the simplification when one of these commodities is selected a s a general reference, and the further simplificatio n whe n one commodity, e.g. gold, emerges as money and relative values become prices. But as the process of exchange was thus simplified the real nature of the social process was obscured. It is , however , just thi s ultimat e mone y form o f the worl d o f commodities that actually conceals, instead of disclosing, the social character of private labour, and the socia l relations between the individua l producer s ... Th e whol e mystery o f commodities, all the magic and necromancy that surround s the products of labour as lon g as the y take the for m o f commodities, vanishe s therefore, s o soo n as w e come to other forms of production (87).

After a paragrap h o n Robinso n Crusoe , Mar x turne d t o th e Europea n middle ages. Here, instea d of th e independen t man, we find every one dependent , serfs and lords, vassals and suzerains, laymen and clergy ... For the very reason that personal dependence forms the groundwork of society, there is no necessity for labour and its products to assume a fantastic for m differen t fro m thei r reality . They take the

290 Fro m Adam Smith to Maynard Keynes shape, in the transactions of society, o f services i n kind and payments in kind. .. . Compulsory labour is just as properly measured by time, as commodity producing labour; but ever y serf know s that what he expends i n the servic e o f his lord, i s a definite quantity of his own personal labour-power ... The social relations betwee n individuals i n the performanc e o f their labour , appea r a t al l events a s thei r ow n mutual relations, and are not disguised under the shape of social relations betwee n the products of labour (88-9). We shal l return t o this theme as the essentia l characte r o f exploitation i s shown t o be the sam e whethe r th e worker s b e slaves , feudal villeins, o r free wage earners. IV

EXCHANGE

The discussion of Exchange and Money in chapters two and three leads up to the conclusion of chapters four and five that there is no place for profit , and it s accumulatio n as capital , i n the simpl e process o f commodity ex change. I propose to quote the conclusion before I note some of the steps in the argument leading thereto. Surplus-value cannot be created b y circulation, and, therefore ... in its formation something must take place in the background, which is not apparent in the circulation itself... Our friend, Moneybags , who as yet is only an embryo capitalist, must buy his commodities at their value, must sell them at their value, and yet at the end of the process mus t withdraw more value from circulatio n than he threw into it at starting. His development into a full-grown capitalis t must take place, both within the spher e of circulation and without it. These are the condition s of the problem. Hie Rhodus, hie salta! (183-5). The resolutio n of the problem is found in Chapter vi on The buyin g and selling of labour power.' The argument begins with a discussion of the origin of exchange. Objects i n themselves are external to man, and consequently alienable by him. In order that this alienation may be reciprocal, i t is only necessary fo r men, by a tacit understanding, to treat each other as private owners of those alienable objects, and by implication as independent individuals . But such a state o f reciprocal indepen dence has no existence i n a primitive society based on property in common ... The exchange of commodities, therefore, first begins on the boundarie s o f such communities, o r wit h members o f the latte r .. . The constan t repetitio n o f exchang e makes it a normal social act. In the course o f time, therefore, some portion at least

Karl Marx 29 1 of the products o f labour mus t be produced wit h a special view to exchange. Fro m that momen t th e distinctio n become s firmly establishe d betwee n th e utilit y of an object fo r the purpose of consumption, an d its utility for the purposes o f exchang e (99-100). As the numbe r and variety of commodities exchange d increase s ther e emerges a specia l commodit y a s a 'genera l socia l equivalent, ' i.e. , a s money. Th e mone y for m attache s itsel f eithe r t o th e mos t importan t articles of exchange from outside ... or ... to the object of utility that forms, like cattle, the chief portion of indigenous alienable wealth ... In proportion as exchange bursts its local bonds .. . in the same proportion the character of money attaches itself to commodities that are by nature fitted to perform the socia l functio n o f a universal equivalent. These commodities are th e precious metals ' (101) . Th e 'value ' o f this commodity is like that of any other commodit y 'determined b y the labour-time required for its production' (104). With the introduction of money, barter is transformed into purchase and sale. This process is laboriously analysed. The sal e of linen, C-M, is at the same time its purchase, M-C . Bu t the sale is the first act o f a proces s tha t end s wit h a transactio n o f an opposit e nature , namely, the purchase of a Bible; the purchase of the linen, on the other hand, ends a movement that began with a transaction of an opposite nature , namely, with the sale of wheat ... Wit h regard t o ou r weave r th e lif e o f his commodity ends wit h the Bible , into which he has converted hi s £2. But suppose th e selle r of the Bibl e turns the £2 set free b y the weaver into brandy. M-C, the concludin g phase of C-M-C (linen, money, Bible) is also C-M, the first phase o f C-M-C (Bible-money-brandy). ... We see here , on th e on e hand , ho w th e exchang e o f commodities break s throug h all local and personal bounds inseparable from direc t barter, and develops the circulation of the products of social labour; and on the other hand, how it develops a whole network of social relation s spontaneous i n their growth and entirel y beyond th e contro l of the actors . I t i s onl y becaus e th e farme r ha s sol d hi s whea t tha t th e weave r i s enabled to sell his linen, only because the weaver has sold his linen that our Hotspur is enable d t o sel l hi s Bible , an d onl y becaus e th e latte r ha s sol d th e wate r o f everlasting life that the distiller is enabled to sell his eau de vie, and so on (123-6). Following this discussion of 'simple circulation' Mar x noted the possibility of breakdown, of'crisis.'No Say'slaw for him! Nothing can be more childish than the dogma, that because every sale is a purchase, therefore the circulation of commodities necessarily implies an equilibrium of sales

292 Fro m Adam Smith to Maynard Keynes and purchases . ... No one can sell unless some one else purchases. Bu t no one is forthwith boun d to purchase, because he has just sold. Circulation bursts through all restrictions as to time, place, and individuals, imposed by direct barter, and this it effects by splitting up, into the antithesis of a sale and purchase, the direct identity that in barter does exist... if the split between the sale and purchase becomes to o pronounced, the intimate connexion between them, their oneness, asserts itself by producing - a crisis (127-8).

This simpl e model show s the possibility of crisis, 'th e conversion o f this possibility int o a reality' i s the resul t o f the developmen t o f complicate d relationships not present in this preliminary simple model. With this rejection of Say's law should be read the discussion of hoarding. The hoarder , therefore, make s a sacrifice of the lust s of the flesh to his gold fetish. He acts in earnest up to the Gospel of abstention ... The more he produces, the more he is able to sell. Hard work, saving and avarice, are, therefore, his three cardinal virtues, and to sell much and buy little the sum of his political economy' (150) . Thi s seem s t o spel l trouble , bu t som e hoardin g ha s a function, providing for expansion and contraction of the amount of money in circulation with variations in the 'extent and rapidity of the circulation of commodities and in their prices' (150). There are many items of interest in his discussion of money but I pass over these, and proceed to his discussion, in Part n, of the transformation of money into capital. Alongside the simple form of the circulation of commodities, C-M-C, 'the transformation o f commodities into money, and the change of the money back into commodities; or selling in order to buy,' there js another form , M-C-M, 'the transformation of money into commodities, and the change of commodities back again into money; or buying in order to sell' (164). Now the object of this second form is to increase the amount of money the trader owns. If he buys commodities worth £100 and sells them for a like amount, would he not be wiser to adopt the 'miser's plan' stick to his £100 instead of 'exposing it to the dangers of circulation' (165). If what is bought for £100 can be sold for £i 10, the money may be spent on commodities for use, or it may be hoarded, or it may be reinvested. If th e expansio n of value is once aime d at, ther e is just th e sam e inducement to augment the valu e of the £i 10 as that of the £100 ... The circulatio n of capital has therefore n o limits. Thus the conscientiou s representative of this movement, the possessor o f money becomes a capitalist. His person, or rather his pocket, is the point from which the money starts and to which it returns ... it is only in so far as the appropriation of ever more and more wealth in the abstract becomes the sole motive

Karl Marx 293 of his operations, that he functions as a capitalist, that is, as capital personified and endowed with consciousness and a will .. . This boundless greed after riches , this passionate chase after exchang e value, is common to the capitalist and the miser; but while the miser is merely a capitalist gone mad, the capitalist is a rational mise (169-71). This process of money makin g more money is then show n to be inexplicable by reference t o simple circulation of commodities. 'Suppose then, that by som e inexplicable privilege, th e selle r i s enabled t o sel l hi s commodities above their value, what is worth 100 for 110... The seller therefor e pockets a surplus value of 10. But after he has sold he becomes a buyer. A third owne r o f commoditie s come s t o hi m no w a s a seller , wh o i n thi s capacity also enjoys th e privilege of selling his commodities 1 0 per cent to clear. Our friend gained 1 0 as a seller only to lose it again as a buyer' (179). Similarly the privilege to buy commodities under their value, would leave our friend gaining as a buyer and losing what he had gained as a seller. 'It is therefore impossibl e fo r capita l t o b e produce d b y circulation , an d i t is equally impossibl e fo r it to originate apar t fro m circulation ' (184) . S o we leave the model of simple circulation of commodities to enter the sphere of capitalist industr y to find there the secret of surplus value in the buying and selling of labour power. V

THE T H E O R Y O F E X P L O I T A T I O N

The solutio n t o th e proble m pose d a t th e en d o f Chapte r v i s tha t Moneybags i s luck y enoug h t o fin d withi n th e spher e o f circulatio n 4 a commodity whos e us e valu e possesses th e peculia r propert y o f being a source o f value ... The possessor of money does find on the market such a special commodit y in capacit y fo r labou r o r labou r power. ' (186) . Tw o conditions ar e necessary : 'th e owner o f money mus t meet i n the marke t with the free labourer , fre e i n the double sense, tha t as a free ma n he can dispose o f his labour powe r as his own commodity, an d that on the othe r hand he has no other commodity for sale, is short of everything necessary for th e realizatio n o f his labour power ' (187-8). The emergenc e o f thes e conditions 'comprise s a world' s history . Capital , therefore , announce s from it s first appearance a new epoch in the process of social production' (189). Moneybags buy s labou r powe r whic h create s value ; bu t wha t deter mines the value of that labour power, the price he must pay for this capacity to produce value. The valu e of labour power is determined, as in the case

294 Fro m Adam Smith to Maynard Keynes of every other commodity by the labour time necessary for the production , and consequently also the reproduction, of this special article' (189). This assertion o f the subsistenc e theor y o f wages is unsupported b y analysis . There is not, for instance, referenc e t o the population respons e to higher wages of Adam Smith or Ricardo. Bu t while it is bare assertion ther e ar e some qualification s o f interest . Lik e Ada m Smit h an d Ricardo , Mar x recognized that a 'historical and moral element' entered into the determination of the value of labour power. 'Nevertheless , in a given country, at a given period, the average quantit y of the means of subsistence necessary for the labourer is practically known' (190). The really interesting problem is how that 'necessary ' averag e quantity has increased ove r the years. If the actual standard of living that has been achieved at successive periods is then defined as the necessary subsistence, the proposition is just a truism. It onl y makes sens e i n the Marxia n scheme i f it is interpreted t o mea n a bare, and miserable, subsistence. Indeed we shall see that he argues, as in the Manifesto, tha t misery will be intensified. But again, as the process of immiserization seems to be replaced by a progressive rise in the standard of living of the workers, are we to interpret the expectation as one of relative immiserization? Rea d i n the contex t o f the descriptio n o f real miser y in Parts in, iv, and vn, the meaning of necessary subsistence must surely be the barel y necessar y amount . It i s interesting , however , i n th e ligh t o f present discussions of investments in human beings to find Marx recognizing tha t som e kind s of labour powe r involv e specia l costs . I n orde r t o modify th e human organism, so that it may acquire skill and handiness in a given branc h o f industry, an d becom e labou r power of a specia l kind , a special education or training is requisite ... the expenses o f this educatio n (excessively small in the case of ordinary labour power) enter pro tanto into the total value spent in its production' (191). Subsistence involve s given quantities of commodities, food, fuel, cloth ing, housing , etc. W e generally think then o f the mone y wages that wil l enable the worker to buy these necessaries. We talk of a subsistence wage. Marx wa s concerne d wit h the 'value ' o f these commodities , value in his special sense, the hours of social labour embodied in them. So he supposed 'that in this mas s of commodities requisit e fo r the averag e da y there ar e embodied 6 hour s o f socia l labour , the n ther e i s incorporate d dail y i n labour-power half a day's social labour, in other words, half a day's labour is requisite for the production of labour-power' (191-2). So to Part in with its description of how the worker is made to work additional hours beyond the six necessary to provide subsistence, mad e to create a 'surplus value' for the capitalists.

Karl Marx 295 The proces s b y which the capitalist consumes labour power is characterized by two features. First, the laboure r work s unde r th e contro l o f the capitalis t t o who m hi s labour belongs; the capitalist takin g good care that the work is done in a proper manner, and tha t th e mean s o f production ar e use d wit h intelligence, s o tha t ther e i s no unnecessary waste of raw material, and no wear and tear of the implements beyond what is necessarily cause d by the work. Secondly, the product is the property of the capitalist an d no t tha t o f th e labourer , it s immediat e producer . Suppos e tha t a capitalist pays for a day's labour-power at its value; then the right to use that power for a day belongs to him (206). Marx developed an example of this process. He assumed 'that the value of a day' s labour-powe r i s thre e shillings , an d tha t si x hour s labou r ar e incorporated i n that sum ; and consequentl y tha t this amount of labour is requisite to produce the necessaries o f life daily required on an average by the labour' (212). He supposed that in six hours the spinner would convert ten pounds of cotton into ten pounds of yarn, and, further, tha t two days' labour (i 2-hour days) would have been embodied in the cotton an d in the substance of the spindle worn away. The quantity of labour embodied in a piece of gold of the value of three shillings he also supposed to be six hours. The valu e o f th e yar n i n whic h two-and-a-hal f days ' labou r ha d bee n embodied would be fifteen shillings. Our capitalist stare s in astonishment. Th e valu e of the product i s exactly equal to the valu e o f th e capita l advance d .. . n o surplu s value has bee n create d .. . Ou r capitalist, who is at home in his vulgar economy, exclaims: 'Oh! but I advanced my money for the express purpose o f making more money.' The wa y to Hell is paved with good intentions , and h e migh t just a s easil y have intende d to mak e money, without producin g at all. He threaten s all sorts o f things ... H e trie s persuasion. 'Consider m y abstinence ; I migh t hav e playe d duck s an d drake s wit h th e 1 5 shillings; but instea d of that I consume d i t productively, and mad e yarn with it. ' Very well, and by the way of reward he is now in possession of good yarn instead of a bad conscience .. . H e now gets obstinate . 'Ca n the labourer,' he asks, 'merel y with his arms and legs, produce commodities out of nothing? Did I not supply him with the materials ... And as the greater part of society consist s of ne'er-do-wells, have I not rendered society incalculable service by my instruments of production... am I to be allowed nothing in return for this service? ... Our friend up to this time so purse proud, suddenly assumes the modes t demeanour o f his own workman, and exclaims: 'Have I not myself worked? Have I not performed the labour of superin-

296 Fro m Adam Smith to Maynard Keynes tendence an d o f overlooking the spinner ? And doe s no t thi s labour , too , creat e value?' His overlooker and his manager try to hide their smiles. Meanwhile aftera hearty laugh, he reassumes his usual mien ... The daily sustenance of labour-power costs only a day's labour, while on the other hand the very same labour power can work durin g a whol e da y .. . tha t wa s th e caus e o f hi s laughter . Th e laboure r therefore finds , i n th e workshop , the mean s of production for workin g not only during six, but during twelve hours (212-17).

In twelv e hour s th e worker s wil l add 6s to the valu e o f the material s o n which the y work, and onl y 38 must be paid t o each. Si x hours o f unpaid labour creating surplus value for the capitalist. No wonder he laughed! At this point Marx introduced a distinction between two kinds of capital (c), constant (c ) and variable (v) . This is a very specia l usage, havin g no connection with the familiar terms, fixed and circulating. 'Constant capital' (c) consists of all the instruments and materials required for production, or , rather, of the outla y necessar y t o provid e them . 'Variabl e capital' (v ) is 4 sum o f mone y expende d upo n th e labou r power ' (235) . Th e valu e o f constant capital merely reproduces itself , without expansion, in the value of the product; the variabl e capital, by contrast, i s the sourc e o f 'surplus value' (s). Th e capitalis t focuses hi s attention on the rat e o f profit o n his total capital: Mar x focused attentio n o n the rate of surplus value (s/v), for this i s th e measur e o f th e degre e o f exploitation . Thi s represent s th e relation betwee n 'th e necessary labou r time,' th e time necessary t o produce the mean s of subsistence, time in which he may be said to work for himself, an d 'th e secon d perio d o f the labour process , that i n which hi s labour i s no longe r necessar y labour ' durin g which tim e 'h e create s n o value for himself. He creates surplu s value which, for the capitalist, has all the char m of a creation ou t o f nothing' (240) . Thi s portio n o f the da y h e named 'surplu s labou r time. ' S o th e rat e o f surplu s valu e (s/v ) ca n b e expressed a s (surplu s labour/necessar y labour) . Thi s rat e i s 'a n exac t expression for the degree of exploitation of labour power by capital, or of the labourer by the capitalist' (241). In the hypothetical examples this rate had been take n t o be 10 0 per cent , si x hours necessar y labour , si x hours surplus labour . Usin g dat a 'whic h ma y b e relie d on ' give n hi m b y a Manchester spinne r he derived a rate i n that industr y of 15 2 n pe r cent ; from som e agricultura l data a rat e o f jus t ove r 10 0 pe r cent . I t i s i n connection with these examples that he noted the problem of deviations of price from value , depending on the structure of capital. 'The calculations given i n th e tex t ar e intende d merel y a s illustrations . We hav e i n fac t assumed that prices = values . We shall, however, see in Volume in, that

Karl Marx 297 even i n the case of average price s th e assumption cannot b e made in this very simple manner' (244, n. i). But through the remainder of Volume i this assumption i s made. Since the study is focused on the process of exploitation in industry as a whole, an d particular industrie s ar e only discussed a s representative o f the aggregate, th e assumption does no t vitiate the argument. His solution of the problem of the relation of prices and values is not relevant t o the theory of exploitation. VI

THE W O R K I N G

DAY

In hi s examples Mar x too k si x hours t o b e th e 'necessar y labou r time. ' This is the minimu m duration o f the working day. The maximu m is conditioned by two things. First, by the physical bounds of labour power ... Durin g part of the day this force must rest, sleep; during another part the man has to satisfy other physical needs, to feed, was h an d cloth e himself . Beside s thes e purel y physica l limitations , th e extension of the working day encounters moral ones. The laboure r needs time for satisfying hi s intellectua l an d socia l wants, the exten t an d numbe r o f whic h ar e conditioned by the general state of social advancement (256).

The capitalis t seek s th e longest da y possible: the workers resis t a s they can, demanding 'a working day of normal length.' What is that length? 'In the history of capitalist production , th e determination of what is a working day, presents itself as the result of a struggle, a struggle between collectiv e capital, i.e., the class of capitalists, and collective labour, i.e., the working class' (259). This struggle , and its results, Marx documented from English industrial experience, by data from those Commissioners of Inquiry whom he had lauded in his Preface. Befor e sampling this material I want to quote from the section o n 'the greed for surplus value.' Here Marx was drawing attention to the continuity of exploitation under various social forms. Capital has not invented surplu s labour. Wherever a part of society possesses th e monopoly of the means of production, the labourer free or not free, mus t add to the working time necessary for his own maintenance an extra working time in order to produce th e mean s of subsistenc e for th e owner s o f th e mean s of production, whether the proprieto r be the Athenian KaXos KayaOos, Etrusca n theocrat, Civis Romanus, Norma n baron, America n slave owner , Wallachia n Boyard , modern landlord o r capitalis t .. . Wher e not th e exchang e value bu t th e use-valu e o f th e product predominates, surplus value will be limited by a given set of wants ... here

298 Fro m Adam Smith to Maynard Keynes no boundless thirst for surplus value arises. Hence in antiquity overwork becomes horrible only when the object is to obtain exchange value in its specific independent money-form; in the production of gold and silver. Compulsory working to death is here the recognized form of over-work. Only read Diodorus Siculus ... Hence the negro labour in the Southern States of the American Union preserved something of a patriarcha l character, s o long as production was chiefly directe d t o immediate local consumption . But i n proportion , a s th e expor t o f cotto n becam e o f vital interest to these states, the overworking of the negro and sometimes the using up of his life i n 7 years' of labour became a factor in a calculated and calculating system (260).

Marx the n compare d th e gree d fo r surplu s valu e i n the Danubia n Prin cipalities with the same greed in English factories. The difference was that under th e Reglemen t Organique , th e day s o f labou r fo r th e lor d ar e identifiable, th e surplu s labou r wa s devote d t o th e lords ' land . I n th e factory this division of the labour of the free labourer lies hidden under the cloak o f money transactions; but th e essence o f the process is the same , and the greed is no less. He then contrasted th e Reglement Organique, ' a positive expression of the greed for social value,' and the English Factor y Acts, 'a negative expression of the same greed.' These act s curb the passio n for a limitless draining of labour-power, by forcibly limitin g th e working day b y stat e regulations , made by a state tha t is ruled by capitalist an d landlord. Apart from the working class movement that daily grew more threatening, the limitin g o f factor y labou r wa s dictate d by th e sam e necessity which spread guano over the English fields. The same blind eagerness for plunder that in the one case exhausted the soil, had, in the other, torn up by the roots the living force of the nation (263-4).

Marx followed his general discussion of the 'greed' that could be satisfied only b y th e extensio n o f the workin g day, b y descriptio n o f specifi c instances. Fro m th e Factor y Inspector s h e derive d a n accoun t o f th e 'fraudulent mil l owner' who started early , stopped late , an d reduced th e time allowed fo r meal s s o as to ad d 340 minutes a week to th e 'normal ' working day. Others did the same on a smaller scale: 'these "small thefts " of capital from the labourer's meal and recreation time, the factory inspectors als o designat e a s "pett y pilferin g o f minutes, " "snatchin g a fe w minutes," o r as the labourers technicall y calle d the m "nibbling an d cribbling at meal times"' (267). To thi s evidence o f 'petty pilfering ' h e added evidenc e o f the over-al l

Karl Marx 299 length of the workin g day in some industrie s which were, o r had been til l very recently, 'free from the fetters of the Factory Acts.' One such industry was the Staffordshire potteries. From a report b y Dr Greenhow, published by order of the medical officer o f the Privy Council, Marx took the following examples. William Wood, 9 years old, was 7 years and 10 months when he began t o work. H e 'ran moulds' (carrie d ready-moulded article s int o the drying, afterwards bringin g back the empty mould) from the beginning. He came to work every day in the week at 6 a.m., and left off about 9 p.m. Fifteen hours of labour for a child of 7 years old. J. Murray, 12 years of age, says: I turn jigger, and run moulds. I come at 6. Sometime s I come at 4.1 worked all last night, till 6 o'clock this morning. I have not been in bed since the night before last . There were eight or nine other boys working last night. All but one have come this morning (269). Another of his examples was the bread bakery industry. The evidence of overwork came from a report o f a Royal Commissioner (1863). His report, together wit h the evidence given, roused no t the heart of the public but its stomach. Englishmen , always well up in the Bible , knew well enough that man, unless by elective grace a capitalist, or landlord, or sinecurist, is commanded to eat his bread i n the swea t o f his brow, but they did not know that he had to eat daily in his brea d a certai n quantit y of human perspiration mixed with th e discharge s o f abscesses, cobwebs, dea d blac k beetles, an d putrid German yeast, without counting alum, sand, and other agreeable minera l ingredients. Without any regard to his holiness, Free Trade, the free baking trade was therefore placed under the supervision of the State inspectors .. . and by the same Act of Parliament, work from 9 in the evening to 5 in the morning was forbidden for journeyman bakers under 18 . One last example, glass manufacture, taken from a long footnote on the 'waste o f fuel (instea d of , a s now , a waste o f the livin g substance o f th e workers)' if the steel rolling mills were idle during the night. To similar tender scruple s o f the glass manufactures that regular meal times for the children ar e impossibl e becaus e a s a consequenc e a certai n quantit y o f heat , radiated b y th e furnaces , woul d b e a pur e los s o r wasted . Commissione r Whit e makes answer . Hi s answe r i s unlik e that o f Ure , Senior, etc. , and thei r pun y German plagiarists a la Roscher, wh o are touched b y the 'abstinence,' 'self-denial,' 'saving' o f th e capitalist s i n th e expenditur e o f thei r gold , an d b y thei r Timu r Tamerlanish prodigalit y of human life! 'A certai n amoun t o f heat beyon d wha t is

3OO Fro m Adam Smith to Maynard Keynes usual at present might also be going to waste, if meal-times were secured i n these cases, bu t it seems likel y not equal in money-value to the waste o f animal power now going on in glass houses throughout the kingdom from growing boys not having enough quie t tim e t o ea t thei r meal s a t ease , wit h a littl e res t afterward s fo r digestion.' And this in the year of progress 1865 ! (290)

The work itself wa s heavy, involved walkin g some 1 5 to 20 miles in every six hours of work, and lasted 1 4 or 1 5 hours a day. The footnote ends with this: 'Meanwhile , lat e by nigh t perhaps , self-denyin g M r Glas s Capital , primed with port wine, reels out of his club homeward droning out idioti cally, "Britons never, neve r shall be slaves".' After the examples, the summation: All the worker's disposable time is to be 'Devoted to the self-expansion of capital.' Time for education , for intellectua l development, for th e fulfillin g o f social func tions and social intercourse, for the free play of his bodily and mental activity, even the rest of Sunday (and that in a country of Sabbatarians) - moonshine ! But in its blind unrestrainable passion, its were-wolf hunger for surplus-value, capital oversteps no t only the moral , but even the merel y physical maximum bounds fo r the working day. It usurps the time for growth, development, and health maintenance of the body. It steals the time required for the consumption of fresh air and sunlight ... Capital cares nothing for the length of life of labour-power. All that concerns i t is simply an d solel y the maximu m of labour-power, that can be rendered fluent in a working day. It attains this end by shortening the extent of the labourer's life , as a greedy farme r snatche s increase d productio n fro m th e soi l b y robbin g i t o f it s fertility (291-2).

Comparison was then made with the slave economy, with a reference to the book by Professor Cairne s on The Slave Power. As long as slaves mus t be bred on the plantation 'consideration s of economy .. . afford som e securit y for human e treatment by identifying the master's interes t wit h the slave' s preservation.' Bu t i n slav e importin g countrie s 'th e mos t effectiv e economy is that which takes out of the human chattel in the shortest space of time the utmost amount of exertion it is capable of putting forth' (293). In England ther e wa s n o slavery , n o slav e trade , ye t th e sam e story , h e argued, held . 'Fo r slav e trad e rea d labou r market , fo r Kentuck y an d Virginia, Ireland an d the agricultura l district s of England, Scotland , and Wales, fo r Africa , German y .. . Th e Londo n labou r marke t i s alway s over-stocked wit h German and other candidates for death in the bakeries' (293). He then quoted a member of the House of Commons as saying of the

Karl Marx 30 1 cotton trad e tha t 'i t has existed fo r three generation s o f the English race , and .. . durin g tha t perio d i t ha s destroye d nin e generation s o f factor y operatives' (293) . The discussion o f the working day ends with an account o f the struggle for lega l limitatio n o f hour s i n the Factor y Acts . I quot e onl y th e final sentences: For 'protection' against 'the serpent of their agonies,' the labourers must put their heads together, and, as a class compel the passing of a law, an all-powerful socia l barrier that shall prevent the very workers from selling , by voluntary contract with capital, themselve s an d thei r familie s int o slaver y an d death . I n plac e o f th e pompous catalogu e o f th e 'inalienabl e right s o f man ' come s th e modes t Magn a Charta o f a legall y limited working-day, which shal l make clear 'whe n th e tim e which the worker sells is ended and when his own begins.' Quantum mutatis ab illo! (330).

How much more have things changed a s the collective agreemen t betwee n Trade Unions and the employers secur e ever shorte r hours ! VII

ABSOLUTE AND RELATIVESURPLUS VALUE

Up to this point th e 'condition s of production,' the stat e o f the industrial arts, ha s bee n take n a s given . Th e 'mas s o f surplu s value, ' tha t i s th e aggregate o f the labou r power whic h is embodied i n commodities fo r th e capitalist class , depende d o n th e numbe r o f worker s employe d b y th e capitalists and the rate of surplus value. Increase i n this 'mass,' with given technology, require d eithe r a n increas e i n th e numbe r employe d o r a further lengthenin g of the workin g day. But as technology develops , th e productivity of labour power increases. In so far as this improved technology affect s th e wage-goo d industrie s th e 'necessar y labou r time ' i s de creased. Withou t any increase i n the number of hours in the working day, more hours becom e 'surplus ' a s fewer become 'necessary. ' 'The surplus value produce d b y prolongatio n o f th e workin g day , I cal l absolute surplus-value. O n the other hand , the surplu s value arising from th e curtailment of the necessary labour-time , and from th e corresponding altera tion in the respective length s of the two components o f the working day, I call relative surplus-value' (345) . Of course technological improvemen t i s not confine d t o th e wage-goo d industries . I n s o fa r a s i t reduce s th e labour-time necessar y t o produce th e instrument s of labour an d the ra w material tha t ar e require d fo r th e productio n o f wag e goods , relativ e

302 Fro m Adam Smith to Maynard Keynes surplus-value increases. But in so far as it reduces th e labour-time neces sary to produce luxur y goods for the bourgeoisie, o r the instruments an d materials necessar y fo r their production , ther e i s no increase in surplu s value, though there i s an increase i n the aggregate product o f the surplu s value. In Ricardo's terms, the riches of the capitalists and landlords would have increase d bu t th e valu e of those riche s woul d be unchanged. Mar x was not interested i n 'riches' but in exploitation: and he would, perhaps , add that the capitalists ar e not really interested i n riches bu t in accumulation. Following this analysis there is an excellent sketc h of the process of that industrial development which had so greatly increased productivity in the wage good industries and thus provided for the increase of relative surplus value. I shal l onl y refe r t o th e fina l stag e wher e Mar x emphasize d th e importance of the machine tool and of machines to make machines. The mos t essentia l conditio n t o th e productio n o f machines by machine s wa s a prime move r capabl e o f exertin g an y amoun t o f force , an d ye t unde r perfec t control. Suc h a conditio n was alread y supplied by th e steam-engine . But a t th e same time i t was necessary to produce the geometricall y accurate straigh t lines, lines, circles , cylinders , cones, an d spheres , require d i n th e detai l part s o f th e machines. This problem Henry Maudsley solved in the first decade of this century by th e inventio n of the slid e rest, a tool that was soo n mad e automatic, and i n a modified for m wa s applied t o other constructiv e machine s besides th e lathe , fo r which i t was originall y intended. Thi s mechanica l applianc e replaces , no t som e particular tool, but the hand itself... Thus it became possible to produce the forms of the individua l parts of machinery 'with a degree of ease, accuracy , and speed , that n o accumulated experiences of the han d of the mos t skilled workman could give.' If we now fix our attention on that portion of the machinery employed in the construction of machines, which constitutes the operating tool, we find the manual implements reappearing, but on a Cyclopean scale. The operating part of the boring machine is an immense drill driven by a steam engine; without this machine, on the other hand, the cylinders of large steam engines and hydraulic presses could not be made (420-21).

Perhaps i t i s becaus e fift y year s afte r Mar x I wa s mad e t o stud y th e 'industrial revolution ' a s i f it wer e a matte r o f the relativel y simpl e de velopment o f machine productio n i n the textil e industry , tha t I find this emphasis on the later stage of that revolution especiall y interesting . Marx was not content i n Part i v to describ e industria l development in terms of productivity, most of the Part is concerned with the impact of this

Karl Marx 30 3 development o n the working class. He saw the process not as one that lef t the workers more exploited bu t equally well fed, clothed and comfortable. On th e contrary , th e them e i s progressive 'immiserization, ' progressiv e deterioration i n th e conditio n o f th e workin g class . Severa l area s ar e explored; first , 'th e appropriatio n o f supplementar y Labour-Powe r b y Capital.' In s o fa r a s machiner y dispenses wit h muscula r power, i t become s a mean s of employing labourer s o f sligh t muscula r strengt h .. . Th e labou r o f wome n an d children was, therefore, the first thing sought for by capitalists who used machinery ... Compulsory work for the capitalist usurped the place, not only of the children's play, but also of free labou r at home within moderate limits for the support of the family (432).

Second, 'prolongatio n o f the working-day. ' Becaus e machine s suffe r rapid depreciation fro m obsolescence, as either new machines of the same sort are produced cheaper , o r as better machine s are developed, ther e is a strong incentive to use them fully, t o wear them out, before 'mora l depreciation' has gone far. The shorte r th e period take n to reproduce it s total value, th e les s i s th e dange r o f mora l depreciation ; an d th e longe r th e working day, the shorter i s that period' (443). In the early days of machinery ne w method s o f producin g machines , an d ne w improvement s tha t affect no t onl y details of the machine s but thei r entire build 'follow blo w upon blow. It is , therefore, i n the earl y days of the lif e o f machinery that this specia l incentiv e to the prolongation o f the working day makes itself felt most acutely' (442). Marx added two other reasons for this pressure t o lengthen the working day as the use of machinery increases. First , as new machines are 'introduce d sporadically into an industry, by converting the labour employed b y the power o f that machinery , into labour o f a higher degree an d greater efficacy , b y raising the socia l valu e of the articl e produced b y i t abov e it s individua l value' th e owne r ha s gained , ' a sor t o f monopoly' and his profits are therefore exceptional. H e will 'endeavour to exploit thoroughl y "th e sunn y time of his first love," b y prolongin g the working day a s muc h as possible. Th e magnitud e of the profi t whet s his appetite fo r mor e profit ' (444) . Second, a s th e proportio n o f constant t o variable capita l increase s (a s machine s replac e men ) the capitalis t i s impelled t o 'excessive lengthening of the working day, in order tha t he may compensate th e decrease in the relative numbe r of labourers exploited, by an increase not only of the relative surplu s value [as machinery reduces the necessary labou r time ] but o f the absolut e surplus-labour ' (445) . Surely

304 Fro m Adam Smith to Maynard Keynes here Mar x has been misle d as to the effect i n the economy a s a whole by looking at the individual enterprise. Like John Stuart Mill he saw the use of capital for investment in machinery and buildings as depleting the working capital whic h constitute d th e 'wage-fund. ' H e though t to o muc h o f th e machines an d to o littl e o f the productio n o f the machines ; th e constan t capital o f th e capitalis t increasin g hi s stoc k o f machiner y become s th e source of variable capital of the producer of the machine, and so on at one stage of production afte r another. This section concludes with a highly literary passage. Hence th e remarkabl e phenomeno n i n th e histor y o f Moder n Industry , tha t machinery sweep s awa y ever y mora l an d natura l restrictio n o n the lengt h o f the working day. Hence, too , the economical paradox , that the most powerful instrument fo r shortenin g labour-time , become s th e mos t unfailin g means fo r placin g every moment of the labourer's time , and that of his family, a t the disposal o f the capitalist... 'If,' dreame d Aristotle, th e greatest thinker of antiquity, 'i f every tool when summoned, or even of its own accord, coul d do the work that befits it, as the creations of Daedalus moved themselves, or the tripods of Hephaestos went of their own accor d t o thei r sacre d work , i f th e weavers ' shuttle s wer e t o weav e o f themselves, the n ther e woul d b e n o nee d eithe r o f apprentice s fo r th e master workers, o r o f slaves fo r the lords ! ... Oh! these heathens ! They understoo d .. . nothing of political econom y an d Christianity . The y di d not, for example , comprehend that machinery is the surest mean s of lengthening the working day. They perhaps excuse d th e slaver y o f one on the ground tha t i t was a means t o the ful l development of another. Bu t to preach slaver y of the masses , i n order tha t a few crude an d half-educated parvenus , migh t become 'eminen t spinners, ' 'extensiv e sausage makers, ' an d 'influentia l shoe-blac k dealers, ' t o d o this, they lacke d th e bump of Christianity (446). Third, 'intensificatio n o f labour.' The lengthenin g of the workin g day provoked a social reactio n s o that the 'normal ' working day was fixed by law. But if hours could not be increased, the intensity of work during those hours coul d be . A greater mas s of labour coul d b e condensed i n a given period. After som e examples of the 'speed up' Marx concluded : There cannot be the slightest doubt that the tendency that urges capital as soon as a prolongation of the hours of labour is once for all forbidden, to compensate itsel f by a systematic heightening of the intensity of labour, and to convert ever y improvement i n machinery into a mor e perfec t mean s of exhausting the workman , must soon lead to a state of things in which a reduction of the hours of labour will again be inevitable (456).

Karl Marx 30 5 There remain two further topics in this account of the impact of machinery an d modern industr y on the worker. Th e first Marx dealt wit h briefly , the nature of the factory. Here Mar x noted tha t some machine processe s did lighten the burden of labour, bu t even so it becomes ' a sort of torture, since the machine does no t free the labourer fro m work , but deprives th e work of all interest' (462). He noted too the autocratic rule of the capitalist, unaccompanied b y tha t divisio n o f responsibility , i n othe r matter s s o muc h approved of by the bourgeoisie .. . The plac e of the slave-driver' s lash is taken by the overlooker's book of penalties. All punishments naturally resolve themselves into fine s an d deduction s fro m wages , an d th e law-givin g talen t o f th e factor y Lyrcurgus s o arrange s matters, that a violatio n of his law s is, i f possible, more profitable to him than the keeping of them (464).

The other topi c h e deal t wit h a t greate r length , thi s i s displacemen t o f workers by machines, and the doctrine of 'compensation' of the bourgeois political economists. The introduction of machinery renders obsolete, an d superfluous, whole classes o f labour; the workma n becomes unsaleable , like mone y thrown out o f circulation ... that portion of the working class, thus by machinery rendered superflous ... either goes to the wal l in the unequa l contes t of the old handicrafts and manufacture s with machinery, or else floods the more easily accessible branches of industry, swamp the labour market, and sinks the price of labour power below its value (470).

It is little consolation t o assure th e workers that thei r sufferin g i s temporary ; for the promise that the introduction of machinery is gradual threatens 'chronic misery. ' 'Histor y disclose s n o traged y mor e horribl e tha n th e gradual extinction o f the Englis h hand-loo m weavers , a n extinction tha t was sprea d ove r severa l decades ' (471) . Bu t th e bourgeoi s economist s argued that the labour displaced in one industry would find employment in other industries . Ricard o 'originall y wa s als o o f this opinion , bu t after wards expressly disclaime d it , with the scientifi c impartiality and love of truth characteristic o f him' (478, n.2). Marx recurred t o this theme in Part vii where he developed hi s theory of the 'reserve army' of the unemployed which played a key role in the theory of progressive immiserization. In this earlier part Mar x recognized tha t 'althoug h machinery necessarily throw s men out of work in those industries into which it is introduced, yet it may ... bring about an increase o f employment in others' (483). But he noted to o that 'eve n shoul d the y find employment, wha t a poor lookou t i s theirs . Crippled as they are by division of labour, these poo r devil s are worth s o

306 Fro m Adam Smith to Maynard Keynes little outsid e thei r ol d trade , tha t the y canno t fin d admissio n int o an y industries, except a few of inferior kind, that are over-supplied wit h underpaid workmen' (481). Such, he concluded, ar e the contradictions o f capitalism: Machinery considered alone , shortens th e hours of labour, but, when in the service of capital, lengthens them .. . i n itself i t lightens labour, but , when employed b y capital, heightens the intensity of labour, ... in itself it is a victory of man over th e forces of nature, but in the hands of capital, makes man the slave of those forces ... in itself it increases the wealth of producers, but in the hands of capital, makes them paupers (482).

Looking back from 186 7 over the history of modern industry all this was a plausible interpretation ; but whe n i t came t o projection o f trends an d t o prophecy of doom Marx might have considered mor e seriously the effect of a development which was just beginning. He had seen that modern industry required workers who were adaptable. Society wa s compelle d under penalty of death, to replace the detail worker of today, crippled by life-lon g repetition o f on e an d th e sam e trivia l operation , an d thu s reduce d t o th e mer e fragment o f a man, b y th e full y develope d individual , fit for a variety of labours, ready t o face an y change in production ... One ste p already spontaneously taken towards effecting thi s revolution is the establishment of technical and agricultural schools ... when the working class comes into power, as inevitably it must, technical instruction , both theoretica l an d practical , wil l tak e it s prope r plac e i n th e working class schools (534).

viii 'NE T REVENUE ' AN D 'SURPLU S VALUE ' In Digression Three I equated Ricardo' s net revenue with Marx's surplu s value. U p t o thi s point i n my discussion o f Marx this seem s reasonable . Necessary labour-tim e seems to be that necessary t o produce bare subsis tence, though there is a 'moral' or 'historical' element in the determinatio n of the amount of goods covered by that term. Surplus value, or net revenue, is, then, entirely at the disposal of the capitalists, o r the propertied class . From thi s surplus value must come th e maintenance of all the service s of the state, the living expenses o f the rich and of the servants of the rich, and the expense of expanding capital with a view to an increase i n productivity and in production. I have suggested above that this distinction between net and gross revenue and the derivative notion of surplus is valid and useful .

Karl Marx 307 My criticis m o f Mar x lie s i n hi s apparen t failur e t o recogniz e tha t th e working class might come to enjoy some part of that surplus -as in fact they have done in the Western industrialized world. This failure was not complete, as the following example shows. If the value of labour-power be 3 shillings, and the necessary labour-time amount to 6 hours, if the surplus value likewise be 3 shillings, and the surplus-labour 6 hours, then i f the productivenes s o f labou r wer e doubled withou t alterin g th e rati o o f necessary labou r t o surplus-labour , ther e woul d b e n o chang e o f magnitud e in surplus-value and the price of labour power. The onl y result would be that each of them woul d represen t twic e a s man y use-values a s befor e .. . Althoug h labour power would be unchanged in price, i t would be above it s value. If, however, the prices of labour-power had fallen, not to is 6d the lowest possible point consistent with its new value, but to 2s lod , or 2s 6d, still this lower price would represent an increased mas s of necessaries. I n this way it is possible with an increasing productiveness of labour, for the price o f labour to keep on falling, an d ye t this fall to be accompanied b y a constant growt h in the mass of the labourer's means of subsistence (573). The possibility i s recognized bu t there is no attempt to find the conditions under whic h thi s possibilit y woul d b e realize d o r t o wha t extent ; no r is there any readiness to predict any such rise in the standard of living of the workers. What concerned Mar x was that there would still be an increase in surplus value and that 'the abyss between the labourer's positio n and that of th e capitalis t woul d kee p widening ' (573) . Relativ e immiserizatio n comes into the picture. In the above example the worker is considered to enjoy some part of the product o f th e surplu s labou r time . I n a late r exampl e th e meanin g of necessary labour-tim e is so extended that all labour-time becomes 'neces sary'! Only b y suppressin g th e capitalis t for m o f productio n coul d th e lengt h o f th e working day be reduced t o the necessary labour-time . But, eve n in that case, th latter would extend it s limits . On the on e hand , becaus e th e notio n of 'means of subsistence' woul d considerably expand , and th e laboure r woul d lay claim to an altogether differen t standar d o f life. On the other hand, becaus e a part o f what is now surplus-labour , would then coun t a s necessar y labour ; I mean the labou r of forming a fund fo r reserve and accumulation (580-1). Surely it would be more useful t o consider the use of surplus value, or net revenue, rather than to explain it away by making it become all 'necessary.'

308 Fro m Adam Smith to Maynard Keynes A goo d standar d o f livin g for th e worker s depend s o n thei r abilit y t o produce mor e tha n bar e subsistence . An improvemen t i n that standar d depends on the us e o f part o f the surplu s for increase i n real capital , fo r research an d development , fo r healt h services , educatio n an d training . Perhaps one should add that it depends on the use of part of that surplus for the maintenance of law and order, and of such community goods as roads, parks, etc. But finally the standard of living of the workers depends on the amount o f that produc t a t the disposa l o f the propertie d class . The rea l problems relate to the use and distribution of this surplus product. But if the theme is exploitation, the right of the workers to the whole produce of their labour, the n th e distinctio n between necessar y an d surplu s labou r tim e gives way to a distinction betwee n th e labour tim e spent by the working class producing things for themselves, and the time spent producing things for the propertied class. IX

ACCUMULATION

After a short discussion of 'simple reproduction' (the process in which all the surplus, after providin g for the reproduction of the workers' abilit y to work and for the maintenance and replacement of the elements of constant capital, is consumed by the capitalists) Marx went on to discuss the process of accumulation, the use of all, or part, of the surplus value to increase the amount of capital in each successive round of operations. In the chapter on simple reproduction he 'treated surplus value as a fund fo r supplying the individual consumption of the capitalist,' he went on to treat 'it solely as a fund fo r accumulation, ' bu t i t is of course bot h an d Mar x proceeded t o discuss 'saving. ' Whil e the divisio n of surplus value between thes e tw o uses, consumptio n an d accumulation , appeare d t o b e a matte r fo r th e capitalist's voluntary decision, there was emphasis in Marx on the involuntary characte r o f tha t decision , th e pressur e t o sav e inheren t i n th e capitalist system. So far as he is personified capital, it is not values in use and the enjoyment of them, but exchange-valu e an d it s augmentation , tha t spu r hi m into action. Fanaticall bent on making value expand itself, he ruthlessly forces the human race to produce for production' s sake; he thus forces the development of the productive powers of society, and creates those material conditions, which alone can form the real basis of a higher form of society, a society in which the full and free development of every individual form s th e rulin g principl e .. . Moreover , the developmen t of capitalist production makes it constantly necessary to keep increasing the amount of capital

Karl Marx 30 9 laid ou t i n a given industria l undertaking , an d competitio n make s th e immanen t laws o f capitalist productio n t o b e fel t b y eac h individual capitalist , a s externa l coercive laws. It compels him to keep constantly extending his capital, in order to preserve it, but extend it he cannot, except by means of progressive accumulation. So far, therefore, as his actions are a mere function of capital - endowed as capital is, in his person, with a consciousness and a will - his own private consumption is a robbery perpetuated on accumulation, just as in book-keeping by double entry, the private expenditur e o f the capitalis t i s placed on th e debto r sid e of the accoun t against his capital. But the capitalist i s not free from the desire for luxury. Original si n is at wor k everywhere . A s capitalis t production , accumulation , an d wealth, becom e developed , th e capitalis t cease s to b e th e mer e incarnatio n o f capital. H e ha s a fellow-feelin g fo r hi s ow n Adam , an d hi s educatio n graduall y enables hi m t o smil e a t th e rag e fo r asceticism , a s a mer e prejudic e o f th e ol d fashioned miser . Whil e th e capitalis t o f the classica l typ e brand s individua l consumption as a sin against his function, an d as 'abstinence' from accumulating , the modernised capitalist is capable of looking upon accumulation as 'abstinence' from pleasure ... When a certain stage of development has been reached, a conventional degree o f prodigality , whic h i s also an exhibitio n o f wealth , an d consequentl y a source o f credit , become s a busines s necessit y t o th e 'unfortunate ' capitalist . Luxury enters into the capitalist's expenses of representation (650-1). This last poin t Veble n develope d brilliantl y in the Theory o f th e Leisure Class an d th e Theory o f Business Enterprise. Finall y Mar x noted tha t a s capital increased s o did the mass of surplus value, the fund for consumption and for accumulation. Th e capitalis t can , therefore, live a more jolly life , and at the same time show more "abstinence"' (667). The general law of capitalist accumulation As h e had show n i n Chapter x v tha t machiner y 'increase s the wealt h of producers, bu t i n th e hand s o f capital make s the m paupers ' (482) , so in Chapter xxiv Marx argued that accumulation which increases th e wealth that i s produce d unde r th e condition s o f capitalis m contribute s t o th e extension o f that pauperism. Tha t accumulatio n in itself would be neces sary i n the communis t state o f the futur e h e ha d recognize d i n the Communist Manifesto: th e 'proletaria t organize d a s th e rulin g class [will ] increase the total of productive forces as rapidly as possible.' The 'contradiction' o f capitalis m i s tha t mechanizatio n an d accumulatio n whic h ar e

310 Fro m Adam Smith to Maynard Keynes essential t o the increase i n productivity on which the improvement in the standard of living of the workers ultimately depends, under the institution s of capitalism lead to a deterioration o f that standard. Th e theory on which this propositio n i s base d i s no t convincing , bu t th e evidenc e cite d o f contemporary povert y an d miser y wa s sufficien t t o mak e tha t theor y appear plausible . Th e subsequen t histor y prove d t o b e ver y different , however, fro m tha t whic h th e theory , o r th e fact s o f 1867 , seeme d t o predict. First, the theory. If accumulation was accompanied by no change in the 'organic composition of capital' (the proportion of c to v) there would be an increased demand for labour. 'Soone r or later a point must be reached, a t which the requirement s o f accumulation begi n to surpas s th e customar y supply of labour, and , therefore a rise in wages takes place' (672). Under these condition s capita l increase s th e 'numbe r o f it s subjects. ' A s th e workers come to enjoy a 'larger part of their own surplus-product... they can extend the circle of their enjoyments; can make some additions to their consumption-fund o f clothes, furniture, etc. .. . But just a s little as better clothing, food , an d treatment , an d a larger peculium , do awa y wit h the exploitation of the slave, so little do they set aside that of the wage-worker' (677). It is, however, of the essence o f accumulation under the conditions of modern industry that the 'organic composition of capital' will change, and that drastically. With the advance of accumulation, therefore, the proportion of constant to variable capital changes. If it was originally say 1:1 , it now becomes successively 2:1, 3:1, 4:1,5:1,7: i, etc. so that as capital increases, instead of Vz of its total value, only Vs, ! /4, Vs , Ve , Vs , etc. , i s transforme d int o labour-power .. . Sinc e th e deman d for labour i s determined no t b y the amoun t of capital as a whole, but b y its variable constituent alone , that deman d falls progressivel y with the increas e o f the tota l capital, instead of, as previously assumed, rising in proportion to it (690).

Thus capitalisti c accumulatio n produces ' a relativel y redundan t popula tion of labourers,' and 'industrial reserve army,' which is both a 'necessary product o f accumulation' an d a 'conditio n o f existence o f the capitalis t mode of production' (693). The theory of the demand for labour on which this argument is based is, as I have suggested above, based on improperly generalizing the behaviour of the individual firm as indicating what happens in the economy as a whole. What was c to one industry becomes largely v to the industry supplying the additional materials and equipment, and what is c t o tha t industr y becomes largel y v to it s suppliers , an d s o on. Bu t the

Karl Marx 31 1 importance o f th e existenc e o f a reserv e arm y i n explainin g th e slo w improvement o f wages is sound doctrine a s I have argued above in discussing Ada m Smith' s vie w o n productiv e an d unproductiv e labour . 'Th e industrial reserv e army , durin g th e period s o f stagnatio n an d averag e prosperity, weigh s dow n th e activ e labour-army ; durin g th e period s of over-production an d paroxysm, it holds its pretensions i n check' (701). Marx then turned to the facts of history. After some figures on the rate of accumulation an d of its concentration and centralization, h e quoted Glad stone o n the 'intoxicatin g augmentation o f wealth .. . whil e the rich hav e been growing richer, the poor have been growing less poor.' 'How lame an anti-climax!' said Marx: 'If the working class has remained "poor," only "less poor" in proportion a s it produces for the wealthy class "an intox icating augmentation of wealth and power," then it has remained relatively just a s poor . I f th e extreme s o f povert y hav e no t lessened , the y hav e increased, because the extremes o f wealth have' (715-16). Relative immiserization once more! So far Mar x ha d presente d evidenc e o f the condition s o f the worke r inside the factories, no w he turned t o describe 'hi s condition outsid e th e workshop ... his condition as to food and dwelling.' First, diet. The insufficienc y o f food among agricultural labourers, fell, as a rule on the women and children, for 'the man must eat to do his work.' Still greater penury ravaged the town workers examined. 'They are so ill-fed that assuredly among them there must be man y cases o f severe and injuriou s privation. ' ('Privation' o f the capitalis t all this! i.e., 'abstinence ' from payin g for the means of subsistence absolutely necessary for the mere vegetation of his hands.') (719).

Second, housing . One quotation must suffice : On the condition of town dwellings, I quote, as preliminary, a general remark of Dr Simon. 'Althoug h my official poin t of view,' he says, 'is one exclusively physical, common humanity requires that the other aspect o f this evil should not be ignored ... I n it s highe r degrees i t [i.e. , overcrowding ] almost necessarily involves such negation o f al l decency, such unclean confusio n o f bodie s and bodil y functions , such exposure of animal and sexual nakedness, as is rather bestial than human. To be subjec t t o thes e influence s i s a degradatio n which mus t becom e deepe r an d deeper for those on whom it continues to work. To children who are born under its curse, it must often b e a very baptism 'into infamy' (723).

