Bryan Caplan  

Wisdom from the Great Depression: Who Said It?

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Here are some surprisingly modern observations on the Great Depression from the year 1931:

We live in a society organized in such a way that the activity of production depends on the individual business man hoping for a reasonable profit, or at least, to avoid an actual loss. The margin which he requires as his necessary incentive to produce may be a very small proportion of the total value of the product. But take this away from him and the whole process stops. This, unluckily, is just what has happened. The fall of prices relative to costs, together with the psychological effect of high taxation, has destroyed the necessary incentive to production. This is at the root of our disorganization. It may be unwise, therefore, to frighten the business man or torment him further.

What kind of an economist blames high taxes and scary anti-capitalist proposals for a good chunk of the Great Depression? What kind of an economist highlights the fall in prices relative to costs, implying that a fall in costs (including wages!) would alleviate the crisis? Robbins? Hayek? Mises?

Nope. The author is John Maynard Keynes, from Essays in Persuasion. It makes me wonder if there's a lot more wisdom in Keynes than in Keynesianism.


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COMMENTS (15 to date)
Barkley Rosser writes:

OK, I'll take a nibble. Lot here, but let's talk about discretionary monetary policy run through a central bank. In particular, let's talk about it in terms of crisis management. Today is the 18th anniversary of the stock market crash of 1987, which was at the exact same point in the Reagan presidency that we are now at in the W. presidency. Most observers would say that Alan Greenspan won his international reputation on the next day, when his careful preparations for such an event, keeping in mind the lessons of an overly tight monetary policy in 1929 in the face of the stock market crash at that time, was to make dramatic moves to bolster key market players and their confidence, which resulted in the market bouncing midway through the next day.

The other event was the crash of Long Term Capital Management in 1998. In that case also Greenspan essentially stepped outside the box and arranged a settlement that avoided a complete collapse of the international monetary system. For those of you who think that such collapses never happen or are of little concern, let me remind everyone of 1931 when the failure of the Creditanstalt in Vienna triggered a wave of bank failures in Germany that spread to France and Britain, then to the US, then to Japan, and further. This was the event that gave us the Great Depression, which up to then had only been a recession, and led to Adolf Hitler assuming power in Germany and all that followed on that.

Of course one can argue that we do not know the counterfactual. If there had been no Fed, and no Alan Greenspan to engage in his very short run discretionary policies during those events, maybe very little untoward would have happened, and everything would have been hunky dory, indeed perhaps better than what happened, a more efficient financial system with less moral hazard and all sorts of other glorious benefits. Then again, maybe not.

Tom writes:

Yes, but if you don't think wages will fall, as Keynes did, then the answer is to raise prices through inflation. That would not be a surprise coming from Keynes.

Mike Everett writes:

Keynes was a better economist before he became a Keynesian.

Mstanley writes:

Keynes was a serious, big time, genius, and his theories about aggregate demand management still hold up pretty well for economic theories (which are always flawed). Knee jerk "isms" are never good, but the idea that Says Law sometimes does not work and government deficit spending can be necessary to get societies out of a bad equilibrium where productive capacity is underused has historical and empirical support.

Also, Keynsianism is not necessarily statist, it is a way to get many of the benefits of state intervention without micromanaging the economy.

spencer writes:

It is interesting that this is one of the very few times that I remember you bring up the topic of profits. You have talked about many, many things, but hardly ever about profits.

But interestingly, in the US in the depths of the depression of the early 1930s the marginal federal tax rate was the lowest it has ever been since personal taxes were introduced in 1913. Of course, they were the same as they had been in the late 1920s when the economy boomed. So if you look here for evidence of government causing the depression you will not find it. But Keynes was probably talking about the UK in this quote, and I do not have any info on that.

But deflation is horrible for profits because costs pressures lag price pressures. What is going on currently in the US retail sector is a great example. We are having deflation in that area-- the deflator for GAFO --department store type goods-- has been falling at 2% to 4% rates for several years. But look at what happens to them. If a retailer pays $0.50 wholesale for an item and follows standard pratice to mark it up 100% he sells it for $1.00. This gives him $0.50 to pay salaries, overhead, taxes, capital, profits, etc.. Next year he buys the item for $0.48 and sells it for $0.96, a 100% markup. But this only leaves him $0.48 rather than $0.50 to pay salaries, overhead,taxes, capital, etc. But since those costs are going up the poor retailer is in a bind. So far they have used great productivity growth to surmount the problem, but how long can that continue?

eric writes:

A few years later he wrote about the "euthanasia of the rentier". The devil can cite Keynes for his own purposes.

Dezakin writes:

Bleah, Keynes allways gets a bad rap. He made a number of observations about the economy and aggragate demand that was different than the classical model. For some reason ideologues want to use economics to serve their ideology and so Keynes is allways labeled as 'wrong' by the anarcho-capitalist neoclassical crowd.

The problem with keyneianism or whatever isnt as a tool for modeling economies, but rather as a policy tool for centralizing government power in the hands of non-economist ideologues. If we had an independant branch of government whos role was solely to collect taxes and grant the legislature money in a uniform fasion, sort of a federal reserve for fiscal policy, it would go a long ways to pulling the poison out of keynsian policy making.

If such a hypothetical branch of government could ever be independant at all that is.

