History of Economic Analysis part 70 pptx

tutee Marx—though, as may be the case sometimes, neither would have been completely pleased
with the other’s performance.
decreased and population will have become ‘redundant,’ which is what Ricardo set out to
prove.
Ricardo concluded from this that the opinion prevailing in ‘the labouring class, that
the employment of machinery is frequently detrimental to their interests, is not founded
on prejudice and error, but is conformable to the correct principles of political economy.’
It was this sharp-edged pronouncement that monopolized professional attention,
reinforced as it was by another passage in the same chapter which affirmed that in cases
like the one discussed ‘there will necessarily be a diminution in the demand for labour,
population will become redundant, and the situation of the labouring classes will be that
of distress and poverty.’ Friends and foes seem to have seen nothing else and, ever since,
Ricardo has stood in doctrinal history as the chief exponent of the view that those
statements in fact do seem to express. But, if we take account of the rest of the chapter
and bear in mind that it professedly deals with what Ricardo used to call permanent
effects, it is clear, first, that they do not follow from the numerical example alluded to
and, second, that Ricardo was aware of this and did not mean at all what these statements
say. As regards the first point, Ricardo’s example covers only part of the course of events
that the introduction of the machine sets into motion: his analysis of the case is indeed an
example of the method of Comparative Statics, but the second of the two states compared
is not a definitive state of equilibrium, for we are not told what happens to the workmen
who have lost their jobs, yet they cannot remain unemployed unless we are prepared to
violate the assumption that perfect competition and unlimited flexibility of wages prevail.
As regards the second point, Ricardo, though in a particularly narrow and inconclusive
way, fully recognized that mechanization may increase productive efficiency so greatly
‘as not to diminish the gross produce’ (gross produce in his sense, that is, the net national
product including wages) in terms of commodities. This amounts to saying that real wage
income (in our sense) need not fall ‘permanently’; and that in any case, the purchasing
power of profits and rents being increased by the fall in prices resulting from
mechanization, ‘it could not fail to follow’ that, with constant propensity to save,
capitalists and owners of natural agents would fill up the depleted wage fund again by

means of increased savings. These admissions (for brevity’s sake I neglect others) are not
exceptions to his argument but result logically from it, if it be continued beyond the point
reached by the numerical example. Thus they make Ricardo the father of what Marx
called the Theory of Compensation—the theory that the working class is being
compensated for initial sufferings, incident to the introduction of a labor-saving machine,
by favorable ulterior effects—which Marx attributed to James Mill, McCulloch, Torrens,
Senior, and J.S.Mill, thereby constructing an entirely unrealistic contrast between these
men and Ricardo. More or less, most economists have done the same thing, even those
who did not wish, as did Marx, to single out this so-called theory of compensation for
vituperative comment (see Das Kapital, vol. I, ch. 15, sec. 6).
The controversy that went on throughout the nineteenth century and beyond, mainly in
the form of argument pro and con ‘compensation,’ is dead and buried: as stated above, it
vanished from the scene as a better technique filtered into general use which left nothing
to disagree about (see reference to Hicks’s Theory of Wages, first footnote of this
subsection). Nevertheless, in order to understand an important phase of past doctrinal
History of economic analysis 652
history, a few clarifications will be useful. In the first place, the reader must not think that
Ricardo was wrong in the result that he formulated in the two statements quoted above.
On the contrary, if we interpret him to have meant that mechanization may permanently
decrease labor’s relative and possibly even absolute share in national income (no matter
whether this be real income in our sense or in Ricardo’s), he was correct. Only, his
argument taken as a whole does not prove it. In the second place, so far as Ricardo meant
to convey not only an abstract theorem but a picture of practically relevant processes and
likelihood, he obviously underrated the effects of the increase in productive power that
mechanized capitalism would display and of the expansion of output that would result
therefrom—so that long-run ‘distress and poverty’ looms larger in his text than it should
in a realistic picture. On the one hand, this was due to something that is much worse than
defective technique, namely, to lack of imagination: he never clearly realized that the
essential fact about capitalist ‘machinery’ is that it does what, quantitatively and
qualitatively, could not be done at all without it or, to put it differently, that it ‘replaces’