Next, the 'noma d population,' employed in 'building and draining, brickmaking, lime-burning, railway-making, etc. A flying column of pestilence

312 Fro m Adam Smith to Maynard Keynes it carries into the places in whose neighbourhood it pitches its camp, small pox, typhus , cholera, scarlet fever, etc. ' (729). Finally Marx turned fro m the miser y o f th e industria l proletaria t t o tha t o f th e agricultura l pro letariats, documented for county after county. It is this factual material on the conditio n o f th e proletaria t i n Part s in , iv , an d vi i whic h Georg e Bernard Shaw had in mind whe n h e wrote in Chapter 47 of the Intelligent Woman's Guide t o Socialism: Th e respectabilit y an d prosperity o f the propertied and middle classes who grew rich on sweated labour covered an abyss of horror; and it was by raising the lid from that abyss that Karl Marx, in his terrible and epoch-making book called Capital, becam e the prophet of that great revolt of outraged humanity agains t Capitalism which is the emotional force o f the Socialist movement.'7 Primitive accumulation Accumulation from surplus-value is a process which must start from some 'primitive' accumulation, 4 an accumulation not the result of the capitalist made o f production, bu t it s startin g point. ' Firs t come s ridicul e o f th e classical economics. Primitive accumulation plays in Political Economy about the same part as original sin in theology. Adam bit the apple, and thereupon sin fell on the human race. Its origin is supposed to be explained when it is told as an anecdote of the past. In times long gone b y ther e wer e tw o sort s o f people; one, th e diligent , intelligent , and , above all, frugal elite ; the other, lazy rascals, spending their substance, and more, in riotous living. The legend of original sin tells us how man came to be condemned to eat his bread i n the swea t of his brow; but th e history of economic origina l sin reveals to us that there are people t o whom this is by no means essential. Never mind! Thus it came to pass that the former sort accumulated wealth , and the latter sort had at last nothing to sell except their skins. And from this original sin dates the poverty of the great majority that, despite all its labour, has up to now nothing to sell but itself, and the wealth of the few that increase s constantl y althoug h they have long ceased t o work. Such insipid childishness is every day preached to us in the defence of property .. . In actual history it is notorious that conquest, enslavement , robbery, murder, briefly force , play the great part. In the tender annals of Political Economy, th e idylli c reign s fro m tim e immemoria l ... A s a matte r o f fac t th e methods of primitive accumulation were anything but idyllic (784-5).

Two parts of that actual history were told: the expropriation of the land of the agricultural population in England (Chapter xxvn) and the exploitation of new countries (Chapter xxxi). The former i s summarized as follows:

Karl Marx 31 3 The spoliatio n o f th e church' s property , th e fraudulen t alienatio n o f th e Stat e domains, th e robber y o f th e commo n lands , th e usurpatio n o f feuda l an d cla n property, and its transformation into modern private property under circumstance s of reckless terrorism, were just so many idyllic methods of primitive accumulation. They conquere d th e field for capitalis t agricultur e .. . an d create d fo r th e tow n industries the necessary suppl y of a 'free' an d outlawed proletariat (805).

The latter was summarized in similar vein: The discover y o f gold an d silve r in America, th e extirpation , enslavement , an d entombment i n mines of the aboriginal population , th e beginnin g of the conques t and looting of the East Indies, the turning of Africa into a warren for the commercial hunting of black-skins, signalise d th e rosy dawn of the era of capitalist production . These idyllic proceedings ar e the chief momenta of primitive accumulation (823).

The climax This detailed analysi s of capitalist accumulatio n lead s up to a restatemen t of the essential thesi s of the Communist Manifesto. Hand i n hand with this centralisation, or this expropriation of many capitalists by few, develop , o n a n ever expandin g scale , the co-operativ e form s of the labour process, th e conscious technical application of science, th e methodical cultivation of th e soil , th e transformatio n o f th e instrument s o f labou r int o instrument s of labour only usable in common .. . th e entanglemen t of all peoples i n the net of the world market... Along with the constantly diminishing number of the magnates of capital, who usurp and monopolise all advantages of this process o f transformation, grows the mass of misery, oppression, slavery , degradation, exploitation ; but with this too grows the revolt of the working class, a class always increasing in numbers, and disciplined , united , organized , b y th e ver y mechanis m o f th e proces s o f capitalist productio n itself . Th e monopol y o f capita l become s a fette r upo n th e mode of production, whic h has sprung up and flourished along with, and under it. Centralisation of the means of production and socialisation of labour at last reach a point where they become incompatibl e with their capital integument. This integument is burst asunder. The knell of capitalist private propert y sounds . Th e expro priators are expropriated (836-7) . X

TWO NOTES

Value and price In the footnote on page 244, to which I have already drawn attention, Mar x

314 Fro m Adam Smith to Maynard Keynes promised to deal with the relation of price and value in Volume in, and it is so dealt with in that posthumous volume. He had, however, as early as 1862 worked out this relationship in a letter to Engels.8 He wrote: Assume a given rate of surplus valu e (namely the length of the working day and the surplus of the labour above that necessary for the reproduction of the worker's pay) and say it equals 50 per cent. In this case with a working day of, e.g., 1 2 hours, the worker would work 8 hours for himsel f and 4 hours (8/2) for the employer . An d assume this for all trades, s o that any differences in the average working time are simply compensation for the greater or less difficulty o f the work, etc. In these circumstances, with equal exploitation of the worker indifferent trades , different capital s of the same size will yield very different amount s of surplus value in different sphere s of production and therefore very different rates of profit, sinc e profit is nothing but the proportion of the surplus value to the total capital advanced. This will depend on the organic composition of the capital, i.e., on its division into constant and variable capital... Call the constant capital c, the variable v. If in the cotton industry , for instance , th e compositio n wer e c 80 , v 20, the valu e o f th e product woul d be = n o (given 50 per cent surplu s value or surplus labour). The amount of surplus value = 1 0 and the rate of profit = 1 0 per cent, since the profit = the relation of 10 (the surplus value): 100 (the total value of the capital expended) . Assume that in wholesale tailoring the composition is c 50, v 50, then the product = 125, surplus value (at a rate of 50 per cent as above) = 25 and the rate of profit = 25 per cent. Take another industry, where the proportion is c 70, v 30, then the product = 115 , an d th e rat e o f profi t = 1 5 pe r cent . An d finall y a n industr y where th e composition = c 90, v 10, then the product = 105 and the rate of profit = 5 per cent. We hav e here , wit h equal exploitation o f labour , ver y differen t amount s of surplus value for equal sums of capital invested in different trades , and hence very different rate s of profit. But if we take the above four capitals together we get: Value of the product I) C 80, V 2 0

IIO

2) c 50, v>50 125 3) c 70, V30 115 4) c 90, V 1 0 105

Capital 40

0

Per Cent

Rate of profit = Rate of profit = Rate of profit = Rate of profit =

10

25 15 5

Rate of surplus value in all cases = 50 per cent

Profit = 5 5

Regarded as the total capital of the class (400) the rate of profit woul d = i3 3/4 per cent . An d capitalist s ar e brothers . Competitio n (transfer of capital or with -

Karl Marx 31 5 drawal o f capita l fro m on e trad e t o another ) bring s i t abou t tha t equal sums o f capital i n different trades , despit e thei r differen t organi c composition , yiel d th e same average rate of profit... Now in order that 1,2,3 , 4, in the above illustration shall make the same average profit', eac h one of them must sell his commodities at £113.1 and 4 sell them above their value, 2 and 3 below their value. Price regulate d in this way = th e expenses of capital + th e average profit .. . It is to this average price that competition betwee n th e different trade s reduce s th e prices i n differen t branches (b y transfe r o r withdrawa l of capital). Competitio n does no t therefor e reduce commodities to their value, but to their cost price, which is above, below or equal to their value, according to the organic composition of the respective capitals. I shal l not discuss th e literature tha t has grown up around the problem of ' Wertrechnung and Preisrechnung' with Ladislaus vo n Bortkiewicz as the key contributor. All I wanted to do was to scotch the rather commonly held view that Mar x supposed tha t equilibriu m prices i n the capitalist marke t were simply proportional t o labour inputs, and that the analysis in volume in of the divergence of price and value, when the simplifying assumption of uniform organic composition o f capital was dropped, wa s an afterthought, even a recantation. The business cycle I shal l not attempt to piece togethe r th e many scattered reference s to the causes of the cyclical fluctuation of business in volume i, nor do I propose to discuss the posthumous volumes. All I shall do is quote the verdict of Joseph Schumpeter, himself a distinguished contributor to the theory of cycles. It mus t no t b e forgotte n tha t th e mer e perceptio n o f th e existenc e o f cyclica l movements wa s a grea t achievemen t at th e time . Man y economists wh o went before him had an inkling of it. In the main, however, they focussed their attention on the spectacular breakdown s that came to be referred t o as 'crises.' And those crises they failed to see in their true light, that is to say, in the light of the cyclical process of which they are mere incidents. They considere d them , without looking beyond or below, as isolated misfortunes that will happen in consequence o f errors, excesses, misconduct, or of the faulty workin g of the credit system . Marx was, believe, the first economist t o rise above tha t tradition and to anticipate - barring the statistical complement - the work of Clement Juglar. Though ... he did not offer an adequat e explanatio n o f th e busines s cycle , th e phenomeno n stoo d clearl y before hi s eye s an d h e understoo d muc h of its mechanism . Also lik e Juglar, h e unhesitatingly spoke of a decennial cycle 'interrupted by minor fluctuations.' 8 High praise this . His perception of the phenomenon was no doubt sharp ened by his belief that the ultimate breakdown of the capitalist syste m was foreshadowed i n the periodic breakdown s of the cyclical crises.

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BOOK THRE E AFTER MIL L

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Introductory statemen t

For te n o r twenty years afte r th e publication of Mill's Principles English political economy was stagnant. True it was at the zenith of its popularity, but th e scienc e wa s restin g o n it s laurels , showin g no sign s o f growth, believed by its chief expositor, and even more firmly by the public, to have reached finality . Ther e was , however , a stron g undercurren t o f revol t against a priori theory and of enthusiasm for the historical method. I do not propose to discuss the work of the Historical School but some indication of its characte r i s necessary a s a n introductio n t o th e wor k o f Jevons an d Marshall, wh o reconstructe d th e pur e theor y o f valu e an d distributio n while a t th e sam e tim e developin g inductiv e studies , statistica l an d historical.1 I shal l quot e here som e descriptio n o f the 'unrest ' fro m tw o adherents of the Historical School, J.K. Ingram and Arnold Toynbee: then in the chapte r o n Jevons I shal l discuss hi s controversy o n method with Cliffe Leslie , an d in the chapter o n Marshall I shall note the conciliator y statements in the inaugural addresses of W. J. Ashley and Alfred Marshall. First, Ingram, in his History of Political Economy (1888) . Many influences had .. . for some time been silently sapping the foundations of the old system. The students of Comte had seen that its method was an erroneous one. The elevate d moral teaching of Carlyle had disgusted the best minds with the low maxims o f the Mancheste r school. Ruski n ha d no t merel y protested agains t the egoistic spirit of the prevalent doctrine, but had pointed to some of its real weaknesses as a scientific theor y ... The instinctiv e repugnance of the working classes ha d continued, in spite of the efforts of their superiors to recommend its lessons to them

320 Fro m Adam Smith to Maynard Keynes - effort s which were perhaps not unfrequently dictated rather by class interest than by public spirit. All the symptoms boded impendin g change, bu t they were visibl e rather in general literatur e an d in the atmosphere o f social opinion tha n withi n the economic circle . Bu t whe n i t becam e know n tha t a grea t movemen t ha d take n place, especiall y i n Germany , o n ne w an d mor e hopefu l lines , th e Englis h economists themselve s bega n t o recognize th e necessity o f a reform an d even t o further it s advent. The principa l agencies o f this kind, in marshalling the way to a renovation of the science have been those of Bagehot, Leslie, and Jevons -the first limiting th e spher e o f th e dominan t system , whil e seekin g t o conserv e i t within narrower bounds; the second directl y assailing it and setting up a new method as the rival and destined successo r of the old; and the third acknowledging the decline of the hitherto reignin g dynasty, proclaimin g th e necessity o f an altered regime, an d admitting the younge r claimant as joint possessor in the future. Thus , in England too, th e dualism which exists o n the continent ha s been established ; and there is reason to expect that here more speedily than in France or Italy the historical schoo l will displace its antagonist.2 Ingram ha d com e earl y unde r th e influenc e o f Comte , an d becam e a Positivist. Hi s address a s President o f section F of the Britis h Associatio n in 187 8 was a manifest o of th e historica l metho d bu t unlik e his Germa n contemporaries h e did not confine the economist t o description bu t looked for the formulation of laws of development. The reason he gave for delivering this manifesto is interesting: 'Th e matter with which I should deal/ he said, has bee n practicall y determined fo r m e beforehand . A n importan t crisi s i n th e history o f ou r Sectio n ha s take n place . It s clai m t o for m a par t o f th e Britis h Association ha s bee n disputed . Som e o f the cultivator s of the olde r branche s o f research but half recognize th e right of Political Economy and Statistics to citizenship in the commonwealth of science; an d it is not obscurely intimated on their part that thes e studie s would do wel l t o relinquis h pretension s whic h cannot b e sustained, and proceed, with or without shame, to take the lower room to which alone they are entitled. Second, Arnol d Tonybee . Poo r La w Guardian , Cooperator , Churc h reformer, Toynbe e wa s i n th e thic k o f every movemen t t o improv e th e material condition s o f the people - bette r houses , ope n spaces , fre e lib raries. The inspirin g story of his public service was told by Lord Milne r in the preface to his posthumous collectio n o f papers, Lectures on the Indus-

Introductory statemen t 32 1 trial Revolution.3 I n one of these lectures, 'Ricard o and the Old Politica l Economy,' he wrote: The bitte r argumen t betwee n economist s an d huma n being s ha s ende d i n th e conversion o f th e economists . Bu t i t wa s no t b y th e fierc e denunciatio n o f th e moralists, nor by the mute visible suffering of degraded men that this conversion was effected. Wha t the passionat e protest s o f Past an d Present an d the grave, officia l revelations o f governmen t report s coul d no t do , th e chil l breat h o f intellectual criticism has done. Assaile d for two generations a s an insult to the simple natural piety of human affections, the Political Economy of Ricardo is at last rejected as an intellectual imposture.

According t o Arnold Toynbee, it was the labou r question, unsolved by that removal of restrictions which was all Deductive Political Economy had to offer, tha t revived the method of observation. Political Economy was transformed by the working classes. Th e pressing desire to find a solution of problems which the abstract scienc e treate d a s practically insoluble, drew the attention of economists t o neglected facts .

This estimate o f the part playe d b y the wage problem i n the renascence o f economics appear s just. The page s of th e Fortnightly Review giv e ample support to the thesis; and the change from Mill to Marshall is nowhere mor e amazing tha n i n the treatment of trade unions. Tru e the new theory mad e wages theoretically determinate , but as Toynbee said, 'it will no longer be a common erro r to confuse the abstract scienc e of Economics wit h the real science of human life .. . The bitter argumen t between th e economists an d human beings has ended i n the conversion o f the economists.'4

I

William Stanley Jevons

I PAPERS

READ

AT THE B R I T I S H A S S O C I A T I O N

IN

l862

Jevons recorde d i n his Journal that h e had forwarded two papers t o th e meeting of the British Association. I was informed b y the Secretar y that they were read before the F Section and th e second wa s approve d of : (i ) A 'Notic e o f a Genera l Mathematica l Theor y o f Political Economy/ (2 ) 4 On the Stud y of Periodic Commercial Fluctuations with five diagrams.' Brief abstracts are contained in the Report of the Proceedings, 1862, pp. 157 , 158. A fuller explanation and publication of the above-mentioned theory i deferred until a more suitable period for establishing a matter of such difficulty. 1

It was not till 1871 that the theory was presented in a developed form as the Theory o f Political Economy. Th e original paper has been reprinted as an appendix t o th e fourt h editio n (1911 ) o f th e Theory edite d b y hi s so n H. Stanle y Jevons . Th e secon d pape r wa s include d i n the collectio n of papers whic h Jevons prepare d just befor e his death, Investigations into Currency and Finance.21 propose to say a little about each of these papers, but firs t I shal l sa y somethin g abou t th e developmen t o f hi s idea s a s recorded in his Letters and Journals. Jevons went to the University of London in 1851, at the age of sixteen, to study science , especiall y mathematics , chemistr y an d botany . Befor e completing his bachelor's degree he was driven by the financial difficulties of his family t o accept a position as assayer to the new mint in Australia.

William Stanley Jevons 323 This position he held from 185 4 to 1859. He continued his studies of science in his leisure time; amongst other branches he took up meteorology, a study which greatl y influence d hi s late r wor k i n economics . Hi s interes t i n economics seem s to have dated from abou t 1858 . In a letter to his sister in that year he wrote: I a m glad you find political econom y tolerable. The Wealth of Nations i s perhap s one o f th e dries t o n th e subject . Yo u wil l perceiv e tha t economy scientificall y speaking is a very contracted science ; it is in fact a sort of vague mathematics which calculates th e causes an d effects of man's industry, and shows how it may best be applied... I have an idea which I do not object to mention to you that my insight into the foundation s an d nature o f the knowledg e o f man is deeper than mos t me n or writers. In fact I think that it is my mission to apply myself to such subjects and it is my intention to do so ... There are plenty of people engaged wit h physical science and practical scienc e an d arts may be left t o look after themselves , but thoroughly to understan d th e principles o f societ y appear s t o m e no w th e mos t cogen t business.3 In 185 9 h e returne d t o London , complete d hi s wor k fo r th e bachelor' s degree i n 186 0 and too k hi s master' s degre e i n 1863 . Fo r th e bachelor' s degree h e was place d equa l first , bu t i n political economy h e had a 'sa d reverse.' In spite of having studied the subject independently and originally and having read some dozens of the best works in it, almost neglecting other classes for the purpose, I was placed thir d or fourth whe n I felt confiden t o f the first prize. This I can only attribute to a difference o f opinion, which is perfectly allowable, having prejudice the professor against my answers. However I shall fully avenge myself when 1 brin out my Theory o f Economy an d re-establish the science on a sensible basis.4 This arroganc e wa s no t altogethe r unjustified fo r h e had alread y worked out in outline the theory of value for which he became famous. That this is so is shown by a letter to his brother written in June, 1860. During the las t session I have worked a good dea l at Political economy; in the last few month s I have fortunately struck out what I have no doubt is the true Theory of Economy, so thorough-going and consistent, that I cannot now read other books on the subject without indignation. While the theory is entirely mathematical in principle, I show, at the same time, how the data of calculation are so complicated as to be for th e presen t hopeless. Nevertheless, I obtain from th e mathematica l principle

324 Fro m Adam Smith to Maynard Keynes all th e chie f law s a t whic h politica l economist s hav e previousl y arrived , onl y arranged i n a serie s o f definitions , axioms, an d theorie s almos t a s rigorou s an d connected a s if they were so many geometrical problems. One of the most important axioms , is , tha t a s th e quantit y of any commodity , fo r instance , plai n food which a man has to consume, increases, so the utility or benefit derived from the last portion used decrease s in degree. The decreas e of enjoyment between the beginning an d en d o f a mea l ma y b e take n a s a n example . An d I assum e tha t o n a n average, th e ratio o f utility i s som e continuou s mathematica l functio n o f th e quantity o f commodity. This law of utility has, in fact, always been assume d by political economists unde r the more complex form and name of the Law of Supply and Demand. But once fairly stated i n its simple form, it opens up the whole of the subject. Most of the conclusions are , of course, the old ones state d in a consistent form; but m y definition of capital an d law of the interest o f capital are , as far as I have seen quite new.5 In July he reported further progress to his brother. The marginal productivity theory of distribution was beginning to emerge from th e marginal utility theory of value. I expec t ever y succes s fro m m y theor y o f politica l economy , whic h seem s t o develop itself with that facility which is a proof of its soundness. It assumes the form of a complicated mathematical problem, from which all the common laws with due limitations flow. Independently , however, of the mathematical form, it has led me to a new vie w of the actio n o f capital, whic h affords a determining principle for interest, profits o f trade, wages; and I now perceive how the want of knowledge of this determining principle throws the more complicated discussions of economists into confusion. The commo n law is that demand and supply of labour an d capital determine the division between wages and profits. Bu t I shall show that the whole capital employed can only be paid for at the sam e rate a s the last portion added', hence it is the increase o f produce or advantage, which this last addition gives, that determines the interest o f the whole.6 While carrying on his abstract speculatio n he was also heavily involved in quantitative study of concrete phenomena of economic life. His work on meteorology in Australia provided a pattern: collection of statistical infor mation an d analysi s of it to eliminat e disturbing factors an d t o establis h relationships between the various series that he developed. It is difficult t o realize hi s originality, for the kin d of work he did is now so familiar. He recorded i n his Journal the beginning of this activity.

William Stanley Jevons 325 About Octobe r 1860 , havin g then recentl y commence d readin g a t th e Museu m library, and met some statistics, I began to form some diagrams to exhibit them, the first, I think, showing Mr. Newmarch's Bill Circulation Research. I hit upon a mode of dividing a sheet of paper into one-tenth inch and then pricking off curves through it when i n Sydney , an d th e squar e wa s read y a t hand . Afte r doin g two o r thre e diagrams the results appeared s o interesting that I contemplated forming a series for my own information. Then it occurred t o me that publication might be possible, and I finally undertook t o form a statistical atlas o f say thirty plates, exhibiting all the chief materials of historical statistics. 7 The progress of this is described in a letter to his brother in April 1861: I a m ver y bus y a t presen t wit h a n apparentl y dr y an d laboriou s piec e o f work, namely compiling quantities o f statistics concernin g Great Britai n which are to be exhibited in the form o f curves, and, if possible published as a Statistical Atlas .. . The mode of exhibiting numbers by curves and lines has, of course, been practise d more or less any time on this side of the Deluge. At the end of last century, indeed, I find tha t a boo k o f Charts o f Trade wa s published , exactl y resemblin g min e in principle; but in statistics the method, never much used, has fallen almost entirely into disuse. I t ought , I consider , t o be almost a s much used a s maps ar e used in geography.8 In 186 2 Jevons tried to arrange for the publication of his Statistical Atlas, but, finding the cost prohibitive, he decided to publish just two diagrams one showin g all the weekl y accounts o f the Ban k of England since 1844 , with th e circulation an d the Bank' s minimu m rat e o f discount; the othe r showing th e pric e o f Englis h funds , th e pric e o f wheat , th e numbe r of bankruptcies and the rate of discount monthly since 1731. In a letter to the editor of the Economist h e described the purpose of his publication. The diagram s .. . ar e designed , no t s o muc h to allo w for referenc e t o particular numbers, which can be better had from printed tables of figures, as to exhibit to the eye the general results of large masses of figures which it is hopeless to attack in any other wa y tha n b y graphica l representatio n .. . I t i s onl y b y representin g larg e masses of statistics i n this manner that any sure foundation can be laid for political economical arguments ...9 He mad e some comments on the significanc e of his figures, one of which was more fully developed in his pamphlet on the Value of Gold in 1863: 'It is

326 Fro m Adam Smith to Maynard Keynes all nonsense t o ascrib e a rise i n prices t o bank notes bein g increased i n number. I t i s a superabundanc e o f gol d tha t raise s prices , an d perhap s quickens business.'10 From th e Journal I tur n t o th e tw o paper s presente d t o th e Britis h Association; firs t tha t o n ' A Genera l Mathematica l Theor y o f Political Economy.' Critical examination of the ideas there presented wil l be postponed, thei r develope d for m i n the Theory o f Political Economy i s dis cussed below . Bu t a brief indication o f the topics covered will show how closely related this early paper is to the later book. The paper begins with a mathematical manifesto. 'Economy , indeed, being concerned wit h quantities, ha s alway s of necessity bee n mathematica l in its subject , but th e strict and general statement, and the easy understanding of its quantitative laws has been prevented by a neglect of those powerful methods of expression whic h hav e bee n applie d t o mos t othe r science s wit h s o muc h success.'11 Ther e follow s a psychologica l manifesto : ' A tru e theor y o f economy can only be attained by going back to the great springs of human action - the feelings of pleasure and pain.'12 These 'feelings' he treated as 'quantities capable of scientific measurement. Our estimation of the comparative amounts of feeling is performed in the ac t of choice o r volition.' After brief discussion of the intensity and duration of these feelings and of the effec t o f uncertaint y an d remotenes s o n th e expectatio n o f futur e pleasure or pain, Jevons stated the principle of diminishing utility. The utilit y of the last supply of an object, then, usually decreases i n some proportion, or as some function o f the whol e quantity received . This variation theoretically existing even in the smallest quantities, we must recede to infinitesimals, and what we shall call the coefficient o f utility, is the ratio between the last increment or infinitely smal l suppl y o f th e object , an d th e incremen t o f pleasur e whic h i t occasions.13

Next to diminishing utility of the product comes increasing disutility of the labour necessar y t o produc e i t an d th e propositio n tha t 'labou r wil l be exerted ... until a further increment will be more painful than the increment of produce thereby obtained is pleasurable.'14 So to a theory of exchange. Light is at once thrown on the whole matter by stating that in every such exchange we have two unknown quantities and two equations by which to determine them. The unknown quantities are the quantities of commodity given and received. The known quantities are those of the commodities previously possessed. We have also the function o f utility of the commodities with respect to the persons. The equation

William Stanley Jevons 32 7 may thus be established o n either side between the utility gained and sacrificed a t the rati o o f exchang e o f th e whol e commoditie s upo n th e las t increment s exchanged.15 After notin g some complications, Jevons ended with an application of the marginal principle to the theory of capital and interest. The emphasis is on time. I define capital a s consisting of all useful objects which, in supplying a labourer's ordinary wants and desires, enable him to undertake works of which the result will be deferred fo r a greater or less space o f time .. . Wit h capital h e may so w in the spring that he may reap in the autumn; or he may undertake labour-saving enterprises, such a s roads and railways .. . Most improve d mode s of employing labou r require that the enjoyment of the result shall be deferred. 16 From the definitio n o f capital he went to the determination of the rat e of interest by the ratio which a new increment of produce bears to the increment of capital by which it was produced .. . It i s the accepted opinion of writers of the present day, that the rate of interest tends to fall becaus e th e soi l does not yield proportionate returns a s it s cultivatio n i s pushed . Bu t I mus t hol d tha t thi s decreas e i n th e proportionate return would chiefly fall upon the wages of the labourer. The interes t of capital has no relation to the absolute returns to labour, but only to the increased return which the last increment of capital allows.17 The second paper, 4 On the study of periodic fluctuations' was a plea for the analysis of economic time series according t o th e same scientifi c method s wit h whic h w e ar e familia r i n othe r complicated science s suc h especiall y a s meteorolog y an d terrestria l magnetism. Every kind of periodic fluctuation , whethe r daily, weekly, monthly, quarterly, or yearly must be detected and exhibited no t only as a subject o f study in itself, bu t because w e must ascertain an d eliminate such periodic variation s before we can correctly exhibi t those tha t ar e irregula r or non-periodic , and probabl y o f more interest and importance.18 After thi s methodological manifest o Jevons presente d his analysis of the weekly account s o f the Ban k of England with a view to determinin g the seasonal variations. The chie f use of the table of quarterly variations,' he

328 Fro m Adam Smith to Maynard Keynes wrote, 'is that we may by its use eliminate those variations from the whole variations of the year, by simple subtraction. W e thus ascertain th e nature of the yearly variation whic h is due to natural causes.' 19 The importanc e of suc h knowledg e i s indicate d b y th e frequen t misunderstandin g o f the figures. Some, perhaps, would attribute the sudden changes in the rate of discount... to the occurrence o f panics during the month s of October an d November. It woul d be more correct t o sa y that there is a periodic tendency to commercial distress an d difficulty durin g those months, of which all concerned should be aware. It is when great irregular fluctuations aggravate this distress, a s in the year s 1831 , 1847 , and 1857, that disastrous breaches in commercial credit occur.20

Jevons reverted to this problem in a paper read to the Statistical Societ y of London in 1866 on The frequen t autumnal pressure in the money market, and the action of the Bank of England.' It was there argued that if there had been greate r publi c understanding of the normal seasonal pressure i n the autumn there would have been 'far less alarm, pressure, revulsio n of prices and injury' i n the autumn of 1865. He further argued that the action o f the Bank of England should depend on a careful estimation of extent to which any drain on the Bank arises from a purely temporary demand for internal circulation.21 Indeed h e argued that 'carefu l observatio n an d compariso n of the money market are sufficient to enable us to avoid the inconveniences of these periodic pressures . W e should learn to discriminate what is usual and normal... from what is irregular or abnormal. It is a matter of skill and discretion t o allow for normal changes. It is the abnormal changes which are alone threatening or worthy of very much attention.22 II

THE

P A M P H L E T O N G O L D (1863)*

Let me first quote the laudatory comment of Lord Keynes on this pamphlet, 'On a Serious Fall in the Value of Gold Ascertained an d its Social Effects Set Forth': 'Fo r unceasin g fertilit y an d originalit y o f min d applie d wit h a sure touc h an d unfailin g contro l o f the material , t o a mas s o f statistics , involving immens e labours fo r a n unaide d individua l ploughing his wa y through with no precedents an d labour-saving devices to relieve his task, Throughout Par t 1 1 page references i n the tex t ar e t o Investigations into Currency an d Finance (ist ed., 1884 ; 2nd ed., ed. H.S. Jevons, 1909), in which the original pamphlet is reprinted.

William Stanley Jevons 32 9 this pamphlet stand s unrivalle d in the history of our subject.' 23 This high praise is , in my opinion, full y justified as examination of the pamphlet will make abundantly clear. In the preface Jevons noted the predictions of a fall in the valu e o f gold following the discoverie s i n California and Australia , and the doub t te n year s late r a s to whethe r ther e had , i n fact, bee n an y decline. 'M r Newmarch in the last volume of Tooke's "History of Prices," published i n 1857 , an d MacCulloch , writin g i n December , 1858 , bot h doubted th e existence o f any depreciation. The y seeme d t o hold also that the rapi d extensio n o f trade an d the increase o f wealth, migh t cause th e absorption o f th e ne w supplie s o f gold , withou t th e occurrenc e o f an y considerable depreciation ' (13) . Th e reaso n fo r thi s doub t wa s th e difficulty o f identifying the long-ru n chang e whic h wa s obscure d b y th e temporary fluctuations of the trade cycle. Jevons, by eliminating as best he could th e effect s o f th e trad e cycle , wa s abl e t o 'asser t th e fac t o f a depreciation o f gold with the utmost confidence' and 'assign the numerical amount of it wit h equa l diffidence . Th e lowes t estimat e o f the fal l tha t I arrive at is 9 per cent, an d I shall be satisfied if my readers accep t this . At the same time, in my own opinion the fall is nearer 1 5 per cent. It may even be more than this' (14). Jevons asked first, what is the meaning of a fall in the value of gold? He answered tha t what is meant is 'that more gold is now usually required to purchase a n articl e tha n i n former years ' (15) . Bu t ever y commodit y is subject t o independen t variation s o f value, som e rise , som e remai n unchanged, some fall. If the majority of commodities have risen in price, if the average of many prices ha s risen , the valu e of gold ha s fallen. Ther e ar e difficulties: 'Ough t w e to tak e all commodities o n a n equal footing in th e determination? Ough t w e t o giv e mos t weigh t t o thos e whic h ar e leas t intrinsically variabl e i n value ? Ough t w e t o giv e additiona l weigh t t o articles accordin g to their importance, and the total quantities bought and sold?' (17-18) . Next h e considered th e proper average , deciding that the geometric rather than the arithmetic average should be used. The pric e of cocoa ha s nearl y doubled since 1845-50. I t has increase d by 10 0 per cent, s o tha t it s variatio n is no w expresse d b y th e numbe r 200 . Cloves, on th e contrary, have fallen 5 0 per cent, and are now of 50. The arithmeti c mean of these ratios woul d b e .. . 125 . Bu t this i s totally erroneous . The geometri c mean of th e ratios ... is 100. On the average of cocoa an d cloves there has been no alteration o price whatever. In other words, the prices of one is doubled, of the other halved .. . on th e average , then the price s of these articles remain a s the y were , instead of rising 25 per cent (20).

330 Fro m Adam Smith to Maynard Keynes So far he was concerned with the change of prices in general between tw o dates; it is more difficult t o 'prove that any variation observed i s a permanent one ' (21) . T o dea l wit h fluctuation s i n th e suppl y o f variou s com modities he relied on such a 'number and variety of articles independent in their fluctuations , th e variation s o f som e wil l probably compensat e th e others .. . The only mode of eliminating these fluctuations, is to render our inquiry, not mor e exclusive, but mor e inclusive ' (22) . He did , however , exclude the very high prices of hemp, flax, and tallow in 1853-5 resulting from the Russian war, and the very high price of cotton in 1861-2 resulting from blockade of the ports of the Southern States. The final problem is that of cyclical fluctuation, 'the great commercial fluctuations, completing their course in some ten years,' the cause of which 'seems to lie in the varying proportions which the capital devoted to permanent and remote investment bears to that which is temporarily invested soon to reproduce itself (24). T o eliminat e the effec t o f th e cycl e 'w e migh t compar e price s a t corresponding point s o f th e commercia l tid e .. . [but ] commercia l fluctuations ar e neve r s o simila r an d wel l marke d tha t w e ca n discove r exactly corresponding points in each.' Instead Jevon s decide d t o take as his base the average of the yearly average prices over the cycle 1844-50. He identified this as a full cycle by reference to the rate of discount which was around 2 per cen t i n 1843-4 , rose to 5 per cen t i n 1846 , to 1 0 per cen t in 1847, and fell back to 2 per cen t in 1850. 'These tides begin and end with abundant capital and with low water, as it were, in the rate of interest' (31). There followed the detailed explanatio n o f the compilation o f his tables of the monthly prices of 39 selected article s of commerce. One table showed the averag e price o f each o f these commoditie s during each o f the year s 1845-62, the secon d tabl e showe d th e ratio o f the average price s i n each year to the average of the prices of the years 1845-50. The general average was charted, showin g a rise to a peak in 1857 of 129, and a fall to 115 in the years 1858-62. The lowest average range of prices since 1851 has indeed happened in the last year, 1862; but prices even then stood 13 per cent above the average level of 1845-50; and it is most highly improbabl e that prices wil l long continue to fall .. . Examine th e yearly average prices at any point of their fluctuations since 1852, and they stand above any point of their fluctuations before then within the scope of my tablesl There is but one way of accounting for such a fact, and that is by supposing a very considerable depreciation of gold' (45).

In 186 2 Jevon s suppose d th e econom y t o b e a t 'ver y lo w wate r o f th e

William Stanley Jevons 33 1 commercial tide' and expected earl y revival. Th e permanen t elevation of prices, du e t o gol d depreciation, wil l the n b e apparen t t o all ' (45) . In summary one may say that Jevons' achievemen t was to invent the index number of wholesale prices, justify it s use, compile it from ra w data for a period of 18 years, and interpret the result. Having established the fact of depreciation over the past twelve years, and having estimated the magnitude of that depreciation, Jevons turned to speculation a s to the futur e valu e of gold. H e considered th e increas e in demand caused b y the spread of commerce; the increase in the consumption of gold for ornament and luxury as its value falls; and the decrease in the supply of gold as its diminished value renders some existing operation s unprofitable and as the richer gold deposits ar e exhausted and recourse is had to less rich, that is higher cost, deposits. H e concluded that the fall in value of gold 'will be arrested at, perhaps, 30 per cent' (69). Jevons nex t dealt wit h 'social effect s o f the depreciatio n of gold.' ' A fall in the value of gold virtually violates every contract expresse d i n gold money .. . hardl y a perso n amon g the 30,000,00 0 in th e kingdo m but i s affected mor e or less , fo r bette r o r worse ' (73) . He expecte d th e futur e alteration to be gradual and gentle, 'insidious, slow, and imperceptible. It is insidious because we are accustomed to use the standard as invariable ... a rise in the price of any article, whe n observed, i s naturally attributed to a hundred othe r cause s tha n th e tru e one . I t i s slow , becaus e th e tota l accumulations of gold in use are but little increased by the addition of one or of several years. It is imperceptible because the slow rise of prices due to gold depreciation is disturbed by much more sudden and considerable, but temporary fluctuations ' (74-5) . Hence th e mos t serious part of the fall in value occurred 'whil e all the world were either without thought of such an event, o r altogethe r i n doubt o f it' (76) . Jevons the n classifie d income s according to the degree to which they suffer fro m depreciation. At the end of the list came wages and salaries. In a large proportion of cases the salaries of clerks, officials, an d other employe's, or the wages of servants and labourers, will remain unchanged for long periods of time ... where the salary or rate of wages remains unchanged, the office or employment must usually be reduced to a lower rank, and command less efficient services ... I n th e majorit y o f cases the salar y o r wage s will b e raised after th e laps e of a certain time . Artisans , mill-hands , an d othe r skille d labourer s will obtai n th e increased wages by strike, if not by the free acquiescenc e of their employers. It is not unlikel y tha t th e grea t strike s which occurre d a fe w year s ago wer e partl y caused by depreciation of gold (80-1).

332 Fro m Adam Smith to Maynard Keynes Finally Jevons discussed the effect of depreciation o n government finance. 'The most remarkable effect o f the depreciation o f gold is a considerabl e reduction in the National Debt... Should gold, in the course of years, fall in value som e 3 0 per cen t .. . the pressur e of the National Deb t wil l be n o greater than if it were about 550 millions sterling, instead of 800 millions, according to the old value of gold. Annuitants will suffer an d taxpayers in general gain' (86-87). In the final chapter Jevons turned to the issue of policy, the issue of the monetary standard . In this chapter the favourable effects o f depreciatio n on productio n are noted , t o supplemen t the discussio n o f the effect s o n distribution. ' A fall i n the valu e of gold must have .. . a most powerfully beneficial effect. It loosens the country, as nothing else could, from its old bonds of debt an d habit. It throw s increased reward s before all who ar e making and acquiring wealth, somewhat at the expense of those who are enjoying acquired wealth. It excites the active and skilful classes ... to new exertions' (91). Later he said: 'To overestimate the indirect effects of these discoveries in creating new colonies, in spreading the English people an d language, and in newly animating commerce, i s not easy' (98). Jevons did not thin k that th e ultimat e effect o f th e gol d discoverie s shoul d b e th e abandonment o f the gol d standard . 'Gol d ha s no t los t it s characte r o f a standard b y the late gold discoveries. These must be regarded a s one of those runs of luck ... which will in all likelihood not recur in the course of ages'(96). The pamphlet on gold was published at his own expense, and it sold very badly. Jevon s wa s ver y disappointed by it s earl y reception , bu t several months after its issue, it attracted attention. The Times and the Economist agreed that there had been some fall in the value of gold; but they admitted only 'the lowest possible estimate of 10 per cent, whereas, though this is the result given by my tables, as it happens, I believe the real depreciation to be nearer 20 per cent.'24 i n Th e Coal Question (1865)* In marke d contrast with his high praise for the pamphlet on Gold is Lord Keynes's advers e criticism of Th e Coal Question. Wit h his view s on th e former I am in complete agreement, with those on the latter I disagree. It is a much better and more interesting book than Keynes would have us think. Though I disagree I shall quote his assessment before examining the book itself. * Throughou t this part page references in the text are to The Coal Question (1865)

William Stanley Jevons 333 The Coal Question .. . i s b y n o mean s on e o f Jevons' s bes t works . I t i s most brilliantly an d engagingl y written, with nothing omitted whic h could ad d t o it s attractiveness an d the effect of its impact. But its prophecies have not been fulfilled , the arguments on which they were based are unsound, and reread today it appears overstrained an d exaggerated .. . Jevons, it must be confessed, meant the book to be epatant. For i t is not, I think, unfair, to attribute the striking manner in which it is written to his extreme anxiety that his ideas shoul d not be overlooked .. . h e was determined tha t the publi c should listen to him . All the arts of showmanship are exercised to recall Political Economy from Saturn. 25

Keynes ende d hi s discussio n o f the boo k wit h a n amusin g account o f a psychological trai t which h e suspected affected Jevons's conclusions, 4 a hoarding instinct, a readiness to be alarmed and excited by the idea of the exhaustion o f resources.' H e recounted a n 'amusin g illustration' o f this. 'Jevons hel d simila r idea s a s t o th e approachin g scarcit y o f pape r .. . Moreover, h e acted o n his fears and laid i n such larg e store s not onl y of writing paper, but also of thin brown packing paper, that... more than fift years after his death, his children have not used up the stock he left behind him of the latter.' 26 My estimate of the valu e of this book i s very different becaus e I try t o judge not its prophecies b y virtue of hindsight from th e vantage point of a century later, but rathe r its method in the contex t o f the developmen t of modern economics . Afte r th e denunciatio n o f theor y b y th e Historica l School i t is good t o tur n to Jevons, distinguishe d for hi s contribution t o pure theory, bu t concerned with facts, contemporar y an d historical; concerned wit h facts that can be quantified; concerned t o collect an d analyse historical statistic s t o establish th e characte r o f the variation s (seasonal , cyclical, secular ) i n particula r serie s an d t o establis h relation s betwee n series with a view to identifying probable causation. Perhaps as a Canadian I have a further interest i n that attention i s drawn by this book to the stil l largely neglected problems of the economics of exhaustible resources. Jevons firs t examine d th e opinion s o f previou s writers , mostl y geologists. He accepted M r Hull's estimate of the total coal deposits in the United Kingdom as 85.5 billion tons. The rate of increase in coal consumption, Hull believed, would not be maintained: '"Economy will reduce our consumption, the burning waste heaps of coal will be put a stop to; America will reliev e u s fro m th e world-wid e demand for coa l an d wil l eventually furnish even this country with as much as we want... I am inclined to place the possible maximu m production at 10 0 millions a year ... even with this enormous 'output ' ther e i s enough coal t o las t fo r eight centuries" '(15).

334 Fro m Adam Smith to Maynard Keynes Jevons' commen t wa s tha t 'th e chec k t o th e expansio n o f ou r deman d would be the very manifestation of exhaustion we dread' (15). He found the address by Sir William Armstrong, at the British Association in 1863, more satisfactory. Noting that the average annual increase in consumption over the pas t eigh t years ha d been 2 3/4 million tons, h e calculated that , if the rate o f increase continue d a t th e sam e rate, th e availabl e coa l woul d be exhausted in 212 years. ' "The question, " Armstrong properly stated, "is not how long our coal will endure before absolute exhaustion is effected, but how long will those particula r seam s last which yield coal of a quality and at a price to enable this country to maintain her present supremac y in manufacturing industry'" (19). This, the economist's qualificatio n of the geologist's views, was endorsed b y Jevons: but he was not satisfie d with the assumption of a fixed annual increase of consumption. In Chapter n Jevons discussed the way in which the estimate of the total supply ha d been made, and the degre e o f certainty attaching to them. In Chapter in h e examined the 'cost of coal mining' in order to demonstrate the difference between physical and commercial possibilities. As mines go deeper, as thinner seams are worked, costs mus t be expected t o increase. True the increasing difficulty of extracting coal may be offset by technological improvement, but Jevons did not expect muc h relief from this source. 'The greater part of the work within the colliery is of a kind that cannot be executed b y machinery' (55). Even if the improvement in efficiency wer e much greater than he expected, i t would apply to other countries s o that England woul d gradually lose it s comparativ e advantag e a s exhaustio n proceeded faster than in those other countries. 'The question is how soon will our mine s approach th e limi t of commercial impossibility and fai l t o secure u s an y longe r tha t manufacturin g supremacy o n whic h w e ar e learning to be wholly dependent' (56). In Chapter iv Jevons discussed the price of coal to see whether there was any sign of exhaustion. He concluded that ther e ha d been n o recent ris e o f importance, though since 179 4 the price of coal rose 20 per cent while general prices fell 40 per cent. 'The art of coal-making di d no t advance agains t th e obstacle s oppose d t o i t half a s much as the arts producing the other chief materials of commerce advance d in opposition to their obstacles' (62-3). Chapters v, vi and vii, treat of inventions in relation to coal. First, the crucial importance of coal in English industrial development is examined historically and the interrelatedness of coal, the steam engine, and iron and steel i s noted: th e stea m engine permitted the workin g of deeper mines , cheap coa l wa s neede d fo r th e stea m engine ; cheap coa l an d th e stea m engine wer e neede d fo r th e developmen t o f iro n an d stee l production ;

William Stanley Jevons 33 5 cheap iro n and steel were needed fo r the production of the steam engines and the machines the y drove ; and so on. Truly , a s Smiles ha d said, 'th e Lord Chancello r shoul d si t o n a ba g o f coal s instea d o f a woolsack. ' Second, Jevon s considere d invention a s increasing the 'amoun t of usefu l work got out of coal.' He estimated tha t the efficiency o f the steam engine had been increase d ove r th e previous hundre d year s ten - o r fifteen-fold. But h e argue d tha t thi s ver y increas e in efficiency woul d lead t o greate r consumption. 'Economica l invention s .. . woul d enabl e us , fo r a time to neutralize th e evils of dearness when coal begins to get scarce ... But the end woul d onl y thu s b e hastened - th e exhaustio n o f our seam s mor e rapidly carrie d out . Le t u s remember , moreover , tha t w e ar e greatl y dependent on the comparative cheapness of fuel an d motive power' (i 16). The sam e economie s i n the us e o f fuel woul d be availabl e t o England' s commercial competitors. Third , Jevons examined the possibility of findin a substitute for coal. In the light of our present knowledg e of the development o f hydro-electri c power , o f th e enormou s consumptio n o f oi l i n transportation, an d of the mos t recen t emergence o f nuclear power , thi s chapter is surprising in its conclusion that the supremacy of steam and coal will increase. I f Jevons had foreseen th e development o f effective substi tutes he would still have been worried about England' s comparative position. 'It is just possible tha t some day the sun-beams may be collected, o r that som e sourc e o f forc e no w unknow n ma y b e detected . Bu t suc h a discovery would simply destroy our peculiar industrial supremacy' (144). The next four chapters ar e concerned wit h the growth in the consumption o f coal. H e argue d tha t consumptio n ha d grown , and wa s likel y to continue t o gro w fo r som e tim e a t a geometrica l rate . Malthu s ha d ex plained that population tends to grow at a geometrical rate until checked by the increasing difficulty o f raising food: more people ca n rais e mor e food but no t proportionately more . B y contrast stock s o f coal d o not increas e with population: 'exterior nature presents a certain absolute and inexorable limit'(150). For the present our cheap supplies of coal, and our skill in its employment, and the freedom o f ou r commerc e wit h othe r wide lands, rende r us independen t of th e limited agricultural area of these islands, and take us out of the scop e o f Malthus' doctrine. We are growing rich and numerous upon a source of wealth of which the fertility does not yet apparently decrease with our demands upon it... such a rate of growth wil l before long render our consumption of coal comparable with the tota supply. I n th e increasin g depth an d difficult y o f coa l minin g w e shal l mee t that vague but inevitable boundary that will stop our progress. We shall begin as it were

336 Fro m Adam Smith to Maynard Keynes to see the further shore of our Black Indies. The wave of population will break upon that shore , and rol l bac k upon itself .. . A farm, howeve r far pushed , wil l under proper cultivation yield forever a constant crop. But in a mine there is no reproduction and the produce once pushed to the utmost will soon begin to fall an d sink to zero (i 53-5).

The nex t few chapter s lea d t o a n estimat e o f the duratio n o f England' s prosperity. Chapter ix dealt with the growth of population; chapter x, with the progress of industry; chapter xi, with the growth in the consumption of coal. Th e averag e annua l rat e o f growt h .. . i s 3 !/2 pe r cent ' (210) . I f consumption continued to grow at that pace in 'rather more than a century [it] would exhaust our mines to the depth of 4000 feet, or 150 0 feet deeper than our present deepes t mine' (215) . Jevons was not predicting that this would happen; his was a projection of what would happen if there were no check t o th e rat e o f growth . H e di d predic t tha t suc h a chec k woul d 'become perceptible considerably within a century' (215). A century later we may find these predictions so wrong that we accept the verdict of Lord Keynes on this book. Bu t a third of a century after Keynes' s 'centenar y allocution' there has developed a new interest in the rate of consumption of exhaustible resources. In 1935 the rate of population growth was declining and th e prospec t o f absolute declin e seeme d close : and the rat e o f technological chang e seeme d t o be slowin g up. Thi s wa s th e tim e when th e 'stagnation thesis' flourished. Renewed population growth in the Western World a s fertilit y recovered ; th e onse t o f rapid population growth in the Third World as mortality rapidly fell; the surge of technological advance in the years since 1940; all these have made it hard for the present generatio n to appreciate the influence of the stagnation thesis. Now in a world setting, rather tha n i n th e purel y Englis h setting , an d i n th e contex t o f many exhaustible resources rather tha n simpl y of coal, the speculation s o f Jevons take on a new interest. Eve n in 193 5 I disagreed wit h the verdict of Lord Keynes: in 1972 it is easier to argue for its reversal. I pass over the next few chapters, having already sufficiently explaine d the principal thesis. Le t me , however, draw attention t o one policy pre scription. 'The only suggestion I can make towards compensating posterity for ou r presen t lavis h use o f coal i s one tha t require s som e boldnes s t o make. I mean the reduction or paying off of the National Debt' (339). This commended the book to Mr Gladstone. H e wrote to Jevons sayin g that it 'strengthened th e conviction s I hav e lon g entertained, bu t wit h an eve r growing forc e a s t o ou r dut y wit h regar d t o th e Nationa l Debt' 27. Ou r attitude towards the National Debt has changed and our understanding of

William Stanley Jevons 337 its significanc e has increased. Rather tha n arguin g for reduction i n debt, should he not have argued for a more rapid increase in saving and accumulation of real capital? In a country largely dependent on the exploitation of exhaustible resource s ther e i s likely to b e an exaggerated estimat e o f its 'income'; i f i t i s depletin g on e elemen t i n it s capita l shoul d i t no t b e increasing the reproducible element s in its capital at a faster rate than those countries with an apparently similar level of income but a much less rate of depletion? I v Th e Theory o f Political Economy (1871) * In his Preface Jevons described thi s book as an 'attempt to treat economy as a Calculu s o f Pleasur e an d Pain, ' an d adde d 'tha t a s i t deal s wit h quantities, i t must be a mathematical scienc e in matter if not in language' (viii). In the Introduction he followed up these two themes. Repeated reflectio n an d inquir y have led me to th e somewha t novel opinion that value depends entirely upon utility. Prevailin g opinions make labour rather than utility the origin of value; and there are even those who distinctly assert, that labour is th e cause o f value . I show , o n th e contrary , that w e hav e onl y t o trac e ou t carefully the natural laws of the variations of utility, as depending upon the quantity of commodit y in ou r possession , i n orde r t o arriv e a t a satisfactor y theory of exchange .. . Labou r i s foun d ofte n t o determin e value, but onl y i n a n indirect manner, by varying the degree of utility through an increase in the supply (2).

He then developed hi s argument that economics 'i f it is to be a science a t all, must be a mathematical science ... finding that the quantities with which we have to deal are subject to continuous variation, I do not hesitate to use the appropriate branch o f mathematical science , involving though it does the fearles s consideratio n o f infinitel y smal l quantities' (4) . Becaus e th e economist deals with quantities and relations of quantities the reasoning is mathematical eve n whe n the problem s ar e 'state d i n ordinary language' and the solutions are 'traced out by words.' 'We do not render the scienc e less mathematical by avoiding the symbols of algebra - we merely refuse to employ, i n a ver y imperfect science , muc h needing every kin d of assistance, tha t apparatu s o f sig n whic h i s foun d indispensabl e i n othe r sci ences' (5-6) . Thoug h economic s deal s wit h quantities , the y canno t b e measured exactly : bu t Jevon s argued tha t ther e shoul d be n o confusion * Throughou t Part i v page references in the tex t are t o The Theory o f Political Economy (1871)

338 Fro m Adam Smith to Maynard Keynes between the mathematica l and exact sciences . Thoug h w e have not 'th e means of measuring directly the feelings of the human heart,' and though 'a unit of pleasure or of pain is difficult eve n to perceive,' we can measure the 'quantitative effects o f the feelings,' and thus 'estimate their comparativ e amounts.' As we 'measure gravity by its effect in the motion of a pendulum so w e ma y estimat e th e qualit y o r inequalit y o f feelings by th e varyin g decisions of the human mind. The will is our pendulum, and its oscillations are minutely registered in all the price lists of the markets' (13-4). Though this is stated i n terms of the individual will, Jevons explained tha t 'practically it is an aggregate of individuals which will be treated' (21). He note d that while it was impossible to 'detect the operation of general laws of this kind in the actions o f one or a few individuals,' there is a high probability that accidenta l an d disturbin g causes wil l neutralis e eac h other , s o that 'questions which appear .. . indeterminate as regards individuals, may be capable o f exact investigatio n an d solution in regard to great masse s an d wide averages' (23). The Introductio n conclude s wit h references t o J.S . Mil l an d Jeremy Bentham. He agreed with Mill that Political Economy required the 'Con crete Deductiv e Method.' It is 'grounded upon observed facts , and is, so far, an inductive science; but it does not proceed b y an elaborate collectio n of facts and their gradual classification, a s Richard Jone s woul d have us believe' (23-4). The science must build on such general axioms as: 'every person will choose the greater apparent good.' Thus is developed a theory which 'whethe r useful o r useless, mus t be the true one' (24). How usefu l the theory would prove would depend on how much statistical dat a would be collected an d analysed. 'Th e deductive scienc e o f Economy mus t be verified and rendered useful by the inductive science of Statistics. Theory must b e investe d wit h th e realit y an d th e lif e o f fact ' (26) . This book , Jevons's contribution to theory, was part of a whole in which pioneering statistical and inductive investigation played a major part. Next, Bentham and the 'relation of Political Econom y to Moral Philosophy.' The point of view is summarized as follows. The calculus of utility aims at supplying the ordinary wants of man at the least cost of labour. Each labourer, in the absence of other motives, is supposed to devote his energy to the accumulation of wealth. A higher calculus of moral right and wrong would be needed to show how he may best employ that wealth ... Bu t when that higher calculu s give s n o prohibition , w e nee d th e lowe r calculu s to gai n u s th e utmost good in matters of moral indifference. Ther e is no rule of morals to forbi d our makin g tw o blade s of gras s grow instea d of one , if , b y wis e expenditur e of labour we can do so' (32).