Robert writes:


But deflation is horrible for profits because costs pressures lag price pressures. What is going on currently in the US retail sector is a great example. We are having deflation in that area-- the deflator for GAFO --department store type goods-- has been falling at 2% to 4% rates for several years. But look at what happens to them. If a retailer pays $0.50 wholesale for an item and follows standard pratice to mark it up 100% he sells it for $1.00. This gives him $0.50 to pay salaries, overhead, taxes, capital, profits, etc.. Next year he buys the item for $0.48 and sells it for $0.96, a 100% markup. But this only leaves him $0.48 rather than $0.50 to pay salaries, overhead,taxes, capital, etc. But since those costs are going up the poor retailer is in a bind. So far they have used great productivity growth to surmount the problem, but how long can that continue?

Long enough, I think, to render the retail experience as dissimilar to today's as Super Wal-Mart is to a mom 'n' pop corner grocery.

The retail industry is built upon an information crisis: the consumer has insufficient knowledge of what they are going to buy next week. Supply chain managers do know what consumers are going to buy next week, but only in aggregate; not at the individual level. Because of this information crisis, we must go through this ritual of paying people to neatly arrange goods on shelves. Then, we ask the consumer to go among these shelves and select what they want; consumers do this on their own time, but in order to make the experience pleasurable, resources are devoted to enhancing the retail environment. Then, another employee must examine what the consumer actually picked up, and meanwhile, rent is being paid on the aisles where all this takes place, and on the parking lot where the consumer must store their car while they shop.

Surely, there is room for productivity improvement here. Whoever can determine what the consumer wants a week in advance, or enable the consumer to do so for themselves, and put those goods on the doorstep, will short-circuit the retail front-end and in so doing win the retail wars.

Dewey Munson writes:
We live in a society organized in such a way that the activity of production depends on the individual business man hoping for a reasonable profit, or at least, to avoid an actual loss. The margin which he requires as his necessary incentive to produce may be a very small proportion of the total value of the product. But take this away from him and the whole process stops. This, unluckily, is just what has happened. The fall of prices relative to costs, together with the psychological effect of high taxation, has destroyed the necessary incentive to production. This is at the root of our disorganization. It may be unwise, therefore, to frighten the business man or torment him further.

Who produces? 100 employers and 1 business man.

If profit drives incentive then 1 person is productive.

If, however, profit was shared by 100 employees then 101 persons would be productive.

It is amazing (to me) how little economists emphasize that wages purchase production.

Not the wages -profit - of the business man, but the wages of the employee producers.

Ever since calculators have let anyone raise 1.07 to the power 10 we have forgotten what we are doing.

Jim A Syler writes:
Dewey Munson writes:

Who produces? 100 employers and 1 business man.

If profit drives incentive then 1 person is productive.

If, however, profit was shared by 100 employees then 101 persons would be productive.

It is amazing (to me) how little economists emphasize that wages purchase production.

Not the wages -profit - of the business man, but the wages of the employee producers.

Ever since calculators have let anyone raise 1.07 to the power 10 we have forgotten what we are doing.

Hooray for making no sense at all.

The workers are making a profit. They're not "sharing the profits" because "profit" to the entrepeneur comes after the workers are paid. Nonetheless, the worker is receiving at least a normal profit on his labor, or else he would choose to expend his time and effort elsewhere. His incentive is to do whatever is needed to keep his job and to increase his wages. If the businessman has structured his business properly, then the workers' incentives will indeed align (at least largely) with his incentives; otherwise the businesss will be very inefficient and prone to being outcompeted and driven out of business.

Of course the workers are productive. How could it be otherwise? If the workers were not productive, the entrepeneur would not need them.

What you seem to be suggesting is that workers be paid part of the profits of the entrepeneur, which is whatever is left over after all costs are paid, including the cost of the wages of the workers.

I have no idea what the last line of your post means.

thomas writes:

"What kind of an economist blames high taxes and scary anti-capitalist proposals for a good chunk of the Great Depression? What kind of an economist highlights the fall in prices relative to costs, implying that a fall in costs (including wages!) would alleviate the crisis?"

Actually, you forgot to say that in Keynes's (and in keynesians' too) vision wages are rigid, so the neoclassical suggestion of decresing them to offer incentive of producing to the entrepeneur doesn't work in his mind.

Mike Everett writes:

Spencer writes -

"But interestingly, in the US in the depths of the depression of the early 1930s the marginal federal tax rate was the lowest it has ever been since personal taxes were introduced in 1913. Of course, they were the same as they had been in the late 1920s when the economy boomed."

How about another form of taxation as a possible cause? A new tariff circa 1929, perhaps?

Barkley Rosser writes:

While many versions of Keynesianism focus on the downward stickiness of wages, which is a widespread, if not universal, stylized fact, this is not necessary for Keynes's analysis and he does not insist on it.

"For Classical Theory has been so accustomed to rest the supposedly self adjusting character of the economic system on the assumed fluidity of money-wages; and when there is rigidity to lay on this rigidity the blame for maladjustment... My difference from this theory is primarily a difference of analysis." (Keynes, General Theory, 1936, p. 257)

Eric H writes:

You are all Keynesians now. Not me, I would never join a society that would have me as a member.

-- Groucho Keynes

Actually, I'm not that surprised by this "revelation". If you go back to John Flynn's Roosevelt Myth, you can find similar statements from FDR in his 1932 campaign (the first of three New Deals - it wasn't until he got elected that they decided they would actually have to do something and therefore adopted the more enlightened Italian "corporative" program).

Years from now, people will be amazed to look back at Krugman's earlier writing and find that he actually thought that trade and the private sector actually had some small value before he discovered that government programs are more effective, but only when under the control of people with a "D" next to their names.

JC Ernhart writes:

Jim,

But don't you see?? The laborer is not in control of his own destiny. He is merely the producer, a victim of the capitalist who controls the wealth, and confiscates the laborer's production -- Laborer is certainly not out for "profit."

Profit? That's just not what wages "is"!

lol!

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