workmen who have never been born. But, on the other hand, this was due also to the
shortcomings of his analytic apparatus, which did not lend itself readily to the description
of quantitative expansion. In particular, in the Ricardian system prices can fall to cost
level directly, that is, in a way other than by increase of output (Principles, ch. 30): hence
he failed to see that total output in terms of goods must increase, under conditions of
perfect competition, which he assumed, in consequence of mechanization. He further
failed to see clearly that, if we express the wage fund also in terms of commodities, it can
increase without any increase in saving, though it is then much more natural to say
simply that real wage incomes (in our sense) increase than it is to say that the wage fund
increases and that real wages increase in consequence of this.
In the third place, the reader who, on perusal of Ricardo’s chapter on machinery, sets
it down as a mess is perfectly right; and he may well ask for the reason. It seems to me
that the reason is that Ricardo, while retaining his own approach in terms of real value
(‘labor embodied’), at the same time repeatedly crossed the frontier that separates this
approach from analysis in terms of goods. Why he did this is clear: his exact reasoning is
always in terms of the labor-embodied approach; but this approach does not lead to any
results about anyone’s distress or welfare, which were what interested him in this chapter.
And so he mixed up the two, sometimes speaking of ‘distress of labor’ when summing up
an argument that was in terms of labor embodied and hence irrelevant to real incomes in
our sense that is real income in terms of goods, sometimes speaking in terms of his real
value in the course of an argument that makes sense only in terms of absolute quantities
of goods.
Finally, in the fourth place, additional clarification may be desirable as regards that
increase in saving by capitalists to which Ricardo attributed effects that would or may
remedy the injury the machine does to workmen. Since this injury, within Ricardo’s
wage-fund method, is described as a reduction in the Ricardian value of the wage fund,
additional saving will in fact tend to repair the damage. Now this additional saving comes
from profits for two alternative reasons. First, even if the rate of profit be not increased
permanently (if, in Ricardo’s language, the ‘value’ of profits be not increased), a fall in
prices of the goods they consume makes it easier for capitalists to save, which (if

propensity to consume remains constant as it always is with both Ricardo and Keynes)
they will accordingly do. But, second, if the cheapened goods are, wholly or primarily,
General economics 653
consumed by workmen, then, according to Ricardo’s theory, the rate of profits will
increase. And increased saving will follow from this. Let me add that J.S.Mill did accept
Ricardo’s methods, but did not follow them closely. The main comfort he had to offer to
the working class was that mechanization occurs in a process that produces ample
savings that easily replace reductions in the wage fund caused by mechanization (they
would otherwise spill over into colonies and so on) so that these reductions are likely to
be potential rather than real. Marx ought to have liked this—for it offers a nice suggestion
for the socialist theory of imperialism (see below)—but he did not display gratitude when
he used it.
Marx (op. cit. ch. 15) accepted Ricardo’s analysis, adding nothing essential but
minimizing the Ricardian qualifications, beating out the slender result to its thinnest leaf,
making the most of the unemployment that has been historically associated with the
process of mechanization, and allowing himself to be carried on by his glowing rhetoric
to a pitch of excitement such that he even overlooked some points he might have made
for his own theory or against the hated theory of compensation. Perhaps this shows, as do
in his case other excesses of this kind, that he was not quite sure of his ground. Certainly
it shows that he was aware of the decisive importance of the mechanization problem for
his ultimate conclusions concerning the future of the capitalist system. Machines had to
throw the laborers ‘on the pavement’—still better, because of English machines the bones
of Indian weavers had to ‘bleach in the sun.’ Marxist unemployment is essentially
technological unemployment. This technological unemployment had to create a
permanent ‘industrial reserve army’—Ricardo’s redundant population. And the presence
of this permanent industrial reserve army—only temporarily absorbed in spells of high
prosperity—had to depress real wages (in our sense) to levels of everincreasing misery,
degradation, and so on (Verelendung) that would eventually goad the proletariat into the
final revolution. Of course, this was only an ‘absolute law.’
105

Of course, Marx’s
effective display of severely selected his-
105
The reader should remember what this phrase means in the Marxist lingo, namely, the same
thing as an abstract tendency that is not necessarily verified in any given stretch of economic
history.