William Stanley Jevons 33 9 Jevons recognized Boulding' s heroic ma n as well as his economic man . If one is to predict behaviour it is as wrong to ignore the one as the other; but one comes nearer to successful prediction by concentrating on the uniformities of behaviour of the economic man, 'clod' though he be. V

U T I L I T Y AND

EXCHANGE

Jevons founded his theory of utility on Bentham's theory of pleasure and pain. Pleasure was treated by Bentham as a quantity, and pain was considered a s negativ e pleasur e capabl e of being deducte d fro m a quantity of pleasure to give a net result, positive or negative. The quantity was a matter of intensity, duration, certainty, propinquity. The last two elements cam e in for special comment being relevant to the theory of capital which Jevons intended t o develop . 'Th e intensit y of present feelin g mus t .. . b e some function of th e future feeling , an d i t mus t increase a s w e approac h th e moment o f realisatio n .. . Thi s power o f anticipatio n mus t have a large influence i n Economy; for upo n it is based al l accumulation of stocks o f commodities to be consumed at a future dat e .. . In a state of civilisation a vague though powerful feeling of the future is the main incentive to industry and saving' (40-1). But when dealing with future events one must recognize the element of uncertainty, and therefore must estimate the probability of the anticipated resul t being achieved. 'I f the probability i s only one-tenth that I shal l hav e a certain da y o f pleasure, I ough t t o anticipat e i t with one-tenth of the force which would belong to it if certain' (43). Jevons might have noticed that there might be a great difference i n various individuals' feelings with regard to certainty, depending on their character and on their circumstances. He might also have noticed the relevance of uncertainty to the general problem of consumer choice: surel y it is anticipated utility that should be seen as the motive of the buyer. And the greater the element of uncertainty, the more difficult the choice, the more unrealistic the assumption of rational calculation . In chapter three Jevons stated the problem of Economy: 'to satisfy our wants to the utmost with the least effort - to procure the greatest amount of what is desirable at the expense of the least that is undesirable - i n other words to maximise comfort and pleasure' (44). Jevons was led to consider how the quantit y of pleasure, or utility, is related t o th e quantit y of the commodity from which it is derived. He thus arrived at the law of diminishing utility, and saw the crucial importance of the concept of 'final degree of utility.' The degree of utility is , i n mathematical language, the differential coefficient ofu

340 Fro m Adam Smith to Maynard Keynes considered a s a function o/x , and wil l itself be another function of jc [j c signified th e quantity o f th e commodit y consumed; u, the whol e utility proceeding fro m th e consumption of x]. We shall seldom need to consider the degree of utility except as regards the last increment which is consumed, and I shall therefore commonly use the expressio n fina l degree o f utility meanin g the degre e o f utilit y o f th e las t addition, or the next possible addition of a very small, or infinitely small, quantity to the existing stock (61).

In the slightly modified form of 'marginal utility' this concept has become so familiar tha t th e imaginativenes s o f the concep t i s easily underrated . Perhaps mor e importan t tha n th e particula r applicatio n t o utilit y i s th e beginning o f margina l analysis generally. Reasonin g i n margina l term s revolutionized economics . Jevons proceeded to discus s th e rational dis tribution of a commodity between different uses: 'when the person remains satisfied wit h the distributio n h e ha s made , i t follows that n o alteratio n would yield him more pleasure; which amounts to saying that an increment of commodity would yield exactly as much utility in one use as in another ... W e must, in other words , hav e th e same final degrees o f utility i n the three uses' (69-70). In terms of marginal utility this is Marshall's 'law of equi-marginal returns.' He then discussed the 'distribution of a commodity from tim e to time.' Here th e equivalence of the final degrees o f utility on each day had to be qualified with respect to the probability of the expecte d pleasure being achieved, an d to the relative intensit y of present pleasure s and anticipated pleasures. Chapter i v o n th e theor y o f exchange extended th e discussio n o f the distribution of a stock of one commodity by one individual between differ ent use s an d differen t time s t o th e distributio n of a stoc k o f tw o com modities betwee n tw o person s eac h inten t o n maximizin g his aggregat e utility from thes e two commodities. Th e amount held by each initially is a random amoun t but eac h b y voluntar y exchange i s abl e t o increas e hi s aggregate utility by parting with some of the commodity of which he has so much that the final degree of utility is low for some of the other commodity of which he has so little that the final degree of utility is high. The more he exchanges the higher becomes the final degree of utility of the one he gives up and the lower that of the one he gains. But the more he gives up the lower becomes it s final degree of utility t o the other person, an d the higher the final degree of utility of the commodity which this other gives in exchange. Two point s mus t b e mad e befor e statin g hi s solutio n o f the proble m of exchange. Firs t w e must note that , whil e he talk s o f two persons , h e is thinking of two groups of persons, tw o 'tradin g bodies.' As between two

William Stanley Jevons 34 1 persons the result of the process of exchange would be indeterminate. Only if there ar e many individuals each holdin g a very small proportion o f the total supply of either or both of the commodities, so that no one individual can affect th e rate of exchange by withholding part of his stock or reducing his purchasing, would a determinate solution emerge. Jevons did not state this conditio n but i t was , perhaps, implie d in his us e o f trading bodies. Second, ther e will be, can be, only one rate of exchange in the market at any on e time . Thi s conditio n follow s fro m th e assumptio n o f perfec t communication between buyer s and sellers i n a market: indeed the existence of one price became for Jevons the basis for definition o f a market. Given these conditions the ratio of exchange in the market will come to be that at which the final degrees of utility of the two commodities are for each of th e tw o person s proportiona l t o tha t rat e o f exchange. An algebrai c solution followed (100-1). One difference between this treatment and that of Mill or Marshall must be noted. It is a theory of the distribution through price changes of a given stock rathe r than a theory of the adjustment through price changes of the flow of production to the rate of consumption of commodities. It i s more relevant t o activit y o n a Stoc k Exchange , wher e th e quantit y of old securities i s given , tha n t o th e problem s o f th e behaviou r o f th e whol e economy. By contrast with Marshall it is particularly unrealistic in ignoring the function of the entrepreneur. At th e en d o f the chapte r in a sectio n 'O n th e origi n of value' Jevons explored th e relatio n o f his theory t o accepte d doctrine . H e note d with approval that Ricardo recognized that ' "there are some commodities the value of which is determined b y scarcit y alon e .. . Thei r valu e is wholly independent of the quantity of labour originally necessary to produce them, and varie s wit h th e varyin g wealt h an d inclination , o f thos e wh o ar e desirous t o possess them"' (158) . Jevons adde d tha t eve n commoditie s which are producible ma y not exchange in proportion t o the labour spent upon it . ' A grea t undertakin g like th e Grea t Wester n Railway , or th e Thames Tunnel , ma y embod y a vas t amoun t o f labour , bu t it s valu e depends entirely upon the number of persons who find it useful... The fact is that labour once spent has no influence o n the future value of any article; it is gone and lost for ever. In Commerce, by-gones are forever by-gones ' (159). This is important a s leading up to the analysi s of the problem s of overhead costs : bu t i t i s i n n o sens e i n contradiction wit h the classica l theory of value, or even with the Marxian theory. He went on to state that 'though labour is never the cause of value, it is in a large proportion of cases the determinin g circumstance, and i n the followin g way: Value depends

342 Fro m Adam Smith to Maynard Keynes solely on the final degree of utility. How can we vary this degree of utility ? By having more or less of the commodity to consume. And how shall we get more or less of it? - By spending more or less labour in obtaining a supply ... Labour affect s supply , and supply affects th e degree o f utility, which governs value' (160). Except for the addition of the concept of final degree of utility to explain demand, this statement takes us back to Adam Smith. But there followed a very important corollary: 'I hold labour to be essentially variable, so that it s value must b e determined by th e value of th e produce, not the value of th e produce by that of th e labour. I hold it to be impossible t o compare a priori the productive power s o f a navvy, a carpenter, an iron-puddler, a schoolmaster, an d a barrister1 (161). This proposition, which, however, could have been derived from a theory of demand independently of the theory of utility, was a major step forward towards a recognition o f the process of simultaneous determination o f the prices of final commodities and of the goods and services involve d in their produc tion. It would be inappropriate to attempt to deal with the vast literature on the theor y of utility tha t has accumulate d since Jevons wrote; but som e comment o n the limitatio n of Jevons's theor y mus t be made . First , th e theory assumes 'rational' behavior at least in the sense of deliberate calculation of the relative intensity of the buyer's wants. Jevons recognized th e 'action of extraneous motives, or what would seem to be caprice' (89), but he held that these extraneous elements would cancel out. 'Thu s our laws will be theoretically true in the case of individuals, and practically true in the case of large aggregates.' If we find that the behaviour of the mass as determined by observation conforms sufficiently closel y to that which the theoretical analysi s would lead one t o expect , the n we ma y reasonably decide tha t reasonin g fro m thi s assumptio n o f consume r rationalit y i s useful. Bu t we may then ask whether it is reasonable t o suppose that the final degree o f utility of a good i s a function o f the suppl y of that goo d independently of the suppl y of others. Doe s not th e degre e of utility of x depend o n th e suppl y of y an d z hel d b y th e individual ? Later writers identified 'competing ' and 'complementary' goods such that the more one had of y, let us say, the lower the final degree of utility of any given quantity of jc, and the more one had of z the higher that final degree of utility. Nor ar e individuals properly treated as independent: the final degree of utility of x to consumer A may be greater, or less, according as B, c, D et al. have more or les s o f it. Veblen' s theorie s o f 'competitiv e consumption ' an d 'con spicuous waste, ' o r th e familia r phras e 'keepin g u p wit h th e Jones's, ' explain how one may want more of a good the more others have of it. The

William Stanley Jevons 34 3 problems o f overcrowded highway s and parking facilities, or the discom fort o f night driving with many cars with powerful headlights on the road , may illustrate th e case where the more others hav e of a good the less one may want it. In all of this utility is treated as measurable, at least the utility of the final increment is so treated. This is hard to stomach. Alfred Marshall used the similar concept, margina l utility, as comparable rathe r tha n measurable: the marginal utility of x could be said to be greater, equal , or less than that ofy; but nothing could be said about how big it was. Others dropped th e use of utility i n favour of systems o f indifference using geometrical contruc tions of 'indifference curves, ' or algebraic formulation s of 'marginal rates of substitution. ' Fro m an y o f thes e formulation s o f rationa l individua l behavior one can derive individual and market demand curves. Still others dropped thi s effort t o explain the behaviour of the individual and returned to the classical metho d of assuming, on the basis of experience an d empirical data, that the amount purchased o f any commodity varied, other things being equal , wit h variation s i n it s price , an d varie d accordin g t o som e formula peculiar to each commodity. The demand curve and the elasticity of that curv e wer e wha t mattered fo r the explanatio n of price. Marshall, having discussed marginal utility, built his whole equilibrium price theory on market demand curves. For the welfare implication of such equilibrium something ma y seem t o have been lost . Bu t the apparent precisio n o f the demonstration o f th e condition s fo r maximizin g utility was misleading , and, a s I hav e argue d i n Digressio n Two , th e cas e fo r consume r sovereignty has a stronger basis in common sense than in elaborate utility analysis. VI

LABOUR,

LAND,

AND

CAPITAL

Chapter v , o n the 'theor y of labour,' first presents a theory o f individual behaviour: the individual is pictured as working to the point where the final degree of utility of the product is just equal to the final degree of disutility of the work. This i s surely a largely irrelevant analysi s for an industrialized nation i n which the worke r mus t work the normal hours of the establish ment in which he is employed, or be unemployed. For those few who can choose ho w muc h wor k the y wil l d o th e choic e i s not a s simpl e a s th e Jevons' diagram suggests, for the utility to be estimated is not that of the one commodity produced bu t of the many for which that commodity may be exchanged. The suppl y of labour is not independent of its reward; but the relationship betwee n suppl y and price of labour is complicated an d so

344 Fro m Adam Smith to Maynard Keynes little understood , tha t fo r most purpose s i t is wise t o tak e th e suppl y as given. What Jevons had to say about the 'distributio n of labour' is more nearly relevant. But he discussed the distribution of one individual's labour between variou s occupations, wit h a view to achieving equalit y betwee n the fina l degre e o f utility and th e fina l degre e o f disutility i n each. Th e important problem which the classical writers had examined is the distribution o f th e labou r forc e betwee n differen t occupation s wit h a vie w t o equality of net advantages to the workers in each. The real advance was left to the preface to the second editio n when he saw the parallelism betwee n the theories of rent and wages.28 The chapter on rent simply gave a symbolic and diagramatic exposition of the accepte d theory . Bu t in the prefac e t o the secon d editio n Jevon s examined th e Ricardia n doctrin e tha t ren t form s n o par t o f the cos t of production which determined the value of agricultural produce. He noted that Mill allowed that 'when land capable of yielding rent in agriculture is applied to some other purpose, the rent which would have been produce d in agricultur e i s a n elemen t i n th e cos t o f productio n o f othe r commodities.'29 Jevons extende d th e notion to different agricultura l employments: ' a potato-fiel d shoul d pa y a s wel l a s a clover-field , an d a clover-field a s a turnip-field; and so on ... The principle which emerges is that each portion o f land should be applied t o that culture or use which yields the largest total of utility , as measured by the value of the produce.'™ I t i s surprising that this principle was not expressed i n incremental terms: surely he had in mind the equivalence of marginal returns in all uses. But the importance of this discussion of rent lies in the following argument that exactly the same principle applies to wages. A man who can earn six shillings a day in one employment will not turn to another kind of work unless he expects to get six shilling s a da y o r mor e for i t .. . Eac h seek s th e wor k in which his peculiar faculties are most productive of utility as measured by what other people are willing to pay for the produce. Thus wages are clearly the effect not the cause of the value of the produce ... Precisely the same view may be applied, mutatis mutandis, to the rent yielded by fixed capital, and to the interest of free capital. 31

In the classical system land was treated differently from the other factors of production because its supply was taken as given, as independent of price. Once th e suppl y of labour, o r capital , i s taken a s given , the distinctio n disappears an d the concept of rent applies t o all. The stag e is set for the development of a new position, that the prices of products no more deter-

William Stanley Jevons 34 5 mine the prices o f factors, than prices o f factors determine the prices of products, bu t the prices o f products an d factors alike are simultaneously determined b y the interpla y of a given scarcity o f each o f the factors, a given scale of preferences for each of the products, and a given technology determining the mix of factors necessary t o produce an y quantity of each product. Jevon s se t out o n the road : i t was for Marshall in England an d Walras on the continent to take the next step. The study of the equilibrium distribution of given resources between alternative uses became the core of modern economics . Stud y o f the determinant s o f the quantit y o f thos e given resources was rather neglected except by Marshall, as being relevant generally to longer runs than were contemplated in relation to the problems under discussion, and as not being amenable even for very long-run results to the kind of analysis in which economists were expert. After labou r and land, Jevons treated capital . Hi s views, he said, were 'in fundamental agreement with those adopted by Mr Ricardo' (213). First a definition: 'Capital , as I shall treat it , consists merel y in the aggregate of those commodities which are required for sustaining labourers of any kind or class engaged in work. A stock of food is the main element of capital; but supplies of clothes, furniture, and all other articles in common daily use are also necessary parts of capital. The current means of sustenance constitute capital in its free o r uninvested form. Th e single and all-important purpose of capital i s to enable the labourer t o await the result of any long-lasting work - to put an interval between the beginning and end of an enterprise ... Capital simpl y allows us t o expend labour in advance' (214-17) . Jevon s then explained that the 'amount of investment of capital... is a quantity of two dimensions , namely , the quantit y of capital, an d th e lengt h o f time during which i t i s invested ' (221) . Th e objec t o f suc h investmen t - o f increasing th e interva l betwee n wor k don e an d goods enjoye d - is , of course, to increase the supply of goods ultimately available or to reduce the cost o f producing them. 'W e migh t spin an d weav e cotto n good s a s i n former times, or as it is done in Cashmere, with a very small use of capital; but then the labour required would be enormously greater' (219). Now all of this is concerned with the deployment of 'free capital, the wages of labour, either in the transitory form of money, or in its real form of food and other accessories of life' (233) . Plant and machinery, docks, railways , ships are not 'capital ' bu t 'represen t s o muc h capital sun k in the enterpris e .. . I would not say that a railway is fixed capital, bu t that capital i s fixed in the railway. The capital is not the railway, but the food of those who made the railway' (234). Had he forgotten his wise comment in the chapter on labour, bye-gones ar e forever bye-gones? Is i t not mor e sensibl e t o think of the

346 Fro m Adam Smith to Maynard Keynes services that the fixed capital will yield rather than the labour embodied in it over the years? In thinking of the current labour cost is it nor more sensible to think of the increase d productivit y of current labour as a result o f the utilization of fixed capital tha n to estimate th e direct and indirect labou r spent i n a roundabout proces s of production coverin g man y years? I t i s surprising tha t Jevons , wh o revolte d s o violently agains t th e Ricardia n theory o f value shoul d sta y wit h this 'labou r theory' o f capital. It wa s a great advanc e whe n Walras mad e a clear distinction betwee n good s an d services an d between th e service s o f people an d the service s o f durable goods, an d proceede d t o discus s th e simultaneou s pricin g of goods an d services o f men and machines . Marshall with his treatment of the quasi rents of fixed capital made the break from the classical system appear less but was in fact doing as Walras did. 'Abundance of free capital i n a country mean s that ther e are copiou s stocks of food, clothing, an d every other articl e whic h people insis t upon having ... It is in such circumstances possibl e tha t a part of the labourers can be employed in works of which the utility is distant, and yet no one will feel an y scarcit y i n th e present ' (234) . I t i s 'possible, ' bu t w e ar e tol d nothing about the determinants of the total income of the nation that will be so employed; nothing about saving; no backward reference to the preference fo r presen t rathe r tha n futur e goods . An d w e ar e tol d o f th e ne w investment possible by virtue of abundance rather than of the old investment as a condition of that abundance and the new investment as a condition of increased abundance in the future. 'Free capital can be indifferently employed in any branch or kind of industry' (235) . It wil l b e distribute d 'apar t fro m consideration s o f risk, trouble, and other interfering causes' so that the rate of return will be the same in all trades. That rate of return, the rate of interest, wil l depend on the ratio of the increment of product to the increment of investment in any particular industry . This ratio , Jevon s argued , 'mus t rapidl y approac h zero, unles s mean s can b e foun d o f continuall y maintaining the rat e of increase' (237). This doctrine of the falling rate of interest, in the 'absence of constant progres s i n the arts' appeared t o be confirmed historically by statistical facts; and it was held by Adam Smith, Ricardo and the classica l economists generally. Where Jevons differed wa s in his explanation of the phenomenon. Adam Smith explained it by reference to the mutual competition of capital: Ricardo by the rise in the cost of labour. Jevons argued that 'interest i s determine d b y th e incremen t o f produc t whic h i t enable s labourers to obtain, and is altogether independent of the total return which he receives to this labour ... If the soil yields little, and capital will not make

William Stanley Jevons 34 7 it yield more, then both wages and interest will be low ... If the soil yields much, and capital will make it yield more, then both wages and interest will be high; if the soil yields much, and capital will not make it yield more, then wages will be high and interest low' (240-1). In speaking of the yield of the soil one must distinguish the whole yield and the 'final rate of yield.' 'In the Western States of America the land yields a large total, and all at a high final rate, s o that the labourer enjoys the result. In England there is a large total yield, but a small final yield, so that the landowner receives a large rent and the labourer smal l wages' (241) . One last comment on this treatment o f capital and interest. The classical writers seem to have hidden interest in profits: Jevons seems to hide profits within interest. I t remained for later writers to distinguish, and treat sepa rately, th e rat e o f interest o n loans, th e rent s o r quasi-rent s fro m fixed capital, an d profit , whethe r th e norma l profi t o f Marshall , th e profit s (positive or negative) arising from uncertainty as analysed by F.H. Knight, the short-live d profit s o f innovatio n o f Josep h Schumpeter , o r th e monopoly profits , whether o f the stron g monopolist s o r of the relativel y weak competing monopolist s o f E.H. Chamberlin . Absent fro m Jevon s is the entrepreneur: I t was left fo r Marshall to focus attention on his crucial role. The shor t final chapter i s not a very satisfactor y one . H e rejected th e simple wage fund theory of wages as a truism, as 'wholly illusory.' He also rejected the current doctrine tha t explain profits at the margin of cultivation as the residual after wages had been deducted fro m the total produce. 'W e are told that if wage rise profits must fall, and vice versa. Suc h a doctrine is radically fallacious ; i t involves th e attemp t t o determin e tw o unknowns from one equation' (258). His own view he then stated: The wages of a working man are ultimately coincident with what he produces, after the deduction of rent, taxes and the interest of capital. I think that in the equation Produce = profit -I - wages - the quantity of produce is essentially variable and that profit is the part to be first determined. If we resolve profit into wages of superintendence, insurance against risk, and interest, the first part is really wages itself; the second equalises the result in different employments ; and the interest is, I believe, determined as stated in the last chapter (259).

Where those he criticized made profit a residual, h e made wage a residual; it remaine d fo r Marshal l an d Walra s t o demonstrat e th e simultaneou s determination of these quantities . The final paragrap h i s on 'Th e Noxious Influenc e o f Authority.' 'If ,

348 Fro m Adam Smith to Maynard Keynes instead of welcoming inquiry and criticism, the admirers of a great author accept his writings as authoritative, both in their excellences an d in their defects, the most serious injury i s done to truth ... A despotic calm is the triumph of error: in the republic of the sciences sedition and even anarchy are commendable' (266). In a letter to Professor Foxwell in 1875, Jevons wrote: 'I am beginning to think very strongly that the true line of economic science descend s fro m Smit h through Malthus to Senior , whil e another branch through Ricardo to Mill has put as much error into the science as they hav e truth.' 32 In th e preface to the secon d editio n o f his Theory h e said: 'it will be seen that that able but wrong-headed man, David Ricardo, shunted the car of Economic Science onto a wrong line, a line, however on which i t wa s furthe r urge d to confusio n b y hi s equall y able and wrongheaded admirer, John Stuart Mill.'33 As Marshall put it in a note which was found among his papers and printed in the Memorials, Jevons was impresse d by the mischie f which the almos t pontifical authorit y of Mill exercised on young students; and he seemed perversely to twist his own doctrines so as to make them more inconsistent with Mill's and Ricardo's than they really were. But the genius which enabled Ricard o - i t was not so with Mill - t o tread his way safely through the most slippery paths of mathematical reasoning, though he had no aid from mathematica l training, had made him one of my heroes; and my youthfu l loyalty boiled over when I read Jevons's Theory.34

By contrast Marshal l unduly minimized the difference between his theory and Ricardo's, and understated the advance that he made. VII

JEVONS AND

CLIFFE LESLIE

Cliffe Lesli e wa s on e o f th e chie f polemicist s o f th e Englis h Historica l School, but h e was an unproductive practitioner. Hi s attack s o n theory must hav e been al l the mor e irritating to Jevons sinc e hi s empirical and historical wor k was as impressive as his theoretical. Cliffe Leslie' s essay 'On the Philosophica l Metho d of Political Economy' (i8v6) 35 referre d to 'recent apologist s for th e a priori and abstrac t method ' a s feelin g themselves constrained to confine its application 'to the most advanced stage of commercial society,' thus abandoning the 'claims formerly made on behalf of politica l econom y t o th e characte r o f a universal science.' But , sai d Leslie, even i n a commercial societ y suc h a s England , competition wa s modified b y 'the influence of tradition, custom, law, political institutions, religion and moral sentiment'; in it 'the State, the Family, even the Church

William Stanley Jevons 34 9 are powerful elements'; and the behaviour of individuals and the structure of trades and professions are 'incapable of explanation apart from history.' In particular Cliff e Leslie attacked the assumption of perfect mobilit y and was led thereby to an interesting conclusion as to the power of trade unions to rais e wages . 'Wha t neithe r M r Mil l nor Mr . Thornto n seem s t o u s sufficiently t o bring out, i s that th e mai n power o f trade union s to rais e wages in particular case s has arise n fro m th e actua l inequalitie s o f both profits and wages. Where extraordinary gain s have been made in business, the labourer s hav e bee n enable d b y concerte d actio n t o extor t a shar e which competition would not have assigned to them.' 36 Similarly, scepticism as to the orthodox theory of wages led him to denounce the burden of indirect taxes on the working class. Theory said the taxes would be shifted, but he suspected that in fact most of them stuck.37 Jevons in his preface to the second edition of the Theory (1879 ) referred to Cliffe Leslie's essay on Method as an endeavour to 'dissipate altogether the deductiv e scienc e o f Ricardo.' H e note d tha t sprea d o f very activ e criticism 'which can hardly fail to overcome i n the end the prestige of the false old doctrines.' What was to be done? Many woul d b e glad i f the suppose d science collapsed altogether, and becam e a matter of history, like astrology, alchemy, and th e occult sciences generally. Mr Cliffe Leslie would not go quite so far as this, but would reconstruct the science in a purely inductiv e or empirical manne r .. . A s regard s th e fat e o f th e deductiv e method, I disagree altogether with m y friend M r Leslie; he i s in favour o f simple deletion; I am for thorough reform and reconstruction... Subdivision is the remedy. We mus t distinguis h th e empirica l elemen t from th e abstrac t theory , from th e applied theory, and from th e more detailed art of finance and administration. Thus will arise various sciences, such as commercial statistics, the mathematical theory of economics, systematic and descriptive economics, economic sociology and fisca science ... The manner may be theoretical, empirical, historical, or practical.38

Cliffe Lesli e too k u p th e challeng e i n a revie w o f Jevons ' boo k i n th e Academy. H e note d wit h pleasure that : 'M r Jevons full y concur s i n the necessity of historical induction to ascertain th e economic phenomena of society an d thei r laws. ' H e objected , however , t o bein g represented a s favouring 'simple deletion' of the deductive method. 'We are,' said Leslie for the English Historical School, 'fo r deletion of the deductive method of Ricardo: that is to say of deduction from unverified assumptions .. . but we are no t agains t deductio n fro m verifie d generalization s an d principles , though we regard the urgent work of the present as induction and view long

350 Fro m Adam Smith to Maynard Keynes trains of deduction with suspicion.' To Jevons there was equal urgency in the task of reform of the old theory an d in the task of extended inductiv e study. In both theory and empirical study he stood fo r far greater rigour . H.S. Foxwell reminded the adherents of the Historical School that 'there is no greater safeguar d against the misapplication o f theory than the precise expression o f it. No writer s have been s o truly historical i n their us e of theory a s thos e who , lik e Courno t an d Jevons , hav e know n it s exac t limits.'39 Cliffe Lesli e might admit that goo d theory wa s less likely to be misused than bad theory, but he still would not admit that it was of much use. Wha t I thin k wa s significan t was tha t th e theorist s believe d tha t inductive an d historica l studie s wer e als o useful . An d the y practised , where Cliffe Lesli e did little more than preach. VIII

SOME

OTHER

WRITINGS

I do not propose an exhaustive stud y of the other writings of Jevons, but brief reference to some of them is necessary i n order to demonstrate th e breadth o f his interests an d th e magnitud e of his contribution t o th e de velopment o f economics . I star t wit h referenc e t o hi s late r statistica l inquiries -in papers collected b y H.S. Foxwel l in Investigation into Currency an d Finance. In thre e paper s h e examined the coincidenc e o f the 'Solar period and the price of corn' (1875), 'The periodicity of commercial crises' (1875) , an d 'Commercia l crise s an d sunspots ' (1878-9) . O f th e nature o f these inquirie s he ha d thi s to say : 'Soun d conclusion s ca n b e reached onl y b y th e mos t extensiv e analyse s an d comparison s o f larg e series of facts. The searc h for the facts, too, among the records of the last two centuries, the suitabl e part of which has in too many cases probably perished, i s so tedious an d disappointing that it taxes th e patience o f the inquirer very severely. It is no jest a t all.' 40 Keynes said of these papers: 'Whether or not Jevons was wrong or rash in the hypotheses he framed on the basis of his inductive studies, it was a revolutionary change, for one who was a logician and a deductive economist, to approach the subject in this way. By using these methods Jevons carried economics a long stride fro m the a priori mora l science s toward s th e natura l sciences founde d on a foundation of experience.'41 The fact that later inquiry has undermined the validity of his sunspot argument should not blind one to the importance of this long stride towards empirical study. In th e introductio n to th e Investigations into Currency and Finance Professor Foxwel l referred to Jevons's 'unio n o f high speculative ability with th e greates t reserv e an d sagacit y i n th e treatmen t o f practica l

William Stanley Jevons 35 1 problems.'42 Jevons, h e said , wa s a conspicuous exampl e of the truth of Cournot's defence of theoretical work where he argued that 'those who are most concerned fo r the precision of their principles will be most sensible of the limit s of their application , an d therefore the least unpractica l in their treatment of real questions.' He justified his judgment that Jevons was 'the best possible illustration of the justice of Cournot's contention' by referring the 'cautious and balanced papers on Bimetallism' (reprinted in the Investigations) and to the 'admirably wise essays' in the collection papers edited by hi s widow and publishe d a s Methods o f Social Reform. I propose t o examine several of these essays . One of the papers which is hard to describe as 'admirably wise' is that in which he called in question the policy of the whole of our medical charities, including all free public infirmaries, dispensaries, hospitals, and a large part of the vast amount of private charity ... the whole of these charities nourish in the poorest classes a contented sense of dependence on the richer classes for those ordinary requirements of life which they ought to be led to provide for themselves ... Not only is a large part of this [charity] wasted in the excessive costs of management but .. . a further larg e portion really goes to undermine th e mos t valuabl e qualities of self-reliance , and s o t o for m a bribe towards the habits of mendicancy and pauperism.'43

Keynes commentin g on thi s 'ver y od d earl y address ' sai d tha t Jevon s regarded these medical charities as 'undermining the character of the poor (which h e seems t o have preferred to, an d deemed independent , of their health)'.44 Surely it was shortsighted to fail to recognize the vicious circle of poverty an d illness; to see that no t only the characte r bu t the earning power of the poor depended on their health, and that their health was poor because of thei r poverty . 'Self-hel p is the trues t kin d of help , and you confer th e greatest benefi t upo n a person o r a class o f persons whe n you enable and induce them to do without your aid for the future. Money spent in the educatio n of the youn g has thi s beneficient effect . Mone y spent in most othe r mode s o f charity ha s generall y the opposit e effect . Henc e I venture to look upon £i spen t in the education of the young as worth £50 spent in most other charitable uses.'45 The attitude is that of Bentham and the Poor Law of 1832 which Jevons described a s 'the wisest measure ever concerted b y any government.' 46 High wages would provide no solution : 'they may be spent intemperately, and on the slightes t reverse o f fortune his famil y o r himsel f may come t o th e workhous e .. . No peopl e ca n be really well off unless to their material prosperity be joined habits of provi-

352 Fro m Adam Smith to Maynard Keyne s dence an d foresight , whic h wil l lea d the m t o fortif y themselve s i n th e position they have once attained.'47 The Victoria n doctrin e o f thrift i s all very well: but wha t saving s could b e rationally mad e b y workers eve n if their wages were 'high,' when that meant, in fact, not as low as they used to be? And was not the Victorian middle class too ready to see intemperanc e as a caus e o f poverty withou t noticin g ho w poverty mad e for intemper ance? One of the 'wise' papers seem s to me to be that on the 'Amusements of the People. ' O f the method s o f socia l refor m 'ther e i s hardly an y othe r method, take n separately , t o whic h greate r importanc e shoul d b e attri buted than to the providing of good mora l public amusements, especiall y musical amusements. Up to quite recent years, the English people have, in this respect, been woefully backward, as compared with the more cultured Continental nations. 48 I t had been traditiona l to talk of 'Merrie England' but to Jevons this sounded absurdly incongruous: The people seem actually to have forgotten how to amuse themselves, so that when they d o escap e b y a n excursio n train fro m thei r depressin g alleys, there i s n o provision of music, no harmless games, nor other occupation for the vacant time. The unusua l elevatio n o f spirit s whic h th e fres h ai r occasion s vent s itsel f i n horseplay and senseless vulgarity; and in the absence of any counter-attraction, it is not surprisin g tha t th e refreshment-ba r an d th e neares t tap-roo m ar e th e chie f objects of attention ... When our English masses try to amuse themselves, they do it in such a clumsy and vulgar way as to disgust one with the very name of amusement. Witness th e Ban k Holiday s on Hampstea d Heath .. . Then , again , what can b e worse the n th e commo n ru n o f Londo n music-halls , where w e hav e a nightl y exhibition of all that is degraded in taste.49

After som e suggestions for improvement in England Jevons turned to the example of Denmark, where he found that 'th e poorer classe s are , com paratively speaking, ladie s an d gentlemen .. . The socia l superiorit y is , of course, greatly due to the good system of public education which has long existed i n Denmark. ' Bu t h e note d als o th e civilizin g influence o f th e Thorwaldsen Museum and the Tivoli Gardens. 'Of course our magistrates would not permit so demoralising a spectacle a s ballet-dancing in the open air; but I wish they could se e Froeken Leontin e an d Fann y Care y danc e their pas d e deux. They woul d then learn that among a truly cultured and well governed people, dancin g may be as chaste as it is a beautiful performance.' He was enthusiastic, too, about their pantomime, 'not your absurd

William Stanley Jevons 35 3 English pantomime, all grotesque, extravagant, full of tinsel, depending for effect upo n numbers and magnitude, and the introduction o f real donkeys , hansom cab s an d the like .. . bu t the real pantomim e - al l gesture an d incident, n o speech ... a performance a s amusing to the spectators as it was harmless, an d totally devoi d o f vulgarity an d coarseness.' 50 Prim, some what condescending , dated , bu t th e fundamenta l idea tha t recreatio n i s important and that it is a proper subject of social policy, is surely not out of date. In another pape r Jevon s state d th e 'Rationale of Free Public Libraries ' arguing that no mode of expending public money gives a mor e extra-ordinary and immediat e return in utility an d innocen t amusement .. . th e resul t of establishing Free Librarie s i s to brin g the ver y best book s within th e reac h o f th e poorest , whil e leaving the ric h t o pa y th e expense s o f publication of such books .. . Now, if the burgesses o f a British borough are wise enough t o ope n a Fre e Library , it is a free literar y park, where the poores t ma y enjoy a s a right what is well, both for them and everybody else, tha t they should enjoy. 51

After libraries , h e turne d t o museums : but her e h e was more concerne d with the policy of the museum itself than with the social polic y of support for them . 'Man y go to a public Museum just a s they take a walk, without thought or care a s to what they are going to see; others hav e a vague idea that they will be instructed an d civilised by seeing a multitude of novel and beautiful objects ; a very smal l fraction of the total public go because they really understand the things displayed, and have got ideas about them to be verified, corrected , o r extended.' 52 I t i s thi s las t grou p t o who m th e museum should cater. Jevons had much to say about the best methods of governing museums. Believing that a museum ought to be regarded a s 'a place of learning and science' he argued that it should be controlled 'i n the manner of a college, by a neutral and mixed board o f science an d business' which would retain in their own hands most questions relating to finance, the structur e of the museum and what does not touch the professional and scientific work of the curators.'53 Th e boar d bein g mad e u p o f me n o f divers e characte r an d interests shoul d reduc e t o a minimum 'the fear of political influenc e and jobbery i n the appointments.' The board 'shoul d not be elected by themselves, or b y any single power havin g both the means and the motive for one-sided appointments. ' Havin g no common opinions on scientifi c mat-

354 Fro m Adam Smith to Maynard Keynes ters, the board would 'leave the curators in the perfect freedom of thought and action which is requisite for the prosecution of learning and science.'54 There is much in this essay that is as relevant today as it was in his day. In these days when examinations have come under fire it would be well if the paper Jevons wrote on 'cram' were re-read and carefully considered. In his day the examination system was relatively ne w and still unpopular : some regre t th e los s o f patronage; other s th e los s o f patrons an d appointments ; schoolmasters d o not like having their work rudely tested .. . a formidable minority actually have good grounds for hating examinations ... and the general public , ever ready to grumble at a novelty .. . take up the burden of the complaint. Fortunately , too, for the opponents o f examination, an admirable 'cry ' has been found. Examination, they say, leads to 'cram,' and 'cram' is the destruction o f true study. Jevons, being 'in favour o f examinations' decided t o analyse the meaning of th e wor d 'cram, ' an d proceeded t o distinguis h 'goo d cram ' an d 'ba d cram.' A candidate preparing for an important competitive examination, may put himself under a tutor wel l skilled in preparing for tha t examination . This tutor look s fo r success b y carefully directin g the candidates' studie s into the most 'paying ' lines, and restrictin g the m rigorousl y t o thos e lines . Th e trainin g given ma y b e o f an arduous thoroug h character , s o that th e facultie s o f the pupi l are stretche d an d exercised t o th e utmos t i n those lines . Thi s woul d b e calle d 'cram ' becaus e i t involves exclusive devotion to the answering of certain examination papers. I call it 'good cram. ' 'Ba d cram ' o n th e othe r han d i s temporarily impressin g upon th e candidate's min d a collection o f facts, dates , o r formulae , hel d i n a wholly undigested stat e an d ready to be disgorged in the examination room by an act of mere me

Whether 'good cram' will be successful must depend on the quality of the examiners and the character o f the examination papers. With the examiners of the least intelligence is there any reason to fear that the best directed 'ba d cram' will enable a really stupid candidate to carry of f honours and appointments due to others .. . It is really impossible tha t a stupid, slovenl y candi date can by any art of 'cramming' be enabled t o produce th e neat, brief , pertinen t essay, a page or two long, which wins marks from admiring examiners.56 Jevons was ready to assume that examiners would be intelligent and papers

William Stanley Jevons 35 5 sensible. This is a generous commen t having in mind his own experience a s student an d professor. I n a letter to his brother i n 1860 he had written as a student: in political economy I had a sad reverse .. . for in spite of having studied the subject independently and originally, and having read some dozens o f the best works in it, almost neglecting other classes for the purpose, I was placed third or fourth when I felt confiden t of the first prize. This I can only attribute to a difference o f opinion, which is perfectly allowable, havin g prejudiced the professor against my answers. However, I shall fully aveng e myself when I bring out my Theory o f Economy, and re-establish the science o n a sensible basis. 57

Lord Keyne s ha d this to say about Jevons' s experience a s a professor a t Owens College, Manchester, whe n his students sa t for the London Univer sity examinations . 'A s h e though t i t would b e unfai r to subjec t hi s own pupils to the rebuff h e himself ha d suffered , hi s conscience did not allo w him to teach them his own characteristic doctrine . His courses at Manchester were mainl y confined to an exposition o f Mill... this repression o f his own theorie s ha d brough t hi s feelin g agains t Mil l to a boilin g point.' 56 Jevons wa s also preparin g student s i n logic in which subject he also felt it necessary t o repress hi s own doctrine, thu s adding to his irritation. Fundamentally an individualist Jevons cam e to recognize th e necessit y of state intervention in industry, for the protection o f the workers. In a little book, Th e State i n Relation t o Labour (1882 ) h e tried t o explai n 'wh y in general we uphold the rule oflaissezfaire, an d yet in large classes of cases invoke th e interferenc e o f loca l o r centra l authorities.' 59 Hi s attitud e i s made clear in the ffirst chapter o n 'Principles of Industrial Legislation.' It may fairly be said that the individual workman is bound to take care of himself and to be especially wary when approaching machinery. Mere commonsense, we might think, woul d lea d peopl e t o avoi d negligen t conduct likel y t o b e instantl y an d inexorably punished with sudden death, or the most fearful an d painful mutilation. As a general rule, at least, adult persons must take care of themselves ... It may well be urged , too, tha t th e mor e w e guar d people fro m palpabl e dangers, the mor e heedless they will become, an d the mor e likely to fall victim s to some unforeseen danger ... It is all very well for theorists and 'cabine t philosophers' to argue about what people ought to do; but if we learn from unquestionable statistical returns that thousands o f haples s person s do , a s a matte r o f fact , ge t crushe d t o death , o r variously maimed , by unfence d machinery , those ar e calamities which no theory can mitigate. 60

356 Fro m Adam Smith to Maynard Keynes Of course, thos e wh o erect dangerou s machine s shoul d fenc e them; and those who work with them should insist on them being fenced; but observation showe d continued failure to provide adequate protection . Henc e th e law commandin g tha t dangerou s machiner y b e fence d an d providin g that inspectors shoul d be appointed t o detect violations o f the law and to prosecute th e violators . Wha t then o f the dange r o f death fro m inhalin g phosphorus vapours , cla y dust , lead , etc. ? 'Experienc e show s tha t me n from mer e thoughtlessnes s o r ignorance incu r grave injuries to health o r limb which very little pressure from the legislature would avert with benefit to all parties. Th e difficul t questio n thu s arises whether , ou t of respect to some supposed principle of individual liberty, the State ought to allow men to go on working and living in the midst of needless risks.' 61 So he argued 'we must throw off the incubus of metaphysical ideas .. . We must resolv e these supposed principle s and rights into the facts and probabilities whic h they are found to involve .. . All [rights] depend ultimatel y upon the salus populi whic h i s th e onl y le x suprema.' 62 S o h e wen t o n t o argu e tha t legislation shoul d b e 'Baconian, ' proceedin g upo n th e groun d o f experi ence, and making experiments in 'the particular way calculated t o prove or disprove th e conclusion i n view.' He proposed tha t legislative chang e be applied to selected district s s o that one could 'observ e what happens bot h where th e chang e i s in operation, an d als o i n closely proximat e places , where it is not in operation.' In an article in the Contemporary Review Jevons applied his ideas to the problem of 'married women in factories.' The objectio n may no doubt be mad e that the exclusio n of child-bearing women from works in public factories would be a new and extreme case of interference with the natura l liberty o f the individua l .. . [But ] if we find that freedo m to wor k in factories means the destruction of a comfortable home, and the death often ou t of twelve o f the offspring , her e i s a palpabl e evil whic h no theor y ca n mitigat e ... Speaking o f libert y and rights , it mus t b e apparent , too, tha t th e partie s mos t concerned i n the matte r are th e infants . The y hav e no means of raising a public agitation, or, i f they venture to protest in their own manner, are soo n stille d with 'Godfrey.' Bu t surel y if there is any righ t which is clearly founded i n the natural fulness of things, it is the right of the infant to the mother's breast.63

So, he concluded, 'Th e Factory an d Workshop Act of 1878 seems to be a mass o f vexatiou s restrictions : i n realit y i t i s th e Grea t Charte r o f th e working classes.' If this were followed by well-designed legislatio n o n the subject o f marrie d wome n grea t blessing s woul d result . 'Man y a hom e

William Stanley Jevons 35 7 would be a home which cannot now be called by that sweet name. The wife, no longer a mere slattern factory hand, would become a true mother and a housekeeper; and round many a Christmas table troops of happy, chubby children woul d replac e th e "wizene d littl e monkeys " o f girls , an d th e "little old men" boys, who now form the miserable remnants of families.'64 Jevons, the theorist and empirical scientist, was also a Victorian sentimentalist! In a boo k o n th e classica l literatur e i t i s onl y proper t o mak e some reference t o Jevon's interest i n the literature o f the subject. He prepare d lists o f 'Mathematico-Economic ' book s (printe d a s a n appendi x t o th e second editio n o f hi s Theory} an d o f writing s on mone y (printed a s a n appendix ^Investigations i n Currency and Finance). He was a collector of obscure economic book s and pamphlets, a large part of which are now in the Library of Owens College. It was from him, as Lord Keynes put it, that Professor Foxwell 'first caught the affliction.' Indirectly then it is to Jevons that we owe the super b collections that Foxwell made, the first of which was bought by the Goldsmith's of London, the second by the Kress Library of Harvard, from which latter some duplicates happily came to the Library of the University of Toronto. Finally , we should mention Jevons's discovery of Can tillon.65

2 Alfred Marshal l

I

INTRODUCTION *

Jevons had taken a giant step towards modern economics: Marshal l went further an d ma y b e sai d t o hav e founde d moder n economics . Fo r tha t reason it is more difficult t o write about Marshall. To write about his work is to discuss a developing theory of value and distribution explored by him, developed b y his pupils and still developing. In a sense we are all Marshallians: but we have largely ceased to read Marshall and this I consider to be a loss. I shall try to throw some light on the character o f his contribution and hope t o interes t som e student s t o rea d hi s Principles. I t i s withi n my teaching caree r tha t thi s book wa s the principal tex t fo r undergraduate s beginning the serious stud y of economics. W e now use textbooks tha t are more efficien t in their expositio n and tha t introduc e the lates t develop ments i n theory; the y facilitat e th e teachin g o f techniques, bu t ther e i s something missing from the education of political economists. Marshall and Jevons Having writte n a t lengt h abou t Jevon s I propos e firs t t o compar e an d contrast thes e tw o men . Firs t le t m e quote fro m Keynes' s essay i n The Memorials o f Alfred Marshall: 'Jevons ' Theory o f Political Economy i s a brilliant, but hasty, inaccurate and incomplete brochure, as far removed as possible fro m th e painstaking , complete , ultra-conscientious , ultra * Throughou t the introductio n page references in the text are to The Memorials o f Alfred Marshall, ed. A.C. Pigou (1925)

Alfred Marshal l 35 9 unsensational method s of Marshall... Jevons sa w the kettle boil and cried out with the delighted voice of a child; Marshall too had seen the kettle boil and sat down silently to build an engine' (23). In the same volume Professor Kgou also referred to this building of an engine: 'He has built a structure as different fro m anything known before as a modern locomotive i s differen t from Stephenson' s Rocket.' It i s in this kin d of building, whether i n the analysis o f valu e generally , o r o f money o r o f foreign trade , tha t h e i s supreme. Skilled and tireless user of tools as he was, it is as a maker of tools that he, alon e amon g English economists , stand s th e companion an d the equal of Adam Smith and of Ricardo' (87). Marshall no t onl y devised tools , h e educated tool-users . I t i s through his pupils , eve n mor e tha n hi s writings , tha t Marshal l i s th e fathe r o f Economic Scienc e a s i t exist s i n Englan d today . S o lon g ag o a s 1888 , Professor Foxwel l wa s able t o write: 'Hal f of the economic chair s in the United Kingdom are occupied b y his pupils. Today [1925] through pupils and th e pupils of pupils hi s dominion is almost complete' (59) . His grea t pupil Pigou had this to say about him as a teacher. He was, for all of us who knew him, a shining example of single-eyed devotion to an unselfish aim . A studen t i n who m h e sa w promis e woul d sho w hi m u p som e half-digested answer to a question. Marshall's comment in red ink would be as long as the student's answer ... You would go to him on one of his afternoons a t home with some difficulty tha t was puzzling you. It was an instructive experience. Tha t anything s o simpl e as you r real difficult y coul d possibly puzzle anybody would never occur to him. Immediately he would perceive rank upon rank of complicated problems that had never so much as entered your head, and pour out by the hour, enthusiastically, unrestrainedly, a wealth of knowledge that bewildered and overwhelmed you. You went away with your difficulty no t even touched upon; but with a very healthy sense of your own incompetence: with the conviction that here was an astonishin g personality; that this ma n a t leas t believe d whole-heartedl y that economics was worthwhile: that he even believed that you, with all your weakness and immaturity , might, if you reall y tried, do somethin g of service to your fellow men (87-8).

Some sentence s fro m a 'Note on Economic Teaching ' circulate d b y Professor Pigou in the thirties may be quoted here, not only for its relevance to the discussion of Marshall as a teacher, bu t for its relevance to University teaching today. According to my notions undergraduates ought not to be regarded as sausage skins

360 Fro m Adam Smith to Maynard Keynes to be filled. They are human beings to be educated, or , better still, to be allowed to educate themselves ... it is of no importance at all whether they know the very latest facts about the coal industry, or have been told the very latest half-baked specula tions in pure theory. Havin g failed to 'master ' Economic s i n 40 years, I am less optimistic than some of my colleagues that ordinary undergraduates can master it in one year or even in three .. . I would never 'teach' them Economics. Marshall did not 'teach us'; he talked to us in an interesting way about interesting things, and, by that means, developed i n us some rudiments of intelligence. I should never tell an undergraduate, 'The answer to your question i s this ...'To most questions I should answer (with perfect truth) I don't know, but if we look at the thing in this or that sort o f way , it ma y possibl y b e a bi t clearer . Wha t thes e youn g me n nee d i s cooperation, not spoon-feeding. The University touch, not the crammer's. When Marshall returned to Cambridge as Professor in 1885 his inaugural lecture was a plea for an independent status for the study of economics. He was concerned to recruit more students of economics, and to ensure them a more rigorous course of study in it. There is wanted wider and more scientific knowledge of facts: an organon stronge r and more complete, mor e able to analyse and help in the solution of the economi c problems of the age. To develop and apply the organon rightly is our most urgent need; and this requires all the faculties of a trained scientific mind. Eloquence an d erudition have been lavishly spent on the service of Economics. They ar e good in their way; but what is most wanted now is the power of keeping the head cool and clear i n tracin g an d analysin g th e combine d actio n o f man y combine d cause s (56). He concluded the lecture with this statement of his objective. It will be my most cherished ambition, my highest endeavour, to do what with my poor ability and my limited strength I may to increase the numbers of those whom Cambridge, th e grea t mothe r of stron g men, sends ou t int o the worl d with cool heads but warm hearts, willing to give some at least of their best powers to grappling with th e socia l sufferin g aroun d them; resolved no t t o res t conten t til l they have done what in them lies to discover how far it is possible to open up to all the material means of a refined an d noble life (89). It was 1903 before he succeeded in persuading the University to establish a separate Economic s tripos . This wa s a most significant achievement : the great teacher of individuals was also a great architect of educational institutions.

Alfred Marshal l 36 1 The role of mathematics Marshall gave a n account of how he came t o develop hi s theory o f value and distribution , an d i n th e accoun t indicate d bot h th e usefulnes s o f mathematical analysi s and his worry as to its dangers. While still giving private lessons in mathematics [in 1867] he translated as many as possible of Ricardo's reasoning s int o mathematics; an d he endeavoured t o make them mor e general . Meanwhil e h e wa s attracte d toward s th e ne w vie w o f economics taken by Roscher and other German economists; and by Marx, Lasalle, and other Socialists. But it seemed to him that the analytic methods of the historical economists were not always sufficiently thorough to justify their confidence that the causes whic h they assigned to economic events were the true causes. H e thought indeed tha t the interpretatio n of the economi c past wa s almos t a s difficul t a s th e prediction of the future (20).

Some years later in a letter to Professor J.B . Clar k he wrote: 'm y acquaintance wit h economics commence d whil e I wa s stil l earning my living by teaching Mathematic s a t Cambridge; and translating his [Ricardo's] doc trines int o differentia l equations a s fa r a s the y woul d go ; an d a s a rul e rejecting those which would not go' (412). In the preface to the first edition of his Principles he referred to von Thunen by whom he was 'led to attach great importance to the fact that our observations o f nature, in the moral as in th e physica l world , relat e no t s o muc h t o aggregat e quantities , a s t o increments of quantities ... It is not easy to get a clear view of Continuity in this aspect without the aid of either mathematical symbols or of diagrams.'! So much for the use of mathematics, wha t of its dangers? H e explained in the account of the development of his thought quoted above that 'he feared that i f separated fro m al l concrete study of actual condition s the y might seem to claim a more direct bearing on real problems than they in fact had. He began, therefore, to supply some of the requisite limitations and conditions, an d thus was written the kerne l of the fifth book o f his Principles. From tha t kerne l tha t volum e wa s extende d graduall y backward s an d forwards till it reached the form in which it was published in 1890' (21). So, at this early state in his development, his concern for realism constrained his interest in mathematical analysis. As Professor Pigo u has said: 'So far as h e wa s agains t mathematica l elaboration s i n economics , i t wa s onl y because he feared that realism might suffer. Convinc e him that any particular line of mathematical attach would indirectly help realism, and he would have been its enthusiastic friend.'2 In a super b Centenar y articl e o n Marshall' s Principles G.F . Shov e showed 'ho w naturally - one is tempted to say inevitably - the theoretical

362 Fro m Adam Smith to Maynard Keynes framework of the Principles grows out of an attempt to test, and fill the gaps in, Ricardian economics - in other words, "to translate them into differential equations" and "make them more general." Shov e gav e four exam ples. (1) Onc e admit that the (marginal) cost o f producing a commodity may vary with the outpu t of it, an d the Ricardia n theorem tha t the valu e of each commodit y is equal to its marginal cost no longer solves your problem: for each commodity you have two unknowns - price and output - and only one equation ... Either another set of equations, relating the selling price of each commodity and its amount -th e demand equation s - mus t b e introduced or you must assume that everythin g is produced under conditions of constant cost, in which case generality is sacrificed ... (2) Eithe r the theor y of value must be confine d t o th e specia l cas e i n which the technical coefficients relatin g to labour and capital are constants: o r another set of equations mus t b e introduced, connecting this time the proportions i n which the factors ar e combine d in the productio n of each commodity with their prices an d with the output of the commodity. This leads to yet another gap. For how are the prices of the factors determined? ... (3) It was becoming obvious that the Ricardian analysis not only lacked generality, but failed to fit the facts. The commodity wages o f th e variou s grades o f labou r coul d n o longe r b e equate d t o s o many constants: a set of differential equation s was needed connecting the wage of each grade with the amount to be supplied. Further, since the amount supplied depends on the amoun t demanded, the stat e o f the demand must now be given a position coordinate wit h th e condition s of suppl y in th e long-perio d theor y o f wages .. . (4) W e need ... an equation establishing a definite relation between the quantity of capital forthcoming and the rate of profit or return.3

These equations, M r Shove pointed out, are those listed i n note xxl of the Mathematical Appendix in the Principles. In a letter to Professor J.B. Clark Marshall explained that he had worked out the theory of Note xx i 'while still teaching mathematics; and while still regarding myself as a mere pupil in th e hand s o f the grea t masters , especiall y Cournot , vo n Thiinen an d Ricardo; an d whil e stil l extremel y ignoran t o f economi c realities. ' Hi s whole life , h e said , 'ha s been an d will be given to presenting i n realisti c form as much as I can of my Note xxi (417). Th e analysi s there set forth is indeed,' as Mr Shove says, 'the backbone on which Books v and vi in the final version of the treatise .. . is built up by the introduction o f the highly important and original devices for dealing with the time-element (the gradation o f short an d lon g periods, quasi-rent , th e prime-and-supplementar y cost analysi s an d th e rest ) an d b y a continua l testing , illustratio n an d

Alfred Marshal l 36 3 qualification of the pure theory in the light of contemporary an d historica l fact.'4 Professor Schumpete r regrette d Marshall' s failur e to give credit t o his 'great impersonal ally' - mathematics. The poin t i s not merel y tha t hi s mathematical tur n o f mind was favorable t o his achievement in the field of economic theory , but - that the actual use of the methods of mathematical analysis produced that achievement an d that the transformation of the Smith-Ricardo-Mill material into a modern engine of research coul d hardly have been accomplished without it... a performance o f the Marshallian kind practically presupposes a mathematical schema . An d this Marshal l always refused to admit. He hid the tool that had done the work.5 He hi d it in the Appendix: even th e us e o f diagrams he confined to footnotes. In the preface to the first edition of the Principles he explained his practice: It is not easy to get a clear full view of continuity in this aspect without the aid either of mathematical symbols o r of diagrams. The us e of the latter requires no special knowledge, and they often express th e conditions of life more accurately, as well as more easily, than do mathematical symbols; and therefore they have been applied as supplementar y illustration s in the footnote s o f the presen t volume . The argu ment i n th e tex t i s neve r dependen t o n them ; an d the y ma y b e omitted ; bu t experience seem s to show that they give a firmer grasp of many important principles than can be got without their aid; and that there are many problems of pure theory, which no one who has once learnt to use diagrams will willingly handle in any other way.6

Much later, in a letter to Professor Bowley in 1906, he wrote: I ha d a growin g feeling i n th e late r year s o f m y wor k a t th e subjec t tha t a goo d mathematical theorem dealin g with economic hypothese s wa s very unlikely to be good economics: and I went more and more on the rules -(i) Us e mathematics as a shorthand language , rather than as an engine of inquiry. (2) Keep to them till you have done . (3 ) translat e into English . (4 ) The n illustrat e b y example s tha t ar e important i n rea l life . (5 ) Bur n the mathematics . (6 ) I f you can' t succee d i n (4), burn (3). This last I did often (427) . This reluctanc e t o display his mathematics Schumpeter attributed to his fear o f frightening th e layma n and his desire t o be read b y business men.

364 Fro m Adam Smith to Maynard Keynes Surely the reason was much deeper. There was the fear of unreality. His comment on Edgeworth's Mathematical Psychics in The Academy illus trates hi s fear . 'I t wil l be interestin g t o watc h th e developmen t o f his theory, and , i n particular, t o se e ho w far he succeed s i n preventing his mathematics from running away with him, and carrying him out of sight of the actua l facts of economies' (26) . In th e prefac e to th e eight h editio n Marshall noted that the forces to be dealt with are so numerous 'that it is best to take a few at a time; and to work out a number of partial solutions.'7 The danger was that in the process of simplification the complexity would be forgotten, that in the selection of a few 'forces' th e many others would be forgotten. But perhaps even more important in explaining his reluctance to rely on mathematics was his belief that 'the Mecca of the economist lies in economic biology rather than in economic dynamics.' 8 Biological conceptions are, he said, 'more complex than those of mathematics.' Though the mechanica l analog y o f equilibriu m ma y b e usefu l i n preliminar y analysis of the forces making for change and in determining the probabl e direction o f that change , i t i s inadequat e a s a mean s o f forecasting th e ultimate ne w equilibriu m position . An y disturbanc e o f a n equilibriu m position is likely to alter many of the conditions of the problem, many of the things held captive in the ceteris paribus pound. The simpl e use of supply and demand curves suggests that any departure from a n equilibrium position will be temporary and self-correcting. The difficulty lie s in the fact that the processes of economic life are not such as to justify th e expectation of 'reversibility' o f movemen t along give n curves . Al l o f whic h ma y b e considered t o under-rate the possible contribution o f mathematics; but it provides a healthy dose of scepticism in the evaluation of that contribution, and in its application to the problems of the real world. Marshall and the Historical School Marshall, like Jevons, was very conscious of the antagonism of the Historical School to a priori theory. Like Jevons, too, he insisted that such theory was very important but a very small part o f economics. Writin g to F.Y . Edge worth he said: In my view Theory' is essential. No one gets any real grip of economic problems unless h e wil l wor k a t it . Bu t I conceiv e n o mor e calamitous notion tha n that abstract, or general, or 'theoretical' economics was economics proper. It seems to me an essential but a very small part of economics proper: and by itself sometimes even - well, not a very good occupation of time. The keynote of my plea is that the work of the economist is 4to disentangle the interwoven effects of complex causes';

Alfred Marshal l 36 5 and that for this, general reasoning is essential, but a wide and thorough study of facts i s equally essential , an d tha t a combination o f the tw o side s o f the wor k is alone economics proper. Economi c theor y is, i n m y opinion, as mischievou s an impostor whe n i t claim s t o b e economic s prope r a s i s mer e crud e unanalyse d history. Six of ye one, ! /2 dozen of ye other (437).

In his inaugural lecture afte r election t o the professorship at Cambridge in 1885 Marshall discusse d the nature o f the contribution o f the Historica l School and of its weakness. This contribution was not 'the discovery of the importance o f supplementing an d guiding deduction b y induction, for that was wel l know n before. ' Indee d th e economist s o f th e classica l perio d 'wrote economic historie s tha t ar e in their wa y at least equa l to anything that has been done since. They brough t about the collection of statistics by public an d privat e agencie s an d tha t admirabl e serie s o f parliamentar y inquiries, whic h hav e bee n a mode l fo r al l othe r countries , an d hav e inspired th e Germa n historica l schoo l wit h man y of their bes t thoughts ' (153). The charg e of indulging in 'excessively abstract reasoning ' was due to the influence of Ricardo: 'He had very little in common with the English tone of thought... no English economist has had a mind similar to his.' The real contribution of the Historical School , Marshal l argued, was their discovery tha t ma n himsel f is i n great measur e a creatur e of circumstances and changes wit h the m .. . Th e chie f faul t then , o f th e Englis h economist s a t th e beginning of the centur y was not that they ignored history and statistics; but that Ricardo and his followers neglected a large group of facts, and a method of studying those facts which we now see to be of primary importance. They regarded man as, so t o speak , a constan t quantity, an d gav e themselves little troubl e t o stud y hi s variations. The peopl e whom they knew were chiefly city men; and they took it for granted tacitly that other Englishme n were very much like those they kne w in the city .. . Th e sam e bent o f mind , tha t le d ou r lawyer s to impos e civil la w on th e Hindoos, led our economists to work out their theories on the tacit assumption that the world was made up of city men (155).

Henry Main e had clearl y mad e hi s point ! Bu t whil e giving credit t o th e Historical Schoo l fo r thi s contribution , Marshal l proteste d agains t th e disparagement o f theory b y th e 'extrem e win g of the moder n "real " o r "historical" school ' an d note d th e limitatio n o f th e historica l method . While he sai d tha t it would 'be difficult t o overrate th e importance o f the work done by the great leaders of the school in tracing the history of habits and institutions' he argued that their studies

366 Fro m Adam Smith to Maynard Keynes do not throw a direct light on particular economic problems of our age. They do not in an y way help us to dispense wit h the use o f the economic organon : bu t rathe r make use of its aid at every step .. . As thirty years ago a number of men who had never done any solid work for Economics, and knew nothing of its real difficulties , were confidently proclaimin g the solutio n of the most intricate problems b y a few cut-and-dried formulae, so now men of the same class are advocating another shor t cut in the opposite direction . They ar e telling us to discard all theories, and to seek the solution of our economic difficulties in the direct teaching of facts ... The answer is that facts by themselves ar e silent... Experience .. . brings out the impossibility of learning anything from fact s till they are examined and are interpreted b y reason; and teache s tha t th e mos t reckles s an d treacherou s o f al l theorist s i s h e wh o professes to let facts and figures speak for themselves, who keeps in the background the part he has played, perhaps unconsciously, in selecting and grouping them, and in suggesting the argument post hoc ergo propter hoc (165-8). W.J. Ashley, economic historian and an important member of the His torical School , wa s appointe d i n 188 8 as th e first professor o f economic s in th e Universit y of Toronto. I n hi s inaugura l address h e describe d th e 'tendencies i n Englis h economies ' an d particularl y th e 'onslaugh t o n economic orthodoxy not by muddle-headed philanthropists or unscientific men o f letter s bu t b y me n wit h a competen t knowledg e o f economi c literature.' He then affirmed hi s own position . It wil l be evident tha t I regard thes e tendencie s wit h sympathy .. . [bu t I cannot ] agree with thos e wh o should try to disregard the orthodox teachin g altogether .. . indeed, I should go very much further an d even accept mos t of the so-called 'laws ' of rent, wages, profits an d price as hypothetically true - tha t is true under certain conditions, of which the existence of complete competition is the most important. Having mastere d thi s modicu m of abstract theor y - n o difficult tas k - th e most important thing, it seems t o me, is to directly tackle the pressing economic ques tions of the present. The method of investigation in my opinion most fruitful I would call historical, did I not know that the term invites misapprehension .. . The metho d I mean is the method of direct observation and generalisation from facts. 9 This method Ashley put in practice. While at Toronto he published the first volume of his Introduction t o English Economic History and Theory , an d an English edition of Fustel de Coulanges's Origin of Property i n Land. He also inspired, edited and wrote prefaces for several University of Toronto Studies in Political Scienc e o n such subjects as Municipal Monopolies and Their Management, an d The Conditions of Female Labour i n Ontario. At

Alfred Marshall 36 7 this stage Ashley may have had less use for theory than had Marshall, but it is interesting t o compare the kind of work being done by their respective pupils. In 190 4 Marshall wrote to Sydney Chapman to congratulate him on his Cotton Industry an d Work an d Wages', he then referred to Lawrence' s Local Variations in Wages and Pigou's study of Arbitration an d Conciliation. 'I am proud,' he wrote 'of the Cambridge Stables' (456). Ashley delivered another inaugural lecture upon appointment as the first professor o f economi c histor y a t Harvar d University . H e referre d t o Marshall's inaugural lecture as showing 'the dawn of the sun of conciliation ... rather than the present effulgenc e of its noon-tide beams. There reigns just now a spirit of tolerance and mutual charity among political economists such as has not always been found withi n this circle .. . the most abstract sometimes refer to facts and the mos t concrete occasionall y make use of abstraction .. . they are inclined to let others alone who walk not with them or even to cheer them on their way in the benevolent hop e tha t they may arrive at something worth the getting.' In this happy atmosphere economi c historians were getting down to their own work, 'the creation of economic history itself.' So , he concluded, let us 'leave one another severely alone' and, 'i f we have time, let us read one another's books' 10 i i T H E Principles : G E N E R A L C H A R A C T E R I S T I C S * I do not pretend t o summarize or to evaluate this book: m y intention is to try to whet the appetite of my readers so that they may be persuaded to read it, an d rerea d it . Bu t firs t on e mus t war n reader s o f it s misleading superficial appearance. Keynes in the Memorials said : The lac k of emphasis and of strong light and shade , the sedulou s rubbing away of rough edges an d salient s and projections , until wha t is most novel can appea r as trite, allows the reader to pass too easily through. Like a duck leaving water, he can escape fro m thi s douche of ideas with scarc e a wetting . Th e difficultie s ar e concealed; the most ticklish problems are solve d i n footnotes; a pregnant and original judgment i s dresse d u p a s a platitud e .. . I t need s muc h stud y an d independen t thought on the reader's own part, before he can know the half of what is contained in the concealed crevices of that rounded globe of knowledge, which is Marshall's Principles of Economics. l1 * Throughou t the rest of this chapter references in the text are to the variorum edition of the Principles, ed. C.W. Guilleband (1961)

368 Fro m Adam Smith to Maynard Keynes Similarly Pigou wrote: Somebody onc e sai d tha t hi s book wa s writte n as though i t were on e enormou s platitude. I confess that when I read it first many years ago, I thought it was just that ... Th e firs t tim e on e read s th e Principles on e i s ver y ap t t o thin k tha t i t i s all perfectly obvious . The secon d tim e one had glimpses of the fact that one does not understand i t at al l .. . On e discover s a t th e thir d or fourth readin g tha t i n these platitudinous sentence s difficultie s ar e face d an d solve d tha t elsewher e ar e no t perceived a t all or are slurred over .. . When one discovers tha t one did not really know beforehan d everythin g Marshall has to say, one has taken the first step to becoming an economist.M 2 And in another plac e Pigou said: 4 I remember, not once but man y times, getting hold of some problem, and after labouring over it with toil and pain, imagining proudly that I had mad e an original contributio n t o economi c thought. I then turned to Marshall's Principles, an d almost invariabl y in some obscur e footnot e ther e wa s hal f a clause , insid e a parenthesi s perhaps, which made it obvious that Marshall had solved this problem long ago but had not thought it worthwhile to write the answer down.'13 These quotations are intended as a warning that one must work hard when reading the Principles: bu t perhap s the y ma y serv e t o we t th e appetit e o f th e adventurous. Preface to the first edition I have already made some references to the prefaces, but there remains an important discussio n o f the meanin g of 'normal action' a s Marshall conceived it (vi-viii). First, ethics: Attempts have indeed been made to construct an abstract scienc e with regard to the actions of an ^economic man,' who is under no ethical influences and who pursues pecuniary gain warily and energetically, bu t mechanicall y and selfishly . But they have not been successful , no r even thoroughly carried out . For the y hav e neve r really treate d th e economi c ma n as perfectl y selfis h .. . hi s norma l motives have always been tacitl y assumed to includ e the famil y affections . But i f they include these, why should they not include all other altruistic motives the action of which is so far uniform i n any class a t any time or place, tha t it can be reduced to general rule? There seems to be no reason; and in the present book normal action is taken to be that which may be expected under certain conditions ... no attempt is made to exclude the influence of any motives, the action of which is regular, merely because they are altruistic, (vi)

Alfred Marshal l 36 9 Second, sagacity, energy and enterprise. Stress is laid on the fact that there is a continuous gradatio n from the actions of 'city men,' whic h ar e based o n deliberate an d far-reaching calculations , an d are exe cuted wit h vigou r an d ability , to thos e o f ordinary peopl e wh o hav e neithe r th e power no t th e wil l t o conduc t thei r affair s i n a business-lik e way . Th e norma l willingness t o save , th e norma l willingnes s to underg o a certai n exertio n fo r a certain pecuniary reward, or the normal alertness to seek the best markets in which to buy and sell , or to search ou t the most advantageou s occupatio n fo r oneself o r one's children - all these and similar phrases mus t be relative to the members of a particular clas s a t a given place an d time: but, when that is once understood , th e theory o f normal value is applicable t o the actions o f the unbusinesslike classes in the sam e way , thoug h no t wit h th e sam e precisio n o f detail , a s t o thos e o f th e merchant or banker (vi-vii).

Finally, time . As there is no sharp division between conduct which is normal, and that which has to be provisionally neglected a s abnormal, so there is none between normal values and 'current ' o r 'market ' o r 'occasional ' values . Th e latte r ar e thos e value s in which the accidents of the moment exert a preponderating influence; while normal values are thos e whic h would b e ultimately attained, i f the economi c condition s under revie w ha d tim e to wor k ou t undisturbe d thei r ful l effect . Bu t ther e i s n o impassable gul f betwee n thes e two ; the y shad e int o on e anothe r b y continuou s gradations .. . For the element o f Time, whic h is the centre o f the chief difficulty of almost every economic problem , is itself absolutely continuous . Nature know s no absolute partitio n o f time into long periods an d short .. . what is a short perio d fo r one problem is a long period for another. Thus for instance the greater part, though not the whole, of the distinction between Ren t and Interest on capital turns on the length of the period w e have in view. That whic h is rightly regarded a s interest on 'free' or 'floating' capital, or on new investments of capital, is more properly treated as a sort o f rent - a Quasi-rent i t is called belo w - o n old investments of capital (vi-viii).

The notio n of continuity tha t underlie s these propositions led finally to a reference t o the mathematical conceptio n of continuity as represented in Cournot's Principes Mathematiques de la Theorie des Richesses. He taught that it is necessary t o face the difficulty o f regarding the various elements of an economic problem - no t as determining one another in a chain of causation, A

370 Fro m Adam Smith to Maynard Keyne s determining B , B determining c, and so on - bu t a s all mutually determining one another. Nature' s actio n i s complex : an d nothin g is gaine d i n th e lon g ru n b y pretending that it is simple.

Book i: preliminary survey The first of the running heads for pages of the Principles strikes a key note: 'The Urgency o f the Proble m o f Poverty.' (3) In a story o f his early life , quoted by Keynes, Marshall told how he 'saw in a shop window a small oil painting [of a man's face with a strikingly gaunt and wistful expression, a s of one 'down and out'] and bought it for a few shillings. I set it up above th e chimney piece in my room in college and thenceforward called it my patron saint, and devoted myself to trying how to fit men like that for heaven.'14 So in the Principles he wrote: The condition s which surroun d extreme poverty, especially in densely crowded places, ten d t o deade n th e highe r faculties . Thos e wh o hav e bee n calle d th e Residuum o f ou r larg e town s hav e littl e opportunit y fo r friendship ; they kno w nothing of the decencies an d the quiet, and very little even of the unity of family life; and religion often fail s to reach them . No doubt their physical, moral, and mental ill-health i s partly du e to other cause s an d poverty: but thi s is the chief cause .. . Broadly speaking 'the destruction of the poor is their poverty,' and the study of the causes of poverty is the stud y of the cause s o f the degradatio n of a large part of mankind (2-3).

Keynes argue d tha t 'Marshal l wa s to o anxiou s t o d o good' 15 bu t hi s sympathy wa s under th e contro l o f his intellect. Marshal l asserte d 'tha t nearly al l th e founder s o f moder n economic s wer e me n o f gentl e an d sympathetic temper , touche d wit h th e enthusias m o f humanity .. . the y appeared cold , becaus e they woul d no t assum e th e responsibilit y o f advocating rapid advances o n untried paths, for the safety of which the only guarantees offere d wer e the confiden t hopes o f men whose imagination s were eager, but not steadied by knowledge nor disciplined by hard thought' (47-8). I n a manuscrip t quoted b y Pigo u h e wrot e abou t th e dange r of accepting popula r simpl e solution s t o economi c problems . 'Student s of social scienc e mus t fear popular approval: evi l is with them when all men speak wel l of them . . . I t i s almost impossibl e fo r a student t o be a tru e patriot and to have the reputation o f being one in his own time.'16 Because Marshal l wa s s o anxiou s t o d o goo d h e wa s no t conten t t o develop the tools for positive economics: h e was concerned wit h welfare. He therefore tackled head-on the problem of the common sense validity of

Alfred Marshall 37 1 certain welfar e propositions that are not capable of conclusive intellectual validation. The issue was interpersonal comparison of utility. A shilling may measure a greater pleasure (or other satisfaction) at one time than at another even for the same person .. . and persons whos e antecedents are similar, and who are outwardly like one another, are often affecte d i n very different way s by similar events ... It would therefore not be safe to say that any two men with the same income derive equal benefit from its use ... Nevertheless, if we take averages sufficiently broa d t o caus e th e persona l peculiaritie s o f individual s to counter balance one another, the money which people of equal incomes will give to obtain a benefit or avoid an injury is a good measure of the benefit or injury ... Next we must take account of the fact that a stronger incentive will be required to induce a person to pa y a given price fo r anythin g if he i s poor tha n if he i s rich. A shillin g is th e measure of less pleasure, or satisfaction of any kind, to a rich man than to a poor one ... But this source of error also is lessened when we are able to consider the actions and the motives of large groups of people ... By far the greater number of the events with whic h economics deal s affec t i n abou t equa l proportion s all th e differen t classes o f society; so that if the money measures of the happiness caused by two events are equal, it is reasonable and in accordance wit h common usage to regard the amounts of the happiness in the two cases as equivalent (18-20).

It wa s th e expectatio n o f the classica l economists , a s o f Marshall , that increasing wealt h woul d favourably affec t al l classes, but the suggestio n here that it would affect them 'in about equal proportions' is hard to accept. Furthermore, policie s wer e bein g considere d whic h woul d modif y th e proportionate distributio n o f income. Th e commo n sens e cas e for suc h redistribution derives from the proposition that 'a shilling is the measure of less pleasure t o a rich man than to a poor one.' But this point had not been explored. Bookii: some fundamental notions This boo k i s concerne d wit h definition s but mor e interestin g tha n th e particular definition s i s th e discussio n o f th e 'difficultie s o f economi c terminology.' Th e difficult y 'lie s i n makin g shif t wit h a fe w term s i n common use to express a great number of subtle distinctions' (50) . One way out is the construction of a special jargon unrelated to common usage or to historical usag e in the earlier literature of the subject . This wa y out Marshall completely rejected . 'W e must keep constantly i n mind the history of the terms we use ... we should ... keep our use of terms as much as possible in harmony with the traditions of the past; in order that we might be quick to

372 Fro m Adam Smith to Maynard Keynes perceive the indirect hints and subdued warnings, which the experiences of our ancestors offe r fo r our instruction.' A further reason given for eschewing the creation of a new jargon for economics i s that 'its reasonings must be expressed i n language that i s intelligible t o the general public ; i t must therefore conform itself to the familiar terms of everyday life, and so far as possible mus t use them as they are commonly used' (51). Then too there is the 'principle of continuity.' Bold and rigid definitions ... lull the reader int o a false security. Not bein g warned that he must often look to the context fo r a special interpretation clause , he ascribes to what he reads a meaning different from that which the writers ha d in their own minds ... Most of the chief distinction s marke d by economic terms are difference s of opinion a s t o th e exac t place s i n which som e a t least o f the line s o f definition should be drawn. The questions a t issue must in general be solved by judgments as to the practical convenience o f different course s (52-3). Two examples ma y be cited: th e first illustrates hi s unreadiness t o break with historical usage. The balanc e of advantage seems to lie in favour of reserving the term Rent for the income derived from th e free gifts o f nature, whenever the discussio n of business affairs passes from the point of view of the individual to that of society a t large. And for tha t reason , th e ter m Quasi-rent wil l be use d i n the presen t volum e fo r th e income derived from machines and other appliances for production mad e by man ... any particula r machin e ma y yiel d a n incom e whic h i s of the natur e o f rent, an d which i s sometimes calle d a Rent; though on the whole , there seem s t o be som e advantage in calling it a Quasi-rent (74). The second example illustrates his unwillingness to diverge from commo n usage. In purely abstract, an d especially in mathematical reasoning, the terms Capital and Wealth are used as synonymous almost perforce ... But there is a clear tradition that we shoul d speak o f Capital when considering things as agents of production; and that we should speak of Wealth when considering them as results of production, as subjects of consumption, an d as yielding pleasures o f possession .. . At the beginning of this Book it was argued that the economist mus t forego the aid of a complete set of technical terms. He must make the terms in common use serve his purpose in the expressio n o f precis e though t b y th e ai d o f qualifyin g adjective s o r othe r indications in the context. If he arbitrarily assigns a rigid exact use to a word which

Alfred Marshal l 37 3 has several more or less vague uses in the market-place, he confuses businessmen, and he is in some danger of committing himself to untenable positions. The selection of a normal use for such terms as Income and Capital must therefore be tested by actually working with it (81-2).

In Appendix E Marshall discussed furthe r the definition of capital and again argued for a definition 'that will keep realistic economic s i n touch with the market-place' (790). Ill

ON WANTS AND THEIR SATISFACTION (BOOK

III)

Marshall argued that 'new activities give rise to new wants.' 'Although it is man's want s in the earliest stage s o f his development tha t give rise to his activities, ye t afterwards each ne w step upwards is to be regarded a s the development o f new activities givin g rise to new wants, rather than of new wants giving rise to new activities' (89) . The neglect o f this aspect ha d led Jevons t o claim that 'th e Theory o f Consumption is the scientific basis of economics.' (Quoted b y Marshall, 90.) In a footnote Marshall wrote: 'It is unfortunate tha t here a s elsewher e Jevons ' deligh t i n statin g hi s cas e strongly has led him to a conclusion which not only is inaccurate, but does mischief by implying that the older economists were more at fault than they really were. ' Perhaps i t would be only fair t o Jevons t o sugges t tha t th e difference betwee n Marshal l and Jevons o n this matter depends o n their different time horizons. For an explanation of equilibrium prices in the long period, i f th e lengt h o f th e perio d i n cloc k tim e i s no t ver y long , i t i s legitimate t o tak e want s a s give n a s Jevon s did , an d a s fo r al l practica l purposes Marshal l did. But analysis on the basis of this assumption is only safe i n th e hand s o f on e wh o recognize s th e variet y o f influence s im pounded in ceteris paribus. Though Marshal l started from utility, the law of diminishing utility, and marginal utility , he quickl y passed t o th e behaviouristi c concep t o f th e individual deman d schedul e an d deman d curv e an d th e marke t demand schedule an d deman d curve . H e introduce d tw o term s on e o f which , marginal demand price, o r in short for m deman d price, ha s unfortunately gone out of usage; the other, elasticity of demand, has been of great use in a wide variety of problems. Keyne s in the Memorials wrote : 'I n the provision o f terminolog y an d apparatu s t o ai d though t I d o no t thin k tha t Marshall did economists any greater servic e than by the explicit introduction of the idea of'elasticity.' 17 Pigou in his Lectures o n Alfred Marshall and Current Thought devoted the third lecture to 'Elasticities.' He pointed

374 Fro m Adam Smith to Maynard Keynes out that Marshall had been reluctant to use the same concept of elasticity with reference to supply. The principal reason was his recognition that the relations o f price change and quantity change a s regards suppl y ma y be fundamentally different in the long run from what they are in the short run. With referenc e t o demand , however , Marshal l wrote : Those demand s which show high elasticity in the long run show a high elasticity almos t at once; so that, subject to a few exceptions, we may speak of the demand for a commodity as being of a high or low elasticity without specifying how far we are looking ahead!' (456). Marshall was, of course, fully aware that the effects o f price changes on demand may sometimes work themselves ou t slowly, being much more marked in the long run than they are at first. Thus in Industry an d Trade w e read: 'A fall in the fares charged on a tram line or suburban railway will not have exhausted its effect on increasing the traffi c till new houses have been built near one end to accommodate people whose work lies near the other end.' 18 The notio n of elasticity, an d of its measurement , has spread from demand and supply, to many other areas, elasticity o f substitution, elasticit y o f expectations, etc . T o pric e elasticit y of demand w e hav e adde d 'incom e elasticity, ' an d b y th e us e o f cross elasticities hav e moved a little beyond the narrowest partia l equilibrium analysis. The chapter on the 'choice between different uses of the same thing' is very similar to the parallel sections of Jevons. The 'primitive housewife' is a memorable figure, as is that 'clerk who is in doubt whether to ride to town, or t o wal k an d hav e som e littl e extr a indulgenc e a t hi s lunch. ' Bu t Marshall's footnote takes one further afield. 'The vital problems of domestic economy relate as much to wise action as to wise spending. The English and the American housewife make limited means go a less way towards satisfying wants than the French housewife does, not because they do not know ho w t o buy , bu t becaus e the y canno t produc e a s goo d finished commodities out of the raw materials of inexpensive joints, vegetables, etc. as she can' (ii9n.). The treatmen t o f th e choic e betwee n presen t an d futur e benefit s is generally similar to Jevons, but has more qualifications. We cannot compare the quantities of two benefits, whic h are enjoyed a t differen t times even by the same person. When a person postpones a pleasure-giving event he does not postpone the pleasure; but he gives up a present pleasure and takes in its place another, or an expectation of getting another at a future date; and we cannot tell whether he expects the future pleasur e to be greater than the one which he is giving up, unless we know all the circumstances of the case (121).

Alfred Marshall 37 5 Does he expect to be 'about as rich at the future date as he is now' ? Does he expect 'that his capacity for deriving benefit from the things which money will buy will on the whole remain unchanged'? Once tota l utilit y an d margina l utilit y ha d bee n distinguishe d i t wa s inevitable tha t the conception o f consumers surplu s should develop. Th e very diagra m o f diminishin g utilit y an d diminishin g return s sugges t a n analogy between consumer's rent (surplus) and producer's rent. There is a certain common sense in the argument that 'the excess of the price which he would be willing to pay rather than go without the thing, over that which he actually does pay, is the economic measure of this surplus satisfaction' (124). But Marshall was quite clear about some of the limitations. 'Our list of demand prices i s .. . highl y conjectural excep t i n the neighbourhood of the customary price' (133). The deman d prices, further , 'assum e that all other things remain equal, while its price rises to scarcity value: and when the total utilities of two commodities which contribute to the same purpose are calculated o n this plan, we cannot say that the total utility of the two is equal to the sum of the total utilities of each separately ' (131). He furthe r explained this difficulty i n a footnote: If tea wer e inaccessible, people woul d increas e their consumption of coffee, an d vice versa. The los s that people would suffe r fro m bein g deprived both of tea and coffee woul d be greater than the sum of their losses from bein g deprived of either alone: and therefore the total utility of tea and coffee i s greater than the sum of the total utility of tea calculated on the suppositio n that people can have recourse to coffee, and that of coffee calculated on a like supposition as to tea. (131 n.)

The selectio n o f te a an d coffee , o n whic h a relativel y smal l par t o f a person's income is spent, as examples bypassed another objection, namely the increasin g marginal utility of money as mor e of it is absorbed i n th e purchase of the one commodity under consideration. Marshall , however, did note the exceptional 'Giffen' cas e of bread: 'a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat... and, bread being still the cheapest food they can get and will take, they consume more and not less of it' (132). He dismissed such cases as rare, an d generally took his examples from suc h commodities a s absorbe d a n insignifican t proportio n o f the individual' s income. Finally , h e recognize d th e differenc e betwee n individuals , but argued, as he had done earlier, that these differences cancelled ou t in the average behaviou r o f large numbers . H e wa s prepare d 't o measur e th e

376 Fro m Adam Smith to Maynard Keynes surplus satisfactio n whic h th e sal e o f te a affords , say , i n th e Londo n market, b y th e aggregat e o f the sum s b y whic h th e price s show n i n a complete list of demand prices for tea exceeds its selling price' (128). Book i n end s wit h som e philosophica l discussio n o f th e relatio n o f well-being to material wealth. Marshall drew attention to those who believe that 'real riches consist not in the abundance of goods but in the paucity of wants,' an d t o thos e wh o suppos e tha t 'lif e i s fo r working , instea d o f working for life.' His own view was that' man rapidly degenerates unless he has som e hard wor k to do , som e difficulties t o overcome ' an d that 'fo r ordinary peopl e .. . a moderat e incom e earne d b y moderat e an d fairl y steady wor k offers th e best opportunity for the growth of these habits of body, min d and spirit in which alone ther e i s true happiness.' This Victorian moralising concludes with the exhortation: 'Whe n the necessaries of life ar e onc e provided , everyon e shoul d see k t o increas e th e beaut y of things in his possession rather than their number or their magnificence ... The world would go much better if everyone would buy fewer and simpler things, and would take trouble in selecting them for their real beauty ... But we are exceeding the proper scope of the present Book' (136-7). Perhap s he was exceeding the proper scope of economics; but surely not the proper scope of the thoughts and worries of economists as whole men. IV

THE AGENTS OF PRODUCTION (BOOK IV)

Book iv is primarily an examination of the Malthusian thesis. Marshall' s expectation o f continue d populatio n growt h wa s no t unreasonable : h e could no t forese e th e dramati c chang e i n fertility rate s whic h wa s just beginning. Bu t it does see m odd now to read tha t 'ever y increase in the physical, menta l and mora l vigour of a people make s them more likely, other thing s being equal, to rear to adult age a large number of vigorous children' (314). A larger proportion of those born, yes; but a larger number born, surely not. Marshall accepted th e Malthusian-Millia n doctrine o f 'diminishing returns' i n agriculture, but was careful t o examine the 'othe r things' which were held equal. Of Ricardo he wrote: 'He could not anticipate th e great series o f Inventions which were about to open up new sources o f supply, and, with the aid of free trade, to revolutionize Englis h agriculture' (163). Now tha t th e Malthusia n thesi s take s o n a new relevance i n the Thir d World, one may criticize this very narrow English approach, but Marshall could not anticipate th e world population explosio n o f the mid-twentiet h century. I n th e contex t o f Worl d populatio n i t i s th e improvemen t of

Alfred Marshall 37 7 agricultural technology that becomes of supreme importance and, perhaps of equa l importance , th e diffusio n o f tha t technology . Marshal l wrote : 'Very likely those are right who maintain that if all English farmers were as able, wise, and energetic as the best are, they might profitably apply twice the capital and labour that is now applied ... they might get seven hundredweight of produce for every four that they now get: - it is conceivable tha t with still more improved methods they might get eight hundredweight, or even more' (152). The tendency to diminishing returns, however, is seen to reassert itsel f afte r each change in the 'other things,' but still other things may delay the operation of the tendency and even temporarily reverse it . So th e Malthusia n pessimis m persisted : 'Whateve r ma y b e th e futur e developments of the arts of agriculture, a continued increase in the application of capital and labour to land must ultimately result in a diminution of the extra produce which can be obtained by a given extra amount of capital and labour'(153). In a 'Not e o n the La w o f Diminishing Return' (169-72 ) Marshal l explored in a preliminary way the extension of the concept to cover the general problem o f the 'economi c distributio n of economic resource s i n the in vestment of capital.' The concept of variable proportions became explicit, and the distribution of the expenditures of the entrepreneur between differ ent factor s o f production wa s see n t o paralle l th e distributio n o f woo l between the different need s of a family b y the 'primitiv e housewife.' Bu t Marshall emphasized the special nature of the problem in agriculture. First: 'If th e natio n as a whole finds its stoc k o f planing machines, or ploughs inappropriattely larg e o r inappropriately small , it can redistribut e it s resources. It can obtain more of that in which it is deficient, while gradually lessening its stoc k o f such things as are superabundant : but it cannot do that i n regard t o land', i t ca n cultivat e it s lan d mor e intensively , but i t cannot ge t an y more ' (170) . Second , eve n fo r th e individua l farmer th e conditions of tenure and the nature of the market for land meant that land could not be taken as a continuously variable input by small doses. Following these Malthusian chapters Marshall proceeded to discuss the principal causes o f that increasing productivit y whic h had taken, fo r the time bein g and fo r som e tim e t o come , th e stin g out o f the Malthusian doctrine. First , th e improvement of people. 'The progress o f knowledge, and in particular of medical science, the ever-growing activity and wisdom of Government in all matters relating to health, and the increase of material wealth, all tend to lessen mortality and to increase health and strength, and to lengthe n life ' (203) . There was , then , a cumulativ e process a t work , higher productivity pe r ma n provide d a n improve d standar d o f living ,

378 Fro m Adam Smith to Maynard Keynes which in turn increased stil l further productivity pe r man. But there was danger tha t increase d urbanizatio n migh t offset th e advantag e o f highe r wages, so Marshall argued that 'there is no better use of public and private money tha n i n providing publi c park s an d playgrounds i n large cities , in contracting wit h railways to increase the number of workmen's train s run by them , an d in helping thos e of the workin g classes who are willin g t o leave the large towns to do so, and to take their industries with them' (200). Next t o improvemen t i n health and vigour cam e education , genera l an d technical. He was concerned no t only with its quantity but also its character. The absence of a careful general education for the children of the working classes, has been hardly less detrimental to industrial progress than the narrow range of the old grammar-school education of the middle classes .. . The time spent on learning to spell is almost wasted: if spelling and pronunciation are brought into harmony in the English language as in most others about a year will be added to the effectiv e school education without any additional cost (208 n.).

From genera l educatio n h e went o n to technical education . H e wa s not content wit h simple training in manual dexterity o r in the performance of some particular task : 'technica l education .. . shoul d kee p th e ai m of developing the faculties almost a s constantly befor e it as general educatio n does' (209) . Marshall referre d t o the theme o f technical education whe n discussing th e threat s t o Britain' s industria l leadershi p i n Industry an d Trade. I n th e Principles h e referre d t o th e 'excellenc e o f the commo n schools of the Americans' an d the 'diffusion o f scientific knowledge among the middle and even the working classes o f Germany' (211). He noted one element of superiority i n the English an d Americans over the better edu cated Germans : the y 'hav e acquire d i n actua l busines s th e facult y o f rejecting intricacies in machinery and processes, which are not worth what they cost, and practical instinc t of this kind often enables them to succee d in competitio n wit h Continenta l rival s wh o ar e muc h bette r educated ' (209 n.). I close this discussion o f education wit h this manifesto: 'There is no extravagance more prejudicial to the growth of national wealth than that wasteful negligenc e which allows genius that happens to be born of lowly parentage to expend itself in lowly work' (212). To which should be added: The wisdo m of expendin g public an d privat e funds o n educatio n i s no t t o b e measured by its direct fruits alone. It will be profitable as a mere investment, to give the masses of the people much greater opportunities than they can generally avail

Alfred Marshall 379 themselves of. For by this means many who would have died unknown, are enabled to get the start needed for bringing out their latent abilities. And the economic value of one great industrial genius is sufficient to cover the expenses of the education of a whole town; for one new idea, such as Bessemer's chief invention, adds as much to England's productive power as the labour of a hundred thousand men. Less direct, but no t less in importance, is the aid given to production by medical discoveries such as those of Jenner or Pasteur, which increase our health and working power; and agai n by scientifi c wor k such as mathematics or biology, even though many generations may pass away before it bears visible fruit in greater material wellbeing (216).

Next to the improvement of the people a s a cause of increased produc tivity comes the accumulation of capital. In the chapter on the 'growth of wealth' Marshall was more concerned wit h the basic causes of accumulation tha n with the influence of the rate of interest. Th e accumulatio n of wealth is governed b y a variety o f causes: by custom, by habits of self control .. . an d abov e al l by th e powe r o f family affection . Securit y i s a necessary conditio n for it.' But he did recognize tha t ' a rise in the rate of interest offere d fo r capital, i.e . in the demand price fo r saving , tends t o increase the volum e of saving.' H e also recognized th e influenc e of the distribution of income on the volume of saving but he argued: 'th e older economists went too far in suggesting that a rise in interest (or profits) at the expense o f wages always increased th e power of saving: they forgot that from the national point of view the investment of wealth in the child of the working man is as productive a s its investment in horses o r machinery ' (236). He had already noted that 'every increase in the arts of production, and in the capital accumulated ... increased th e surplus out of which more wealth could be accumulated' (224). In the Introduction to Book iv, Marshall said: 'Capital consists in a great part o f knowledge and Organization .. . Knowledge is our most powerful engine of production ... Organization aids knowledge '(138). The relevance of al l thi s t o th e Malthusia n problem i s no t onl y tha t i t i s th e basi s o f increased productivit y pe r ma n wit h an y give n population , bu t tha t i t directs attentio n t o th e possibilit y o f increasin g return s rathe r tha n diminishing returns as population grows . If the y [th e English ] ca n fo r a tim e escap e fro m th e pressur e o f th e la w o f diminishing returns by importing food an d ra w produce on easy terms ... every increase in their numbers is likely/or th e time to be accompanied by a more than proportionate increase in their power of obtaining material goods. Fo r i t enables

380 Fro m Adam Smith to Maynard Keynes them t o secur e th e man y variou s economies o f specialised skil l and specialise d machinery, of localised industrie s and production on a large scale; it enables the m to have increased facilities of communication of all kinds; while the very closeness of their neighbourhood diminishes the expense of time and effort involved in every sort o f traffic betwee n them, and give s them new opportunities o f getting socia l enjoyments an d th e comfort s an d luxurie s of cultur e i n ever y form . N o doub t deduction must be made for the growing difficulty o f finding solitude and quiet and even fresh air: but there is in most cases some balance of good (320-1).

This i s a very nationalistic Englis h view: one might consider th e interna tional externalities, th e effec t o n the productivit y o f the relativel y smal l nation from being part of a large community of nations. So far I have been discussing the concepts of diminishing and increasing return in relation to the problem of increasing population; but Marshall also discussed thes e concept s in relation t o the individual firm and develope d two important elements for the theory of value and distribution o f Books v and vi, viz. the concept o f substitution a t the margin, and the concept of internal and external economie s o f large-scale production . Th e first was introduced in the 'Note on the Law of Diminishing Return' (169-72) which I hav e discusse d above . Her e le t m e simpl y not e th e us e o f the wor d 'substitution,' an d the referenc e t o the proble m o f 'maximization.' I n a footnote, Marshall said that the business man 'will make a large use of what is called below, 'Substitution,' of more for less appropriate means.' And in another footnot e h e said : 'Th e tendencies o f diminishing utility an d diminishing returns have their roots, the one in qualities of human nature, the other i n the technica l condition s o f industry, bu t th e distributio n o f re sources, t o whic h the y point , ar e governe d b y exactl y simila r laws . I n mathematical phrase, the problems in maxima and minima to which they give rise are expressed by the same general equations.' The distinction between internal and external economies is developed in the course o f his investigation o f the economies o f large-scale productio n through ful l utilizatio n o f specialize d labou r an d specialize d machines . This was familiar ground, but at the end he broke new ground. Many of those economies in the us e of specialised skill and machinery which ar e commonly regarded as within the reach of very large establishments do not depend on th e siz e o f individua l factories . Som e depen d o n th e aggregat e volum e o f production of the kin d in the neighbourhood; while others again, especially those connected wit h th e growt h of knowledg e and th e progres s o f th e arts , depend chiefly on the aggregate volume of production in the whole civilized world. And we

Alfred Marshall 38 1 may introduce two technical terms. We may divide the economies arising from a n increase i n the scale of production of any kind of goods into two classes - firstly , those dependent on the general development of the industry; and secondly, thos e dependent on the resources of the individual houses of business engaged in it, on their organization and the efficiency o f their management. We may call the forme r external economies, and the latter internal economies (265-6).

He the n proceede d t o examin e th e externa l economie s 'secure d b y th e concentration o f many small businesses o f a similar character i n particular localities.' This nove l concept ha s proved t o be of very great us e in later economic analysis , and the more general concep t o f 'externalities' which grew out of it has proved immensely fruitful i n 'welfare' economics . V

G E N E R A L R E L A T I O N S OF D E M A N D , SUPPLY, AND VALUE (BOOK V)

Book v contains the core of Marshallian pure theory. Selectio n o f characteristic elements is very difficult, but there is a dominant theme in the book which give s som e unit y t o th e scattere d passage s whic h I quot e an d discuss. Th e them e i s 'th e grea t importanc e o f th e elemen t o f tim e in relation to demand and supply' (347). Marshall referred to the controversy as to whether cost of production or utility governs value and introduced the famous metaphor of the scissors. 'We might as reasonably dispute whether it is the upper o r the under blade o f a pair of scissors tha t cuts a piece of paper, as whether value is governed by utility or cost of production' (348). After some discussion of particular cases he concluded: "As a general rule, the shorte r th e period whic h we are considering, th e greater mus t be the share of our attention which is given to the influence of demand on value; and the longer the period the more important will be the influence of cost of production' (348-9). In the 'Stationar y state' there woul d be no place for the distinction betwee n lon g and short periods , bu t the conditions o f the Stationary state are too unreal for Marshall. Every economic force is constantly changing its action, under the influence of other forces which are acting around it. Here changes in the volume of production, in its methods, and in its cost are ever mutually modifying one another; they are always affecting an d being affected b y the character and the extent of demand. Further all these mutual influence s tak e time to work themselves out, and, as a rule, no two influences mov e a t equa l pace . I n thi s worl d therefor e ever y plai n an d simpl e doctrine a s t o th e relation s betwee n cos t o f production , deman d an d valu e i s

382 Fro m Adam Smith to Maynard Keyne s necessarily false; and the greater the appearance o f lucidity which is given to it by skilful exposition , th e mor e mischievou s i t is . A ma n i s likel y t o b e a bette r economist i f he trust s t o hi s commo n sense , an d practica l instincts , tha n i f h e professes to study the theory of value and is resolved to find it easy (368).

Yet there mus t be methods o f simplification in order to make progress is understanding th e comple x syste m o f th e 'interactio n o f countles s economic causes. ' Th e metho d Marshal l adopte d wa s th e 'statica l method.' In the stationary state all the conditions of production and consumption are reduced to rest ; bu t les s violen t assumptions are mad e by wha t is , no t quit e accurately , called the statical method. By that method we fix our minds on some central point; we suppos e i t for the tim e being to be reduced to a stationary state ; an d we then study in relation to it the forces that affect th e things by which it is surrounded, and any tendency there may be to equilibrium of these forces. A number of these partial studies may lead the way towards a solution of problems too difficult t o be grasped at one effort (369).

This attitud e i s consisten t wit h hi s othe r decisio n t o pursu e particula r equilibrium theory in the text even though he presented in the mathemati cal appendi x a picture o f general equilibrium . Th e simplification s o f the statical metho d an d of particular equilibriu m ar e only saf e when used b y economists wit h somethin g o f Marshall' s understandin g o f the dynami c character o f the economic proces s and the complex interdependence an d interaction of all the quantities involved. To dea l with these problem s o f time Marshall introduced th e notion of the lon g and shor t period s an d gav e clea r basi s o n whic h to distinguis h these periods . Discussin g the market for fish, he distinguished the day-today market in which the supply must be taken as given; the 'short period' market i n which th e stoc k o f equipment an d th e numbe r of fisherme n i s given, subject t o the possibilit y o f renovating ol d fishing boats, adaptin g inappropriate ones , an d inducing retired fishermen to return to work; and the long period i n which new equipment and newly trained fishermen will be attracte d int o th e industry . I n th e day-to-da y marke t a n increas e in demand will increase th e price; in the short run 'an increase in the amount demanded raises the normal supply price' (370). What then of the long run? Will an increased suppl y be available at constant, increasing, or decreasing cost?

Alfred Marshal l 38 3 The sourc e o f supply in the se a migh t perhaps sho w sign s of exhaustion, and th e fishermen migh t have to resort to more distant coasts and to deeper water s .. . On the other hand, those might turn out to be right who think that man is responsible for but a very small part of the destruction offish that is constantly going on; and in that case a boa t startin g wit h equall y goo d appliance s an d a n equall y efficien t cre w would be likely to get nearly as good a haul after the increase i n the total volume of the fishing trade as before. In any case the normal cost of equipping a good boat with an efficient cre w would certainly not be higher, and probably be a little lower after the trade ha d settled dow n to its now increased dimension s than before. Fo r since fishermen require only trained aptitudes, and not any exceptional natural qualities, their number could be increased in less than a generation to almost any extent that was necessary t o mee t th e demand ; while the industrie s connected wit h buildin g boats, makin g nets, etc . being no w o n a large r scal e woul d b e organise d mor e thoroughly and economically (371). Marshall followed this example from th e fish market by a general state ment, but before quotin g parts of it I mus t revert to an earlier chapte r in which he introduced th e concepts of'prime' and 'supplementary' costs. Supplementary cost s ar e take n t o includ e standin g charges o n accoun t o f th e durable plant in which much of the capital o f the busines s has been invested , and also the salaries of the upper employees ... There remain s nothing but the (money) cost of the raw materials ... and the wages of that part of the labour spent on it which is paid by the hou r or the piec e an d the extr a wea r an d tear of plant. This i s the special cos t whic h a manufacture r ha s i n vie w whe n hi s work s ar e no t full y employed, and he is calculating the lowest price at which it will be worth his while to accept a n order, irrespective o f an y effect that hi s action ma y have i n spoiling th e market for future orders [m y italics], and trade being slack at the time ... The price at which it is just worth his while to produce, even when trade is slack, is in practice generally a good deal above this prime cost (360). In a footnot e Marshal l note d th e relationshi p betwee n thi s concep t o f supplementary costs and the concept of'quasi-rent.' 'Th e supplementary costs, which the owner of a factory expects to be able to add to the prime costs of its products are the source of the quasi-rents which it will yield him. If they come u p to hi s expectations, the n his business so far yield s good profits' (36 2 n.). The distinctio n betwee n prim e and supplementary cost s and the concept of quasi-rent ar e relevant onl y to the short period, but , of course, ther e i s 'no hard an d shar p lin e of division between "long " and

384 Fro m Adam Smith to Maynard Keynes "short" periods ' an d ther e i s therefor e n o har d an d shar p distinctio n between what must be included in prime or in supplementary costs. Now, wit h these terms i n mind, I return t o the general treatment that follows the discussion o f the particular exampl e offish. 'Marke t values are governed b y the relation o f demand to stocks actuall y i n the market; with more or less reference t o 'future' supplies , and not without some influence of trade combinations' (372) . Notice ho w the simple statement i s qualified; and notic e particularl y th e reference t o combination. I t mus t be remem bered, afte r ou r lon g indoctrinatio n i n th e precis e definitio n o f perfec t competition, tha t Marshal l wa s no t discussin g a hypothetica l worl d o f perfect competitio n bu t a real world of'much competition.' (341) Remembering this will make it easier to understand his introduction o f the notion of 'spoiling the market.' For short periods people take the stock of appliances for production as practically fixed; and they are governed by their expectations of demand in considering how actively they shall set themselves to work those appliances ... The immediate effect of the expectatio n of a high price is to cause peopl e t o bring into active work all their appliances of production, and to work them full time and perhaps overtime ... The immediate effect o f the expectation of a low price is to throw many appliances for production out of work, and slacken the work of others; and if the producers had no fear of spoiling their markets, it would be worth their while to produce for a time at any price that covered the prime costs of production and rewarded them for their trouble. But , as it is, they generally hold out for a higher price; each ma n fears to spoil his chance of getting a better price later on from hi s own customers; or, i f he produces for a larg e and ope n market , he i s more or les s i n fear o f incurring th e resentment of other producers, should h e sell needlessly at a price that spoils the common market for all ... General opinion is not altogether hostile to that code of morality which condemns the action of anyone who 'spoils the market' by being too ready to accept a price that does little more than cover the prime cost of his goods (374-5)-

Marshall sa w that the individua l firms that he was discussing might have their own particular market s withi n which their demand curves migh t be very steep. Only by assuming such particular markets could one avoid the proposition tha t an y fir m tha t go t a goo d star t i n a n industr y enjoyin g increasing returns would obtain a monopoly of the whole business. He also saw tha t suc h a firm would 'often tr y t o sel l som e o f hi s surplu s goods outside of his own particular market at prices that do little more than cover their prime costs: while within that market he still tries to sell at prices that

Alfred Marshal l 38 5 nearly cove r supplementary costs ' (458). To a later generation i t would be hard to accept these conditions as consonant wit h the basic assumption of competition. Bu t Marshall wa s not only not discussing 'perfect ' competi tion, he was also not advocating perfect competition. H e discussed th e case of 'much competition,' and he was content as long as there was 'much. ' The problem, o f course, is, how much is enough? In a footnote Marshal l stresse d the complication o f the problem o f the long period, but still defended th e simplification. Of course th e period s require d to adap t th e severa l factor s o f production to th e demand ma y b e ver y different ; th e numbe r of skille d compositors , fo r instance, cannot be increased nearl y as fast as the supply of type and printing-presses ... But in fact a theoretically perfect long period mus t give time enough to enable not only the factors o f production of the commodity to be adjusted to the demand, but also the factors o f production of those factor s o f production to be adjusted, and s o on (379 n.)-

This led him to remind his readers that while the method of'partial or total isolation fo r special study of some set of relations' with the assumption that the othe r forces woul d remai n inactive , whe n applied t o problems o f the short period involved 'no great violence' : violence i s require d fo r keepin g broad force s i n th e poun d of Caeteris Parihus during, say, a whole generation. But an answer may be given here to the objection that sinc e 'th e economic worl d is subject to continua l changes , an d i s becoming more complex ... the longer the run the more hopeless the rectification 1; s o that to speak of that position which value tends to reach in the long run is to treat 'variables as constants'... It is true that we do treat variables provisionally a s constants. But it is tru e tha t thi s i s th e onl y metho d b y whic h scienc e ha s eve r mad e an y grea t progress in dealing with complex and changefu l matter , whether in the physical or moral world (380 n.).