History of economic analysis 654
torical facts, which fill out his analysis in that chapter, contains a considerable number of
qualifications of his own as do some passages in the third volume. But since abstract
tendencies drive nobody into misery and despair and since Marx took little heed of his
qualifications when it came to ultimate conclusions and purposes (see, e.g., ch. 32,
‘Historical Tendency of Capitalistic Accumulation’), no Marx apologetics can be
successful that proceed on either of those lines. We have no choice but to take statements
like that above seriously. If we do, the failure of Marx’s attempt to turn the possibility
that Ricardo envisaged into inexorable necessity endangers the logical structure of his
system as much as the actual history of the working class endangers any claim it might
have to realism.
106

But it is only the thesis about increasing misery that needs to be dropped from Marx’s
analysis of the process of technological development, although, from the standpoint of
Marxist orthodoxy, it may be all-important. Other results remain. In order to see them in
their proper light, let us remember that, in Marx’s general schema, social evolution is

propelled by a force that is immanent or necessarily inherent in the profit economy. This
force is Accumulation: under pressure of competition, the individual concern is
compelled to invest as much of its profits as possible in its own productive apparatus;
107

and it is compelled to invest them primarily in technological capital, naturally looking
always for machines of ever-new types. This does not permanently benefit ‘capitalists’ as
a class
108
for, as Ricardo had already pointed out, any supernormal gain is quickly
eliminated by competitors’ adopting each technological improvement. But the temporary
advantage gained by the one who is first to move gives him a lead in the race: rushing
down on declining average-cost curves and annihilating (‘expropriating’) the weaker ones
in the process, capitalist concerns, individually growing in size. build up vast powers of
production that eventually burst the framework of
106
There are Marxists who actually do not mind taking up the ridiculous position that a tendency
for the working class’s standard of life to fall is in fact observable. Others have confined
themselves to the less absurd proposition that Marx’s abstract law has been put out of operation,
owing to uniquely favorable conditions that have prevailed in the nineteenth century (such as the
opening up of new sources of foodstuffs and raw materials through the spectacular cheapening of
transportation), but will assert itself eventually if it has not done so already in the 1930’s. Still other
interpreters have made efforts to make Marx’s law mean relative misery only, i.e. a fall in the
relative share of labor, which, besides being equally untenable, clearly violates Marx’s meaning.
107
Of course, this is saying the same thing as that the individual concern is compelled to save, a
phrase the highly undesirable implications of which Marx fought like a lion to avoid. In pointing
out the existence of this compulsion he did, however, betray a much deeper understanding of the
capitalist mechanism than can be attributed to the ‘bourgeois’ economists of his age. But in
common with them, he saw nothing but the mechanical aspect of accumulation, hence not the

reality of capitalist evolution but only its reflection in growing heaps of inanimate things: besides
accumulating these, ‘capitalists’ did nothing but exploit.
108
On the ‘law of the falling rate of profit.’ see above subsec. 6c.



General economics 655
capitalist society. Not all this has stood up. Particularly vulnerable is the last point: Marx
never made it clear precisely how the economy of giant concerns is to break down, and
his break-down theory (Zusammenbruchstheorie) has in fact been renounced by some of
his most eminent followers. On the whole, however, one cannot but be impressed by both
the analytic and realistic virtues of this conception of capitalist evolution, especially if
one compares it to the modest elements of it that Marx found in Ricardo’s chapter on
machinery.
History of economic analysis 656
CHAPTER 7
Money, Credit, and Cycles
1. ENGLAND’S PROBLEMS
IT IS THE COMMON opinion that the foundations of the monetary science of today (or
yesterday) were laid by the writers who discussed the issues of English monetary and
banking policy from the Restriction Act (1797) to the gold inflation of the 1850’s. This
neglects indeed the French and Italian work of the eighteenth century but nevertheless
comes nearer to the truth than such sweeping statements usually do. Many of those
writers moved on an unusually high level. They soared with ease into the sphere of
abstract generalization and were possessed of a genuine will to analyze. This is the more
remarkable because most of them were men of practical affairs and primarily interested
in practical measures. We are accustomed to a different state of things: few modern
economists would look to men of practical affairs and especially to bankers for help in
their analytic task or even consider them as authorities on the principles of their own

business. But this situation developed in the next period. In the one under survey, it was
the practitioners who were in the van of analytic advance, and research workers of
different types were in most cases content to take their clues from them.
With most of the leading performers we are already acquainted, especially with Ricardo,
Malthus, Senior, Tooke, Torrens, and J.S.Mill.
1
A small num- ber of others will be
introduced as we go along. But Henry Thornton (1760–1815) must be saluted at once. He
was a banker, M.P., philanthropist, and—which he himself and many who knew him
would presumably have put first—a leading figure in the influential group of
Evangelicals that was known as the Clapham Sect. His Enquiry into the Nature