The nature of cost, and the pervasiveness o f the rent element, is further explored i n Chapter s ix , x , an d xi . Th e basi c proble m i s explore d b y examining th e incidenc e o f taxatio n i n variou s cases . Firs t ther e i s th e parable o f the meteoric stones . Let u s suppos e tha t a meteori c showe r o f a fe w thousan d stone s harde r than diamonds fell in one place; so that they were all picked up at once, and no amount of

386 Fro m Adam Smith to Maynard Keynes search coul d fin d an y more . Thes e stones , abl e t o cu t ever y material , woul d revolutionize man y branche s of industry; and th e owner s of them would have a differential advantag e in production, that would afford a large producer's surplus. This surplus would be governed wholly by the urgency and volume of the demand for thei r services on the one hand and the number of stones o n the other hand : it could not be affected b y the cost of obtaining a further supply , because none could be had at any price ... Next let us suppose that the stones were not all found at once but wer e scattere d ove r th e surfac e o f th e eart h o n publi c ground , and tha t a laborious search might expect to be rewarded by finding one here and there. Then people would hunt for th e stone s onl y up t o tha t point, or margin , at whic h the probable gain of doing so would in the long run just reward the outlay of labour and capital involved... Finally, let us bring the case of the stones into accord with that of the lighter machinery and other plant ordinarily used in manufacture, by supposing that th e stone s were brittle, and were soon destroyed, an d that an inexhaustible store existe d fro m whic h additional supplies coul d b e obtaine d quickl y and cer tainly a t a nearl y unifor m cos t .. . variation s in deman d woul d hav e bu t littl e influence on their price ... the income derived from a stone (allowance being made for wea r and tear) would always adhere closely to interest on its cost of production (415-18).

The serie s o f hypotheses ca n be multiplied and show a continuous grada tion from the 'one extreme in which the income derived from the stones is a rent i n the strictes t sense of the term, to the other extrem e i n which it is classed rather with interest on free or floating capital' (418). Marshall then considered th e effect s of a uniform tax o n the stone s collected fro m th e user. I n th e on e extrem e cas e th e ta x 'wil l no t affec t thei r distributio n between several uses; and will fall wholly on the owner, after perhaps som e frictional dela y cause d b y frictiona l resistanc e t o readjustments ' (419) . Note her e a s throughout ho w Marshall qualifie s the simpl e statements o f pure theor y t o remin d u s o f th e complication s o f reality . A t th e othe r extreme th e suppl y ca n adjust s o quickly to change s i n the deman d tha t their 'services can never yield much more or much less than normal interest on the money cost of obtaining them .. . A tax on the stones under these conditions woul d fall entirely on anyone who, even a little while after th e tax had come into force, gave out a contract fo r anything in making which the stones would be used.' (419) Between the two extremes are cases where the long- and short-run effects must be distinguished, and where the length in clocktime o f the short ru n in the economic sens e must be estimated fo r each case . Th e tim e neede d fo r readjustmen t ma y b e lon g 'an d i n th e interval a great par t of the tax would fall upon the owners o f the stones.'

Alfred Marshall 38 7 (420) At the risk of undue repetition, but having in mind Marshall's reiteration of the argument, I quote from the footnote at the end of this chapter . The man y misconception s tha t hav e appeare d i n th e writing s eve n o f th e economists a s t o th e natur e o f a quasi-rent , see m t o aris e fro m a n inadequat e attention to the differenc e betwee n short periods and lon g in regard to value and cost. Thus it has been said that a quasi-rent is an 'unnecessary profit' an d that it is 'no part of cost.' Quasi-rent is correctly described as an unnecessary profit in regard to short periods, because n o 'special' or 'prime' costs have to be incurred for the production o f a machine that, by hypothesis , is already made and waitin g for it s work. Bu t it is a necessary profi t i n regard t o thos e othe r (supplementary ) costs which must be incurred in the long run ... It is no part of cost under any conditions: but the confident expectation of coming quasi-rents is a necessary condition for the investment o f capital in machinery, and fo r th e incurrin g of supplementary cost s generally (424).

From meteori c stone s Marshal l proceede d i n Chapter x t o dea l wit h 'marginal cost s i n relatio n t o agricultura l values ' an d i n Chapte r x i t o 'marginal costs i n relation to urban values.' Once agai n discussion of the effect of a tax is used to illustrate the nature of the problems involved. The simple proposition that a tax on corn, let us say, will be borne by the owner and will not affect th e consumer i s qualified by reference to the possibility that it might discourage capital investment, 'the erection of farm buildings,' and thu s reduc e productio n an d shif t som e o f the ta x forwar d ont o th e consumers. 'But a tax on that part of the (annual) value of the land, which arises from its position, its extension, its yearly income of sunlight and heat and air and rain, cannot settl e anywher e except on the landlord: a lessee being, of course, landlor d for the time' (433). This, as in Ricardo, applies to 'specific' land, or land in all uses. Marshall then dealt, as had Adam Smith, with taxatio n o f particular products o f land, e.g . hops . 'Th e farmer can evade a par t o f the pressur e o f the ta x b y lessenin g th e intensit y of his cultivation of the land which he plants with hops; and yet a further part by substituting another crop on land which he had proposed t o devote to hops ... The tendency towards a general restriction in the supply of hops would tend to raise thei r price. If the demand for them were ver y rigid, and the hops o f adequate quantit y could no t easily be imported from beyon d th e range of this special tax, the price might rise by nearly the full amount of the tax' (437) . I n a footnote , h e rejecte d th e applicatio n o f th e notio n o f 'opportunity cost' as developed i n the second editio n of Jevons. Partl y he seemed t o expect discontinuity . 'If for instance he reckoned tha t he could

388 Fro m Adam Smith to Maynard Keynes get a surplus of £30 above his expenses (other than rent) in spite of the tax by growing hops, an d a surplus of £20 above simila r expenses b y growing any other crop, it could not be truly said that the rent which the field could be made to yield by growing other crops, "entered into" the marginal price of hops' (436, n.). This problem is now handled by considering the 'rent' in one us e a s th e surplu s ove r th e earning s possibl e i n th e nex t mos t re munerative use. His other objection seem s to be to the argument in terms of prices rathe r tha n to the basic proble m o f supply. 'Whe n land capable of being used for producing one commodity is used for producing another, th e price o f th e firs t i s raise d b y th e consequen t limitatio n o f it s fiel d o f production' (437 , n.). Having examined the 'relation in which cost of production stands to the income derive d fro m th e "origina l powers" o f land .. . an d als o t o tha t which is directly du e to th e investmen t o f private capital ' Marshal l pro ceeded t o tha t whic h i s th e 'indirect resul t o f th e genera l progres s o f society' (441) . Thi s h e examine d wit h specia l referenc e t o urba n sites . Generally 'situation value is "public value".' But he noted cases where the increase o f site value was due t o deliberat e investmen t of capital for th e purpose of raising that value. When, for instance, Mr Salt and Mr Pullman determined to take their factories into the countr y and to found Saltair e an d Pullman City, they foresaw that th e land, which they could purchase at its value for agricultural purposes, would obtain the special situation value which town property derives from the immediate neighbourhood of a dense population. And similar considerations have influenced those, who, having fixed upon a site adapted by nature to become a favourite watering-place, have bought the land and spent large sums in developing its resources: they have been willing to wait long for any net income from their investment in the hope that ultimately thei r land would derive a hig h situation valu e from th e concours e o f people attracted to it (442-3).

In a footnote he gave Saltburn an d Letchworth Garden Cit y as examples. Another instanc e o f special interes t t o Canadians i s investment i n a railway: The net traffic receipt s of which are not expected to pay any considerable interest on the capital invested in making it; but which will greatly raise the value of their land. In such cases part of the increase of their incomes as land-owners ought to be regarded as profits on capital which they have invested in the improvement of their land: though the capital has gone towards making a railway instead of being applied directly to their own property (444).

Alfred Marshall 389 The problem s o f taxation of site value Marshall relegated to Appendix G. One quotation seem s eminently justified i n relation t o our contemporary worries. Caution i s necessary . Bu t th e caus e o f hig h sit e value s is that concentration of population, which is threatening a scarcity of fresh ai r and ligh t and playroom so grievous as to lower the vigour and the joyousness of the rising generation. Thus rich privat e gains accrue, no t merel y through causes that are publi c rather than private in their character, but also are at the expense of one of the chief forms of public wealth. (803)

He argued for a 'fresh air rate' to be levied on 'site value,' to be spent by the local authority to 'secure air and light and playroom.' I now revert to the chapter on 'Joint and Composite Demand, Joint and Composite Supply.' In Book in Marshall had discussed consumer demand, here he was concerned with producer demand. He saw that the demand for raw materials and all the means of production was 'derived from the direct demand fo r those directl y serviceabl e product s whic h they help to pro duce.' H e also sa w that the 'deman d for each o f several complementary things is derived from the services which they jointly rende r in the production of some ultimate product' (381) . Marshall then noted the conditions under which a check to the supply of some factor of production may cause a very great rise in its price, or under which plasters, let us say, would be in the strongest position in bargaining. First, the factor must be nearly essential, with no good substitut e being available at a moderate price. Second , the demand for the commodit y in the productio n which it is a necessary factor shoul d be inelastic. Third , the expenditure on this factor must be a small part o f the total expenditure. Fourth, th e suppl y price of the other factors mus t be elastic. H e then noted th e 'moderatin g influence' which might b e expecte d t o chec k th e ris e i n th e pric e o f thi s factor, e.g. , i n plasters' wages, viz. substitution. 'The tyranny, which one factor of production of a commodity might in some cases exercise over the other factors ... is tempered by the principle of substitution ... Some plasters' labour may be indispensable; but people are often i n doubt how much plaster work is worth-while to have in their houses, and if there is a rise in its price they will have less of it' (386). Turning to joint supply Marshall had little to add to the excellent treatment of Adam Smith, except for diagrammatic exposition in the footnote on page 389; and the recognition that the proportions in which joint products are supplied can in the very long run be varied. In Chapte r xm Marshal l developed som e propositions wit h regard t o 'maximum satisfaction.' I shall not give his detailed argumen t but simply

390 Fro m Adam Smith to Maynard Keynes draw attention to the proposal to tax the diminishing return industries and to subsidize the increasing return industries. The argument was in terms of consumer's surplu s whic h I find hard t o accept . Furthe r h e warne d his readers that they would have to reckon u p the direct and indirect cost s of collecting a tax and administering a bounty; the difficulty o f securing that the burdens of the tax and the benefits o f th e bount y wer e equitabl y distributed ; th e opening s fo r frau d an d corruption: and the danger that in the trade which had got a bounty ... people would divert their energies fro m managin g their own businesses t o managing those persons who control the bounties (473). There were other limitations to the general doctrine that maximum satisfaction is generally to be obtained by encouraging each individual to spend his own resources in that way which suits him best. It is clear that if he spends his income in such a way as to increase the demand for the services of the poor and to increase their incomes, he adds something more to the total happiness than if he adds an equal amount to the incomes of the rich ... and that he does good by buying things th e productio n o f which raises, i n preference t o thing s th e productio n of which lowers the character of those who make them (474). So, he concluded, much remained to be done in order to discover the 'limits of th e wor k tha t societ y ca n wit h advantag e d o toward s turnin g th e economic actions of individuals into those channels in which they will add the most to the sum total of happiness' (475). The whole of the Economics of Welfare b y hi s pupil and successo r i n the chai r of economics a t Cambridge, A.C. Pigou, might be considered to be commentary on this chapter. Finally, ther e i s a chapte r o n monopoly . The interes t o f the privat e owner of a monopoly is to 'mak e the greatest possibl e tota l net revenue' (478). The monopolis t would lose al l his monopol y revenu e if he produce d fo r sal e a n amount so great that its supply price ... was equal to its demand price: the amount which gives the maximum monopoly revenue is always considerably less than that. It may therefore appear as though the amount produced under a monopoly is always less and its price to the consumers always higher than if there were no monopoly. But this is not the case. For when the production is all in the hands of one person or company, th e tota l expense s involve d are generall y less tha n woul d have t o b e incurred if the sam e aggregate production were distributed amon g a multitude of

Alfred Marshal l 39 1 comparatively smal l riva l producer s .. . [they ] woul d necessaril y spen d i n th e aggregate a great deal more on advertising ... and they would be less able to avail themselves of the many various economies whic h result from production on a large scale. In particular they could not afford to spend as much on improving methods of production and the machiner y used i n it, as a single firm which knew that it was certain to reap the whole benefit of any advance it made (484).

Marshall then drew attention t o the difference between short-ru n maximi zation and long-run maximization: the monopolist ma y lower his price with a view to the future development o f his business. H e cited as an example a railway company with a practical monopoly of the transport of persons and goods to a sea-port, or to a suburban district which is an yet but partly built over. The railwa y company ma y find it worthwhile , as a matte r o f business , t o lev y charges much below those which would afford th e maximum net revenue, in order to get merchants into the habit of using the port, to encourage the inhabitants of the port to develop their docks and warehouses: o r to assist speculative builders in the new suburb to build houses cheaply and to fill them quickly with tenants, thus giving to the suburb an air of early prosperity which goes far towards insuring its permanent success (486).

Marshall nex t considere d th e possibility o f a monopolist havin g som e interest i n welfar e o f consumers i n additio n t o hi s interes t i n monopoly revenue: this may be a philanthropic private monopolis t o r a wise public monopolist. 'The total benefit o f the monopoly is the sum of the monopoly revenue an d consumers ' surplus ' (487) . Th e behaviou r o f suc h a monopolist will depend on whether he treats 4 £i of consumers' surplu s as equally desirable wit h £i of monopoly revenue' or as equivalent to ro s of monopoly revenue, or as irrelevant. The amount which the monopolist will offer for sale will be greater (and the price at which h e wel l sel l i t wil l b e less ) if he i s t o an y exten t desirous to promot e th e interest of consumers ... and secondly, the amount produced will be greater (and the selling price will be less) the greater the desire of the monopolist to promote the interests of consumers: i.e. the larger be the percentage of its actual value at which he counts in consumers' surplus with his own revenue (489).

At the end of this chapter is a footnote referrin g to Book in of Industry and Trade a s 'occupied with a study of problems aki n to those which have

392 Fro m Adam Smith to Maynard Keyne s been sketche d i n this chapter ' (495) . Industry an d Trade (1919 ) is full o f historical an d institutional facts and careful analysis. The facts are now half a century ou t of date; but the analysis i s still relevant. I urge student s to return to it as I urge them to return to the Principles. Of this book Keyne s wrote: Such unity as the book possesses derives from its being an account o f the forms of individualistic capitalism as this had established itsel f about the year 1900 , of how they came to pass, and of how far they served the public interest... It represents th e fruits o f Marshall's learning and rip e wisdom on a host o f different matters . Th e book is a mine rather than a railway - lik e the Principles, a thing to quarry in and search fo r buried treasure .. . I t contain s th e suggestions , th e startin g points fo r many investigations. There i s no better tool for suggesting lines of original inquiry to a reader so disposed. But for the ignorant the broad generalisations of the book are too quiet, smooth, urbane, undogmatic, to catch him.' 19 VI D I S T R I B U T I O N OF THE N A T I O N A L INCOME (BOOK Vl)

Book v i i s somethin g o f an anticlimax , th e basi c element s havin g bee n worked out it was only necessary to put them together i n order to deal with the problems o f distribution o f the national dividend . On the demand sid e this involved recognizing that the demand was derived from the value of the product, that it was a joint demand for the various cooperating factors , but that i t wa s a join t deman d fo r factor s tha t coul d b e varie d a s t o th e proportions in which they were combined in accordance with the 'principle of substitution. ' S o a margina l productivit y solutio n o f th e proble m o f pricing the factors (their supply being given) emerged. Every agent of production, land, machinery, skilled labour, unskilled labour, etc., tends to b e applied in production as far as i t profitably ca n be . I f employers, and other business men, think they can get a better result by using a little more of one agent they will do so. They estimate the net product (that is, the net increase of the money value of their total output after allowing for incidental expenses) that will be got by a little more outlay in this direction, or a little more outlay in that; and if they can gain by shifting a little of their outlay from one direction to another, they will do so (521).

All this had already been developed in Book v. Just a s i n the theor y o f the valu e of commodities i t was necessar y t o

Alfred Marshal l 39 3 study th e par t playe d b y cos t o f productio n a s wel l as tha t playe d b y demand, or to stud y the reflex influence s o f price on supply as well as the influence o f price on consumption, s o in the theor y o f distribution it was necessary to supplement the study of demand, or marginal productivity, by a stud y o f suppl y particularl y wit h reference t o th e influenc e o f rates o f remuneration o n the supply of the different agent s of production. Ricardo an d the able businessme n wh o followed i n his wake took th e operation o f demand too much for granted, as a thing which did not need to be explained ... I n the reaction to o muc h insistenc e ha s bee n lai d on the fac t tha t th e earning s of ever y agent o f production com e from , and are for the time mainly governed by , the value of the product which it takes part in producing; its earnings being so far governed on the sam e principle s as the ren t o f land; and som e hav e even thought it possible t o constitute a complete theory of Distribution out of multifold applications of the law of rent. Bu t they will not reach t o that end. Ricardo and his followers seem to have been rightly guided by their intuitions, when they silently determined that the forces of supply were those , th e stud y of which is the mor e importan t and involve s the greater difficult y (525). So Marshall having taken one chapter to deal with demand for the agents of production devoted man y chapters t o th e problems of supply. As ever in Marshall th e elemen t of time is important : indeed one ma y sugges t that those economist s wh o stress deman d and margina l productivity are con cerned wit h periods of clock-time that are relatively short, while Marshall is concerne d wit h muc h longer periods . Bu t als o ther e i s in Marshal l an insistence on the 'cost of production' of the agents as basic to the explanation of their supply, and an expectation o f a long-run equilibrium between demand price and their costs of production. The national dividend is distributed among them [the agents of production], speaking generally, in proportion t o the need whic h people hav e for their several service s - i.e. , not the total need, bu t th e marginal nee d .. . Other thing s being equal, each agen t i s likel y t o increase the faster, the larger the share which it gets, unless indeed it is not capable of being increased at all. But every such increase will.. . lessen the marginal need for it and lower the price at which it can find a market... This reflex action may be slow. But if there is no violent change in the arts of production or in the general economic conditions of society, th e supply of each agent will be closely governed by its cost of production: accoun t bein g taken o f thos e conventiona l necessaries, whic h constantly expand a s the growin g richness o f the nationa l income yields to one clas s after another an increasing surplus above the mere necessaries for efficiency (537).

394 Fro m Adam Smith to Maynard Keynes Three chapter s are devoted to the special problems of the 'earnings of labour' (Chapters in, iv, and v). Marshall qualified the simple doctrine that competition would equalize earnings of workers in particular grades . The first qualification relate d to 'efficienc y earnings' : 'Give n that the averag e strength an d energ y o f th e working-classe s ar e highe r i n th e Nort h o f England than in the South, it then follows that the more completely "com petition make s thing s find their ow n level," th e mor e certai n i t i s tha t average weekly wages will be higher in the North than in the South' (547). Within any district there 'is a tendency to equality of efficiency earning s ... This tendency will be stronger, the greater is the mobility of labour, the less strictly specialized it is, the more keenly parents are on the look-out for the most advantageous occupations for their children, the more rapidly they are able to adapt themselves to changes in economic conditions, and lastly the slowe r an d th e les s violen t thes e change s are ' (549) . Th e secon d qualification related to the concept of'net advantages.' This does not go far beyond Adam Smith's treatment but it does en d with a reference t o th e paradox that 'the dirtiness of some occupations is the cause of the lowness of the wages in them' (558). 'The progress of society has kept alive many people who are unfit for any but the lowest grade of work. They compet e eagerly fo r th e comparativel y small quantity of work for whic h they ar e fitted, and in their urgent need they think almost exclusively of the wages they ca n earn ; the y canno t affor d t o pa y muc h attention t o incidenta l discomforts' (558) . Skille d workers o f high character employe d i n suc h work woul d hav e to b e pai d high wage s to offse t th e 'discomforts, ' an d would hav e t o b e equippe d wit h 'improve d appliances' ; therefor e em ployers 'often adhere to old methods which require only unskilled workers of bu t indifferen t characte r an d wh o ca n b e hire d fo r lo w tim e wages, because they are not worth much to any employer. There is no more urgent social nee d tha n tha t labou r o f thi s kin d shoul d b e mad e scarc e an d therefore dear' (558). Chapter iv is mainly concerned with the investment of capital in human beings. Such investment in 'the rearing and early training of the workers of England i s limite d by th e resource s o f parents i n th e variou s grade s o f society, by their power of forecasting the future, and by their willingness to sacrifice themselves for the sake of their children.' Of the 'higher industrial grades' h e said that they 'distinctly realize the future an d 'discount it at a low rate of interest.' They exert themselves much to select the best careers for thei r sons , an d th e bes t training s fo r thos e careers ; an d the y ar e generally willing and able to incur a considerable expens e for the purpose ... while generally eager to save some capital/or their children, [they] are

Alfred Marshal l 395 even mor e on the alert fo r opportunities o f investing it in them' (562). By contrast, in the lower ranks of society the slender mean s and education o f the parents, an d the comparative weaknes s of their power of distinctly realizing the future, prevent them from investin g capital in the education an d training of their children with the same free and bold enterpris e with whic h capita l i s applie d t o improvin g the machiner y o f an y well-managed factory. Man y o f th e childre n o f th e working-classe s ar e imperfectl y fed an d clothed; they are housed in a way that promotes neithe r physical nor moral health; they receiv e a schoo l educatio n which , though i n modern Englan d i t may no t b e very bad so far as it goes, yet goes only a little way ... they go to the grave carrying with them undeveloped abilities and faculties; which if they could have borne fruit , would have adde d t o the material wealth of the country - t o say nothing of higher considerations - man y time s a s muc h a s woul d hav e covere d th e expens e o f providing adequate opportunitie s for their development (562). One valuabl e aspect of the chapte r lies in its emphasis on the cumulative process relatin g income distribution present and future. If at any time it [the action of demand and supply] presses hardly on any individuals or class, the direct effects of the evils are obvious. But the sufferings tha t result are of different kinds : those, the effects of which end with the evil by which they were caused, ar e no t generally to be compared i n importance wit h those that have th e indirect effec t o f lowerin g th e characte r o f th e workers , o r o f hinderin g it fro m becoming stronger . Fo r thes e las t caus e furthe r weaknes s and furthe r suffering , which again in their turn cause yet further weakness and further suffering, and so on cumulatively. On th e othe r hand , hig h earnings, an d a stron g character , lea d t o greater strengt h and higher earnings, which again lead to still greater strengt h and still higher earnings, and so on cumulatively (560). Here th e emphasi s wa s o n 'character. ' Late r th e emphasi s passe d t o parental investmen t i n thei r children , perhap s a muc h mor e important aspect. Again emphasis is on the cumulative process. The worse fed are the children of one generation, the less will they earn when they grow up, and the less will be their power o f providing adequately for the material wants of their children; and so on to following generations. And again, the less fully their ow n facultie s are developed , th e les s wil l the y realiz e th e importanc e o f developing th e bes t facultie s of their children, and th e les s wil l b e their power o f doing so. And conversely any change that awards to the workers of one generation

396 Fro m Adam Smith to Maynard Keynes better earnings, together wit h better opportunitie s of developing their best qual ities, will increase the material and moral advantages which they have the power to offer t o thei r children : while b y increasin g their ow n intelligence , wisdo m an d forethought, suc h a change will also to som e extent increase thei r willingnes s to sacrifice thei r own pleasures for the wellbeing of their children; - thoug h there is much of that willingness now even among the poorest classes, so far as their means and the limits of their knowledge will allow (562-3).

Even when he turned to the limit set by their 'means,' Marshall continue d to emphasize intelligence an d character, foresigh t and unselfishness. This smacks of middle class snobbery and Victorian moralizing: but if, perhaps, overplayed, it was, and is, relevant. Some investmen t in human capital i s made by employers , 'partl y be cause it pays them to do so, and partly because the character tha t fits them to take the lead in the acts of production i s likely also to make them take a generous interes t i n th e wellbein g o f thos e wh o wor k fo r them ' (565) . Marshall recognized that the number of such employers was comparatively small, and that none of them could carry such investment as far as they would have done, if the results of the investment accrued to them in the same way as the results of any improvements they might make in their machinery ... The liberal employer confers benefits which do not end with his own generation. For the children o f hi s wor k peopl e shar e i n them , an d gro w up stronge r i n bod y an d character than otherwise they would have done. The pric e which he has paid for labour will have borne the expense s of production of an increased suppl y of high industrial faculties in the next generation; but these faculties will be the property of others ... neither he nor even his heirs can reckon on reaping much material reward for this part of the good that he has done (566).

Again the cumulative process, again the emphasis on character. The chapter s o n interest, profi t an d rent I shall cover wit h very brie f comment. In the introductory chapter s o n distribution, Marshal l had discussed the demand for capital. So far as particular items of real capital were concerned, the demand was seen to depend, as did the demand for particular types of labour, on the expected ne t product. Of the aggregate deman d for capital he said: Each undertaker having regard to his own means will push the investment of capital in his business in each several direction until what appears in his judgment to be the margin of profitableness is reached; and that margin is, as we have said, a boundary

Alfred Marshal l 397 line cutting one after another every possible line of investment, and moving irregularly outwards in all directions whenever there is a fall in the rate of interest... Thus the demand for the loan of capital is the aggregate of the demands of all individuals in all trades (520-51).

In th e chapte r o n interest , i n th e cours e o f a repl y t o Marx , Marshal l indicated hi s own view as to the supply of capital, and thus as to the degre e of scarcit y o f those durabl e good s tha t yiel d rent . 'If i t be tru e tha t th e postponement o f gratifications involves in general a sacrifice on the part of him who postpones, just as additional effor t doe s on the part o f him who labours; an d i f it b e tru e tha t thi s postponemen t enable s a ma n t o us e methods of production .. . by which the aggregate o f enjoyment is increased ... it cannot b e true that the value of a thing depends simpl y on the amount of labou r spen t o n it' (587) . Thi s misrepresent s Marx , bu t i t does sho w Marshall's position . Here , a s throughou t th e Principles, h e i s directin g attention to the supply, or the supply price, o f capital. Demand affects it s distribution between uses so as to equalize 'net interest.' Having discussed the elements of risk involved in the loan contract h e concluded that : Th e tendency o f competitio n i s therefor e no t toward s equalizin g this gros s interest; on the contrary th e more thoroughly lenders and borrowers un derstand their business, the more certainly will some classes o f borrowers obtain loans a t a lower rate than others' (591) . But, he then asks, can we properly spea k o f 'capita l i n genera l a s bein g accumulate d unde r th e expectation o f a certain net interest which is the same for all its forms'? He answers yes on the ground that not less than a quarter of the real capital of the country is annually destroyed, s o that its owners 'have been able in the main to adapt its forms to the normal conditions of the time, so as to derive as good a net income from their investments in one use as another' (592). At the end of chapter si x Marshall enunciated th e concept o f the 'real' rate of interest: if prices fel l 1 0 per cent over the year for which a loan was made a t 5 per cen t 'whil e normall y paying 5 per cen t fo r th e us e o f his money, h e ha s reall y bee n payin g i$ l/2 pe r cen t .. . o n th e othe r han d if prices ha d risen .. . 1 0 per cent, durin g the year .. . he would really be paid 5*/2 per cen t fo r takin g charge o f th e money ' (594) . Keyne s sai d o f this concept: Th e firs t clea r expositio n o f thi s is , I think , give n i n th e Principles. '20 But was there any improvement on Henry Thornton's exposition which I discussed above ? On profit, as on interest I think, Marshall is led by his desire to establish the relationshi p betwee n pric e an d norma l cos t t o overemphasiz e th e importance of 'normal' profit. He recognized that the profit of the innovat-

398 Fro m Adam Smith to Maynard Keynes ing entrepreneur would be temporarily 'above the average': but his neighbours would copy his plan, 'soon competition will increase the supply and lower the price of their wares, until their profits fall to about their old level: for n o one could get extra high wages for making eggs stand on their ends after Colombus' s pla n had become public property' (598) . Thi s does not differ, o n the face of it, from Schumpeter' s treatmen t o f 'innovation,' and the 'perennial gale of creative destruction.' The difference lies in a different estimate a s t o th e quantitativ e importanc e o f the exceptiona l profit s of innovation and the 'normal ' profit s o f a settled industry , an d of the con tribution t o increasin g (cumulativel y increasing) inequalit y o f propert y ownership an d o f incom e mad e b y suc h exceptiona l profits . Partl y thi s difference may be related to an increase in the rate of technological change. But theoretical , an d perhaps political, bias seems to have been involved. 'We shal l find that th e reward s of every business undertaker ten d t o b e proportionate t o the direct services he renders to the community' (598). In the chapters o n the rent of land the interesting part s ar e concerned with tenure . On e migh t hav e hope d tha t ther e woul d b e a systemati c discussion o f the effec t o f various forms of tenure on productivity, on the prices o f the product s an d on the distributio n o f income, al l leading to a consideration of public policy in relation to land ownership. Instead there is some rathe r genera l discussio n o f form s o f tenure, reminiscen t o f John Stuart Mill. Two Englis h problems , socia l rathe r tha n economic , ar e examine d briefly. First: 'There is a public need in every district for small holdings, as well as large; for allotments and large gardens; and generally for holdings so small that they can be worked by people who have some other occupation' (654). It i s not clear how far the difficult y o f making such smal l holdings available was due to the 'prejudices of the landlord' and how far to the net financial advantage to the landlord of large over small holdings. The social case for small holdings was developed i n a footnote. They increas e the numbe r o f people wh o ar e workin g in the ope n ai r with their heads an d thei r hands ; they giv e t o th e agricultura l labourer a steppin g ston e upwards, prevent him from being compelled to leave agriculture to find some scope for his ambition, and thus check the great evil of the continued flow of the ablest and bravest lad s t o th e towns . The y brea k th e monoton y of existence, the y giv e a healthy change from indoo r life, they offer a scope for variety of character and for the play of fancy and imagination in the arrangement of individual life; they afford a counter-attraction to the grosser and baser pleasures (654)

Alfred Marshal l 39 9 and so on. The secon d problem i s similarly concerned wit h fresh air, viz. the private interests wit h regard to open space s i n town: A closely peopled district is impoverished by every one who adds a new building or raises an older one higher. The want of air and light, of peaceful repose out-of-doors for al l ages and of healthy play for children, exhausts the energies of the best blood of England which is constantly flowing towards our large towns. By allowing vacant spaces to be built on recklessly w e are committing a great blunder from a business point of view. For the sake of a little material wealth we are wasting those energies which ar e th e factor s o f production o f al l wealth : w e ar e sacrificin g thos e end s toward which material wealth is only a means. (659)

He referre d t o hi s Appendi x G for furthe r discussion . H e ha d alread y discussed som e aspect s of policy in this area in an article in the Contemporary Review o n 'Wher e t o hous e th e Londo n Poor ' (reprinte d i n the Memorials). H e there argued , amongs t othe r things , that pressure shoul d be brought to bear on the directors o f railway companies t o give full effec t to the 'beneficen t Ac t just passed,' t o mee t i t in a 'liberal' rathe r tha n a 'higgling' spirit. 'The actual cost of running an extra train is often not very great; an d ther e i s scarcel y an y othe r directio n i n whic h a ver y littl e unselfishness wil l purchase s o much good fo r others ; wil l cause s o much happiness unalloye d by any harm; will do so much to raise th e qualit y of human life.' 21 H e again discusse d these problems i n a 'Memorandu m on the Classification and Incidence o f Imperial and Local Taxes' reprinted in Official Papers of Alfred Marshall. Marshal l went beyond discussion of the incidence of local rates to discuss problems of the distribution of authority between levels of government. Again we get to 'fresh air. ' The centra l government should se e to i t that towns and industria l district s do not continue to increase without ample provision for that fresh ai r and wholesome play which ar e require d to maintai n th e vigou r o f th e peopl e an d thei r plac e among nations ... We need not only to widen our street s and increase the playgrounds in the mids t o f ou r towns . W e nee d als o t o preven t one tow n fro m growin g int o another, or int o a neighbouring village; we need to kee p intermediate stretches of country in dairy farms, etc., as well as public pleasure grounds.22

Of the final chapters o n 'Economic Progress' I shall refer only to the last three sections of Chapter xin, which are concerned wit h the prospects for the poor. A quotation from Edgeworth's 'Reminiscences' in the Memorials seems to provide an appropriate introduction .

400 Fro m Adam Smith to Maynard Keynes Marshall's success i n handling the theory of wages was largely due to his sympathy with th e wag e earner s .. . Hi s inquirie s wer e stimulate d b y a n arden t desir e t o improve th e conditio n o f the great mas s of workers .. . H e enjoye d a n advantag e which does not fall t o the lot of many academic economists , tha t o f acquaintanc e and friendship with leading men among the ranks of Labour. I had an opportunity of observing how much he was appreciated by , and how well he 'got on with' members of that clas s when I staye d i n the sam e hote l a s the Marshall s a t Ipswic h o n th e occasion of that Co-operative Congres s (1889) at which as President h e delivered a memorable addres s ful l o f hope fo r th e futur e o f cooperative Labour . I ca n wel l believe what I heard from th e Principal of Ruskin College that work-people studying the Principles of Economics recognize d in the author a sympathetic friend. Th e only other economist about whom they had the same feeling was Mill. 23 For the so-called 'Residuum ' Marshall urged the need for 'exceptional treatment.' Whil e he believe d tha t th e 'syste m o f economic freedo m is probably the best fro m bot h a moral and material point of view for thos e who ar e i n fairly goo d healt h o f mind an d body,' h e though t it might be much bette r for th e natio n if this class came 'under a paternal discipline something like that which prevails in Germany.' He suggested a program of action in a long footnote. A beginnin g might b e mad e with a broader, mor e educative, an d mor e generou s administration of public aid to the helpless ... Elderly people might be helped with a chief regard to economy an d to their personal inclinations . Bu t the case of those, who ar e responsibl e fo r youn g children, woul d cal l fo r a greate r expenditur e o f public funds, an d a more stric t subordinatio n o f personal freedo m t o public necessity. The most urgent among the first steps towards causing the Residuum to cease from th e land, is to insist on regular school attendance i n decent clothing , and with bodies clean and fairly well fed. In case of failure the parents should be warned and advised; a s a las t resor t th e home s migh t b e closed , o r regulate d wit h som e limitation of the freedom of the parents. The expense would be great: but there is no other s o urgent need fo r bold expenditure. It would remove th e great canke r tha t infects th e whol e body o f the nation: and when the work was done th e resource s that had bee n absorbe d b y i t would be free for som e mor e pleasan t an d pressin g social duty (714-5, n. i). Turning from th e 'paupers ' t o th e poor , fro m th e unemployable s t o th e unskilled workers, Marshall argued that economic progress was improving their condition, but he still argued for state action to speed up the process . He estimated that those 'capabl e only of rather unskilled work constitute

Alfred Marshall 40 1 about a fourth of the population' and those fit for the 'lower kinds of skilled work' constitute about another fourth. A century earlier 'more than a half would have been unfit for any skilled labour at all.' He further argue d that the wages o f the uskilled 'hav e risen faster than those of any other class , faster even than those of skilled labour' (716). Finally he argued that a n increase by (say) a quarter of the wage s of the poore r class of bona fide workers adds more to the sum total of happiness than an increase by a quarter of the incomes of an equal number of any other class ... for it arrests positive suffering and active causes of degradation, and it opens the way to hope as no other proportionate increase of incomes does. Fro m this point of view it may be urged that the poorer classes hav e derive d a greate r rea l benefi t fro m economi c progres s .. . tha n i s suggested b y th e statistic s o f thei r wage s .. . W e hav e the n t o striv e t o kee p mechanical progress in full swing: and to diminish the supply of labour, incapable of any but unskilled work (717).

To thi s en d public mone y mus t flow freely int o education , an d int o th e provision of fresh air and space for wholesome pla y for the children in the working-class quarters. Indeed the State seems to be required to contribute generously, and even lavishly to that sid e of the well-being of the poore r working class which they cannot easily provide for themselves. The objective was to make the children of the unskilled capable of earning the wages of skilled work, and the children of the skilled capable o f doing still more responsible work. The summar y at the side of the text of section 14 raised new questions: 'It is easier to work well than to use wealth well, and much easier than to use leisure well.' In the text he gave an estimate that 'perhaps £100,000,000 annually are spen t eve n b y the working classes, an d £400,000,000 by the rest of the population of England, in ways that do little or nothing towards making life noble r o r trul y happier' (720) . He conclude d tha t it might be well that mos t people should wor k rathe r less, 'provide d that the consequent loss of material incom e could b e met exclusively by the abandon ment by all classes o f the least worth y methods of consumption; and that they could learn to spend leisure well' (720). As ever his emphasis is on the young. 'Th e most imperative duty of this generation is to provide for the young suc h opportunitie s a s wil l both develo p thei r highe r nature , an d make them efficien t producers . And a n essential condition t o this end is long-continued freedom from mechanica l toil; together wit h abundant leisure fo r schoo l an d fo r suc h kind s o f pla y a s strengthe n an d develo p character'(720).

402 Fro m Adam Smith to Maynard Keynes The Principles ends with a plea for patience. Progress in the standard of life had been experienced an d seemed likely to continue. Pessimistic descriptions of our own age, combined with romantic exaggerations of the happiness of past ages, must tend to the setting aside of methods of progress, the work of which if slow is yet solid ; and to th e hast y adoption of others o f greater promise, but which resemble the patent medicines of a charlatan, and while quickly effecting a little good, sow the seed s of widespread and lasting decay. This impatient insincerity is an evil only less great than that moral torpor which can endure that we, with our modern resources and knowledge, should look on contentedly at the continued extinction of all that is worth having in multitudes of human lives, an solace ourselves with the reflectio n tha t anyhow the evils of our own age are less than those of the past (722). VII

MARSHALL ON MONEY

I canno t ignor e Marshall' s contributio n t o monetary theor y bu t I do not want to persuade an y but a few specialists to read these contributions. My generation a s students learn t fro m Marshal l th e hard wa y by reading hi s submissions to the Royal Commissions o n 'The Depression of Trade and Industry' (1886) , on The Valu e of Gold an d Silver' (1887-8) , and to the Committee on Indian currency (1899). All of these are now easily accessi ble in Official Papers by Alfred Marshall (1926) . It was a hard way becaus e the argumen t was developed largely in response t o questions fro m members wh o were each followin g their own lines of thought, an d who were generally no t ove r effectiv e i n their thinking. It ha d a n advantag e tha t it showed th e relevanc e o f monetary theory t o monetar y policy, and illustrated th e appropriat e rol e o f the politica l economis t a s advise r to, an d educator of , legislators an d the public . His book wa s an anti-climax: his teaching had already become familiar and had been developed in the works of others. Keynes' s assessment may be quoted: 'He had passed his eightieth year ; hi s strengt h wa s n o longe r equa l t o muc h more tha n piecing together fragments; and its jejune treatment, carefully avoiding difficulties and complications, yield the mere shadow of what he had it in him to bring forth twent y o r (better ) thirt y year s earlier.' 24 Keyne s liste d wha t h e considered th e mos t importan t an d characteristi c o f Marshall' s origina l contributions to this part of Economics. I shall quote the items, but leave the interested reader to follow up in the Memorials for his comment on each item.

Alfred Marshal l 40 3 (1) Th e expositio n o f th e Quantit y Theory o f Mone y a s a par t o f th e Genera l Theory o f Value ... (2) Th e distinctio n betwee n th e 'real ' rat e o f interes t an d th e 'money ' rat e of interest an d relevanc e o f thi s t o th e credi t cycle , whe n th e valu e o f mone y is fluctuating [ I hav e suggeste d abov e tha t Thornton' s priorit y should b e recog nized] ... (3) Th e causa l train by whic h in modern credit systems , an additiona l supply of money influences prices, and the part played by the rate of discount... (4) Th e enunciatio n of the 'Purchasin g Power Parity ' Theory a s determining the rate o f exchang e betwee n countrie s wit h mutuall y inconvertible currencie s .. . (5) Th e 'chain' method of compiling index-numbers ... (6) Th e proposa l o f paper currency for th e circulatio n (on the line s of Ricardo's 'Proposals fo r a n Economica l an d Secur e Currency ) base d o n gold-and-silve r symmetallism as the standard ... (7) Th e proposal of an official Tabular Standard for optional use in the case of long contracts.'25 VIII

MARSHALL ON THE CLASSICS

Any studen t of the classical English literature o f political economy finds in Marshall a wealt h o f wise commen t an d generou s interpretatio n o f tha t literature. M y ow n treatmen t ha s bee n influence d b y Marshal l s o tha t quotation is less necessary tha n reference. In the Principles I would draw particular attention to the sketch of the distribution theory of the classica l writers in Book vi, chapter i, section 2. Then to the Appendices; B, on Th Growth of Economic Science' ; i, on Ricardo's Theory o f Value; J, on 'The Doctrine o f the Wages-Fund. ' In Industry an d Trade Appendi x D deals with 'The English Mercantilists and Adam Smith,' and E, with The Britis h Movement towards Free Trade.' Finally in the Memorials are reprinted his review o f 'M r Jevons' Theor y o f Political Economy, ' hi s essa y o n 'M r Mill's Theory o f Value,' and his inaugural address a t Cambridge (alread y quoted i n m y chapte r o n th e conflic t o f th e historica l an d analytica l methods) o n the 'Presen t Positio n o f Economics.' I n a later addres s o n The Ol d Generation of Economists and the New' (1897) he discussed 'th e preparation whic h has bee n mad e by the nineteent h centur y an d the old generation o f economist s fo r th e ne w generatio n o f economist s an d th e twentieth century. ' Thi s chapte r o n Marshal l i s conclude d wit h som e quotation from that later address. 'Economic science as I first knew it, just thirty years ago, was more confident than now. Its general propositions an d

404 Fro m Adam Smith to Maynard Keynes general principles were bold and peremptory.' Times changed, economists became less dictatorial an d more willing to admit their own limitations. Never again will a Mrs Trimmer, a Mrs Marcet, or a Miss Martineau earn a goodly reputation by throwing the m into a for m o f catechism o r o f simpl e tales, b y ai d o f which an y intelligent governess might make clear to the children nestling around her where lies economic truth, and might send the m forth read y to instruct statesme n an d merchants how to choose the right path in economic policy, and to avoid the wrong. It is now patent , even t o those wh o are i n a hurry, that n o practical problem s can be settled offhand b y appeal to general doctrines; for the things of which account must be taken are so diverse, and our knowledge of them is so slight, that they yield no firm hold fo r forma l proof . Muc h mus t b e take n o n conjecture ; muc h mus t b e decided by commonsense rather than by reasoning on strictly logical lines. Thus the growing perfection of scientific machiner y in economics, so far from lessenin g the responsibilities of commonsense, increases those responsibilities. 26 This change , 'th e retirin g dispositio n o f genera l principle s an d genera l propositions' had led to an increase, not a diminution, in the 'real authority' of economists. 'They no longer wield the big battle-axe and sound the loud war-cry like a Cceur de Lion; they keep in the background like a modern general: bu t the y contro l large r force s tha n before . The y exer t a mor e far-reaching an d more powerful influenc e o n ideas, an d ideas fashion the course of the world ever more and more.'27

3

John Maynard Keynes

I

INTRODUCTION

Paul Samuelson onc e said: It i s impossibl e fo r moder n student s t o realiz e th e ful l effec t o f wha t ha s bee n advisably calle d th e 'Keynesia n Revolution ' upo n those o f us brough t u p i n th e orthodox tradition . What beginners today often regar d as trite and obvious was to us puzzling, novel and heretical... To have been born as an economist before 1936 was a boon - yes . But not to have been born too long before: Bliss it was in that dawn to be alive, But to be young was very heaven. The General Theory caugh t mos t economist s unde r the ag e of 35 with th e unexpected violence of a disease first attacking and decimating an isolated tribe of South Sea Islanders.

I was just over thirty-five when the General Theory wa s published, and can testify t o the excitement generate d ove r the previous twent y years b y this brilliant, provocative , humane , patrioti c economist . I hav e sai d tha t m y generation studie d monetar y theory and policy by reading the submission s of Alfred Marshall t o various Officia l Inquiries . On e o f these was that on Indian Currency . W e had Keyne s t o hel p u s wit h that, throug h hi s first bookjndian Currency and Finance (1913 ) and his Memorandum on a State Bank for India which was published a s an addendum to the Report o f the Royal Commission on Indian Finance and Currency (1913-14) of which he

406 Fro m Adam Smith to Maynard Keynes was a member. As a young student at Oxford I was excited and stimulated by theEconomic Consequences of the Peace Treaty (1919) . It is, perhaps, as har d t o recreat e tha t excitement , a s th e excitemen t o f th e General Theory. Then for the first fifteen years of my professional career there was a regular stream of articles, pamphlets, books whic h continued th e excite ment. Keynes was writing continually about the great economic issues of that period , especiall y th e nationa l proble m o f unemploymen t an d th e world proble m o f developin g internationa l co-operatio n i n trade , mon etary, and investment, policies. We watched for the annual supplements of the Manchester Guardian in which he advanced many of his ideas; we read the Nation an d the New Statesman an d Nation fo r his current comment; and we read and worried over each of his pamphlets and books. For most of us he was a leader (almost a prophet); to all of us he was an economist who, however provocative and controversial, ha d to be taken seriously. I never met Keynes: but through his writings and through his influence on those of my students who became his pupils at Cambridge and then my colleagues in Toronto, hi s influenc e o n my development a s a political economis t wa s very great indeed. Of th e economist s tha t I hav e discusse d i n this book , Ada m Smith , Alfred Marshall , and John Maynard Keynes stan d ou t a s the thre e wh o have influenced me most, and they may be singled out as perhaps, the three greatest i n th e Englis h traditio n o f political economy . Bu t i t i s no t m y purpose t o apprais e hi s work , to estimat e hi s influenc e o n th e presen t generation, o r t o engag e i n the fashionabl e attempt s t o determin e wha t Keynes would have recommended in the present age. It is about Keynes , or rather about some of his many contributions to the literature, that I want to write: not about present day Keynesianism. Professor Austin Robinson, in a recent articl e o n 4 J.M. Keynes: Economist , Author , and Statesman' had this to say: The frontier of economics is in a different plac e from where it was in the I93o's and one find s discussio n not s o muc h abou t wha t Keyne s did thin k a s abou t what Keynes would have thought. There are some who believe that they have learned to think like Keynes and can interpret what Keynes would have thought. I hope I may be forgiven if I express a little scepticism about this process. I, with a much more pedestrian and less radical mind, lived under his shadow for twenty-four years . I hardly ever saw for myself i n advance what he was going to sa y about the crise s through which we lived.'

At another point he said:

John Maynard Keynes 40 7 Keynes would, I feel certain, have hated to be judged, as he so frequently is , sub specie aeternitatis, as if he had sought to write an economic bible, to survive as the verbally inspire d truth for al l time. He wa s seeking , in th e General Theory, a s always, 'to trust in the efficacy o f the cooperation o f many minds'... No one, least of all Keynes himself, thought for one moment in 1936 that the last word was being said in economics. It was an interim report from on e who was himself expecting to move on.1

The questio n i s not what Keyne s woul d have written, but, what modern economists wit h the new resources which have become available to them are writin g as the y i n turn, trustin g as Keyne s di d in the efficac y o f th e cooperation o f many minds, move nearer t o acceptabl e solution s of our current problems. And, let us remember, as they come nearer to solution of the problem s o f their age , ne w problems requirin g new solutions wil l be challenging another generation of economists. They will not learn solutions to their problems from Keynes; but they may be stimulated by his constant search; their interest an d imagination may be stimulated along with their intellects, an d the y ma y be influence d (I would sa y for th e good ) b y th e humane, liberal, aesthetic value s of this economist. It is my object then to introduce students to some of his writings: hoping that this will lead them to read them in full, and to read others that I have omitted. I am confident that they will not be wasting their time if they read what Keynes said, not just in the General Theory, bu t in writings scattered over som e thirty years. The current position seem s to be to rely on what others say Keynes said; or if Keynes is read at all to confine attention to the General Theory, to explain that there was really nothing novel in it, and to identify eithe r its poverty in compariso n wit h th e riche s o f modern Keynesianism , o r it s fallacie s which led many into the morass of modern Keynesianism. In this game I play no part. II

INDIAN CURRENCY*

I do not intend to recount the life of Keynes: that has been done admirably by R.F. Harrod . Perhaps , however , I may be allowed a brief note on the background o f preparation fo r thi s book, Indian Currency and Finance (1913). Having graduated a s Twelfth Wrangler in 1905 , Keynes spen t a n additional yea r a t Cambridg e studyin g economics, attendin g Marshall' s * Pag e reference s throughout part n ar e t o volum e i o f th e Collected Writings o f John Maynard Keynes (1971)

408 Fro m Adam Smith to Maynard Keynes lectures an d being tutored b y Pigou. In 190 6 he wrote the Civi l Servic e Examinations an d sinc e h e stoo d secon d h e di d no t ge t th e Treasur y appointment that he would have preferred, but went to the India Office . Having in mind the unfortunate experience of Jevons in his degree examination it is of some interest to note his own comment in a letter to Strachey: My marks have arrived and left m e enraged. Reall y knowledge seem s an absolute bar to success. I have done wors t in the only two subjects o f which I possessed a solid knowledge - Mathematic s and Economics. I scored mor e marks for English History than for Mathematics - is it credible? For Economics I got a relatively low percentage and was eighth or ninth in order of merit - whereas I knew the whole of both paper s i n a really elaborate way . On the other hand , in Political Science , to which I devoted less than a fortnight in all, I was easily first of everybody. I was also first in Logic and Psychology an d in Essay.2 I quote this not just for anecdotal interest, but as evidence of the state of the profession i n th e firs t decad e o f thi s century . Hatred' s commen t i n a footnote takes issue with Professor Robinson's defence of the examiners. Let me quote: On the one hand we have to consider Keynes absorbing Economics throug h every pore a t Harve y Road , correctin g Sidgwick' s proofs , readin g solidl y fo r som e months ... receiving instruction from Marshall and from Pigou at weekly breakfasts ... When reading the Principles, he would not be beguiled by its apparent facility; he would apprehend at once the bare bones of the argument. In his papers he would, no doubt, hav e discussed th e difficul t mathematica l substratum, carried th e analysi s farther, raise d abstrus e difficulties . O n th e othe r side , w e hav e t o thin k o f th e extraordinarily smal l numbe r o f peopl e i n Englan d o n who m th e Civi l Servic e Commissioners had to draw, who were capable of understanding such by-play with Marshall. I hav e th e advantag e ove r Professo r Robinso n i n havin g been a t a n eminent University (Oxford) before Economics becam e the subject o f an Honour s examination (1923) and I know what extraordinarily jejune stuff passed muste r with the authoritie s a s economic s (Professo r Edgewort h standin g apar t i n gloriou s isolation); and, after all, Oxford was contributing a fair proportion of those who sat for th e Civil Service examination - an d perhaps eve n occasionally a n examiner in economics!3 As a student at Oxford I wrote the 'History Previous' examination in 1918: it include d a paper o n Economic s for whic h the assigne d textbook wa s

John Maynard Keynes 409 Mill's Principles. My tutor made me read Marshall's Principles too: but he warned me that the examiner s might very well not have! It wa s anothe r year befor e I foun d m y wa y t o th e isolate d Edg e worth. T o retur n t o Keynes: it was his short period of service in the India Office tha t directed his attention t o the problem o f Indian currenc y an d provided hi m with a wealth of institutional, historical an d administrative information. In 190 8 he returned to Cambridge to teach economics, and it was from that position that he wrote this study. Of it Harrod wrote : 'It is the work of a theorist, giving practical applicatio n t o thos e esoteric monetar y principles whic h Marshall had expounded and Keynes was explaining in Cambridge classrooms, and at the same time it showed an outstanding gift fo r penetrating the secrets of how institutions actually work.'4 India 'had drifted into a system,' a 'gold-exchange standard,' on the way to th e orthodo x goa l o f a gol d standar d wit h a gol d currency . Keyne s argued effectivel y tha t th e gold-exchang e standar d wa s preferable , fo r India and for many other countries, to the ful l fledged gold standard. He cited the authority of Ricardo: the theoretica l advantages were first set forth b y Ricardo at th e tim e of the Bul lionist controversy. He laid it down that a currency is in its most perfect state when it consists of a cheap material, but having an equal value with the gold it professes to represent; an d h e suggeste d tha t convertibilit y for th e purpose s o f th e foreig n exchanges shoul d b e ensure d b y tenderin g on deman d gold bar s (no t coin ) in exchange for notes - so that gold might be available for purposes of export only, and would be prevented from entering into the internal circulation of the country (22).

Keynes further noted tha t Marshal l in 188 7 'agai n brought these advan tages to the notice of practical men.' His own judgment on this standard is expressed at the end of Chapter 2: 'Speaking as a theorist, I believe that it contains on e essentia l elemen t - th e us e o f a chea p loca l currenc y artificially maintained at par with the international currency or standard of value (whatever that may ultimately turn out to be) -is th e ideal currency of the future' (25) . The system had developed fro m Ricardo's time when the local currency wa s convertible int o gold bar s an d a sufficien t reserv e of gold was held: the new system guaranteed convertibility into international currency and part of the necessary reserve was held as sterling balances in London on which interest was earned. In Chapte r i Keyne s describe d th e India n currenc y syste m an d the history of its development. At that time rupees were de facto convertibl e

410 Fro m Adam Smith to Maynard Keynes into sterling in London a t no more than is 3 29/32d. Thus the rupee coul d not fal l belo w i s 3 29/32d, no r ris e abov e i s 4Vsd , th e cos t o f remittin g sovereigns to India determining the spread. The system was as automatic as a gold standard. In Chapter 2 Keynes first noted the peculiar condition s of th e Englis h currenc y syste m wit h it s continue d us e o f gol d coi n fo r certain kind s of out-of-pocket expenditure , its use of cheques rathe r than paper money as the principal medium of exchange, and the use of the bank rate for regulating the balance o f immediate foreign indebtedness. As the gold standard spread in Europe 'foreign observers seem to have been more impressed by the fact that the Englishman had sovereigns in his pocket than by the fact that he had a cheque-book in his desk'; and took more notice of the 'efficacy ' o f the bank rate 'tha n of the peculiar organisatio n o f ... th e London money market, and of Great Britain's position as a creditor nation' (14). A n initia l inclinatio n t o imitat e th e Britis h syste m ha d give n way before pressures o f different economi c conditions . 'Tw o devices - apar t from th e bullion reserve itself and the bank rate - hav e been evolved for protecting local currencies . Th e first is to permit a small variation in the ratio of exchange between the local currency and gold, amounting perhaps to a premium of 3U% on the latter .. . The secon d is for the government or central bank to hold resources abroad , which can be used for maintaining the gold parity of the local currency, when there is need for it' (19). The greater the part of the reserves held in international currency, the nearer to a full gold-exchange standard. India 'was the first to adopt it in a complete form' (23), and 'in the last ten years the gold exchange standard has become the prevailing monetary system in Asia' (25). Chapters 3 and 4 deal with the internal currency. The existing condition, with the rupee 'virtually a note printed on silver,' might be justified so far as small payments are concerned, by 'custom and convenience. But in itself it is extravagant. ' T o us e gol d coin woul d be eve n mor e extravagant. An 'economical' currency , if the chequ e canno t become supreme , is one of paper. Th e requiremen t o f convertibilit y int o internationa l currenc y guarantees th e maintenanc e of its value, but Keyne s was concerne d t o show the need for much more flexibility in the system of issue. He foun d that unde r existin g arrangement s th e 'India n currenc y i s internall y .. . absolutely inelastic. There is no method whatever by which the volume of currency can be temporarily expande d ... to meet the regularly recurrent seasonal demand s o f trade ' (40) . I n th e absenc e o f a stat e bank , an d accepting the general view that the establishment of an Indian Central Bank would b e premature , Keyne s propose d a 'partia l remedy. ' Par t o f th e reserve shoul d be availabl e for loans in India. 'Suitabl e security for this

John Maynard Keynes 41 1 purpose would be government of India securities ... and bills of exchange of the highes t class ' (42) . This proposa l i s further discusse d i n Chapters 6

and 8.

Chapter 4 discussed 'proposal s for a gold currency.' Keynes' comment went beyond the Indian to the world problem, and shows him, at this early date, already critical of the gold standard. India, as we all know, already wastes far too high a proportion o f her resources in the needles s accumulatio n o f the precious metals. Th e governmen t ought not t o encourage in the slightest degree this ingrained fondness for handling hard gold. By the elimination of both precious metals, to the utmost extent that public opinion will permit, from amongs t the hoards and the circulation of the country, they ought to counteract a n uncivilised and wasteful habit. It is interesting to reflect that India's love o f th e preciou s metals , ruinou s thoug h i t ha s bee n t o he r ow n economi c development, has flourished in the past to the great advantage of Western nations. Everyone know s Jevons's description o f India as the sink of the precious metals , always ready to absorb the redundant bullion of the West and to save Europe from the mor e violent disturbances t o her pric e level . In ver y recent years , whil e the South Africa n mine s have bee n reachin g th e zenit h o f their production , sh e ha s been fulfilling t o perfection her role of sink. Prices have been rising, as it is, much faster tha n is healthy .. . withou t the assistance o f the Indian demand, they would have risen still faster... If India ceases to demand fresh gold and begins to disgorge some part of her huge stock ... she may involve the world ... in a very great inflation of gold prices. If, however, India is thus to turn the tables on the West, she must not delay too long. The time may not be far distant when Europe, having perfected her mechanism o f exchang e o n th e basi s o f a gold standard , wil l find it possibl e t o regulate her standard of value on a more rational and stable basis. It is not likely that we shal l leave permanentl y the mos t intimat e adjustments of our economi c or ganism at the mercy of a lucky prospector, a new chemical process, or a change of ideas in Asia (70-1). In th e late r chapter s Keyne s examine d i n detai l th e mor e technica l aspects o f th e syste m a s i t wa s an d a s h e woul d hav e i t become . Th e theoretician shows his mastery of the institutional elements in the problem, and his fertility o f imagination in the searc h fo r expedients, policies , an d new institutions. Later, as a member of the Royal Commission on Indian Currency and Finance (1913-14) he wrote a memorandum on 'An Indian State Bank' which was published as an addendum to the Report.5 Her e at this early point in his career Keynes was demonstrating his interest i n the development o f new institutions, not conten t wit h general principle s bu t

412 Fro m Adam Smith to Maynard Keynes struggling with the details o f administration: in 1913 a banking system for India; thirty years later, at Bretton Woods, a banking system for the world. 111 Th e Economic Consequences of the Peace Treaty I do not propose to recount the services of Keynes to the British Treasury during world war i and during the negotiations o f Versailles. H e resigne d in June 1919, frustrated and distressed. He wrote to Lloyd George : 1 ought to le t yo u kno w that on Saturda y I a m slipping away from thi s scene of nightmare. I can do no more good here. I've gone on hoping even through these last dreadful weeks that you'd find some way to make of the Treaty a just and expedient document. But now it's apparently too late. The battle is lost. I leave the twins to gloat over the devastation of Europe and to assess t o taste what remains for the British taxpayer.6

He began almost immediately to write The Economic Consequences of the Peace Treaty whic h was on sale by December. Havin g failed to convinc e the politicians, he decided t o try to persuade the public. It was a superb performance: it is a book that should still be read rather for the 'values' and insights that illuminate it than for the economic analysis . As an introduction I think that one cannot do better than to read the posthumous Memoir, Dr Melchior, A Defeated Enemy. 11 shall therefore quote a few passage s from this Memoir before turning to the Economic Consequences. I t is, as ever, my object to induce my readers to read these books: my summary is not an adequate substitute . The Melchior story* The Armistice of n November 191 8 had provided for the continuance of the naval Blockade but included a statement that the 'Allies contemplated the provisioning of Germany to the extent that shall be deemed necessary.' When th e Armistice wa s renewed i n December th e French, withou t th e knowledge of the UK, or of the USA, included a clause prohibiting Germany from disposin g abroa d o f an y o f her gol d o r internationa l assets o n th e ground that the Allies had a lien on these assets for the purpose of ultimate reparation payments . Thus German y could no t buy food, and the Allied obligation t o 'provision' Germany was unfulfilled. Th e second renewal of * Throughou t this section o n the Melchio r story, page references in the text are to J.M. Keynes, Collected Writings, x

John Maynard Keynes 41 3 the Armistice was negotiated at Treves in January and Keynes, much to the disgust o f the French , wa s there . 'W e wer e ther e t o mak e preliminar y arrangements fo r the suppl y of food to Germany and to explore wit h the German civilian representatives thei r available mean s of payment' (399) . The Allies wanted to make the surrender of the German merchant marine a condition of the renewal; and linked the surrender of the ships to the supply of food. Little progress wa s made on the ships for food project, but a useful provisional agreemen t wa s reached b y which the Germans were t o hand over £5,000,00 0 i n gol d an d foreig n currencie s i n exchang e fo r a n im mediate supply of fats and condensed milk . 'On a small scale, the supply of food for them had started' (404). At Treves Keynes was greatly impresse d by on e o f th e Germa n representatives , D r Melchior . H e notice d hi m immediately: 'his eyes gleaming straight at us, with extraordinary sorro w in them, yet like an honest animal at bay' (395). And later, after hearing him argue the German cause, Keynes said he, and 'he only, upheld the dignity of defeat'(403). In February ther e was a second conferenc e at Treves. While the Allies demanded tha t the merchant marine be handed ove r as a condition o f the supply of food, the Germans now insisted that the guarantee of this supply was ' a condition preceden t o n the handing over o f the mercantil e fleet. ' There remaine d th e proble m o f how th e foo d wa s t o b e pai d for . 'Ou r undertakings wer e i n substanc e broken , if , afte r having given them , w e then forbad e German y t o emplo y he r liqui d resource s t o pa y fo r he r purchases' (408) . After an impasse a t Treves there wa s a meeting at Spa . This tim e the British Admiral Hope was the leader. 'W e were quit of the Marshall's sou r presence an d unfriendly courtesies' (410). After one of the distressing an d ineffectiv e session s Keyne s asked, an d secured , th e Admiral's permission to speak privately with Dr Melchior. The account of their interview is moving. At las t we wer e by ourselves i n a smal l room. I wa s quivering with excitement, terrified out of my wits by what I was doing, for the barriers of permitted intercourse had not then begun to crumble, and somewhat emotional. Melchior wondered what I wante d .. . I trie d t o conve y t o hi m what I wa s feeling , how w e believe d hi s prognostications of pessimism, how we were impressed, not less than he, with the urgency of starting food supplies, how personally I believed that my Government and the American Government were really determined that the food should come, but that in the giving of formal undertakings our hands were tied ... if only he could secure a little latitude from Weimar, we could between us concoct a formula which would allow the food supplies to move in practice and would evade the obstructions

414 Fro m Adam Smith to Maynard Keynes of the French .. . He was as much moved as I was, and I think he believed m e ... He would do his best, he said, but had little hope of success (414-15).

Melchior faile d o n thi s occasion , bu t a basis ha d bee n lai d fo r a late r successful intervention . The next scene in the drama was played in the Conference Chambe r of the Quai d'Orsay. Keynes's account of the performance of Lloyd George is memorable. He ca n be amazin g when one agrees wit h him. Never hav e I mor e admired his extraordinary powers than in the next half hour of this conference. S o far he had said nothing, but I could see from behind that he was working himself up, shaking himself and frowning a s he does on these occasions. No w he spoke; the creepin g lethargy of the proceedings was thrown off, and he launched his words with rage. He wished to urge with all his might that steps should at once be taken to revictual Germany. The honour of the Allies was involved ... S o far not a single ton of food had been sent into Germany. The fishing fleet had even been prevented from going out t o catc h a fe w herrings . The Allie s wer e no w o n top , bu t th e memorie s of starvation might one day turn against them ... The Allies were sowing hatred for the future: the y were piling up agony, not for the Germans, but for themselves. Th e British troop s wer e indignan t about ou r refusa l t o revictua l Germany. Genera l Plumer ha d sai d tha t h e coul d no t b e responsibl e fo r hi s troops i f children wer e allowed to wander about the streets half-starved (419).

Later i n the debat e a secretary hurrie d i n with a telegram fro m Genera l Plumer. Lloyd George, who had carefully stage-managed the performance, read it immediately.4 "Please inform the Prime Minister that in my opinion food mus t b e sen t int o thi s Are a b y th e Allie s withou t dela y .. . Th e mortality amongs t women , children an d sick du e to hunger is spreading . The attitude of the population i s becoming one of despair, an d the people feel that an end by bullets is preferable to death by starvation"' (421). The debate wen t on but the French wer e forced at last to agree to the use of the German gold for the purchase o f food. So for the last act of the Keynes-Melchior drama , this time at Brussel s with Admiral Wemyss as the Allied leader : 'Well,' sai d the Admiral, 4ls this business going to go all right, d'you think? Will they give us the ships?' ... * You've had something to do with these fellows, haven't you?' he added, looking at me rather oddly; evidently Hope had told him about my

John Maynard Keynes 41 5 escapade wit h Melchior. 'Yes,'I said, 'alittle.' 'D'yo u think you could see to it that they don' t mak e any unnecessary trouble ? Ther e has got to be no mistake about this, you know.' I tumble d t o hi s meaning, looked hi m in the eyes , an d we both smiled. 'Yes,'I replied, T might.' [So Key nes accompanied b y Captain Jack Grant, the Admiral's Chief of Staff, went to talk to Melchior.] 'I want to tell you,' I began, 'the order o f the afternoon's proceedings . A t the beginning Excellenz vo n Braun will be called upo n to make the following declaration abou t th e ships and until he has made it no further business can be proceeded with.' Melchior's face fell. 'But,' I went on , 'fo r you r ow n most privat e informatio n I thin k i t is desirable tha t yo u should know what will follow. If von Braun feels able to make this declaration freel y and without qualification, the Allied representatives wil l then proceed t o undertake to r e victual German y on th e followin g conditions. Ca n yo u assur e m e that vo n Braun will do this?' Melchior started; looked around from me and saw on his other side, Captain Jack Grant , RN. This was evidently more than a personal impulse on my part; and the situation was clear to him. After only a moment's pause he looked at m e again with his solem n eyes . 'Yes, ' h e replied , 'ther e shal l be n o difficult y about that' ... A few minutes later we were lunching at the Hotel Britannique with our delegation. The Admiral at the head of the table goggled his eyes at me. 'I fancy it wil l be al l righ t this afternoon, ' I murmure d to him . And s o i t was ; all went according to program (424-6). This story has been retold here for the light it throws on the Economic Consequences: o n th e characte r o f the autho r an d o n th e natur e o f th e problem, and on the climate of opinion at the time of publication. Economic Consequences of the Peace Treaty* Underlying the argument of this book is a belief that the economic system of Europe ha d bee n desperatel y fragile , an d that it s restoration afte r th e shattering effect o f war required great effort an d wisdom. Moved by insane delusion and reckless self-regard, the German people overturned the foundations on which we all lived and built. But the spokesme n of the Frenc h and British peoples have run the risk of completing the ruin which Germany began, by a peace which, if carried into effect mus t impair yet further, when it might have restored, th e delicate , complicate d organisation , alread y shake n an d broke n by war , through which alone the Europea n people s ca n emplo y themselves an d live(i). * Throughou t th e remainde r of par t m pag e reference s i n the tex t ar e t o th e Collected Writings of John May nard Key nes, n

4i6 Fro m Adam Smith to Maynard Keynes Along wit h th e ple a o f economi c expedienc y ther e wa s a n underlyin g current of justice and magnanimity. In the preface to the French edition he said: 'Le t m e no t b e accuse d o f distributin g m y sympathie s wrongly , because I als o ad d recommendation s tha t w e shoul d kee p fait h wit h a humbled enemy and should seek the recovery and the health of Europe as a whole" (xx). And at the end of the introductory chapter he said: 'It is under the influence of Paris, not London, tha t this book has been written by one who, thoug h a n Englishman, feel s himself a European also ' (4) . Thoug h there wer e time s whe n Keyne s advocate d nationalis t policies , h e wa s essentially not just a European bu t a world citizen. Throughout hi s career he was concerned t o find ways to international order and co-operation. Bu t he was determined that England should not accept th e consequence o f the stupidity of other nations. If they could not be persuaded t o take a sensibl e line, then Englan d mus t take he r own. If the rest of the world would no t take steps to avoid the evils of inflation or deflation, England must refuse to allow the disease to spread to her. But I think this early protestation tha t he wrote as a European indicated an enduring characteristic. For Keynes, the nationalist isolationist policy was second best . Let m e illustrat e furthe r the elemen t o f magnanimity . A t th e en d o f Chapter n h e wrote: 'It wa s the task o f the peace conference t o honou r engagements an d to satisfy justice; but not less to re-establish lif e an d to heal wounds. These tasks wer e dictated a s much by prudence a s by the magnanimity which the wisdom of antiquity approved in victors' (16) . And at the end of Chapter v on 'Reparation' Keynes wrote: I cannot leave this subject as though its just treatment wholly depended either on our pledges or on economic facts. The policy of reducing Germany to servitude for a generation, of degrading the lives of millions of human beings, and of depriving a whole natio n o f happiness should be abhorrent and detestable - abhorren t and detestable, even if it were possible, even if it enriched ourselves, even if it did no t sow the decay of the whol e civilised lif e o f Europe. Some preach it in the name of justice. In the great events of man's history, in the unwinding of the complex fate of nations, justice i s no t s o simple . And i f it were , nation s are no t authorised , by religion or by natural morals, to visit on the children of their enemies the misdoings of parents or of rulers (142).

It was this high moral tone that made the book so exhilarating to me at the time: an d I confes s tha t i t stil l exhilarate s me . Bu t I mus t tur n t o th e economics. There i s a brief but interesting chapter on 'Europe before the War.'

John Maynard Keynes 41 7 What an extraordinary episode in the economic progress of man that age was which came to an end in August, 1914. The greater part of the population, it is true, worked hard and lived at a low standard o f comfort, yet were, to all appearances reasonably contented wit h thi s lot . Bu t escap e wa s possible , fo r an y ma n o f capacit y o r character a t all exceeding the average, int o the middle or upper classes, fo r whom life offered , at a low cost and with the least trouble , conveniences, comforts , and amenities beyond the compass o f the richest and most powerful monarchs of other ages ... Most importan t o f all he [the inhabitant of London] regarded thi s state of affairs a s normal , certain, an d permanent , except i n the directio n o f furthe r im provement (6-7). There were , however , element s o f instabilit y whic h Keyne s identified . First, there was the Malthusian devil; second, there was the delicacy of the international orde r an d th e peculia r importanc e o f the rol e o f Germany; third, ther e wa s th e 'doubl e bluf f involve d i n th e socia l arrangement s which secured rapid accumulation of capital, of which I shall say more; and fourth, 'Europe' s claim on the resources o f the New World was becoming precarious' (15). It i s the sectio n o n the 'psycholog y of society', 'th e double bluff fro m which I propose to quote. Europe wa s s o organise d sociall y an d economicall y as t o secur e th e maximu m accumulation o f capital . Whil e ther e wa s som e continuou s improvemen t i n th e daily conditions of life o f the mas s of the population , society wa s s o framed a s t o throw a great part of the increased income into the control of the class least likely to consume it. The ne w ric h of the nineteent h century were no t brough t up to large expenditures, and preferred the powe r which investments gave them to the pleasures o f immediat e consumption . I n fac t i t wa s precisel y th e inequality o f th e distribution o f wealt h whic h mad e possibl e thos e vas t accumulation s of fixe d wealth an d o f capital improvements which distinguished tha t age from al l others. Herein lay , i n fact, the mai n justification o f the capitalis t system. If the ric h ha spent thei r new wealth on thei r own enjoyments , the worl d would long ago have found such a regime intolerable ... This remarkable system depended for its growth on a double bluff or deception. On the one hand the labouring classes accepted fro m ignorance or powerlessness, or were compelled, persuaded, or cajoled by custom, convention, or authority, and the well established order of society into accepting a situation i n which they could call their own ver y littl e o f th e cak e tha t the y an d nature and the capitalists were cooperating to produce. And on the other hand the capitalist classe s wer e allowe d t o cal l th e bes t par t o f th e cak e their s an d wer e theoretically fre e t o consum e it , o n th e taci t underlyin g condition tha t the y con-

418 Fro m Adam Smith to Maynard Keynes sumed very little of it in practice. The duty of 'saving' became nine-tenths of virtue and the growth of the cake the object of true religion (11-12).

In vie w of his later worrie s abou t oversavin g thi s passag e i n the Consequences ma y see m surprising . Bu t there is no real conflict . Her e is th e recognition of the importance of saving enough to permit a desired rate of accumulation, withou t inflation . And th e rat e o f accumulatio n tha t wa s desirable appeared t o be high. The cake was really very small in proportion to the appetites of consumption, and no one, if it were shared all round, would be much better off by the cuttin g of it. Society was working not for the small pleasures of today, but for the future securit y and improvemen t of the race - i n fact fo r progress .. . Perhaps a day might come when there would at last be enough to go round, and when posterity would enter into th e enjoymen t o f ou r labours . I n tha t da y overwork , overcrowding , an d under-feeding would come to an end, and men, secure of the comforts and necessities of the body, could proceed to the nobler exercises of their faculties' (12).

But i f a high rate of accumulation require s a high rate of saving to avoi d inflation, a high rate of saving requires a high rate of accumulation to avoid deflation and unemployment. The problem of too high a degree of thrift in a period of low 'investment' was to be the main theme of the later writings: then the threat was deflation. But in 1919 the threat was inflation. 'The war has disclosed th e possibility of consumption to all and the vanity of abstinence to many. Thus the bluff is discovered, th e labouring classes may be no longer willing to forego so largely, and the capitalist classes , no longer confident o f th e future , ma y see k t o enjo y mor e full y thei r libertie s o f consumption s o long a s the y last , an d thu s precipitat e th e hou r o f thei r confiscation' (13). It was not till 1939 that Keynes had to turn again to think of the dangers of inflation, and of how to finance World War n without, or with relatively little inflation. A few years later H.D. Henderso n i n Supply and Demand (on e of the Cambridge Economi c Handbook s sponsore d by Keynes)8 raised a doubt about the defence of inequality as the condition of rapid accumulation ; ha d it, he wondere d a s had hi s teacher Alfre d Marshall, led to an imbalance between investment in human capital and material capital? I shall pass over Chapter i n on 'The Conference.' It is brilliant writing with sparkling characterizations of Clemenceau and Wilson. Lloyd George was not included and it was not till the publication of Essays in Biography in 1933 tha t th e Lloy d Georg e sketc h wa s published . I n introducin g th e

John Maynard Keynes 41 9 'Fragment' on Lloyd George he said that he had not been 'content with it'; and that he was 'influenced by a certain compunction. I had been very close to Lloyd George a t certain phases of the Conference, and I felt at bottom this, lik e almost everythin g else tha t on e could sa y about him, was only partial. I did not like to print what seemed t o me, even in the heat of the moment, to b e incomplete.' 9 M r Harrod i n a brief not e i n the Economic Journal said : 'I f Keyne s had no t ha d "compunction " in 1919 , it is most unlikely that Lloyd George would have been willing to collaborate with him in the late twenties. Although they did not secure success at the time, their campaign had great influence on political thought in subsequent years.'l ° It may be that Keynes should also have had 'compunction' as to the sketches of Clemenceau an d Wilson: perhaps som e important policy-makers were offended an d therefor e les s easil y persuaded o f the validit y of the mai n argument. Bu t Keyne s wa s appealin g t o th e peopl e rathe r tha n t o th e politicians an d t o the m the pictur e o f the cynicis m and hypocris y of the policy-makers ma y have bee n a n effectiv e elemen t in persuasion. In Chapte r i v Keyne s 'se t fort h boldl y the principal economic provisions of the treaty,' but he left to Chapter v his comment on the reparation clauses an d his assessment o f Germany's capacity t o meet the payments demanded of her. 'Th e German economic syste m as it existed before the war depende d o n the thre e mai n factors: (i ) Overseas commerc e as represented b y her mercantile marine, her colonies, he r foreign investments, her exports , an d th e oversea s connection s o f he r merchants , (ii ) Th e exploitation of her coal and iron and the industries built upon them, (iii) Her transport and tariff system ... The treaty aims at the systematic destruction of all three, but principally of the first two' (41). Having outlined the detail he concluded: 'Thus the economic clauses of the treaty are comprehensive and little has been overlooked which might impoverish Germany now, or obstruct he r developmen t i n future ' (70) . Thu s impoverishe d the Allies then made claims for payment of reparations on a gigantic scale. Clemenceau's aim was to weaken and destroy Germany in every possible way ... he did no t troubl e hi s hea d to understan d eithe r th e indemnit y o r poo r M . Klotz' s overwhelming financial difficulties. I f it amused the financiers to put into the treaty some very larg e demands, well there was no harm i n that; but th e satisfactio n o f these demands must not be allowed to interfere with the essential requirements of a Carthaginian peace (95).

An impoverishe d Germany could no t pay: a prosperous German y could pose a risk. France had sought revenge for 1870: would a revived Germany

420 Fro m Adam Smith to Maynard Keynes seek reveng e for 1918 ? Would a punitive or a magnanimous treaty be the more likely to lead to revenge or to peaceful co-existence ? The chapte r o n 'Reparation ' i s concerned wit h muc h mor e tha n th e ability to pay. It was directed also at the morality of the proposals in view of the undertakings given at the Armistice, and at the cynicism of the politicians. But what was required besides this discussion of morals and politics was an assessment of quantities. Keynes estimated the 'general magnitude of th e legitimat e claims, ' unde r th e term s o f the Armistic e t o b e £212 0 million. He said of this estimate: 'I feel som e confidence that the general magnitude, as distinct fro m th e precise figures, is not hopelessly errone ous' (84). He put the £3000 million as the extreme upper limit of the amount which 'we were entitled to present to the enemy' (85). The additional claim, that Keynes believed t o be illegitimate, the clai m in 'respect of pension s and allowances ' h e estimated woul d amount to som e £5000 million. Th e claim under the Peace Treat y migh t then be for as much as £8000 million (101). Th e Treat y di d not specif y th e amount s but th e categorie s t o b e covered. Keynes' s estimates o f the amounts implied by these categorie s was o f great importanc e i n judging th e provisions . H e followe d thes e estimates o f the magnitud e of the claim s b y estimates o f the capacit y t o pay. Detailed analysi s led him to the conclusion tha t £200 0 million was a 'maximum figure of Germany's capacit y t o pa y .. . A capacit y o f £8000 million or even £5000 million is, therefore, not within the limits of reasonable possibility. It is for those who believe that Germany can make an annual payment amounting to hundreds of millions sterling to say in what specific commodities they intend this payment to be made, and in what markets the goods are to be sold' (126-7). Of course, 'i f the Allies were to "nurse" the trade and industry of Germany for a period of five or ten years ... deliberately applyin g al l their resource s t o makin g her th e greates t industria l nation of Europe'; of 'if the value of gold were to sink to a half or a tenth of its presen t value' ; or if 'the progress o f science shoul d brin g within our reach method s and devices b y which the whole standard of life would be raised immeasurably' ; then 4 all standard s o f capacity woul d be change d everywhere. But the fact that all things mzpossible i s no excuse for talking foolishly' (128) . Faced with the impossibility o f prediction 'w e cannot a s reasonable me n do better tha n base our policy o n the evidence w e have, and adapt it to the five or ten years over which we may suppose ourselves to have some measure of prevision' (129). We must also be fully cognizant of the difficulty o f what came to be known as the 'transfer problem.' An annua l surplu s available for hom e investment can onl y b e converte d int o a surplus availabl e fo r expor t abroa d b y a radica l chang e i n th e kin d o f labour

John Maynard Keynes 42 1 performed. Labour, while it may be available and efficient fo r domestic service s in Germany, may yet be able to find no outlet in foreign trade ... in what export trade is German labour going to find a greatly increased outlet? ... The annual surplus which German labour can produce for capital improvements at home is no measure, either theoretically o r practically, of the annual tribute which she can pay abroad (131). And eve n i n th e estimatio n o f th e annua l surplu s fo r hom e investmen t Keynes foun d exaggeratio n throug h refusa l t o recogniz e th e degre e o f impoverishment from th e exhaustion of war and the losses imposed by the Peace. And i n s o far a s i t migh t be argue d tha t a defeate d enem y must accept a lower standard of life and comfort, thus increasing the 'surplus,' it had t o b e remembere d tha t a lowe r standar d o f livin g migh t decrease productivity. A footnote merits full quotation. It canno t b e overlooked , i n passing , tha t i n it s result s o n a country' s surplu s productivity a lowering of the standar d o f life act s bot h ways. Moreover, we are without experience of the psychology of a white race under conditions little short of servitude ... It is, however, generally supposed that if the whole of a man's surplus production i s taken from him , his efficiency an d his industry are diminished. Th e entrepreneur and the inventor will not contrive, the trader and the shopkeeper will not save, the labourer will not toil, if the fruits of their industry are set aside, not for the benefit o f their children, their old age, their pride, or their position, but for the enjoyment of a foreign conqueror (131) . Chapter vi, on 'Europe after the Treaty' is 'one of pessimism' for there was in the Treaty n o provision for the economic rehabilitation of Europe. The Counci l o f Fou r pai d n o attentio n t o thes e issues , bein g preoccupied wit h others - Clemencea u to crush the economic life of his enemy, Lloyd George to do a deal and bring home something which would pass muster for a week, the Presiden t to d o nothin g tha t wa s no t just an d right . I t i s a n extraordinar y fact tha t th e fundamental economic problem of a Europe starving and disintegrating before their eyes, was the one question in which it was impossible to arouse the interest of the Four. Reparation was their main excursion into the economic field, and they settle d it a s a problem of theology, of politics, o f electoral chicane , from ever y point of view excep t tha t o f th e economi c futur e o f the state s whos e destin y the y wer e handling (143). Two aspects ma y be noted: the decline in productivity in Europe an d the menace of inflation. Of the first Keynes wrote:

422 Fro m Adam Smith to Maynard Keynes The decreas e o f productivity canno t b e easil y estimate d .. . Bu t the prima facie evidence of it is overwhelming ... A variety of causes have produced it: violent and prolonged an d interna l disorde r a s i n Russi a an d Hungary ; th e creatio n o f new governments and their inexperience in the readjustment of economic relations, as in Poland and Czechoslovakia; the loss throughout the continent of Europe of efficient labour, through the casualties o f war or the continuance o f mobilisation; th e falling of efficiency throug h continued underfeedin g in the Centra l Empires ; th e exhaus tion of the soi l from lac k of the usual applications o f artificial manures throughou t the course of the war; the unsettlement o f the minds of the labouring classes on the fundamental economi c issue s o f their lives . Bu t abov e al l (to quot e M r Hoover ) 'there i s a grea t relaxatio n o f effor t a s th e refle x o f physical exhaustio n o f larg e sections o f the population from privatio n and the mental and physical strain of the war' (146-7). And ther e wer e accordin g t o M r Hoover' s estimat e som e 1 5 millio n families living on unemployment allowances, 'bein g paid in the main by a constant inflatio n of currency' (147). So to inflation : Lenin is said to have declared that the best way to destroy the capitalist system was to debauc h th e currency . By a continuing process o f inflation , government s ca n confiscate, secretl y an d unobserved , a n importan t par t o f th e wealt h o f thei r citizens. By this method they not only confiscate, but they confiscate arbitrarily; and while the process impoverishe s many, it actually enriches some . Th e sigh t of this arbitrary rearrangements of riches strike s not only at security, but at confidence in the equity of the existing distribution of wealth. Those t o whom the system brings windfalls, beyon d thei r desert s an d eve n beyon d thei r expectation s o r desires , become 'profiteers' , who are the object of the hatred of the bourgeoisie, who m the inflationism ha s impoverished , not les s tha n the proletariat . As the inflatio n proceeds and the real value of the currency fluctuates wildly from mont h to month, all permanent relations between debtors an d creditors, which form the ultimate foundations of capitalism, become s o utterly disordere d a s to be almos t meaningless; and th e proces s o f wealth-getting degenerates int o a gamble and a lottery. Leni n was certainly right (148-50). Keynes wen t o n t o contras t th e chang e i n th e capitalis t clas s fro m a triumphant and 'all-powerful master ' to a timid group of individuals which has los t confidenc e i n its role. Twenty-fiv e year s ag o - th e capitalist s believed in themselves, in their valu e to society , in the propriety of their continued existenc e i n the full enjoymen t of their riches an d the unlimited exercise o f their power. Now they tremble before every insult - cal l them

John Maynard Keynes 42 3 pro-Germans, international financiers, or profiteers, and they will give you any ransom you choose to ask' (150). Such are the effects o f inflation; but the probability of inflation continuing was very high. A brief examination of the budgetar y problem s o f Europea n government s mad e thi s clear : I n France the estimated receipt s from taxatio n woul d not cover muc h more than half the budgeted expenditure; in Italy the situation was a little better but no t much ; in Germany expenditure wa s 'estimate d at 25 milliards of marks of which not above 1 0 milliards are covered b y previously existing taxation'; in Russia, Poland, Hungary and Austria 'such a thing as a budget cannot be seriously considered to exist at all.' 'Thus,' Keynes, concluded, 'the menace of inflationism .. . is not merely a product of the war, of which peace begins the cure. It is a continuing phenomenon of which the end is not yet in sight'(157). A final chapter (vii ) proposed 'remedies. ' The first requirement was a revision o f the Treaty : reparatio n paymen t shoul d b e fixed 'well within Germany's capacit y t o pay, ' sa y £150 0 millio n payabl e ove r 3 0 year s without interest o n the outstanding debt. This would 'mak e possible th e renewal of hope and enterprise within her territory.' Add to this 'moderation' o f th e clause s relatin g t o coa l an d iro n or e s o a s t o 'permi t th e continuance of Germany's industrial life.' Finally let a free-trade union be promoted. Suc h a union would retrieve some part of the 'loss of organisation an d economi c efficienc y .. . whic h mus t otherwise resul t fro m th e innumerable new political frontiers no w created between greedy, jealous, immature, and economically incomplete, nationalist states.' The proposal was based on the belief 'that the prosperity and happiness of one country promotes that of others, that the solidarity of man is not a fiction, and that nations can still afford t o treat other nations as fellow creatures' (168-70). The secon d elemen t i n Keynes' s remedia l progra m wa s a generou s settlement of interallied indebtedness. First , th e Unite d Kingdom should waive any claim to a share of the Reparation payments. Second, the United Kingdom, the United States, and France should agree to the cancellation of all interallied indebtedness arising out of the expenditure on war. Cancellation of all these debt s (assumin g all the loan s to b e good) woul d mean a surrender by the United States of about £2000 million, and by the United Kingdom of about £900 million: France woul d gain about £700 million and Italy abou t £80 0 million. In a paragraph directe d t o Americans Keyne s argued that the English would not be avoiding 'due sacrifice.' (i) Th e sums which the British Treasury borrowed from th e American Treasury, after th e latte r came into the war , were approximately offset b y th e su m which

424 Fro m Adam Smith to Maynard Keynes England lent to her allie s during the same period .. . s o that almos t th e whole of England's indebtedness to the United States was incurred, not on her own account, but to enable her to assist the rest of her allies, who were for various reasons not in a position t o dra w their assistanc e fro m th e Unite d State s direct . (2 ) The Unite d Kingdom has disposed of about £1000 million worth of her foreign securities, an d in addition ha s incurre d foreign deb t t o th e amoun t of £1200 million . The Unite d States, s o fa r fro m sellin g has bough t bac k upward s of £1000 million , an d ha s incurred practically no foreign debt . (3) The population of the United Kingdom is about one-hal f that o f th e Unite d States , th e incom e abou t one-third , an d th e accumu'ated wealth between one-half and one-third. The financial capacity of the United Kingdom may therefore be put at about two-fifths tha t of the United State s ... Excluding loans to allies (as is right on the assumption that these loans are to be repaid), the war expenditure of the United Kingdom has been about three times that of the United States, o r in proportion to capacity between seve n and eight times (175).

So Keyne s calle d fo r a 'genera l bonfire ' mad e fro m th e mas s o f paper indebtedness; fearin g 'tha t unless w e can make of it an orderly an d goo d tempered affair ' i t may grow into a 'conflagration that may destroy muc h else as well' (178). If the debts were not formally cancelled, Keynes did not believe tha t the y woul d b e paid ; wha t h e had sai d abou t German y an d reparations coul d b e applied to England and the American debt : 'Europe must depend in the long run on her own daily labour and not on the largess e of America; but, on the other hand, she will not pinch herself i n order tha t the fruit of her daily labour may go elsewhere. In short, I do not believe that any of these tributes wil l continue t o be paid, at the best, for more than a very few years. They d o not square with human nature or agree wit h the spirit o f th e ag e .. . expedienc y an d generosit y agre e together , an d th e policy which will best promote immediate friendship between nations will not conflict with the permanent interests o f the benefactor' (179). The third element in the program was an international loan. 'Th e requirements of Europe ar e immediate.' H e recognized tha t the burden of finding immediate funds must lie to a very great extent with the United States. But he also recognize d tha t ther e wa s good reaso n t o distrust Europea n gov ernments; indeed he said: 'If I had influence at the United States Treasury, I would no t len d a penn y t o a singl e on e o f th e presen t government s o f Europe. The y ar e no t t o b e truste d wit h resource s whic h the y woul d devote to the furtherance of policies i n repugnance to which ... the Republican and the Democrati c partie s ar e probably united' (181) . If the Euro -

John Maynard Keynes 42 5 pean peoples would give some evidence tha t they were turning away from the 'false idols which have survived the war that created them,' and if they appeared read y t o substitut e 'fo r th e hatre d an d nationalis m whic h now possess them, thought s an d hopes of the happines s an d solidarit y o f the European family, ' then , he hoped that 'natura l piety and filial love' might impel the American people 'to complete the work that they began in saving Europe fro m th e tyrann y of organised force , b y saving her from hersel f (181). The amount required he believed t o be relatively small; immediately some £200 million in cash and a guarantee fund o f about the same amount. Of the economi c an d politica l consequence s of the Economic Consequences o f th e Peace Treaty I shal l sa y nothin g except tha t I fin d th e discussion of thes e matter s in Harrod' s life highl y satisfactory, and the criticism by Etienne Mantoux in the Carthaginian Peace, or the Economic Consequences o f M r Keynes (1946 ) unacceptable. I n thes e verdict s I am influenced no t onl y b y th e memor y o f m y feeling s i n 1919 , bu t b y th e experience o f the mor e magnanimou s treatment o f a defeate d Germany after worl d war n. Nor shal l I dea l wit h Keynes's Revision o f th e Peace Treaty (1922) , with the history of reparations i n the decade followin g the Treaty, nor with the doctrinal disputes over the transfer problem in which Keynes engaged. In the context of this study of the classical literature of political economy I thin k i t i s prope r fo r m e t o conclud e thi s sectio n o n th e Economic Consequences b y saying that it seems to me to be representative of much of what is best in that literature. It is in the fine tradition of Adam Smith, John Stuart Mill, and Alfred Marshall. IV

M O N E T A R Y P O L I C Y , T H E Tract

AND

The Economic Consequences of Mr Churchill

A Tract on Monetary Reform (1923) * The object and the tone of this Tract are indicated in the Preface. 'We leave saving t o th e privat e investo r .. . w e leav e th e responsibilit y for settin g production in motion to the business man ... these arrangements ... cannot work properly if the money, which they assume as a stable measuring rod, is undependable. Unemployment , the precariou s lif e o f the worker , th e disappointment of expectation, th e sudde n loss of savings, the excessiv e windfalls to individuals, the speculator, th e profiteer -all proceed , in large measure, from th e instability of the standard of value.' Keynes also refer * Throughou t this sectio n on th e Tract pag e references in the tex t ar e t o th e Collected Writings o f John Maynard Keynes, iv

426 Fro m Adam Smith to Maynard Keynes red to the cost involve d in risk: The rewar d of risk bearing is one of the heaviest, an d perhap s th e mos t avoidable , burde n o n production . Thi s element of risk is greatly aggravated by the instabilit y of the standar d of value.' An d s o he concluded : 'nowher e i s the nee d o f innovation mor e urgent' than in monetary institutions (xiv). The historical context of this book is one of violent changes in the value of money. In Europe it was a matter of continuing inflation: as a percentage of 1900 the index numbers of wholesale prices quoted in the Tract were, in the firs t hal f o f 1923 , i n Franc e 411 , i n Ital y 582 , in German y 765,000 . Keynes had discussed the social effects o f inflation in the Economic Consequences . He repeated the argument in the first chapter of the Tract. But a new proble m ha d emerged , tha t o f deflation . Th e inde x numbe r o f wholesale prices, a s a percentage o f 1913, had rise n in England to 295 in 1920, an d ha d fallen back t o 15 9 in the firs t hal f of 1923 . Similarl y in th e United States, th e index had risen to 226 in 1920 and fallen back to 15 7 in 1923. 'Each process, inflatio n and deflation alike, has inflicted great injur ies. Eac h ha s a n effec t i n alterin g th e distribution o f wealt h betwee n different classes , inflatio n in this respect bein g the worse of the two. Eac h also has an effect i n overstimulating or retarding the production of wealth, though here deflation is the more injurious' (3). In Chapter i Keynes examined first the effect o f changes in the value of money on distribution, and then on production. First , the investing class: 'Throughout the Continent the prewar savings of the middle class .. . have been largely or entirely wiped out .. . What was deemed mos t secure ha s proved least so ' (16). Second, the business class. 'I f the depreciation i s a source of gain to the business man, it is also the occasion of opprobrium ... To convert the business man into a profiteer is to strike a blow at capitalism ... The business man is only tolerable so long as his gains can be held to bear some relatio n t o what , roughl y an d i n som e sense , hi s activitie s hav e contributed t o society' (23-4) . The n ha d come falling prices : 'Excessiv e losses bearing no relation to the efficiency of the business, took the place of windfall gains ... Unemployment succeeded profiteerin g as the problem of the hour' (26). Third, the earner. It had been generally accepted tha t wages tended to lag behind prices s o that real earnings would fall in a period of rising prices. Bu t in England and the United States importan t sections of labour had secure d afte r 191 8 higher real wages and shorte r hours . Thi s Keynes attribute d t o bette r organization ; t o a rise i n the 'conventiona l standard of requirements' as the soldiers were better fed, clothed and shod, and as the soldiers ' wive s added separatio n allowance s t o their wages in newly opened occupations; and to the 'fact that the business man had been

John Maynard Keynes 42 7 gaining, an d gainin g notoriously, considerabl e windfal l profits' an d wa s thus 'open to pressure, no t only from hi s employees but from publi c opinion generally .. . it was worth his while to pay ransom and to share with his workmen the good fortune of the day' (27). From effect s on distribution Keyne s turned t o effects on production. I f business men 'expect a fall, it may pay them as a group to damp production down, althoug h suc h enforced idleness impoverishe d societ y a s a whole' (31). To continu e t o allow th e leve l o f production t o be governed b y the expectation of profit requires tha t the delicate adjustment of interests is not upset by fluctuation s i n the standar d of value .. . The fact o f falling prices injure s entrepreneurs ; consequently the fear o f falling prices causes them to protect themselves by curtailing their operations ... It is one of the objects of this book to urge that the best way to cure this mortal disease of individualism is to provide that there shall never exist any confident expectation that prices generally are going to fall or that they are going to rise; and also that there shall be no serious risk that a movement, if it does occur, will be a big one (35).

So to the conclusion. 'Inflatio n i s unjust and deflation inexpedient. O f the two perhaps deflatio n is, if we rule out the exaggerated inflation s such a s that of Germany, the worse; because it is worse, in an impoverished world, to provoke unemploymen t tha n to disappoint th e rentier' (36). All of this led Keyne s t o argu e tha t individualisti c capitalis m 'presumes a stabl e measuring rod of value, and cannot be efficient -perhaps cannot survive without one.' He therefore insisted that the standard of value should be the subject of deliberate decision. From the social effects o f inflation Keyne s turned to the social functio n of inflatio n a s a n instrument of public finance (Chapter n). First , h e discussed 'inflatio n as a method of taxation.' A government can live for a long time ... by printing paper money. That is to say, it can by this means secure the command over real resources, resources just as real as those obtaine d by taxation . The metho d is condemned, but it s efficacy , u p t o a point, must be admitted. A government can live by this means when it can live by no other. It is the form of taxation which the public find hardest to evade and even the weakest government can enforce, when it can enforce nothing else (37).

Its efficac y i s reduced, ultimatel y destroyed, whe n the public, to protec t itself against these 'ingeniou s depredations' change s its habits in the use of money, deciding to hold less of its wealth as money.

428 Fro m Adam Smith to Maynard Keynes They can do this in various ways: (i) instead o f keeping some part of their ultimat e reserves i n mone y the y ca n spen d thi s mone y o n durabl e objects , jeweller y o r household goods, an d keep their reserves i n this form instead; (2 ) they can reduc e the amount of till money and pocket money that they keep and the average length of time for which they kee p i t .. . ; and (3) they ca n employ foreign money in many transactions wher e i t would have been mor e natural and convenient to us e thei r own (41). In a footnote he developed items (2) and (3). In Mosco w the unwillingness to hold money except for the shortes t possibl e tim e reached at one period a fantastic intensity. If a grocer sold a pound of cheese, he ran off wit h th e ruble s as fas t a s hi s leg s coul d carr y hi m t o th e Centra l Marke t t o replenish his stocks by changing them into cheese again, lest the y lost their valu e before h e go t there ; thu s justifying th e previsio n o f economist s i n namin g th e phenomenon 'velocit y o f circulation' ! In Vienna , durin g the perio d o f collapse mushroom exchang e banks spran g up a t ever y corner , wher e yo u coul d chang e your krone into Zurich francs within a few minutes of receiving them, and so avoid the risk of loss during the time it would take you to reach you r usual bank (41 n.). Keynes also discussed inflation as an instrument for reducing the burden of the internal debt of the government. It would be too cynical to suppose that, in order to secure the advantages discusse d in this section, governments (except, possibly, the Russian government) depreciat e their currencies on purpose .Asa rule they are, or consider themselves to be, driven to it by their necessities. Th e requirements of the Treasury t o meet sudden excep tional outgoing s .. . ar e likel y to b e the origina l occasio n of , a t leas t temporary, inflation. Bu t th e mos t cogen t reaso n fo r permanent depreciation , tha t i s to sa y devaluation ... is generally to be found in the fact that a restoration o f the currency to its former value would raise the recurrent annual burden of the fixed charges of the National Debt to an insupportable level (53). The choice was repudiation, devaluation or a capital levy. This last Keynes considered the 'rational, the deliberate method' (55). In a superb paragraph he swep t awa y the argumen t against al l three expedient s 'o n the ground that the y infring e th e untouchabl e sacrednes s o f contract ; o r rathe r o f vested interest, for an alteration o f the legal tender and the imposition of a tax on property are neither of them in the least illegal or even contrary to

John Maynard Keynes 429 precedent.' He argued that there was 'a fundamental distinction between the right of the individual to repudiate contract and the right of the State to control veste d interests. ' Indeed , h e said , 'nothin g ca n preserv e th e integrity of contract between individuals, except a discretionary authorit y in the State to revise what has become intolerable'(56). Having discusse d th e evi l consequences o f instability in the valu e of money Keyne s proceede d in Chapter 3 to lay theoretical foundations on which he would then build his practical suggestions. First he examined the 'quantity theory of money': a theory which he said was fundamental; 'its correspondence wit h fact is not open to question. Nevertheless it is ofte n misstated an d misrepresented' (61). What he presented wa s the orthodox Cambridge doctrine long taught by Alfred Marshall: i n place of the mor e familiar Fishe r equation, MV = PT , he developed the Cambridge equation, n = p(k + rk'}. 'Le t us assume that the public require to hold an amount of money having a purchasing power ove r k consumptio n units.' Le t u s assume furthe r that the y 'kee p the equivalen t o f k consumptio n unit s in cash and a further k' available at their banks against cheques, and that the bank kee p i n cas h a proportio n r of their potential liabilities {k') t o th e public. Our equation then becomes, n =p(k + rk'Y wher e n is the amount of cash i n circulation (63) . Now th e misstatemen t an d misrepresentation t o which he had referred lay in the improper expectation that 'a mere change in the quantity of the currency cannot affect /:, r and k' .. . It would follow from this that an arbitary doubling of n, since this in itself is assumed not to affect k, r, and /:', must have the effect of raising/? to double what it would have bee n otherwise . Th e quantit y theor y i s ofte n state d i n this , o r a similar, form. Now "in th e long run" thi s is probably true ... But this long run is a misleading guide to current affairs. In the long run we are all dead' (65). In fact changes in n are likely to affect A: , k', and r. With a characteris tic readines s t o giv e statistica l illustratio n even i f h e coul d no t clai m precision, he presented the following table. Price level ( October 192 0 15 0 58 October 192 2 10 0 50

Cash circulation Ban k deposits £ million) ( £ million) 5 200 0 4 170 0

The valu e of r wa s not very different a t the tw o dates - sa y about 1 2 pe r cent. Consequently our equation for the two dates works out as follows: October 192 0 n = 585 p 1. 5 k 23 0 k' 133 3 October 192 2 n = 504 p i k 30 0 k' 1700 .

430 Fro m Adam Smith to Maynard Keynes In a footnote he wrote out the equations: For 585 = 1.5(23 0 + 133 3 x 0.12) and 504 = 1(30 0 + 170 0 x 0.12)... It thus appears that the tendency of A: and k' t o increase had more to do than the deflatio n of cash had wit h the fall o f prices between the tw o dates. Thu s even in Great Britai n the fluctuations of k and k' can have decisive influence on the price level; whilst we have already seen how enormously they can change in the recent condition s of Russia and Central Europe (67-8).

It follows from thi s theory that th e business of stabilizing the price leve l consists partly in exercising a stabilizing influence on k and k' and 'in so far as this fails or is impracticable in varying n and r so as to counterbalance th e movement of A: and k'... Old fashioned advocates of sound money have laid too much emphasis on the need of keeping n and r steady, and have argued as if this policy by itself would produce th e right results. So far from thi s being so, steadiness ofn an d r, when k and k' ar e not steady, i s bound to lead to unsteadiness o f the price level' (68-9). Keynes nex t discusse d th e 'purchasin g powe r parity ' theor y o f th e foreign exchanges. The doctrine is Ricardian, and Gustav Cassel had made it familiar in the post-war years and given it its name. Keynes was highly critical: perhaps because he underrated the effectiveness of the doctrine in shaking the public loose from the belief in the normality of the old parties; but principall y because h e wa s concerne d wit h a theor y tha t woul d b e useful for monetary management. As with the quantity theory of money, so with this theory o f the exchange rat e long-run theory i s inadequate. Th e difficulty o f applying the simpl e theory aros e from th e divergenc e i n the movement of the prices of those goods that do enter into international trade and of those which do not. The theory does not provide a simple or ready-made measure of the 'true' value of the exchanges. When it is restricted to foreign-trade goods it is little better than a truism. Whe n it i s no t s o restricted , th e conceptio n o f purchasing power parity becomes much mor e interesting, but i t is no longer an accurate forecaster o f the course o f the foreig n exchanges .. . The essenc e o f the purchasin g power parity theory ... is to be found, I think, in its regarding internal purchasing power as being in the long run a more trustworthy indicator of a currency's value than the market rates of exchange, because internal purchasing power quickly reflects the monetary policy of the country, which is the final determinant (77-9).

To discussion of the theory, Keynes added tables and charts showing the

John Maynard Keynes 43 1 divergence o f actual rates of exchange with the United States dollar fro m the purchasin g powe r paritie s fo r Grea t Britai n (1919-23) , France , and Italy (1919-21). These charts demonstrate th e susceptibility of the foreign exchange rates to seasonal influence , and thus led Keynes to a discussion of 'seasonal fluctuation. ' That th e rat e o f exchang e wil l b e raise d i f th e financia l polic y o f a country is directed to lowering the internal price level relative to that of the other country, and will be lowered by policies that raise the internal price level relativ e t o th e othe r country , follows fro m th e purchasin g powe r parity theory, and is correct. It is not correct, however, that financial policy which maintains a stable relation between internal and external price levels will guarantee stabl e exchanges. The balance of payments must balance every day... Formerly the daily balance was adjusted b y the movemen t of bankers' funds .. . Bu t now it is no longer a purely bankers' business, suitably and sufficiently rewarde d by an arbitrage profit... Hi s profit i s no longer definitely calculabl e beforehand ... The seasona l adjustment of credit requirements has ceased to be arbitrage banking business, and demands the service of speculative finance (90).