1
Some of the relevant publications of these and others have also been mentioned already. Others
will be mentioned in the appropriate places. Ricardo’s main contributions will, however, be listed
at once. As the reader knows, it was as a writer on monetary policy, in the discussion on war
inflation, that Ricardo first made his reputation. His three letters to the Morning Chronicle (1809,
Hollander reprint as Three Letters on the Price of Gold, 1903) were followed by a fuller statement
of his views in pamphlet form: The High Price of Bullion, a Proof of the Depreciation of Bank
Notes (1810). The Reply to Mr. Bosanquet’s Practical Observations on the Report of the Bullion
Committee, Ricardo’s only exploit in ‘factual’ work—but very interesting as



and Effects of the Paper Credit of Great Britain (1802)
2
is an amazing performance. The
product, according to Professor von Hayek’s estimate, of work that extended over about
six years during which the author’s energy was largely absorbed by business and political
pursuits, not faultless in detail and not fully matured, it anticipated in some points the

analytic developments of a century to come. No other performance of the period will bear
comparison with it, though several, among them Ricardo’s, met with much greater
success at the time as well as later. In part this was because the author put no emphasis at
all upon his novel results—the book reads as if he himself had not been aware of their
novelty. Perhaps he was not, though he paid an almost academic amount of attention to
such predecessors as he knew. He was one of those men who see things clearly and who
express with unassuming simplicity what they see.
We shall confine ourselves almost exclusively to English work—a decision which, for
the epoch and the topic, may be justified even apart from the considerations of space that
impose it. With qualifications to be mentioned, this work was successfully summed up by
J.S.Mill. The relevant chapters of the Principles contain some of Mill’s best work. It
displays indeed some contradictions, hesitations, and unassimilated compromises—as
does his work on value—but even these were not unmixed evils since they brought out, in
strange contrast to Mill’s own belief in the finality of his teaching, the unfinished state of
the analysis of that time and thus indicated lines for further research to follow. In any
case, it was primarily in Mill’s formulation that
such—appeared in 1811; the Proposals for an Economical and Secure Currency in 1816. Chapter
27 of the Principles (1817), ‘On Currency and Banks’ retains independent importance in spite of
the long quotation from the Proposals. The Plan for the Establishment of a National Bank (1823)
has been reprinted by Professor Hollander in Minor Papers on the Currency Question, 1809–23, by
David Ricardo (1932; see the discussion of this plan in Professor Rist’s, History of Monetary and
Credit Theory, pp. 177–9), which contains also other pieces that are quite essential to a full
understanding of Ricardo’s views. Other items might be added. Ricardo’s theory of money, credit,
and banking gains on acquaintance, and in perusing his letters as well as his evidence before the
Committees on the Usury Laws and on Resumption, one discovers more and more fragments that
might be combined into a spacious structure. No attempt will be made, however, to do so. We shall
have to be content with a few features of Ricardo’s analysis that are of major importance to
doctrinal history. The reader is warned that this may involve some injustice to his performance as a
whole. But the impression the reader is bound to get, that Ricardo did not contribute much that was
both true and original, agrees with Viner’s judgment (op. cit. p. 122), and so does, I believe, my

opinion that as an analyst of money and credit Ricardo was inferior to Thornton.
2
The Library of Economics reprint (1939) is prefaced by an essay by Professor von Hayek, the
scholarship of which is surpassed only by its charm. The reader who misses it deprives himself not
only of much valuable information but of an exquisite pleasure.




History of economic analysis 658
the work of the first half of the nineteenth century reached the writers of the second half,
and we shall therefore keep this formulation in view, as a point of reference, throughout
this chapter.
I have commended the taste and ability for theoretical analysis of the writers of that
period. Nevertheless, their analysis was too closely bound up with the conditions and
problems of their time and country to admit of exposition without reference to these
conditions. Accordingly we shall now cast a perfunctory glance at them—neglecting
entirely, for the reason stated, the much more exciting experiences of the United States
and of some continental countries. Sources of more adequate information are presented
below.
To the student who wishes to have a single reference on which to concentrate I
recommend Professor Viner’s presentation in Studies in the Theory of International
Trade, Chapters III, IV, and V. This masterly piece of research—admiration for which
does not, however, imply agreement in every particular—will serve both for the history
of the most important facts and controversies, and as a guide to further historical
literature. For statistical figures, see N.J.Silberling, ‘Financial and Monetary Policy of
Great Britain during the Napoleonic Wars,’ Quarterly Journal of Economics, May 1924,
and ‘British Prices and Business Cycles, 1779–1850,’ Review of Economic Statistics,
Preliminary vol. V, 1923, and E.V.Morgan, ‘Some Aspects of the Bank Restriction
Period, 1797–1821,’ in Economic History, A Supplement to the Economic Journal,

February 1939.
By far the greatest contemporaneous histoire raisonnée is Tooke and Newmarch,
History of Prices (discussed above ch. 4, sec. 8a). Perusal of Sir T.E.Gregory’s
introduction to the 1928 edition of this work is the second recommendation I have to
make. Mr. R.G.Hawtrey’s Currency and Credit (3rd ed., 1928, ch. 18) and Art of Central
Banking (1932, ch. 4), usefully supplemented by Mr. W.T.C.King’s History of the
London Discount Market (1936), come next. Further help will be derived from
J.W.Angell, The Theory of International Prices (1926); E.Cannan, The Paper Pound of
1797–1821 (1919), which contains a reprint of the Bullion Report; A.E. Feavearyear, The
Pound Sterling (1931, ch. 9); A.W.Acworth, Financial Reconstruction in England, 1815–
22 (1925); R.S.Sayers, ‘The Question of the Standard in the 1850’s,’ Economic History,
A Supplement to the Economic Journal, January 1933, and ‘The Question of the
Standard, 1815–44’ (ibid. February 1935); R.H.I.Palgrave, Bank Rate and the Money
Market (1903); and Elmer Wood, English Theories of Central Banking Control, 1819–
1858 (1936), with a valuable bibliography which in particular presents a list of reports of
committees on monetary subjects and of other official papers to which, as usual, no
justice can be done here.



Money, credit, and cycles 659
(a) War Inflation, 1793–1815.
In spite of the suspension of the Bank of England’s obligation to redeem its notes in gold,
1797,
3
war finance did not produce any great effects upon prices and foreign-exchange
rates until about 1800. To the modern student who is inured to stronger stuff, the most
striking feature of the subsequent inflation is its mildness: at no time was the public’s
normal behavior with respect to money seriously disturbed; at no time did the impact of
the government’s war expenditure blot out those fluctuations that might have been

expected to occur in the usual course of things; at no time was the government driven to
anything more unorthodox than abnormally heavy borrowing from the Bank, and even
this borrowing never surpassed the limits beyond which the term ‘borrowing’ becomes an
euphemism for printing government fiat; at no time, finally, was the national wage bill—
the chief conductor of inflationary effects—so seriously expanded as to endanger the
currency. It was in fact this very mildness of the inflationary process that made diagnosis
so difficult. In particular, it made it more difficult to recognize the inflationary element in
the situation and to distinguish it from the effects upon foreign exchange of the two
circumstances that a great part of war expenditure was for financing allied and English
armies on the Continent, and that English exports and imports were for years together
seriously interfered with.
Government spent lavishly. But it also did its best, by the introduction of an income
tax and in other ways, to keep the inflationary advances from the Bank down to a
minimum, and its finance never ceased to remain competent and responsible. But the
reticence of the government about the extent of its borrowings from the Bank, quite
understandable until Waterloo, was a contributory factor in people’s propensity to blame
the Bank for whatever consequences they did not like. This propensity, strong at all
times, which was fully shared by the majority of writers, must be borne in mind
throughout: from Ricardo to the most unsophisticated man in the street, everybody loved
to make a whipping boy of the central bank, a habit economists have retained to this day.
In public at least, the Bank was unable to defend itself, because no effective defense was
possible without giving the government away—and politicians in power are in a position
to make their resentment felt. This may conceivably explain much that strikes historians
as lack of insight in the official pronouncements. As a matter of fact, the Bank was
obviously not free to refuse the government’s ‘requests’ for advances. If there can be any
question at all of its ‘responsibility for inflation,’ it must be understood to refer to its
loans to (discounts for) the public, which were inevitably increased as a consequence of
the government’s deficit spending. But they were rationed and kept down whenever
government borrowed heavily, and cannot be said, everything considered, to have been
obviously excessive—though it is, of course, always possible to argue that they could