Because of the risk bankers who would have been ready in pre-war days to remit millions, in the period unde r consideration hesitate d t o remit hundreds of thousands. So, 'the exchange must fall (or rise, as the case may be) until either the speculativ e financier feels sufficiently confiden t of a large profit to step in, or the merchant... decides t o forego the convenience of purchasing at that particular season of the year' (90). The extent to which the exchange fluctuations of the previous three years had been seasonal , i.e., not 'due to a continuing or increasing disequilibrium, but merely t o the absence of fixed exchange,' had not, he felt, been fully appreciated. It was necessary t o adop t a polic y o f stabilization : 'banker s shoul d hav e a sufficiently certai n expectation' o f stability and this required action by the monetary authority , b y a guarante e o f convertibilit y o r b y som e othe r means. In a final section Keyne s discussed th e forward market in exchanges. First, h e presente d table s comparin g th e spo t an d futur e (on e month forward) exchang e rates i n London on New York , Paris, Ital y and Germany. The n h e considere d th e functio n o f the speculator . Th e forwar d market enabled merchants to reduce their risks at very little expense. Nevertheless, in practice merchants do not avail themselves of these facilities to the

432 Fro m Adam Smith to Maynard Keynes extent that might have been expected. Th e nature of forward dealings in exchange is not generally understood ... Moreover, for the ordinary man, dealing in forward exchange has, it seems, a smack of speculation about it. Unlike Manchester cotton spinners, wh o hav e learnt by lon g experience tha t i t is not th e hedgin g of open cotton commitment s on th e Liverpoo l future s market , bu t th e failur e t o d o so , which i s speculative , merchants , wh o bu y o r sel l good s o f whic h the %price i s expressed in foreign currency, do not regard it as a part of the normal routine of prudent business to hedge these indirect exchange commitments by a transaction in forward exchange ... It is not clear that even the banks themselves have yet learnt to look on the provision for their clients of such facilities at fair and reasonable rates as one of the most useful service s they can offer (100-1).

Having discusse d th e us e o f the forwar d marke t Keyne s proceede d t o theoretical analysi s of the factors determinin g the degree o f divergence o f forward from spot rates. This was a highly original contribution. Followin g the theory came som e conclusions, i ) The stat e bank s in Europe shoul d organize facilitie s for forwar d dealings . 2 ) Banks should ceas e t o tr y t o distinguish between speculativ e dealing s in forward exchange fro m thos e intended to hedge commercial transactions . Any such attempt t o regulat e ignores the fact 'tha t the speculator wit h resources can provide a useful , indeed almost an essential service ' (i 12). 3) The relation between spo t and forward rate s shoul d b e considered i n determining bank-rate policy ; th e effect o n any 'moderate difference' i n the bank rates i n London and New York had little effect o n the spot rate, but largely affected the discount for forward dollars. Having discussed th e evils of instability and having laid a foundation of theory, Keynes turned to 'remedies.' In chapter iv he examined the 'alternative aims' an d in chapter v mad e 'positiv e suggestions.' Three sets of alternative aim s were examined: devaluation versus deflation, stability of prices versus stability of exchange, restoration o f the gold standard versu s the developmen t o f a 'more scientifi c standard.' As t o the first, Keynes argued tha t deflatio n wa s neithe r desirabl e nor , i n mos t countrie s o f Europe, possible . H e quoted wit h approval the opinion of David Ricardo , stated in a speech i n the House of Commons in June 1822: If in the yea r 1819 the value of the currency had stoo d at 14!- for the pound note, which wa s the case in 1813 , he shoul d have thought that, on a balance of all the advantages an d disadvantage s o f th e case , i t woul d hav e bee n wel l t o fi x th e currency at the then value, according to which most of the existing contracts ha d

John Maynard Keynes 43 3 been made: but when the currency was within 5 per cent of its par value, he thought they had made the best selection in recurring to the old standard (125).

The specia l cas e of England wa s later argue d in a famous pamphlet , The Economic Consequences of Winston Churchill which I shall discuss below . As to the second alternative , Keynes favoured stability of prices. In pre-war days, when almost the whole world was on a gold standard, we had all plumped for stability of exchange as against stability of prices, and we were ready to submit to the social consequences of a change of price level for causes quite outside our control , connected , fo r example , wit h th e discover y o f ne w gol d mine s i n foreign countrie s or a change of banking policy abroad. Bu t we submitted, partly because we did not dare trust ourselves to a less automatic (though more reasoned) policy, and partly because the price fluctuations experienced wer e in fact moderat e (126).

Keynes recognized that the right choice was not necessarily the same for all countries; but h e did believe tha t ther e wa s 'i n almos t every case a presumption i n favour of the stabilit y o f prices, if only it can b e achieved. ' Finally a s t o th e gol d standard . Keyne s repeate d som e o f hi s boo k o n Indian Currency as to the doubtful prospects o f the good behaviour of gold as a standard. He noted that 'enlighted advocates o f the restoration of gold, such a s M r Hawtrey , d o no t welcom e i t a s th e retur n o f a "natural " currency, and intended, quite decidedly, that it shall be a "managed" one. They allow gold back only as a constitutional monarch, shorn of its ancient despotic power s an d compelle d t o accep t th e advic e o f a Parliament o f banks' (138) . I f th e currenc y wer e t o b e managed , wh y incu r th e 'vai n expense o f bottling up the world's redundant gold'? If it were to be managed woul d no t joint managemen t wit h the Unite d State s 'make s us too dependent on the policy and on the wishes of the Federal Reserv e Board ' (140). The 'positive suggestions for the future regulation of money' in Chapter v are outlined first in the context of Great Britain, then their applicability to the United States and other countries is briefly considered. The objective is stability o f th e interna l pric e leve l an d avoidanc e o f 'purel y temporar y fluctuations' in the exchange rate due to seasonal influences 'and not due to lasting disturbance i n the relation between the internal and external price level' (141) . Afte r describin g th e monetar y syste m actuall y operatin g i n England, h e noted tha t Britai n had gone a long way 'towards the ideal of directing bank rate and credit policy by reference to the internal price level

434 Fro m Adam Smith to Maynard Keynes and other symptom s of under- or over-expansion o f internal credit, rathe r than by reference to the pre-war criteria of the amount of cash in circulation (or o f gold reserve s i n the banks ) o r th e leve l o f dollar exchange ' (146) . Keynes aske d tha t thes e existin g arrangement s b e develope d o n mor e deliberate an d self-consciou s lines , tha t th e stabilit y o f sterlin g price s should be the 'primary objective.' Exchange stability might be a secondar y objective. I f the Federal Reserve Boar d achieve d reasonabl e stability o f dollar prices ther e woul d be little difficulty i n reconciling th e primary and secondary objectives: but if the Board failed to keep prices steady, 'sterling prices shoul d not , i f it could b e helped, plung e with them merel y fo r th e sake of maintaining a fixed parity of exchange' (147). As to internal man agement Keyne s wa s no t satisfie d wit h Professo r Fisher' s proposa l for automatic adjustment of the money supply by reference to an index number of prices 'withou t any play of judgment or discretion.' He agreed wit h Mr Hawtrey that 'it is not the past rise in prices but thefuture ris e that has to be counteracted.' To wait till the rise in prices is evident may mean that action will be too late. Attention must be paid not only to movements of prices, but also 'to the state o f employment, the volume of production, the effec tive demand for credit as felt b y the banks, the rate of interest on investments o f various types, the volum e of new issues , th e flow of cash int o circulation, the statistic s o f foreign trad e and the level of the exchanges ' (149). Judgmen t wa s necessary : deliberat e decisio n no t automati c re sponse. To provid e fo r stabilizin g th e exchang e rat e 'ove r shor t periods, ' Keynes recommended that the Bank of England should regulate the pric e of gold: ' "regulate" but not "peg".' Ever y Thursday mornin g the Bank should announce its buying and selling prices of gold, with a difference of l /2 to i per cent. This would keep the dollar sterling exchange steady within those limits, 'so that the exchange rate would not move with every breat h of wind but only when the Bank had come to a considered judgment that a change was required for the sake of stability of sterling prices' (150) . This policy required tha t the Bank hold adequate gol d reserves, whic h in turn required that the gold held in Britain should no longer be immobilized as a required reserv e agains t the interna l currency. This wa s good Thornto n doctrine! At this point Keynes referred to the Cunliffe Repor t on Currency and Foreig n Exchang e (1918 ) afte r th e War , 'a n unadulterate d pre-war prescription,' which omitted any mention of the problem of the stability of the price level, and 'cheerfully explain s how the pre-war system, which it aims at restoring, operated to bring back equilibrium by deliberately causing a "consequent slackenin g of employment".' The Report, he said, rep-

John Maynard Keynes 43 5 resented a n 'extinct ' orde r o f ideas , ye t th e 'Ban k o f Englan d an d th e Treasury ar e said still to regard it as their marching orders' (153). Reading this fifty years later one cannot help but say that the reliance on 'slackening of employment,' as a means of maintaining an exchange rate or of controlling an inflation is, unfortunately, far from 'extinct. ' The proposals fo r reform were recommended for Great Britain and the details were related to her institutions. 'But the principles underlying them remain just a s true across the Atlantic.' In the United State s as in Great Britain, the monetary authority was acting 'half consciously, half unconsciously' o n the line advocated. 'I n practice th e Federa l Reserve Boar d often ignore s th e proportion o f it s gol d reserve s t o it s liabilitie s an d i s influenced, in determining its discount policy, by the object of maintaining stability in prices, trade, and employment. Out of convention and conservatism i t accept s gold . Ou t o f prudenc e an d understandin g it burie s it. ' From th e da y that Federa l Reserve Boar d bega n t o accep t gol d without allowing it to exercise its full influence gold was demonetized by almost the last country which still continued to do it lip-service, and a dollar standard was set up on the pedestal o f the Golden Calf. Fo r th e last two years the United State s ha s pretended t o maintai n a gol d standard . In fact i t ha s established a dollar standard; and, instead of ensuring that the value of the dollar shall conform to that of gold, it makes provision, at great expense , that th e valu e of gold shal l conform to tha t o f the dollar ' (155) . If Grea t Britain and the United States were successful in maintaining stable prices, stable exchanges would follow. Keynes recognized the ideal state of affairs as on e o f 'intimat e cooperation ' betwee n th e Ban k o f Englan d an d th e Federal Reserve Board, but he was not sufficiently confiden t of the quality of the Board's management or to the strength of the Bank's influence on the Board, to recommend that the value of sterling be fixed in terms of dollars. 'We hav e reache d a stag e i n evolutio n o f mone y whe n a "managed " currency i s inevitable , bu t w e hav e no t ye t reache d a poin t wher e th e management can be entrusted t o a single authority. The bes t w e can do , therefore, is to have two managed currencies, sterlin g and dollars, with as close a collaboratio n a s possibl e betwee n th e aim s and method s o f th e managements' (159). Perhaps my appreciation o f the Tract i s related, fifty years later, to the excitement induced by this book when I first read it. I am happy to record Harrod's appreciation . H e suggeste d tha t ther e migh t b e a fascinating debate as to which of Keynes's books had the most ultimate significance. In the Treatise on Probability he explored the foundations of human knowledge in a

436 Fro m Adam Smith to Maynard Keynes work which , althoug h no t definitive , ha s continue d t o stimulat e though t upo n it s deep problems . Th e Economic Consequences wa s hi s greates t masterpiec e of polemic ... The two large books, the Treatise on Money an d The General Theory of Employment Interest an d Money, hav e ha d fa r reachin g effect s o n economi c science and thereby indirectly on public policy. There are still purists who give the first prize to his book on Indian Currency. In spite of all this, a claim could be made on behalf of the Tract on Monetary Reform. 11 The Economic Consequences of M r Churchill (1925)* This pamphlet i s a seque l t o th e Tract. On 29 April, 1925 , Grea t Britai n returned to the gold standard. The return to gold was a disappointment, but Keynes might well have expected it , and might have been ready to condone it: but to return to gold at its old price, to return the pound to the old relation with th e dollar , appeared t o him to be so disastrous tha t vigorous attac k was necessary. The consequences of this action must be deflation at home. 'Mr Churchill' s polic y o f improvin g the exchang e b y 1 0 pe r cen t was , sooner or later, a policy of reducing everyone's wages by 2 s in the £' (208). The expert s ha d made , Keyne s argued , a seriou s miscalculatio n o f th e adjustment necessar y t o justify th e pre-war parity. In expectation o f that restoration th e exchange rate had risen towards par. This in itself had hurt the economy, but it had also played a part in misleading the experts by its effect o n th e price s o f internationa l good s an d consequentl y o n th e wholesale price index. His experts miscalculated the degree of the maladjustment of money values which would resul t .. . becaus e the y attende d t o inde x number s o f price s whic h wer e irrelevant o r inappropriat e t o th e matte r i n hand. I f yo u wan t t o kno w whether sterling values are adjustin g themselves t o an improvement i n the exchange, i t is useless t o consider, fo r example, the pric e o f raw cotton in Liverpool. Thi s must adjust itself to a movement of the exchange... but it is not sensible to argue from this that th e mone y wage s o f dockers or of charwomen an d the cos t of postage or of travelling b y trai n als o adjus t themselve s hou r b y hou r i n accordanc e wit h th e foreign exchanges . Yet this, I fancy, is what the Treasury did. They compare d th usual wholesale price index numbers here and in America - sinc e these are made up to th e exten t o f a t leas t two-third s from th e ra w material s o f international com merce, the prices of which necessarily adjust themselves to the exchanges -the true disparity of international prices wa s watered dow n to a fraction o f its true value. * Throughou t thi s sectio n o n th e pamphle t of 192 5 pag e reference s i n the tex t ar e t o th e Collected Writings, ix, Essays i n Persuasion, where the original pamphlet is reproduced in full

John Maynard Keynes 43 7 This led them to think that the gap to be bridged was perhaps 2 or 3 per cent, instead of the true figure of 10 or 1 2 per cent , which was the indication given by the index numbers o f th e cos t o f living , of th e leve l o f wages , an d o f th e price s o f ou r manufactured exports - which indexes are a much better rough-and-ready guide for this purpose, particularly if they agree with one another, than are the index numbers of wholesale prices (212-13).

The second mistake of the experts was to underrate the 'technical difficulty of bringin g abou t a genera l reductio n o f interna l mone y values. ' The y should hav e warne d M r Churchill tha t hi s policy wa s certain t o involve unemployment and industrial disputes. If in face of this warning Mr Churchill determine d t o g o ahea d h e shoul d hav e bee n tol d t o expec t th e following sequence of events. To begin with, there will be a great depression in the export industries. This in itself will be helpful, sinc e it will produce an atmosphere favourable to the reduction of wages. The cos t of living will fall somewhat. This will be helpful too, because it will give yo u a good argumen t in favour o f reducing wages. Nevertheless, the cos t of living will not fall sufficientl y and , consequently, the expor t industries wil l not b e able t o reduc e thei r prices sufficientl y unti l wage s hav e falle n i n th e sheltere d industries. Now wages will not fall in the sheltered industries merely because there is unemployment in the unsheltered industries, therefore you will have to see to it that there is unemployment in the sheltered industries. The way to do this will be b credit restriction. By means of the restriction of credit by the Bank of England you can deliberately intensify unemploymen t to any required degree until wages do fal l (214-15).

He added that the experts should have warned Mr Churchill also 'that it will not b e saf e politicall y t o admi t tha t yo u ar e intensifyin g unemployment deliberately in order to reduce wages.' He harped on this phrase, 'deliberate intensification': 'By whatmodus operandi does credit restriction attain' its purpose? 'In n o other wa y than by the deliberate intensification o f unemployment' (218) . And again : 'Credi t restrictio n i s an incredibly powerful instrument, an d eve n a littl e o f i t goe s a lon g wa y .. . Th e polic y o f deliberately intensifying unemployment with a view to forcing wage reductions is already partl y in force .. . We are depending for the reductio n of wages on the pressure of unemployment and of strikes and lock-outs; and in order to make sure of this result we are deliberately intensifying unem ployment'(219-20).

438 Fro m Adam Smith to Maynard Keynes In the final section of the pamphlet Keynes proposed that , if the existing policy were not reversed, the government should attempt to 'effect a uniform reductio n of wages by agreement, on the understanding that this shall not mean in the long run any fall in the average real wages below what they were in the first quarter of this year ... Can we not agree ... to have a uniform initial reduction of wages throughout the whole range of employment, including Government and Municipal employment, of (say) 5 per cent, which reduction shall not hold good unless , afte r a n interval , it ha s bee n compensate d b y a fall i n the cos t o f living?' (228)

To meet the objection whic h Labour woul d certainly raise , tha t the recipients of money payments other than wages would not be subjected to the same treatment, and, indeed, woul d generally gain from the fall in prices, Keynes suggeste d a 'rough-and-ready expedient o f levying an additiona l income tax of i s in the £ on all income other than from employment, which should continu e unti l rea l wage s ha d recovere d t o thei r previou s level ' (229). Failin g suc h all-roun d reductio n i n wages, Keyne s sai d h e would 'stake everything on an attempt to raise prices in the outside world -that is on a reversal of the present policy of the Bank of England' (229). He closed by sayin g that th e 'presen t policy o f deliberately intensifyin g unemployment .. . is a policy which the country would never permit if it knew what was being done' (229). V FROM

MONETARY

POLICY

T H E W A Y T O T H E Treatise

TO I N V E S T M E N T POLICY:

In the Tract an d in the Economic Consequences of M r Churchill Keyne s argued for a monetary policy that would not precipitate unemployment nor intensify i t if it was already undul y high. More generally, he was arguing against the use of unemployment as a deliberate instrument of policy. (The present readines s t o accep t a trade-of f betwee n unemploymen t an d inflation would surely have been unacceptable t o him.) But though he saw monetary policy causing unemployment through restrictions on credit with a view to deflation, he quite soon became sceptica l as to the possibility of monetary policy alone solving the intense unemployment of England in the twenties. He turned his mind to investment policy. A brief examination of a sample of his writings on this problem in the six years before the publica tion o f the Treatise ma y hel p t o understan d th e natur e o f the scientifi c advance made by that book.12 There was first the insistent question, how to

John Maynard Keynes 43 9 alleviate and , i f possible, eliminat e th e huma n distress an d th e materia l waste of unemployed men and unemployed material resources. There was an intuitive vision of a possible justification of policies whic h appealed t o his common sense . There was a determined effor t o f intellectual analysis directed towards the solution of the social problem which worried him and the intuitive solution which could not satisfy him until he could develop a tough intellectua l justification . Problem , vision , analysis , thi s seem s t o have been the sequence not only in the achievement of Keynes but of all the great economists, perhaps of all great scientists. It all started wit h an article in the Nation, in May 1924, under the title, 'Does Unemployment Need a Drastic Remedy?' The answer Keynes gave was, of course, yes: the problem was, what remedy? He proposed tha t one hundred millio n pounds a year be diverted fro m th e Sinkin g Fund t o the 'construction of capital work s at home:' housing, roads, electrica l powe r transmission. 'I look,' he said, 'for the ultimate cure of unemployment and for th e stimulu s which shal l initiate a cumulative prosperity t o monetary reform - whic h will remove fea r - an d to the diversion of the National Savings fro m relativel y barre n foreig n investment into stat e encourage d constructive enterpris e a t home , whic h wil l inspir e confidence.' 13 Tw o weeks later he justified suc h state action as follows: I bring in the State: I abandon laissez faire - not enthusiastically, not from contempt of that good old doctrine but because, whether we like it or not, the conditions for its success have disappeared. It was a double doctrine -it entruste d the public weal to private enterpris e unchecked an d unaided. Privat e enterpris e is n o longe r un checked ... And if private enterprise is not unchecked, we cannot leave it unaided.

So he suggested 'that State encouragement of new capital undertakings by employing the best technical advice to lay the foundations of great scheme s and by lending the credit and the guarantee of the Treasury to finance them more boldly than hitherto, is becoming an inevitable policy.14 The importance of investment in relation to employment, and the prospect o f inadequate investment for this purpose, was thus brought into the picture. But at that stag e th e proble m o f 'saving ' i n relatio n t o 'investment ' wa s stil l viewed in a more or less orthodox way. Harrod comments that 'throughout the discussion Keynes seems to have the idea that there was, so to speak, a lump of saving .. . At thi s point Keyne s was ill-equipped to combat what came to be called the Treasury view, which was that public works simply diverted savings from one outlet to another.'15 In 1929 the Liberal Party published a pamphlet entitled We Can Conquer

440 Fro m Adam Smith to Maynard Keynes Unemployment: Lloyd George's Pledge. In the previous year the famous 'Liberal Yellow Book,'Britain's Industrial Future, had made proposals for the improvement of the industrial and financial structure of England and for the ultimate achievement of high-level employment. Keynes had played an important part i n the committee which planned this report, and we have Harrod's word for it that he was 'primarily responsible for the compositio n of Book ii ("The Organization of Business") and of Book v, Chapter s 28 and 2 9 ("Currenc y an d Bankin g an d th e Refor m o f th e Nationa l Accounts").'16 He had been able to get endorsement for his views on the management of the currency, on means to stimulate domestic investment and to limit foreign investment, and on the importance of the semi-public concern a s an alternative to public or private enterprise. Thes e sections , and indeed the whole report, are still well worth study. But the proposals of The Yello w Book were for the long run: the immediate problem of heavy unemployment called fo r emergency measures to produce quic k results . Whereas unemployment before the war had been, on the average, 4.7 per cent, or about half a million unemployed, since 1921 the rate had exceeded 10 per cent and the number had not fallen below a million. In April 1929 it stood at 1,140,000 . The cost to the Unemployment Fund was 50 million a year: to which should be added a large sum paid in poor relief to those who had exhausted their benefits. 'Innumerable things,' said the pamphlet, 'cry to be done and a very Niagara of fine labour power is running to waste.'17 Of these innumerable things a select list was prepared. In place of a general exhortation specifi c proposals wer e made which 'would begin to absor b labour within three months ... and would before the end of twelve months reduce the number of unemployed workers to normal proportions,' and all this 'without inflation and without increasing the scale of taxation.'18 The proposals were worked out in considerable detail with estimates of cost and of the additional employment that could be expected to result. The whole plan called for expenditure of £ ioo million a year, and was estimated to bring 500,000 workers into employment.19 The estimates were of the 'direct' effect on employment: indirect effect s were noted but not quantified. We have taken no account of the large increase in employment everywhere resulting indirectly from the addition to the national purchasing power represented by the wages of those workers directly employed in this way. The income of every one of these wil l hav e increased twice or thrice ; and thi s will b e reflecte d at once i n a corresponding increase in expenditure on food, clothing, boots, housing, travelling entertainment and other amenities. As a result, a stimulus will be given to the whole

John Maynard Keynes 44 1 of th e industr y an d commerc e o f th e country , reflecte d i n turn , i n increase d employment.20

Finally, ther e wa s discussio n o f th e financia l feasibility . Som e o f th e expenditure, telephone , electrical , transpor t development , coul d b e justified a s commercia l requirin g 'onl y sligh t assistanc e i n th e wa y o f reduced interest... in the first two or three years.' The interest and sinking fund arisin g fro m borrowin g fo r expenditure o n roads 'offerin g n o direc t financial return, though a large indirec t retur n i n savings t o the natio n in cost o f transport' woul d b e easil y me t fro m increas e i n the yiel d o f th e motor vehicle tax. Housing would require a n increased annua l charge for the subsidies . Bu t there woul d be a direct savin g t o the Unemployment Fund o f som e £2 5 millio n an d 'a n increas e i n receipt s fro m existin g taxation of some £10,000,000 to £12,000,000 per annum.' The increase in tax revenue was estimated on the basis of the direct effect of the proposals: no account was taken of the indirect effects through the general stimulus to industry. Nor wa s any estimate given of the 'reductio n in poor law relief, nor in the cost of health an d similar services resultin g from th e increase d well-being of the worker.'21 In sectio n x , 'Som e Objection s Met, ' th e pamphle t deal t wit h th e orthodox objectio n 'tha t a polic y o f national development b y th e Stat e (assuming inflation to be ruled out) simply means that the State is providing employment wit h funds whic h would otherwise be use d by private indi viduals at least as effectively, and that, therefore, at best, the aggregate of employment can be no greater.' This was the 'Treasury View.' The reply was that the objection 'proves too much.' When the ordinar y man hears of the launchin g of a new enterprise he thinks it is good for trade ; and he is right. Yet if the developmen t of privately-owned telephones i s good fo r trade , th e positio n cannot be reverse d simpl y because thos e telephones become State-owned ... Growth comes from ne w enterprise. In special circumstances lik e th e present , privat e enterprise ma y not b e forthcomin g on a sufficient scale ; an d ye t ther e ma y b e wor k waitin g to b e don e whic h is either outside th e spher e o f private enterprise, o r whic h private enterprise unassiste d cannot be expected t o undertake ... I f State enterpris e is invoked in directions in which it will not conflict wit h or displace private enterprise, it has no less effect i n increasing employment than that of any other enterprise.22

So much for Investment, what about Saving? 'It is quite wrong to assume

442 Fro m Adam Smith to Maynard Keynes that all savings available for investment are always being fully utilized. In a time of trade depression "froze n savings" accumulate; that is to say, sums available for investment have to await the arrival of a suitable enterprise to ' 'thaw'' them out. '23 In this statement of the problem the emphasis is on the use of a given amount of savings, it is not far from an explanation in terms of hoarding, an d it leads one to try to locate the 'accumulation. ' Referenc e was made to the increase in 'time deposits.' It was not suggested that this money was not being used at all; 'it is, in fact, used by the banks in loans to the money market and in short period investments. The point is that there is evidence of large sums at present used to less advantage from an employment point of view, available for long term investment i f and when openings of sufficient attraction occur.'24 The estimat e that re-employment of some 570,000 men would mean an increase i n the incomes of the citizen s and thus generate a n increase of £10 million to £12 million in tax receipts has already been noted. It would not have been a very big step forward to recognize tha t thi s sam e increas e i n incomes woul d generat e increase d savings. That step was not taken. In 192 6 D.H. Robertson had published his important but very difficul t little book, Banking and the Price Level. In the introduction he referred to his man y discussions wit h Keyne s an d sai d o f Chapter s v an d v i tha t 'neither of us knows how much of the ideas therein contained is his and how much mine.' Keynes in his preface to the Treatise recorde d ho w much he owed t o 'th e atmospher e o f discussio n an d conversation ' i n whic h h e worked at Cambridge, adding: 'Mr D.H. Robertson has cast a penetrating light on certain fundamental matters, and this book would never have taken its present shape without the help of his ideas. '25 1 do not propose to discuss Professor Robertson's book in detail but having in mind what I have quoted from the Lloyd George pamphlet on the accumulation of inactive savings, I propose to quote certain relevant passages. Suppose a man to acquire a sum of money, in exchange for the sal e of part of his current output. If he uses his money-claim in the purchase of an instrument, or in making advances to productiv e workers, he ma y be sai d to b e applyin g lacking directly to the provision of Capital. If he hands his money-claim to another person who use s it for th e provisio n of Capital, he ma y b e sai d to b e applyin g lacking indirectly. If, however, he ... simply adds it to his existing money stocks, he may be said to be Hoarding, or more strictly, performing New Hoarding. In this case he is from hi s own point of view saving, but is taking no steps to ensure the creation of capital. Unless others take such steps, the effect of his action ... is that consumption of other persons is increased by as much as his own consumption is diminished.26

John Maynard Keynes 44 3 This leads the way to thinking of an abortive action of saving rather than an accumulation of inactive savings. Next let me quote him on the effect of the rate of interest: 'Whil e there is always some rat e of money interest which will check an eager borrower, there may be no rate of interest which will stimulate an unwilling one.'27 The orthodo x doctrin e wa s that what was saved woul d be borrowe d b y enterprisin g businessmen and spen t o n instruments, materials, and labour, and that a fall in the rate of interest would always bring into the marke t the necessar y borrowers . If there wer e no confident expectation of profits sufficient t o justify offering to pay interest, the orthodox doctrine and the orthodox policies derive d from i t lost their validity. Finall y o n 'accumulatio n o f savings, ' conside r thi s statement : 'Individuals may hoard bank-balances an d use them later for purposes of investment, but thei r actio n canno t resul t i n the communit y as a whole putting th e activit y lackin g int o col d storag e an d takin g it ou t agai n a s required.'28 The Cabinet responded t o the challenge of Lloyd George's Pledge b y a number of memoranda prepared i n the Ministrie s of Labour, Transport , Health, by the Postmaster General , an d by the Chancellor o f the Exche quer, whic h wer e publishe d a s a Whit e Paper, Memoranda o n Certain Proposals relating to Unemployment. Th e objections to the details of the proposed plan of development need not be reviewed, but the attitude of the Treasury mus t be examine d i n orde r t o understan d th e stat e o f exper t opinion. 'The contention of the pamphlet is that the additional £125 million a yea r required fo r new State o r local authorit y borrowing ca n be foun d without impinging on the suppl y of capital fo r other hom e requirements . This on the face of it appears t o be highly improbable.'29 Section 8 of the memorandum i n whic h thi s statemen t i s mad e i s heade d 'Diversio n o f Savings from Home Enterprise.' This was the essence of the criticism: that the proposals would divert savings from private enterprise to public works without an y increas e i n aggregate employment . The memorandu m estimated total national savings before the war at about £380 million, of which half went to capital development at home and half to development abroad. In terms of 1929 pounds, this represented saving s of £625 millions a year. In the postwa r period saving s had falle n off , the estimat e bein g some £450 millions a year of which £330 million went into home investments and £120 millions into Foreig n an d Colonial investments . Hom e investment 'afte r the pla n i n th e Pamphlet ' woul d b e £45 5 million s a yea r whic h would require investment abroad t o fall to £5 millions.30 No one yet saw that the decline in savings had been largely the result of the failure of the nationa l income to reach it s high employment level, rather tha n of any decline in

444 Fro m Adam Smith to Maynard Keynes thrift. So the Treasury memorandum, like the pamphlet, ignored the possibility tha t ne w saving s woul d be generate d b y th e highe r incom e o f the economy when operating neare r to capacity. I t concentrated it s criticis m on the suggestion of the Pamphlet that 'froze n savings ' i n the form of time deposits would provide for much of the financing of these proposed works , and tha t a reduction i n foreign loan s woul d provide stil l more. Th e or thodox doctrine with reference to foreign loans was that they were required to maintai n ou r export s s o that 'i f th e pla n wer e successfu l i n divertin g money fro m investmen t abroa d tha t chang e woul d be accompanied b y a great decreas e i n our export s o r increase i n our imports, eithe r o f these things bein g highl y prejudicia l t o importan t branche s o f industry.' 31 Keynes had been arguin g for some years that this heavy export of capital was prejudicial to home development. H e may have overstated th e case, but in view of the urgency of the problem of unemployment the lag in the impact of foreign investment on employment in the export industries was , perhaps, justificatio n fo r th e ple a tha t mor e o f th e availabl e fund s b e directed to home investment. Finally, let me note the solution favoured by the Treasury . Unemploymen t 'mus t be solve d b y reducin g th e cost s of production an d th e cos t o f living, ' no t b y reductio n o f wage s bu t b y 'improved organisation an d efficiency' i n industry and by 'adjustmen t t o the change s tha t hav e taken plac e i n world demands,' an d by al l that i s implied in the term 'rationalisation.' 32 This sound s ver y like the Libera l Yellow Book's long-ru n policy. The immediate concern wa s for the shor t run. Whil e waitin g fo r tha t long-ru n reorganizatio n o f industry , sai d Keynes, 'the unused labour of the workless is not piling up to our credit in a bank, read y t o b e use d a t som e late r date . I t i s runnin g inevitably t o waste.'33 But even for that long-run reduction in costs that the Chancellor of the Excheque r sa w as the prime objective, Keyne s argued, the Lloy d George progra m was highl y relevant : e.g. , 'Tim e save d o n th e road s i s money saved to the nation;'34 'telephone development... while increasing our national efficiency .. . '35; 'electrical development is directly calculated to increase the efficiency o f industry.'36 Keynes replied t o the critics , an d particularly to the criticism s o f the White Paper in the pamphlet Can Lloyd George Do Itl H.D . Henderson , editor of the Nation, was co-author. The answer was, of course, a resounding yes. 'We believe that the cumulative effect o f renewed prosperity will surpass expectations . I t ma y well turn out in practice tha t a smaller programme .. . wil l be sufficien t t o set the ball rolling, and to shif t th e whole outlook o f th e countr y fro m depressio n t o prosperity. ' Th e on e 'soli d reason for hesitation' they found 'not in the difficulty o f finding work to do or in the difficulty of financing it, but in the "transfer problem" -i n th e task

John Maynard Keynes 44 5 of shifting men from industries where they are permanently redundant and settling the m i n thei r ne w work. ' Thi s ha d bee n th e burde n o f th e memorandum from the Ministry of Labour. 'Bu t this difficulty,' the y said, 4 ... is a reason not for delay, for holding back, or for timidity, but for pushing on wit h redoubled effort s .. . I t i s useless t o tr y t o tackl e th e "transfer " problem seriousl y unti l th e jobs hav e firs t bee n create d elsewher e an d employers are crying out for men.'37 Chapter n is entitled Th e Commo n Sens e o f the Problem.' I t i s very characteristic o f Keynes, revealin g th e intuitive character o f his thought. 'Our main task .. . will be to confirm th e reader's instinct that what seems sensible i s sensible , an d what seems nonsens e i s nonsense .. . that t o se t unemployed me n t o wor k o n usefu l task s doe s wha t i t appear s t o do , namely increases th e national wealth; and the notion that we shall... ruin ourselves financiall y i f we us e thi s mean s t o increas e ou r well-being , i s what it looks lik e - a bogy.' 38 The y then , in a series of short chapters , reviewed the facts of unemployment, the program of work, the estimates of the employmen t tha t woul d result, an d the cost of the program. Bu t the important ne w contributio n wa s i n Chapte r ix , 'Wil l i t merel y diver t employment from othe r enterprises,' which gave the coup de grace to the 'Treasury view ' b y a t las t recognizin g tha t a s th e increasin g nationa l income woul d generat e ne w ta x revenu e fo r th e government , s o als o i t would generat e ne w saving s fro m th e public . Thi s mark s a n importan t advance to the theory of the Treatise and the General Theory. The Chancello r o f th e Excheque r i n hi s budge t speec h ha d tol d th e House o f Commons that: 'it is the orthodox Treasur y dogma , steadfastl y held, that whatever might be the political or social advantages , very little additional employment and no permanent additiona l employment can, in fact, an d a s a general rule , b e created b y the Stat e borrowin g an d Stat e expenditure. '39 To this Keynes and Henderson made first the reply made in the earlier pamphlet: it proves too much. If i t i s vali d a t all , i t mus t appl y equall y to ne w work s starte d b y Morri s o r Courtaulds ... if it were announced that some of our leading captains of industry had decided to launch out boldly, and were about to sink capital in new industrial plant to th e tune , between them, of £100 millions , w e shoul d all expect t o se e a great improvement in employment. And, of course, we should be right... The argument is certainl y no t derive d fro m commo n sens e .. . Bu t th e argumen t is no t onl y implausible. It is also untrue.40

So they turned to explore the sources from which the capital would come to enable new investment to provide a net addition to the amount of employment.

446 Fro m Adam Smith to Maynard Keyne s The first source of supply comes out of the savings which we are now disbursing to pay the unemployed. The secon d source of supply comes from th e savings which now run to waste through lack of adequate credit. The third source of supply comes from a reduction in the net amount of foreign lending. Let us consider these in turn, beginning wit h th e firs t source . Individua l saving mean s som e individual s are producing mor e tha n the y consume . Thi s surplu s may , an d should , b e use d t o increase capita l equipment .. . I t ca n als o be used t o enabl e othe r individual s to consume mor e than they produce .. . Thi s is what happens whe n there i s unemployment. We are using our savings to pay for unemployment instead of using them to equip the country. The saving s which Mr Lloyd George's schemes will employ will b e diverte d no t fro m financin g othe r capita l equipment , bu t partl y fro m financing unemployment. 41

It i s in discussion o f the secon d sourc e of supply that th e most importan t propositions were advanced. The saving s o f individual s do no t necessaril y materialis e i n investments . Th e amount o f investment in capital improvement depends, o n th e on e hand , o n th e amount of credit created b y the Ban k of England; and, on the other hand , on the eagerness of entrepreneurs to invest... So far from the total of investment... being necessarily equal to the total of saving, disequilibrium between the two is at the root of many of our troubles. When investment runs ahead of saving we have a boom, intense employment, and a tendency to Inflation. When investment lags behind, we have a slump and abnormal unemployment, as at present... Not all credit creation means Inflation . Inflatio n onl y results when we endeavour .. . t o expan d our ac tivities stil l further afte r everyon e i s already employed and our saving s are being used up to the hilt.42

They returned to the discussion of saving and investment when considering the problem of the rate of interest and the Treasury concern to convert th e National Debt at lower rates of interest. The rat e of interest can fall for either of two reasons. I t may fall o n account o f an abundant suppl y of saving s ... o r i t ma y fal l o n accoun t o f a deficient suppl y of investments .. . Now a fall i n the rate of interest for the first reason is , obviously, very much in the national interest. But a fall for the second reason, if it follows fro m a deliberate restriction of outlets for investment, is simply a disastrous metho d of impoverishing ourselves. A nation is enriched not b y the mer e negative act o f an individual not spending all his income on current consumption. It is enriched by the positive act of using these savings to augment the capital equipment of the country.

John Maynard Keynes 44 7 It i s no t th e mise r wh o get s rich ; bu t h e wh o lay s ou t hi s mone y i n fruitfu l investment.43

And later: 'Busines s profits ar e poor, with the result tha t the yield of the income tax disappoints the Chancellor of the Exchequer... Unemployment is rampant. This want of prosperity actually diminishes the rate of saving... So rates of interest are, after all, high. '44 One last quotation on this 'second source': 'part will come from the savings which now run to waste through lack of adequate credit. Somethin g will be provided by the very prosperity which th e ne w policy wil l foster.'45 Th e amoun t o f savings i s no longe r treated a s given, s o that us e fo r one purpose divert s capita l fro m us e in another: saving s ru n t o wast e becaus e investmen t lags , o r rathe r th e expected saving s do not materialize since the income from which they were to be made does not materialize. The thir d source o f supply was reduction i n net foreig n lending. If the policy of national development cannot be financed wholly from the savings used to finance unemployment, and 'out of the savings which are at present running to waste, granted that to meet the borrowing demands of the State other borrowers must go without, why should we assume that these other borrowers mus t b e Britis h business men ? The techniqu e o f the capita l market makes it far more probable that they would be some of the overseas Governments o r municipalitie s which London a t presen t finance s o n s o large a scale.' 46 A s i n the Economic Consequences o f M r Churchill the adverse reaction on our exports o f a reduction in foreign lending is considered unlikely. But there was at that time an exchange problem such that the Ban k of England would welcome a reduction in the volume of foreign issues: indeed there had been a semi-official embargo on foreign issues. 'In relation t o ou r les s favourabl e balanc e o f foreign trade w e are investin g abroad dangerousl y much; and we are investing abroad t o this dangerou s extent partl y becaus e ther e ar e insufficien t outlet s fo r ou r saving s a t home.'47 The pamphlet closed wit h a rousing call to positive, expansive action : Negation, Restriction, Inactivity -these are the Government's watchwords. Under their leadership we have been forced to button up our waistcoats and compress ou r lungs. Fears and doubts and hypochondriac precaution s ar e keeping us muffled u p indoors. But we are not tottering to our graves. We are healthy children. W e need the breath of life. There is nothing to be afraid of . On the contrary. The future hold s in store for us far more wealth, and economic freedom, and possibilities of personal life tha n th e pas t ha s eve r offered . Ther e i s n o reaso n wh y w e shoul d no t fee l

448 Fro m Adam Smith to Maynard Keynes ourselves fre e t o b e bold , t o b e open , t o experiment , to tak e action , t o tr y th e possibilities of things.48

v i Th e Treatise* The Treatise o n Money (1930 ) i s a grea t boo k whic h is , unfortunately , neglected becaus e of the later excitement o f the General Theory. Harro d put it this way: The appearanc e of the General Theory greatl y militated against the reading of the Treatise. Fe w have time to read two large works by the same author which cove r partly th e sam e ground . Everyon e wishe d t o lear n hi s lates t though t an d no t something that was already superseded .. . Finally, since both sets of terminology were difficul t t o understand, many readers, includin g many serious students , fel t dismayed at the idea of reading both books, since they feared getting thereby into a terminological muddle beyond repair. The fact remains that the future student who wishes t o ge t th e ful l measur e o f Keynes' s importanc e an d influenc e a s a n economist will not do so unless he reads the Treatise. 49

Because I completely agre e I want to do my utmost t o tempt student s t o return to the Treatise. Bu t I recognize with Harrod tha t on e cannot sum marize its contents: 'that would mean covering the whole field of money in all its richness. I shal l not summarize bu t 'taste,' hopin g to convey suc h feeling fo r th e flavour as to temp t m y readers t o proceed fro m selectiv e tasting to serious digestion. Book i o n th e 'Natur e o f Money ' i s mainl y concerne d wit h 'ban k money.' It is hard for the present generation of economists t o realize that as late as the twenties bank 'deposits' were looked o n as deposits o f money rather tha n a s money , a 'cloak-room ' theor y a s Edwi n Canna n pu t it . 'Practical bankers , lik e Walte r Leaf, ' sai d Keynes , hel d 'tha t fo r th e banking system as a whole the initiative lies with the depositors, an d that the banks can lend no more than their depositors have previously entruste d to them.' C.A. Philips in Bank Credit in 1920 and F.W. Crick in Economica in 192 7 had tried t o make clear th e fallacy in this. Keyne s finally laid th e ghost. 'Th e rate at which a bank passively creates deposits partl y depend s on th e rat e a t whic h it is actively creatin g them.' To th e exten t tha t th e borrowing customer s pa y depositor-customer s o f the sam e ban k 's o far from th e activel y create d deposit s bein g th e offsprin g of th e passivel y * Throughou t part v i pag e reference s in the tex t are t o A Treatise on Money, Collected Writings o f John Maynard Keynes, v-vi

John Maynard Keynes 44 9 created deposits, it is the other way around.' But many of the payments are to customers o f other banks, so we must look at the banking system as a whole: 't o th e exten t tha t th e borrowin g customers pa y awa y thei r deposits to customers of other banks, these other banks are strengthened by the growth of their passively created deposit s t o the same extent that the first bank has been weakened; and in the same way our own bank finds itself strengthened wheneve r the other banks are actively creating deposits.' So, if all payments were by cheque an d no cash was used ther e woul d be 'no limit t o th e amoun t o f ban k mone y whic h th e bank s ca n safel y creat e provided that they move forward i n step.' Bu t people stil l want cash fo r some purposes, and the amount of cash they want 'will generally bear some proportion, mor e o r les s stable , t o th e amoun t o f ban k mone y .. . th e creation of more bank money by the banks as a whole will lead to a drain of cash... which will set a limit to the extent that the banks can afford to create bank money.' The amount of cash is under the control o f the central bank which i s therefore 'th e conducto r o f the orchestra , an d set s th e tempo. ' Finally, the conductor may be limited by 'law or custom outside its deliberate control , bein g regulated b y som e rigi d rule, i n whic h case w e might describe i t as an "automatic" system' (22-6). Familiar doctrine now; but its clear statement in 1930 was very important. In the Tract Keynes had distinguished the amount of purchasing power which the public wanted to hold in cash (K) an d in deposits (k f). No w i n the Treatise h e introduced a distinction between 'income deposits,' the 'industrial circulation ' an d th e 'financia l circulation. ' Th e amoun t o f income deposits would be a 'more or less stable fraction' o f the aggregate money income of the community (ki) (39) . The 'industria l circulation,' made up of payments between producers an d by producers t o consumers, would also 'fluctuate on the whole with the money value of the year's output' but the price level s appropriate t o [th e industria l circulation ] will no t mov e precisely with the price level appropriate to the consumption paid for out of the income deposits' (41). Transactions in the 'financia l circulation' 'need not be, an d are not , governed by the volum e of current output. The pac e a t which a circle of financiers, speculators and investors hand around one to another particular pieces of wealth, or title to such, which they are neither producing nor consuming but merely exchanging, bears no definite relation to the rate of current output' (42). The conclusion is that the proportion, ki of the average level of business deposits to the volume of business transactions may be quite different fro m ki .. . it is likely both to vary differentl y and to be much more variable ... Thus it is misleading to represent the total cash deposits ... as bearing any stable or normal relationship to the national

450 Fro m Adam Smith to Maynard Keynes money income' (43). Keynes recurred t o this problem, particularly t o that of the financial circulation, i n chapters 1 5 and 23. There were three reasons for devoting Book n to The Valu e of Money,' that i s to a discussion o f index numbers. First, and most obvious , i f you plan to manage money with a view to stability, or good behaviour, o f prices you mus t choose a measur e o f purchasing power; yo u mus t choose th e index numbe r o f prices whic h yo u wis h t o hol d unchanged , o r wis h t o change i n som e agree d manner . Keyne s chos e a 'consumption ' index . 'However grea t th e theoretica l an d practica l difficultie s o f measurin g changes in the purchasing power of money, there need not be any doubt as to what we mean by it. W e mean by the purchasing powe r o f money th e power of money to buy the goods and services on the purchase of which for purposes of consumption a given community of individuals expend thei r money income ' (48) . Neither th e wholesal e pric e inde x no r th e cos t of living inde x wa s satisfactory . Th e forme r 'ha s th e defec t tha t it s movements do not occur at the same time or in the same degree as the correlate d movements in the purchasing power of money' and 'it omits altogether o r weights inadequatel y certai n importan t object s o f consumption - i n particular, personal service s an d complex manufacture d goods (e.g. , moto r cars).' As to the latter, 'i f i t is extended t o appl y t o other classe s in the community ... it underweights expenditure on services i n comparison with expenditure on commodities' (51) . Most nearly satisfactory to Keynes was the 'inde x o f th e genera l pric e level ' compile d b y Car l Snyder fo r th e United States, a weighted blend of the index numbers of wholesale prices , wages, cos t o f living and rent . A n inde x o f thi s sor t i s give n fo r Grea t Britain, 1913-29 (55). Taking this as a fairly goo d measure of the purchasing power of money Keynes showed that the wholesale price index number 'exaggerated the fall and rise in the purchasing power of money in the post war boom and slump' (55). The secon d reaso n fo r thi s discussio n o f index numbers has alread y been notice d i n the Economic Consequences o f M r Churchill: if you ar e concerned with foreign exchange policy, with revaluation or devaluation as at th e tim e of the retur n t o gold , yo u mus t be carefu l i n estimating th e purchasing powe r party no t to rely on index numbers which are heavily weighted in favour o f internationally trade d goods . 'A t the time of Great Britain's return to the gold standard the Treasury and the Bank of England were led to the false conclusion that , becaus e th e wholesale pric e index , which wa s almost th e sam e thin g as the Britis h internationa l index , was moving rapidly into adjustment -as a n international index necessarily must

John Maynard Keynes 45 1 - wit h the movement o f the gold exchange , therefor e the same thing was true of prices generally' (66). The third reason related to the examination of the different behaviour of the consumption , industrial , an d financial circulations, rathe r tha n th e aggregative behaviour of the money supply. This led necessarily t o a study of the divergent behaviour of the price levels of consumers' an d producers ' goods an d of financial assets. All of which, finally, involved dismissing the accepted notio n o f a general pric e leve l an d the belie f tha t change s i n a general inde x numbe r of prices reflec t '"changes on the sid e o f money" which (subject to friction in the dimension of time) affect al l prices equally in directio n an d degree ' unlik e '"change s o n the sid e o f things" which affect price s relativel y t o on e another ' (73) . Jevons , Bowley , an d Edgeworth ar e quoted , an d th e relianc e o n 'numerou s observations ' a s giving a 'sound scientific basis' is discussed. Keyne s found thes e idea s t o be 'root-and-branch erroneous.' B y contrast with those who sought som e one satisfactor y measur e o f variatio n i n general prices , Keyne s argue d 'that it is much safer to keep our minds alive to the plurality of secondary price levels and the separate influence s which determine their movements in relatio n t o genera l purchasin g power , rathe r tha n t o regar d an y di vergence o f particula r pric e level s fro m uniformit y o f movemen t a s a temporary abnormality which will soon cure itself (83) . Book m , on 'The Fundamental Equations, ' contain s th e basic theor y and th e essentiall y origina l contribution . I thin k that i t would have bee n better without the equations. The y were , I suggest, simply a sort o f symbolic shorthand and a check list of the factors involved. Their mathematical manipulation added little , if anything, and was indeed somewhat spurious since th e quantitie s o f outpu t coul d no t b e give n precis e meanin g (you cannot add elephants and camels). Keynes said of these equations they 'are purely formal ; they ar e mer e identities ; truism s which tell us nothin g in themselves. In this respect the y resemble all other versions of the quantity theory of money. Their only point is to analyse and arrange our material in what will turn out to be a useful wa y of tracing cause an d effect, whe n we have vitalised them by the introduction of extraneous facts from th e actual world' (125). The literary summary of the argument is found in chapter xn. As becam e clea r i n his discussion o f price level s in Book n Ke y nes's concern wa s wit h th e 'purchasin g powe r o f money ' a s measure d b y a consumers' inde x number of prices. H e was seeking to identify th e conditions of stability in the purchasing power of money thus measured, and the factors whic h would make for change. Where in the Tract h e had focused

452 Fro m Adam Smith to Maynard Keynes attention on the quantity of money in relation to the amount of purchasing power whic h people wanted t o hold unspent , i n the Treatise he concen trated o n the flow of money income in relation t o the flow of consumers' goods, th e price s o f whic h entere d int o th e consumers ' index . I n thu s turning t o th e flo w o f incom e h e wa s revertin g t o a n approac h which Malthus ha d favoure d bu t whic h ha d bee n smothere d i n th e Ricardia n orthodoxy of the quantity theory. For th e purpos e o f this inquir y Keyne s foun d i t necessar y t o defin e certain term s which he proposed t o use in his own special sense. Since in what follows I shall use them in his sense, some of these must be prefixed to discussion o f his theory. Th e first and most important, perhaps th e mos t difficult to work with, involved the related concepts of income and profits. Keynes distinguished, as Marshall had done, the normal remuneration of the entrepreneur, which was part of the cost of production, from 'windfal l profits o r losses,' i.e., the 'differenc e betwee n the actual remuneration of the entrepreneurs , arrived at by deducting from th e sale s proceed s thei r outgoings ... and their normal remuneration' (112). The word 'profits' was restricted i n his usage to the windfalls. He defined income as consisting of the earnings of the factors of production includin g the 'norma l remuneration o f th e entrepreneurs ' bu t excludin g thes e windfal l profits. Saving s were define d i n what at first seems th e accepte d wa y as the 'su m of the differences betwee n th e mone y incomes o f individuals and thei r money expenditure o n curren t consumption / bu t on e ha s t o b e carefu l to re member that the money incomes, as defined, excluded windfall profits. 'I f an entrepreneur spends part of his profits on current consumption, then this is equivalent to negative saving; and if he restricts his normal consumption because he is suffering windfall losses, this, on the other hand, is equivalent to positiv e saving ' (112) . Finall y Keyne s gav e a specia l meanin g to th e word investment , takin g i t fro m th e real m o f financ e int o th e real m o f production, to refer to the net increment to the real capital of the community produced in a given period. H e further isolated for treatment the 'value of investment ' a s th e valu e o f tha t incremen t o f rea l capita l 'no t th e increment of value of the total capital' (i 14). Now the purchasing power of money depends on the amount of money income spen t o n consumer s goods an d th e amoun t of consumers good s available fo r sale: it depends o n the price s a t which the suppl y can, an d under competitio n will , b e al l sold . Tw o condition s o f stability , o r influences whic h ma y chang e th e purchasin g powe r o f mone y ar e identified. First, 'efficiency earnings, ' that is 'the rate of earnings per unit of output, ' mus t b e constant . A s w e woul d pu t i t no w earning s mus t

John Maynard Keynes 45 3 increase i n the sam e proportio n a s doe s productivity , no more , n o less . Second, an d this is the nu b of the argument , the cos t o f new investment must be equal to the volume of current savings : 'worker s are paid just as much when they are producing for investment a s when they are producin g for consumption ; bu t havin g earne d thei r wages , i t i s the y wh o pleas e themselves whethe r they spend or refrain from spending them on consumption. Meanwhile , th e entrepreneur s hav e bee n decidin g quit e indepen dently in what proportions the y shall produce the two categories of output' (123). Th e ke y wor d i s 'independently. ' I n th e classica l orthodox y in creased saving was expected to lower the rate of interest an d at the lower rate of interest investment was expected to increase, so that there appeare d to be an automatic mechanis m for guaranteeing the equivalence o f the cost of new investment and the volume of current saving . I shall not attempt to reproduce th e analysis which led Keynes to reject this doctrine, but I shall quote som e parts o f the 'parable ' which he used to 'mak e the conclusion clearer - or at least more vivid.' He asked his readers to imagine a community whic h produce d nothin g bu t bananas , an d consume d nothin g bu t bananas; and which was in a condition of equilibrium such that the money income save d equalle d th e cos t o f production o f new investmen t in th e development o f banana plantations , an d suc h tha t th e pric e o f banana s equalled thei r cos t o f production (includin g the norma l remuneration of entrepreneurs). Finally , suppose wha t is plausible, that ripe bananas will not keep for more than a week or two. Into this Eden ther e enters a thrift campaig n ... Bu t at the sam e time there is no corresponding increase in the development of new plantations - for one or other of many reasons .. . What, in such a case, wil l happen? The same quantity of bananas will continue to be marketed, whilst the amount of current income devoted to their purchase will, by reason of the thrift campaign, be dimished. Since bananas will not keep, their price must fall; and it will fall proportionately to the amount by which saving exceed s investment . Thus, a s before , the publi c will consum e th e whol e crop of bananas, but at a reduced price level. This is splendid, or seems so ... But the end is not yet reached. Sinc e wages are still unchanged, only the selling price of bananas will have fallen and not their cost of production; so that the entrepreneurs will suffe r a n abnorma l loss .. . Thi s wil l caus e entrepreneur s to see k t o protec t themselves by throwing their employees out of work or reducing their wages. But even this will not improve their position, since the spending power of the public will be reduced by just as much as the aggregate costs of production. By however much entrepreneurs reduce wages and however many of their workers they throw out of work, they will continue to make losses so long as the community continues to save

454 Fro m Adam Smith to Maynard Keynes in exces s of new investment . Thus ther e will be no positio n of equilibrium until either (a) all production ceases and the entire population starves to death; or (b) th e thrift campaig n is called of f or peter s ou t a s a resul t o f growing poverty; o r (c) investment i s stimulate d by som e mean s or othe r s o that it s cost n o longer lags behind the rate of saving (158-60).

How near and yet how far was the possibility (b) fro m th e doctrine o f the General Theory, wher e it is shown that with the sam e degree of thrift th e amount of income saved would decline as income declined, s o that equilib rium coul d b e expecte d a t som e leve l shor t o f complet e cessatio n o f production. Let m e refer t o another of the colourful illustrations o f the theory: th e widow's cruse and the Danaid jar: If entrepreneurs choose t o spend a portion of their profits o n consumption ... th e effect i s to increase the profit on the sale of liquid consumption goods by an amount exactly equal to the amount of profits which have been thus expended. Thus profits ... are a widow's cruse which remains undepleted however much of them may be devoted t o riotou s living. When , o n th e othe r hand , entrepreneurs are makin g losses, an d seek to recoup these losse s b y curtailing their normal expenditure on consumption, i.e. by saving more, the cruse becomes a Danaid jar which can never be filled up; for the effect o f the reduced expenditure is to inflict on the producers of consumption goods a loss of an equal amount (125).

At this point I would like to pause to indicate a source o f much of the error in the orthodoxy which Keynes was replacing. We had been too ready to use demand curve s fo r purposes wher e the y wer e clearl y illegitimate . We explaine d i n price theor y tha t th e deman d curv e wa s draw n o n th e assumption tha t al l other price s of commodities wer e equal , tha t th e incomes of the consumers of this one commodity were given, and that habits remained unchanged. We went on to say that the use of the demand curve was restricted to small industries, because the bigger the industry the less plausible were these assumptions, the more difficult t o impound the othe r things. But too often we used a demand curve for labour t o demonstrat e that mor e woul d b e employe d a t a lowe r wage . Thi s wa s legitimat e i n dealing with a small industry subject to the fairly plausibl e assumption of other thing s bein g equal : quit e illegitimat e i n dealin g wit h labou r a s a whole, for the demand curve was based on consumers wit h given incomes bidding for th e produc t o f this labour . Lowe r wage s of labour meant , of course, lower incomes of consumers and a consequent shift to the left of the

John Maynard Keynes 45 5 demand curve s fo r mos t consume r good s an d therefor e o f th e deman d curves for the labour that produced them. Similarly, the expectation base d on a naive application of the demand curve of borrowers was that increased supply o f saving s woul d b e matche d a t som e lowe r rat e o f interes t b y increased borrowin g an d consequently increase d investment outlay . Bu t the increased savin g meant decreased consumptio n expenditure and acted in the same way that decreased income of consumers would , to shift to the left the demand curves for those consumer goods on the profitable production o f which decision s t o inves t depended . Naiv e a s this no w sounds I believe tha t a stud y of textbooks o f the twentie s would sho w how prevalent it was: and I am not quite sure that one could not still find examples. The mainsprin g of change, of expansion or contraction, bein g profit o r loss, it was necessary for Keynes to explore the condition of 'zero profits' and the determination o f actual profits or losses. In the consumption good s industries th e solutio n followe d directl y fro m th e earlie r analysi s o f th e determinants of the purchasing power of money. Profits are the difference , positive o r negative , between th e valu e of current outpu t and it s cost of production: for the difference t o be zero the cost of new investment which is a source of earnings to be spent on the consumers' goods must be equal to saving which is that part of their income that consumers d o not spend on such goods. Profits in the investment sector rais e quite different, an d very difficult, problems . Profi t o n the outpu t of investment goods i s the differ ence between the value of new investment and the cost of new investment. Now it is clear that if profit is positive in this sector investment will increase so that the difference between savin g and the cost of new investment will increase, and profit in the consumer industries will increase: the aggregate profit of the economy, in all industry, will therefore increase by more than the increase in the investment sector. There follow s a length y an d highl y complicate d explanatio n o f th e determination o f the valu e o f new investmen t which I ca n onl y refe r t o briefly, first noting that in the Treatise new 'investment' is held to be highly responsive to the rate of interest, or the rate of capitalization, and therefore to the price of old securities. Th e explanatio n of the determination of the price of old securities i s in terms of the 'bearishness' or 'bullishness' of the public. I thin k one ca n sa y tha t th e essenc e o f his argumen t lies i n th e expansion of the theory o f the Tract, with its emphasis on changes in the desire of the public to hold money, to include changes in the desire to hold assets o f which money was only one. This i s how Keynes introduced th e discussion of 'the price level of new investment goods.'

456 Fro m Adam Smith to Maynard Keynes When a ma n i s decidin g wha t proportio n o f hi s mone y incom e t o save , h e i s choosing between consumption and the ownership of wealth. In so far as he decides in favou r o f consumption, h e mus t necessaril y purchas e good s - fo r he canno t consume money. But in so far as he decides in favour of saving, there still remains a further decisio n for him to make. For he can own wealth by holding it either in the form of money (or the liquid equivalent of money) or in other forms of loan or real capital... the choice betwee n "ban k deposits" and "securities" ... Now when an individual is more dispose d tha n before t o hold hi s wealth i n the form of saving s deposits an d less dispose d t o hold it in other forms , this does no t mean that he is determined to hold it in the for m o f savings deposits a t all costs. It means that h e favours saving s deposits (fo r whatever reason) mor e than befor e a t th e existing price level of other securities .. . If, therefore, the price level of other securities falls sufficiently, h e can be tempted bac k int o them, If, however , th e bankin g syste m operates in the opposite direction to that of the public and meets the preference of the latte r fo r saving s deposits b y buyin g th e securitie s whic h the publi c i s less anxious to hold and creating against them the additional savings deposits whic h the public is more anxious to hold, then there i s no need fo r the pric e level of investments to fall at all (127-8). From this explanation of the price level of all items of wealth, develops a n explanation of the price level of new investment and therefore o f the leve l of profits i n the investmen t industries. I f old investments ris e i n price s o must new investments: if old investments are capitalized a t a new rate, s o must new investments be capitalized at this rate. All of this leads to a new function fo r the Central Bank to 'offset b y the creation of savings deposits' the bearishness of the public, or to 'offset by the contraction o f savings deposits' the bullishness o f the public. The rol e of the Bank is explored in a superb chapter on 'The "Modus Operandi" of the Bank Rate,' with an historical account of bank rate policy in England and a plea for a new orientation, a concern for investment. The connection between th e bank rate an d the volume of new investment, in its simplest form i s stated a s follows: If, for example, a rise of i per cent in the bank rate has the effect o f raising bond rate from 5 to 5!/8 per cent, this means an average decrease of 2! /z per cent in the price of new fixed capital .. . This mus t necessarily be deterrent t o the production of such goods ... Moreover the deterrent or attractive effect o n the demand for new capital goods is often greater than one might expect if one was to concentrate on the mere change of (say) 2 '/2 to 5 per cent in the value of such goods due to a change in the rate of interest. For investment is much more capable of postponement or anticipation

John Maynard Keynes 45 7 without seriou s disadvantage ... than is consumption. If, therefore, the change in bank rate is considered by the market... to be of a temporary character, the effect is to cause borrowers for investment purposes to put off or to anticipate their investment plans, and thus to cause the immediate rate of investment to fluctuate muc h more than would be the cas e if borrowers believed that the chang e in the rat e of interest had come to stay (181-2).

The basi c ideas of Book in are elaborated and extended i n Book iv on 'The Dynamics of the Price Level.' I shall not attempt to deal with this, but before moving on to the second volume, 'The Applied Theory of Money,' I want to refer to the application by Keynes of this theory as developed for a closed system to the problems of international equilibrium, on pages 145-9 and 191-3, and in Chapter 21. When imported into Canada it was the theory of th e close d syste m tha t caugh t on , thoug h ther e wer e fe w mor e ope n economies than the Canadian. So there developed in Ontario arguments for increased investment, particularly construction, at a time when the drastic decline in exports was probably more important than the decline in investment, an d whe n th e declin e i n export s wa s largel y responsibl e fo r th e decline in investment. One last quotation which seems to me to provide a glimpse of the later development. 'Th e busines s o f saving i s essentially a stead y process . If there are disturbances in the economic world, these by affecting prosperity may react on the rate of saving. But a disturbance will seldom or never be initiated by a sudden change in the proportion o f current incom e which is being saved. Investment i n fixed capital, on the one hand, has been accus tomed t o procee d irregularl y an d b y fit s an d starts ' (251-2) . Her e th e amount save d i s almost see n a s varying with income, the degree of thrif t being unchanged; an d th e smoot h respons e o f investment to th e rat e of interest is seen as unlikely. Volume ii of the Treatise (volume vi in the Collected Works*) consist s of three Books . Boo k v treat s 'th e monetar y factors and their statistical fluctuations, suc h as the proportions in which the aggregate of bank money is divide d betwee n saving s deposit s an d cas h deposits , th e velocit y of circulation o f bank money, and th e cause s whic h make this aggregate of bank money to be what it is,' all of which is essential 'tojudge of the relative quantitative importanc e o f differen t factors ' (3) . Th e result s ar e sum marized i n two table s a t th e en d o f the Book . Keyne s there sai d o f this quantitative work : 'Th e reade r mus t no t overloo k th e larg e elemen t of * I n the remainder of part vi the page references in the text are to volume vi of the Collected Writings

458 Fro m Adam Smith to Maynard Keyne s guess-work, approximatio n an d probabl e error ' relate d t o th e 'presen t deplorable stat e of our banking and other statistics.' He added: I hav e n o doub t tha t i n a fe w years ' tim e suc h guesse s wil l appea r hopelessl y amateurish and inaccurate , and wil l be replace d by scientifi c estimates . But by indicating what figures i t would be interestin g t o know , and b y makin g doubtful attempts at their value, I may stimulate others, wh o are in a position to get better data, to correct me . The compilation of official figures has generally been precede d in England by the rash and imperfect efforts o f individuals (78).

I quote this to remind modern economists ho w little quantitative dat a was available, an d how imperfect i t was. This is important i n judging Keyne s and his contemporaries. But I also would remind them how great was the stimulus t o improvemen t o f statistica l collectio n an d analysi s whic h Keynes gave. And finally, I would refer to his uncanny ability to estimat e quantities. I have been told tha t a t Bretton Wood s h e would mak e 'rash ' estimates which the American staff would after days of work find to be very close to their more scientific estimates. Book v i treats 'i n turn the causes and degree o f fluctuations of investment in fixed capital, working capital and liquid capital' (83). Again Keyne s is workin g wit h inadequat e statistica l information . Le t m e giv e on e example. The impairmen t in the fun d o f Great Britain's working capital between boom and slump i n 1920-2 2 wa s o f the orde r o f £250 million .. . A s before , I d o no t clai m statistical accuracy for these figures. But they will serve to illustrate my argument, as indications of the order of quantity which we are dealing with in extreme cases ... The most reliable estimates of the present level of savings in Great Britain put them at £500 million per annum ... Thus the depletion of working capital between boo m and slum p may o n thi s occasio n hav e represente d full y hal f o f a year' s saving ' (99-100).

In the context of present concern over inflation in a period of unduly high unemployment I cannot resis t quotin g the following passage: Full employmen t o f th e factor s o f productio n require s a redistribution , no t a reduction, of the aggregat e of consumption. It woul d seem obviou s that circumstances can conceivably exist in which... it would be better to redistribute by a profit inflation... than to allow unemployment to continue: in which, that is to say, the evil of not creating wealth would be greater than the evil that the wealth, when created ,

John Maynard Keynes 45 9 should not accrue to those who made the sacrifice, namely to the consumers whose consumption ha s bee n curtaile d b y th e highe r price s consequen t o n th e profi t inflation'(112-13).

Thus again , a s in the Tract, Keyne s proteste d tha t thoug h inflation is bad; unemployment is worse. Chapter 30, 'Historical Illustrations,' is an illuminating illustration of the ideas o f the Treatise b y applying them to certain well-know n episodes i n the history of prices rather than to hypothetical cases . The chapter may not satisfy the historian; he may be tempted to say of it, as C.R. Fay said of the 'Macmillan' repor t on Finance an d Industry, 'ther e you have suc h bits of history a s a dominant theor y allow s t o ornamen t th e preface.' 50 But , as with his statistical exercises so with his historical one s Keyne s probabl y came ver y nea r th e truth . Certainl y a s illustratio n thi s chapte r i s ver y helpful, and to the historian it should prove stimulating. The main thesis is again stated . Mere abstinence is not enough by itself to buil d citie s or drai n fens ; i t may serve instead to increase the current consumption of other individuals ... It is enterprise which builds and improves the world's possessions. Now , just as the fruits of thrift may g o t o provid e eithe r capita l accumulatio n or a n enhance d valu e of money income for the consumer, so the outgoings of enterprise may be found either out of thrift, or at the expense of the consumption of the average consumer... If enterprise is afoot, wealth accumulates whatever may be happening to thrift; and if enterprise is asleep , wealt h decays whateve r thrift ma y b e doing . Thus thrif t ma y b e th e handmaid an d nurs e of enterprise. But equally sh e ma y not .. . The engin e whic h drives enterprise is not thrift, bu t profit (132).

As a preface t o his examination o f certain 'episodes ' in modern time s Keynes speculate d o n the ancien t world: did the civilizations of Sumeria and Egypt dra w their stimulu s from th e gol d of Arabia an d the coppe r o f Africa 'which , being monetary metals, left a trail of profit behin d them in the course o f their distribution through the lands between th e Mediterra nean an d th e Persia n Gulf ? (134) . T o wha t degre e di d the greatnes s o f Athens depen d o n the silve r mine s o f Laurium? Not tha t th e 'monetar y metals are more truly wealth than other things, but because b y their effec t on prices they suppl y the spea r o f profit.' Ho w far was th e dispersa l b y Alexander o f the ban k reserve s o f Persia 'responsibl e for the outburs t of economic progres s i n the Mediterranean basin, of which Carthage attempted an d Rom e ultimatel y succeeded' i n reapin g th e fruits ? An d wa s i t a

460 Fro m Adam Smith to Maynard Keynes coincidence that the 'decline and fall of Rome was contemporaneous with the most prolonged deflation yet recorded'? The first episode selecte d wa s the inflation o f the sixteenth and seventeenth centuries resultin g from the flow of precious metal s from America . Keynes admitte d tha t he was 'particularl y ill-equipped' t o deal wit h thi s episode but said 'the suggestiveness o f what I know about this period is so great that I cannot refrain fro m puttin g it forward for the examinatio n of experts' (135) . The 'broa d conclusion' whic h he drew to the attentio n of historians was 'the extraordinary correspondence between the periods of profit inflatio n an d profit deflatio n respectively wit h those of national rise and decline' (143) . Now i t is a necessary characteristi c of profit inflation that th e level of real wage s would be relatively low . 'I t doe s no t follow, therefore, that a profit inflation is desired -it is a much safer conclusion that a profit deflation is to be avoided.' But there was a case for profit inflation in spite of the forced abstinence of the poor and the greater inequality in the distribution of wealth. 'The working class may benefit far more in the long run fro m th e force d abstinenc e whic h a profit inflatio n imposes o n them than they lose in the first instance in the shape of diminished consumption' (144). The secon d 'episode ' wa s th e depressio n o f th e eighteen-nineties . 'There has been no other case where one can trace so clearly the effects of a prolonged withdrawal of entrepreneurs from undertaking the production of new fixe d capita l o n a scal e commensurat e wit h current savings ' (150) . Prices fell: thos e worker s who continued i n employment enjoyed highe r real wages but a high proportion of them were thrown out of work. Could the Bank of England have prevented the deflation? In the matter of bank rate it did what lay in its power to make credit easy. It is not obvious what further action it coul d have taken in accordanc e wit h th e notion s of thos e days , whe n 'ope n market' policy had not been heard of ... The purchase of securities in those years might have done something to make the tide turn sooner. But consols were already at a high price, and it must be doubtful whether purchases of consols by the Bank of England woul d have done anything to stimulat e investment ... Borrowing by the Government and other public bodies to finance large programmes of work on public utilities and Government guarantees on the lines of the recent Trade Facilities and Export Credit Acts were probably the only ways of absorbing current savings and so averting the heavy unemployment of 1892-5 (151-2).

Monetary policy may not be enough. The third 'episode' was the 'War Boom, 1914-18.' What Keynes had to

John Maynard Keynes 46 1 say in this section should b e compared wit h his pamphlet How t o Pay for the Wa r (1939). To follow the advice o f the 'financia l purists' would hav e involved heav y taxation no t only of the rich but of the relatively poor. 'It would have meant... a tax of (say) 58 in the £ on all wages, perhaps more . No governmen t engage d i n wa r coul d b e expecte d t o ad d t o it s othe r difficulties the political problem s o f such a tax' (153). Keynes conclude d that t o allo w prices t o ris e b y permitting a profit inflatio n is , in time of war, both inevitable and wise. Bu t the object, w e must remember, is to let prices rise more than earnings; we desire primarily, that is to say , a profit inflation , no t an income inflation ... It is expedient to use entrepreneurs as collecting agents. But let them be agents not principals. Having adopted fo r quite good reasons a policy which pours a booty into their laps, let us be sure that they hand it over in the form o f taxes, and that they are not enabled to obtain a claim over the future income of the community by being allowed to 'lend' to the State what has thus accrued to them (155).

The proposal o f a means to avoid using inflation as a tool of war finance in World Wa r n, o r t o us e i t as littl e a s possible , ca n be explaine d b y tw o principal difference s betwee n 191 4 an d 1939 : 'tota l war ' involve d mag nitudes muc h greate r tha n thos e o f the earlie r period , an d ther e ha d de veloped a greater confidenc e in, and acceptance of , administrative control. Laissez faire was not dead; but social control had become pervasive, and administrative skill had developed wit h practice. S o in world war n we got payroll deductio n an d refundabl e taxe s alon g wit h price control : an d we held price inflation to about 30 per cent over the five years of the war. The fourt h 'episode ' chose n wa s th e inflatio n an d quic k deflatio n of 1919-21. In 191 9 'the impulses to investment at a rate in excess of savings were tremendousl y stron g .. . a profi t inflatio n was , therefore , inevitabl e unless war-time restrictions were continued and reinforced, and unless the process of absorption o f demobilized men into employment was protracte d over a considerable period. ' Keynes recognized tha t 'in the circumstances of th e da y i t wa s quit e ou t o f th e questio n tha t th e bankin g authoritie s should put adequate obstacle s i n the way of a profit inflation' (157) . Indeed he doubted whethe r suc h actio n woul d hav e bee n desirable . H e di d hold them 'highl y culpable ' fo r allowin g the profi t inflatio n t o develo p int o an income inflation . Eve n wors e wa s the initiatio n of a profit deflatio n in the beginning of 1921. This wa s doubtles s inspired b y th e objec t o f cancelling some par t o f the income inflation o f th e wa r an d post-wa r periods .. . Bu t fro m th e standpoin t of national

462 Fro m Adam Smith to Maynard Keynes prosperity it was a mistake. We might have avoided most of the troubles of the last ten years ... if we had endeavoured to stabilise our monetary position on the basis of the degree of income inflation existing at the end of 1920, i.e. about 17 5 per cent up as compared with pre-war. Incidentally this would have left th e real burden of the war deb t at less than two-thirds of its present figure. The polic y actually adopted increased the severity of the debt problem by 50 per cent, and gave us a decade of unemployment (161-2).

The fift h 'episode ' wa s Britain' s retur n t o th e Gol d Standard . Thi s episode he had discussed i n the pamphlet, the Economic Consequences o f Mr Churchill, here he re-examined the problem in the light of his distinction between profi t deflatio n and income deflation. The objectiv e wa s a 'cold blooded incom e deflation'; whe n prices fel l 'th e Governor o f the Bank of England felt himsel f able to infor m th e Chancello r o f the Excheque r tha t the task was accomplished.' But the 'fal l in prices reduced, no t costs and rates of earnings, but profits .. . The entrepreneur faced with prices fallin g faster tha n cost s ha d thre e alternative s ope n t o him : t o pu t u p wit h his losses as best he could; to withdraw from his less profitable activities, thus reducing outpu t an d employment ; to embar k o n a struggl e wit h his employees t o reduc e thei r mone y earning s pe r uni t o f output ' (163) . Th e entrepreneurs trie d al l three expedients. They submitte d to a 'surprisin g extent' to the fall in profits. They curtailed their activities; five years later 'the curtailment of employment was still in operation.' They struggle d for lower wages and thus precipitated the general strike of 1926. The las t 'episode ' t o b e discusse d wa s the experienc e o f the Unite d States in the years 1925-30. Keynes attributed the slump of 1930 'primarily to th e deterren t effect s o n investmen t of the lon g period o f dear mone y which precede d th e stoc k marke t collapse , an d onl y secondaril y t o th e collapse itself.' But that collapse aggravated the situation 'by discouraging investment and by encouraging saving.' The effect o n saving he attribute d to the 'psychological poverty' which the collapse o f paper values brought with it'(176). The chapte r close s wit h a 'commen t o n the contemporar y situation. ' The grea t evi l an d th e grea t obstacl e t o economi c progres s seeme d t o Keynes to be found in the unwillingnes s of the centra l banks of the worl d to allow the marke t rate of interest t o fal l fas t enoug h ... Saving s had bee n o n a n unexample d scale. Bu t a proportion of them has been wasted, spilt on the ground, by the unwillingness of central banks to allow the market rate of interest to fall to a level at which they can

John Maynard Keynes 46 3 be fully absorbe d b y the requirements of investment... There has been a school of thought which has believed that the way to bring down the rate of interest in the long run .. . i s t o stimulat e savin g b y a thrif t campaig n whils t simultaneousl y putting obstacles in the way of investment by an 'economy' campaign - oblivious of the fact that saving s whic h are no t investe d ar e spil t .. . I t i s investment .. . whic h alone increases national wealth, and can alone in the long run bring down the natural rate of interest (185-6).

This statement o f the problem inevitabl y suggest s tha t somewher e i n the economy there are savings going to waste: it was necessary t o go on to the doctrine o f the General Theory an d to the expositions (Swedis h i n inspiration) i n terms o f ex ante an d e x post o f intentions t o sav e an d o f saving achieved. The statemen t als o continued th e emphasis o n the responsive ness of investment t o the rate of interest, though one of the 'episodes' led him to recognize that mor e may be needed i n deep depressio n tha n monetary action t o lower the rate of interest. Nearly hal f th e volum e i s devoted (Boo k vii ) t o th e 'Managemen t of Money.' Th e theoretica l argumen t o f volume i lead s t o th e propositio n 'that the control o f prices i s exercised i n the contemporary world through the control of the rate of investment.' I t follows that the art of management of money consists partly in devising technical methods by which the central authority can be put in a position to exercise a sensitive control over the rate of investment, which will operate effectively and quickly, and partly in possessing enough knowledge and prognosticating power to enable the technical methods to be applied at the right time and in the right degree to produce the effects on prices and earnings which are desirable in the interests of whatever may be the prescribed ultimate objective of the monetary system which is being managed (189-90).

What follows is a discussion o f these 'technica l methods.' The first problem is the control of the member banks by the central bank. Keynes noted the emergence after the war of 'open-market' operations a s a new element of control , substitutin g 'almos t efficaciou s "management " fo r th e "au tomatic" system. ' Th e trouble , a s h e sa w it , wa s 'tha t n o on e know s exactly t o what objects th e "management " is directed o r on what principles i t proceeds . I t ca n scarcel y clai m hithert o t o hav e trie d t o appl y scientific principles to the attainment of the economic optimum , in the light of day an d with the assistanc e o f expert discussio n an d criticism .. . Th e Bank's method s ar e i n extraordinar y contras t t o th e ful l an d splendi d publicity of the Federa l Reserv e Syste m of the United States' (207). The

464 Fro m Adam Smith to Maynard Keyne s experience o f the United States he discussed a t length, particularly th e use of open-market policy . One simple conclusion is reached: 'The success of open-market polic y depend s o n the centra l ban k alway s havin g o n han d adequate ammunitio n in the shape o f open-market securitie s availabl e fo r sale' (231). The possibility o f the inadequacy of this ammunition led him to recommend th e use of a supplementary device , viz. discretionary authority for th e centra l ban k 't o var y wit h du e notic e an d b y smal l degree s th e proportion of legal reserves whic h the member banks are required t o hold' (233). This, which seeme d 'revolutionary ' at the time has become part of the accepted power s of the Central Banks, and has added a valuable tool to their equipment. Chapter 33 on the 'Regulation of the Central Reserves' i s in the tradition of Henry Thornton , but would involv e a major change i n most countries. Let me quote the last paragraph: A country now holds a reserve i n gold and foreign currency for no other purpos e than as a war chest and as a safeguard against being unduly sensitive to unexpected or temporary fluctuations in its immediate international indebtedness: that part of the reserve which is held for the latter purpose should be at the free disposal of the central ban k .. . it s norma l amoun t shoul d b e determine d b y referenc e t o th e probable magnitude, generously estimated, of the requirements it may have to meet - whic h are not likely to be measured by a proportion, such as 35 per cent, of that part of the note issue which it would be practicable to withdraw from circulatio n at short notice (248).

This wa s th e doctrin e h e ha d persuade d th e Macmilla n Committe e o n Finance and Industry to adopt. In their report (1931) they said : Now tha t .. . th e gold reserve of the Ban k of England is held for no other purpose than to mee t a foreign drain, the effec t o f enforcing the principl e of the fiduciary issue is to forbid the Bank of England to use by far the greater part of its gold for the only purpose for which it is held or could be used. At present (April, 1931) the Bank holds about £145 millions in gold, at holiday seasons it s note in circulation rises t o about £38 0 million s an d th e fiduciar y issu e i s fixe d a t £26 0 millions. Thus £12 0 millions of the gold held by the Ban k ... i s immobilized and at certain times of the year onl y £25 millions is actually available ... We cannot regard a s satisfactor y a system under which so high a proportion of the gold stock is locked up in such a way as not be be available for export if the Central Bank should so desire.51

The tenacit y wit h which bankers , politicians , and , indeed , peopl e gener -

John Maynard Keynes 46 5 ally, held t o the notion o f the gold reserve a s a reserve agains t the note s circulating internall y wa s illustrated , an d th e consequen t il l effects fel t severely, in the dreadful monetary experience of the United States in the year of the Treatise. From nationa l managemen t Keyne s turne d t o internationa l manage ment. With a fixed exchange rate, such as is implied in an international gold standard, the freedom of the national monetary authorities i s limited: they must kee p i n step . 'Th e advantag e o f this i s tha t i t prevent s individual follies and eccentricities. The disadvantage i s that it hampers each centra l bank i n tacklin g it s ow n nationa l problems , interfere s wit h pionee r im provements of policy the wisdo m of which is ahead o f average wisdom, and doe s nothin g t o secur e eithe r th e short-perio d o r th e long-perio d optimum if the average behaviour is governed by blind forces such as the total quantit y o f gold , o r i s haphazar d an d withou t an y concerte d o r deliberate polic y behind it on the part of the central banks as a body' (256). The orthodox case for the gold standard was examined in Chapter 35. The cas e for an international gold standard .. . mus t stand or fall , I think, by the answer we give to the question whether the ideal standard of value ... should be of an internationa l character .. . I t ha s bee n usua l to assum e that th e answe r is so obviously in the affirmative a s to need no answer. I do not know where it has been questioned except in my own Tract on Monetary Reform . .. The conveniences and facilities which an international standard offers t o foreign trad e and investment is thought sufficien t t o clinc h the matter . The lac k of a n internationa l standard of value is assumed to be just on e more of those foolish hindrances to international mobility, such as tariffs, which can only serve to impoverish the whole world in the misguided attempt to benefit some separate part of it (269).

In Chapte r 3 6 the problem s o f nationa l autonom y wer e examined . I n restrospect, afte r th e experienc e o f the competitiv e devaluation s o f th e thirties an d in the light of later discussion of 'floating' exchang e rates with recognition o f the vital difference between clea n and dirty floats, I find the discussion somewhat unsatisfactory. As a response to the rigid orthodoxy it was useful: but the dangers of'misguided attempts' t o secure differential advantages, e.g. , to export unemployment, were unduly discounted. Th e problem of autonomy is considered principally within the framework of an international system . Adequac y o f liquid foreign resources to offse t 'in convenient fluctuations in the rate of foreign lending'; readiness to regulate the rate of foreign lending; a widening of the separation of the gold points; these ar e th e element s i n the resolutio n o f the dilemm a o f national au -

466 Fro m Adam Smith to Maynard Keynes tonomy and national interest in a continuing international system. With all his worrie s abou t committin g hi s ow n countr y t o th e il l effect s o f ba d monetary managemen t elsewher e h e nevertheless concluded: 'In spite of the disastrous inefficienc y with which the international gol d standar d ha s worked sinc e its restoration five years ag o (fulfilling th e wors t fear s an d gloomiest prognostication s o f its opponents) , an d th e economi c losses , second only in amount to those of a great war,' he saw good reaso n to accept, substantially, the/a// accompli of an international standard; and to hope for progress from that starting point towards a scientific management of the central controls - for that is what our monetary system surely is - of our economic life. For to seek the ultimate good via an autonomous national system would mean not only a frontal attac k on the forces of conservatism entrenched with all the advantages of possession, but it would divide the forces of intelligence and goodwill and separate the interests of nations.

He concluded that the 'best practical objective might be the management of the value of gold b y a supernational authority, wit h a number of nationa l monetary system s clustering aroun d it , each wit h a discretion t o vary the value of its local mone y in terms of gold within a range of (say) 2 per cent' (302-3). The problems of such supernational managemen t were discusse d in Chapter 38. The proposal for a 'supernational bank money' became th e basis for his later negotiations at Bretton Woods. In these days of 'Special Drawing Rights,' his SBMS do not sound as exciting as they did in 1930! I turn back to Chapter 37, to national management and the control of the rate of investment. There were, Keynes admitted, limits to the power of the banking system to control the price level. It is much easier to preserve stability than to restore it quickly, after a serious state of disequilibrium has bee n allowed to se t in ... Granted all reasonable intelligence and foresigh t o n th e par t of the manger s of the monetar y system, non-monetar y causes o f instabilit y ma y sometime s arise s o suddenl y tha t i t i s impossibl e to counteract the m i n tim e .. . I f ther e are stron g social or politica l force s causin g spontaneous changes in the rates of efficiency wages , the control of the price level may pas s beyond the powe r of the bankin g system ... I f a country adheres to an international standard and that standard is itself unstable, it is, of course, impossible t o preserv e th e stabilit y of the pric e leve l in face o f this ... Eve n wher e th e banking system is strong enough to preserve the stability o f the price level, it does not follo w tha t i t i s stron g enough both t o alter th e pric e leve l and t o establish equilibrium at the new level without long delays and frictions (314-15).

John Maynard Keynes 467 Monetary managemen t i s no t easy . Bu t i t migh t b e a lo t bette r i f th e significance o f investment wer e recognize d an d i f control o f the rat e of investment became a prime objective of policy. Keynes was confident that the monetary authority could operate with sufficient effec t on the short and long rate s o f interes t s o a s t o influenc e investment . Bu t i n a seriou s emergency the Central Ban k would have to carry out open market operation 'a outrance." He added however: Circumstances can arise when, for a time, the natural rate of interest falls s o low that there is a very wide and quite unusual gap between the ideas of borrowers and of lenders in the market on long term. When prices are falling, profits low, the future uncertain an d financial sentiment depressed an d alarmed , the natura l rate o f interest may fall, for a short period, almost to nothing. But it is precisely at such a time as this that lenders are most exigent and least inclined to embark their resources on long ter m .. . s o tha t th e bon d rate , fa r fro m fallin g toward s nothing , may b e expected -apart from the operations of the Central Bank -to b e higher than usual.

If the Centra l Ban k will not, o r can not, brin g down the rat e of interes t sufficiently, there may have to be 'socialistic action by which some officia l body steps into the shoes which the feet of the entrepreneurs are too cold to occupy' (534-5) . A t thi s stag e i n Keynes' s developmen t th e 'publi c works' them e of 1929 seems to be almost drowned out by the 'monetar y management' theme -and be it remembered by those who know of Keynes only throug h elementary textbooks o f the post-wa r period 'fisca l policy ' was not yet one of the mingling themes. The Treatise ends with a plea for the development of 'exact quantitative information concernin g contemporar y economi c transactions. ' Al l th e pioneer work , 'muc h o f i t o f th e highes t quality ' ha d bee n don e i n th e United States, by the Federal Reserve Board and such semi-private bodies as the National Bureau of Economic Research and the Harvard Bureau of Business Research. This wor k was of vast importance 'i n order to eliminate impressionism.' The Ban k of England and the Big Five, by contrast, had 'looked on the economic inquirer as though he were the policeman in the pantomime who warns the fellow under arrest that "everything he says will be taken down , altere d an d used i n evidence agains t him." ' Meanwhile th e statistica l department s i n Whitehall hav e bee n 'hampere d b y inadequate staf f an d resources.' Th e ple a wa s for statistic s 't o sugges t theories, to test them, and to make them convincing' (365-6).

468 Fro m Adam Smith to Maynard Keynes v i i B E T W E E N T H E Treatise A N D T H E General Theory In 193 1 Keynes gave one of the three series of lectures on Unemployment as a World Problem fo r th e Harri s Foundatio n i n Chicago. 52 Tha t b y Keynes, 'A n economi c analysi s o f unemployment' 53 i s useful a s a shor t summary of the theory o f the Treatise and of its policy implications . Th e third lecture, b y E.J. Phela n o f the ILO , is useful a s reporting th e state of opinion 'as reported to Geneva.' Forty years later the magnitude of the gap between th e orthodoxy o f that tim e and the Keynesia n heres y i s hard t o believe. Fo r tha t reaso n I shal l mak e som e reference s t o it . Bu t first , Keynes. After a few pages on the magnitude of the investment boom in the United States an d in almost the whole world, 'with one partial exception, namel y Great Britain, ' Keyne s turne d t o th e slump . H e disagree d wit h thos e 'austere an d puritanica l souls ' wh o regarde d th e slum p a s a 'desirabl e nemesis o n s o muc h over-expansion , a nemesi s o n man' s speculativ e spirit,' and who said that we needed 'wha t they politely call a "prolonge d liquidation" to put us right. ' H e found the explanation of the high level of unemployment 'not in the high level of investment which was proceedin g up to the spring of 1929, but in the subsequent cessation o f this investment,' and h e saw 'no hope o f a recovery excep t i n a revival of the high level of investment.' Th e cause s o f th e declin e i n investmen t were , o f course , complex, but a major influence was the unduly high rates of interest. Once the declin e starte d 'th e mer e fac t o f a decline precipitate d a further de cline.' He ended this first lecture by stating his belief 'that if the volume of investment falls off, then of necessity the level of business profits falls away also.' The reason s for this belief he had set forth in his recently published Treatise on Money, 'bu t the argument is not easy, and I cannot claim that it is as yet part of the accepted bod y of economic thought. ' So in the second lecture he gave an 'outline of this reasoning' adapted for the medium of oral expression. The fundamental equation of the Treatise is reduced to words. The cost s o f productio n o f th e entrepreneur s are equa l t o th e income s o f th e public. Now the incomes of the public are, obviously, equal to the sum of what they spend an d wha t they save . O n th e othe r hand , the sale s proceed s o f the entrepreneurs are equal to the sum of what the public spend on current consumption and what the financial machin e is causing to be spent on current investment. Thus the costs of the entrepreneurs are equal to what the public spends plus what they save; while the receipts of the entrepreneurs are equal to what the public spends plus the

John Maynard Keynes 46 9 value of current investment. It follows .. . that when the value of current investment is greater than the savings of the public, the receipts of the entrepreneurs are greater than their costs, so that they make a profit.

And vice versa. 'Tha t is my secret... when the rate of current investment increases (withou t a corresponding chang e in the rate of savings) business profits increase. Moreover, th e affair i s cumulative.' Now Keyne s argue d that savin g 'eithe r varie s i n th e wron g directio n .. . o r i s substantiall y unchanged,' but that the rate of investment is highly variable, being 'capable of sudden and violent change' and having in fact 'suffered a sudden and violent change.' To restore profits the volume of investment must increase. But what of the cumulative decline when investment has fallen off, is there a bottom to the decline? Keynes saw a decline in saving as providing such a bottom, especially the negative saving by the unemployed and indeed by all whose income s ha d declined significantly , an d by the government' s bor rowing to finance unemployment relief. As he would later put it the propensity to save may be relatively stable, but the amount of saving varies with income. In a characteristic quantitativ e illustratio n in which rough magnitudes are selected a s 'not too remote from the facts,' he discussed the problem of the American slump . In 192 8 investment was of the orde r o f $10 billions, national savings were $9 billions; there woul d be 'abnorma l profits' of $i billion. Now suppos e investmen t to fal l to $5 billions , in plac e of the abnormal profit there will be abnormal losses of $4 billion as long as savings continue a t $ 9 billion. Suppos e ther e t o b e 'disinvestmen t i n working capital' at the rate of $1.5 billions: then the rate of net investment may fall as lo w a s $3. 5 billio n an d th e abnorma l losse s ris e t o $5. 5 billion . Bu t suppose tha t a governmen t defici t o f $ i billio n ha s develope d an d tha t saving by the publi c has fallen b y $i billion , suppose to o that 'a s output ceases t o fal l further , disinvestment i n working capital wil l cease,' the n abnormal losse s wil l b e reduce d b y $ 2 billion . Ther e woul d b e som e increase in output and consequent reinvestmen t in working capital, but this recovery i s 'bound t o be an illusion and a disappointment' a s long as the nation's saving s stand a t $9 billions 'granted a normal level of output and employment' and if 'the rate of long-term interest in conjunction with other factors is too hig h to allo w mor e tha n $5 billio n expenditur e on fixed investment.' Prescription followe d thi s diagnosis . T o reestablis h th e volum e of investment there must be a fall in the long-term rate of interest and a return of confidence. Keyne s added tha t recovery wa s 'indissolubly bound up with

470 Fro m Adam Smith to Maynard Keynes the restoration of prices to a higher level' and he found it necessary to meet the arguments of those who would bring costs down to the new low level of prices. 'Wil l not social resistanc e t o a drastic downward readjustment of salaries an d wages be an ugly and a dangerous thing?' If such adjustment were possible, was it desirable to increase the burden of monetary indebtedness, the burde n on the public of the national debt an d the burden on the farmer of his mortgage? Now an increase of investment would not only increase profits an d employment, it would raise prices 'thu s ameliorating the burden s arisin g ou t o f monetar y indebtedness. ' Bu t ho w ca n thi s increase i n investment be induced? There may be little that can be done 'deliberately t o restor e confidence ' bu t somethin g coul d b e don e b y 'favorable internationa l developments ' suc h as 'alleviation of war debts.' A secon d metho d i s a n increas e i n publi c investment : ' a governmen t program is calculated to improve the level of business profits and hence to increase the likelihood of private enterprise again lifting up its head.' But it is no t eas y t o devis e a t shor t notic e appropriat e program s s o tha t h e applauded th e ide a but hesitate d t o depend to o muc h in practice o n this method. There remained a drastic reductio n i n the long-ter m rate o f interest. Thi s called for massive open-market operations on the part of the central banks and a lowering of the rat e o f interest paid on deposits. All three methods must be used. Keynes concluded his lectures with an emphatic statement of the need for lower interest rates; rates 'appropriate to the underlying facts.' 'As houses and equipment of every kind increase in quantity we ought to be growing richer ... As technological changes mak e possible a given output of goods of every description with a diminishing quantity of human effort, agai n we ought to b e forever increasing our level of economic well-being . But the worst of these developments is that they bring us to what may be called the dilemma o f a ric h country , namely , that the y mak e i t mor e an d mor e difficult to find an outlet for our savings.' A decade later war, two decades later th e technologica l revolution s o f th e electroni c an d nuclea r age , changed, for the time being, 'the underlying facts.' In contrast t o this positive analysis and confident proposal s fo r action was the report by Dr Phelan on 'the problem as reported to Geneva. '56 'The workers wer e practicall y unanimou s in describing th e depressio n a s the result of production having outstripped consumptio n ... They vigorously denounced th e polic y o f reduction o f wages and urge d that th e onl y immediate remedy ... lay in shorter hours and increased wages.' The employers were less certain of the causes of the crisis. But the most evident causes were: 'overproduction in agriculture financed in incredibly

John Maynard Keynes 47 1 exaggerated condition s .. . and , overproduction i n industry and generally excessive speculatio n .. . a cessation of credit and loss of confidence.' They dismissed th e proposal s fo r monetar y expansion : 'thi s woul d onl y b e inflationary .. . it is an illusion to suppose that there can be any short cut to world prosperity by monetary manipulation.' They saw some possibility of controlling production , bu t recognize d tha t contro l migh t be too rigi d to permit technica l progress. Their main emphasis wa s on the reductio n o f production costs. Here they noticed som e possibilities of reduction in cost through rationalization, but few: and they noticed that the workers' offer to collaborate in rationalization wa s qualified b y unacceptable proposal s fo r worker participation i n management. The only solution was, therefore, to reduce money costs, and in particular to 'reduce wages and social expenditures.' Unemployment insurance came in for special treatment as 'a factor making fo r unemployment ' b y preventin g o r delayin g th e fal l i n wage s necessary t o restore equilibrium. 'Although we may think that it is impossible to leave the unemployed in a state of destitution, we must not come to their assistance i n such a way that we reverse th e operation o f economic forces an d thus aggravate th e evil.' There followed a curious repl y to the deficient purchasin g power argumen t of the workers . 'Economist s have shown that only about half the revenue of a country goes to the workers as wages. If you wish to increase artificially this proportion you can only do it by reducing the proportion that goes elsewhere. You therefore reduce the purchasing power whic h i s no t exercise d throug h wages. Yo u ca n only increase purchasing power, then, if you decrease th e costs of production.' It is this sort of argument that Keynes was dealing with. In the context the advance made by him towards understanding the problem must be recognized as revolutionary. On th e ev e o f th e Internationa l Economi c Conferenc e summone d in 1933 Keynes published four articles in The Times which were expanded as a pamphlet, The Means t o Prosperity.55 Th e argumen t for internal expansion presented i n Chapter n is not very different fro m tha t of 1929 ; but it included a referenc e t o th e doctrin e o f th e multiplie r which ha d bee n developed b y R.F . Kah n in The Economic Journal i n June 1931 . I n this article Kah n made a major move toward th e General Theory b y introduc ing the concep t o f the 'employmen t multiplier,' relatin g the incremen t of total employmen t whic h woul d resul t fro m an y give n increment o f em ployment in the investment industries. Perhaps the crucial change was that increased demand , when there was unused capacity, was seen to increase output rather than to raise prices; prices would rise only if money costs rose with increased output.

472 Fro m Adam Smith to Maynard Keynes In the Means to Prosperity Kahn' s influenc e on Keynes is evident an d acknowledged. A s i n 192 9 Keyne s firs t dre w attentio n t o th e indirec t employment i n the productio n an d transpor t o f materials relate d t o th e direct employment of men in building. But i f the ne w expenditure i s additional an d no t merel y in substitution fo r othe r expenditure, the increase of employment does not stop there. The additional wages and other incomes paid out are spent on additional purchases, which in turn lead to further employment . If the resources of the country were already fully employed, these additional purchases would be mainly reflected in higher prices and increased imports. But in present circumstances this would be true of only a small proportion of th e additiona l consumption ... Nor hav e we yet reached th e end . The newly employed .. . will , i n their turn , spend more , thus adding to th e employmen t of others; and so on.56

Some enthusiast s 'greatl y exaggerate d th e tota l result, ' neglectin g th e leakages a s som e o f th e increase d incom e i s saved , som e use d t o bu y imported goods and some 'may reach the Exchequer withou t relieving the taxpayer t o a n equal extent. ' Th e 'multiplier ' Keyne s estimate d fo r the Britain of his day to be 2; but he argued his case from a more conservativ e estimate o f iVz . A capita l expenditur e o f £3 million woul d increas e th e national incom e by a t leas t £4. 5 million. The Excheque r woul d sav e £ i million i n unemploymen t benefit, an d collec t a t leas t £450,00 0 in extr a taxes. Half the loan expenditure would be costless. 'Take, for example, the proposal to spend £7 million on the new Cunarder. I say that this will benefit the Exchequer by at least half of this sum, i.e., by £3,500,000, which vastly exceeds th e maximum aid which is being asked from the Exchequer.' 57 Chapter n was concerned wit h raising world prices. 'Fo r commodities as a whole there can be no possible means of raising their prices except by increasing expenditure upon them more rapidly than their supply comes to market.' Increased expenditure require s eithe r tha t people spend mor e of their income s o r that thei r income s increase . Ther e ar e narrow limit s to increased expenditur e fro m existin g incomes s o that on e shoul d concen trate o n increasin g incomes , an d thi s require s a n increas e i n 'loan expenditure' throughou t th e world . T o promot e suc h a n increas e th e central banks should make bank credit 'cheap and abundant.' The banks by open marke t operations , an d government s b y 'wel l judged conversio n schemes' shoul d striv e t o reduc e th e long-ter m rat e o f interest . Ther e remained a third instrument, public works:

John Maynard Keynes 473 Hitherto war has been the only object of governmental loan-expenditure on a large scale which governments hav e considered respectable . In all issues of peace they are timid, over-cautious, half-hearted ... thinking of a loan as a liability and not as a link i n the transformatio n of the community' s social resources , whic h will otherwise be wasted, int o usefu l capita l assets. I hope that her Government will show that Great Britain can be energetic even in tasks of peace. It should not be difficul t to perceive that 100,000 houses are a national asset, and i ,000,000 unemployed men a national liability58

But nationa l actio n wa s no t enough : 'loan-expenditur e mus t sprea d it s beneficent influence round the world.' There followed in Chapter 4 proposals for international action . First , a restoratio n o f international lending . Second, concerted actio n by the stronger countries to increase loan expenditure at hom e so that th e nationa l leakage throug h purchase o f imports could becom e th e basi s o f internationa l multiplie r action . I n s o fa r a s increased home investment 'leads to expenditure on imported goods, it will set up ... favourable repercussions abroad, and will strengthen the position of the countries from which we buy, both to make reciprocal purchases and also to augment their loan-expenditure. I t will have set the ball rolling.'59 Third, the issue by an international authority of a special type of note that would supplement gold in the reserves of the national central banks.60 In th e Means t o Prosperity, influence d by R.F . Kahn , th e theor y o f prices o f the Treatise was wel l on the wa y t o th e theor y o f 'outpu t a s a whole' of the General Theory. Already in his lectures Keynes had made the transition. Lorie Tarshis, who had gone from the University of Toronto to study a t Cambridge , ha s tol d m e o f th e shoc k a t hi s firs t lectur e fro m Keynes when it began with an announcement that the cours e o f lectures would not be, as announced, on the theory of money but on the theory of output as a whole. It is hard for the modern student to realise why it was so shocking, even well nigh incomprehensible. To those of us who were outside the magic circle help came from Joa n Robinson's articl e i n the first number of the Review of Economic Studies (October, 1933) , 'The Theory of Money and the Analysis of Output.' This article wa s reprinte d i n volum e i o f Professo r Robinson' s Collected Economic Papers .61 In he r introductio n t o tha t volum e sh e sai d o f this article: 'It gives an outline of Keynes' theory as far as it had got in 1933.' She wen t o n t o explai n tha t th e Review ha d been 'founde d a s part o f a movement b y som e o f th e younge r members o f th e Londo n Schoo l of Economics an d of the Cambridge Faculty to get together behind the backs

474 Fro m Adam Smith to Maynard Keynes of their embattled seniors. ' In those exciting days Abba Lerner journeyed regularly fro m th e London Schoo l t o hear Keyne s lectur e i n Cambridge , and to wrestle wit h the difficulties i n company with Tarshis and others. It was for this London-Cambridg e grou p that R.B. Bryce, anothe r Toront o student i n Cambridge , prepare d hi s repor t o n th e stat e o f thinkin g i n Cambridge in 1935. This report was never published but in mimeographed form did much to prepare us in Toronto, and many at Harvard when Bryce went from one Cambridge to the other Cambridge, for the General Theory. Let me say a word or two about the Robinson and Bryce articles. First, Joan Robinson. It has always been admitted that the chief justification for a study of the price level lies in the fact that changes in the price level may affect th e volume of output... But until recently no economist appears to have considered the possibility of tackling this problem directly, and setting the supply-and-demand apparatus to work on the question in which he was really interested - the forces determining the volume of output .. . M r Keynes, when he published the Treatise, had no very clear conception o f the fac t tha t th e subjec t wit h which he wa s dealin g was th e Analysi s of Output. This can be illustrated from several of the conceptions in the Treatise. For instance, consider the Widow's Cruse of Profits ... This argument is valid under the assumption tha t th e increas e i n the deman d for consumptio n good s lead s t o n o increase in their supply. Now, to assume that the supply is perfectly inelastic is a natural simplification to make ... if we are primarily interested in the price-level, but to mak e such a n assumptio n when we are primaril y interested i n the volum e of output is to assume away the whole point of the argument. 62

If the other extreme assumption were made, of a perfectly elastic supply of output as a whole, no increase in demand will raise prices. Second, R.B . Bryce . I t i s perhap s unfai r t o tak e ou t on e summar y paragraph fro m a paper which included new definitions and discussion of new functional relations. But as indicating the establishment of a new level of discussion, and in view of our present familiarity with the definitions, I think it may be justifiable. Let u s begin by assuming that the amount of investment, the suppl y functions of consumption and investment goods, an d the propensity to spend are given. The n we can show that income , expenditure an d employment are determined b y thes e data. For the amount of investment being given, income must be such as to yield that amount of saving, with the given propensity to save and spend .. . Income and the propensit y t o spen d bein g the n determine d an d given, expenditur e mus t be

John Maynard Keynes 475 determined. Expenditure being determined and the supply function of consumable goods, th e employmen t in producing consumable goods is determined. Because investment an d suppl y function o f investment goods are known , employment in investment is easily determined. Therefore total employment is determined.

Three comments are in order. First, we had to adjust to the new, and really more natural, definition of income, no longer excluding windfall profits and losses, s o that savin g an d investment wer e necessaril y equa l (e x post) . Second, we were given a formal statement of the relation of saving to the level o f income which had bee n implie d in som e earlier writings . Bryce made 'one fundamental assumption about the propensity to spend' which he thought 'likely to be true of the real world.' If incomes increase expenditure on consumption may increase bu t i t cannot increas e b y as much as incomes, a s long as the propensity t o spen d remain s the same . Thi s as sumption, h e explained , 'i s necessar y - fo r if when incom e increase d expenditure increased equall y then the output of consumption goods would be in neutral equilibrium, for an increase i n employment would generat e sufficient expenditur e to maintain itself. It is because thi s is not the cas e that unemployment can persist i n a state o f at least short-perio d equilib rium, and that th e actua l amoun t o f employment is a function of investment. ' Third, many of us were worried about the definition of employment. The difficulty of measuring output because of the lack of homogeneity in its constituents led to attention being paid to employment. But labour is not homogeneous either , an d fo r Bryc e employmen t wa s measure d b y th e aggregate wag e bill divided by the rate of money wages of 'common road labour.' This, o f course, wa s the definitio n Keyne s used i n the General Theory: 'I f E is the wage s (and salaries ) bill , w th e wag e unit, and N the quantity of employment, E = Nw.' 63 If the object is to establish a reasonably stabl e relationshi p between employment and outpu t this is a usefu l definition. S o it is if the objec t i s to estimat e th e socia l los s i n foregone product of any given level of unemployment. But most of us were, and are, interested i n the number of persons unemployed . W e find it inhumane to treat th e unemployment of one highly skilled worker as equivalent to the unemployment of three or four 'commo n road' labourers. Fo r this reason many have failed to take proper notice of the Bryce-Keynes definition and have read int o the equations an d the argument the unweighted number of persons employed, or unemployed. I have said of Bryce's paper that it helped to prepare u s in Toronto for the General Theory: perhap s I should add that the presence amongs t us of one who had been a pupil of Keynes in the days when the Treatise was in

476 Fro m Adam Smith to Maynard Keynes preparation, Wynne Plumptre, made that preparation easier . Plumptr e is mentioned in Harrod'sL//