have been less had the Bank been willing to take the responsibility for disturbing
production in wartime. Moreover, punitive rates
4
above 5 per cent were rendered
impossible by the usury laws until 1832. There is no doubt that such inflation as there
was

3
This Restriction Act was not passed as a war measure but in order to stop a run upon the bank.
4
I shall take this opportunity to clear up a point that played a role in the discussion of the Bank’s
responsibility and arises in every war inflation. Government expenditure financed in any way that
does not reduce the public’s expenditure by the same amount will raise prices, if it impinges on a
well-employed business organism, which in the case before us was so at times but not at others.
History of economic analysis 660
When prices have risen, then, the money cost of producing being increased thereby,
nongovernmental borrowing will be increased also: the government inflation produces in this case a
secondary wave of credit inflation and also reinforces itself currently. Now it is evidently possible
to say, since such government inflation by definition implies increase in the means of payment and
since
was strong enough to accentuate speculative excesses and breakdowns, a boom in
agriculture, and conditions of general prosperity in most of the years to 1815, none of
which could, however, have been entirely prevented by the Bank.
On the surface, then, the controversy that contributed so much to monetary analysis
was simply a controversy between writers who sought to prove and to indict inflation and
to locate the responsibility for it with the Bank, and other writers who sought to deny the
presence of inflation or to justify it and to locate the responsibility for rising prices and
unfavorable exchanges with circumstances other than the behavior of the Bank. So far as
this goes, it is possible to speak of two fairly well defined and opposing groups or parties.
Also, the first one may be said to have prevailed in the sense that it succeeded better than

did the other in impressing its views upon the famous Bullion Report of 1810.
5
In
consequence, it has become usual to affix to the members of this group the meaningless
label Bullionists and to the opponents of the report the label Anti-Bullionists, although
the report itself really represents various compromises. However, the practical issues and
the recommendations as to ‘what should be done about it’ are of no great importance for
us. Important is the analytic quality of the arguments and diagnoses produced. And from
this standpoint the party lines lose much of their definiteness and almost all their interest.
The differences between the supporters of the Bullion Report are actually much more
interesting than is the common bond between them. But before taking leave of this
historic document, let us note the significant fact that the Report of the Cunliffe
Committee that recommended England’s return to gold at prewar parity in 1918 (final
report, 1919) displayed little, if any, knowledge of monetary problems that was not
possessed by the men who drafted the Bullion Report.
(b) The Question of the Standard.
About twenty years of irredeemable paper and all the economic changes that had
occurred during that time made the problem of deciding on a monetary policy much more
difficult than it would have been after a shorter disturbance. De facto, though not legally,
the secondary inflation does the same, that the whole trouble is ‘increase in the quantity of money.’
But since this increase in the quantity of money is an incident in a process that involves many more
fundamentally ‘causal’ elements (the policy that led to the war, among others), and since the
secondary inflation is in fact induced by a preceding rise in prices, it is equally possible to say that
the bank or banks which finance the increase in both governmental and business expenditure are
playing a ‘passive’ role and in particular, so far as business borrowing is concerned, are but
‘responding to needs’ that have arisen in consequence of high prices and high money wages—or
else that the ‘quantity of money’ (notes and deposits) increases because prices have risen. Neither
of these two statements is necessarily erroneous. But each of them becomes erroneous as soon as it
is interpreted to deny the element that the other one emphasizes. This, however, is what happened
in the English controversy of 1800–1810, as it happens in any discussion of any inflation. But the

Money, credit, and cycles 661