With his usual astuteness, Mises observed that it is
common for one and the same doctrine to circulate in more than one version,
typically, in its original, scholarly version and then also in a greatly
simplified version designed for popular consumption. He illustrated how this
applied to doctrines as diverse as Catholicism, Darwinism, and Freudianism (Money, Method, and the Market Process, pp. 301f).
Not surprisingly, his observation also applies to
Keynesianism and its claim that a free economy is incapable of eliminating
unemployment, because its method of doing so, namely, a fall in wage rates, is
allegedly unable to increase the quantity of labor demanded.
Popular Keynesianism
The popular version of the Keynesian doctrine, which
is championed above all by the labor unions, is simply that a fall in wage
rates, in reducing the incomes of wage earners, causes a fall in consumer
spending, which allegedly serves to worsen the problem of unemployment. This
doctrine can be disposed of fairly simply, before proceeding to the scholarly
version of Keynesianism, which is known as the IS-LM doctrine.
First of all, it overlooks the fact that at lower wage
rates more workers will be employed. The effect of this is to enable total wage
payments and consumer spending in the economic system to remain the same or
even increase while the wages of the individual worker decline. For example, 10
workers each employed at 90 percent of the wages earn the same total wages and
can spend just as much in buying consumers' goods as could 9 workers each
earning the original wage. (It's as simple as the fact that 10 times .9 equals
9 times 1.) And, of course, more than 10 workers employed at 90 percent of the wage
per worker would earn more collectively
and spend more for consumers' goods
collectively than was possible before.
The popular version of the Keynesian doctrine also overlooks the fact that even if total wage payments and consumer spending did decline, business sales revenues would not decline insofar as reduced wage payments made possible increased expenditures for capital goods. Indeed, to the extent that additional spending for capital goods took the place of wage payments and the consumer spending supported by wage payments, not only would sales revenues in the economic system remain the same, but, what is particularly important for the process of economic recovery, the amount of profit earned on those same total sales revenues would actually increase.[1]
This result follows because wage payments as a rule
show up fairly quickly — usually within a matter of weeks or months — as
equivalent costs that must be deducted from sales revenues in calculating
profits. In contrast, expenditures for machinery will not show up as equivalent
costs deducted from sales revenues for several years or more, in accordance
with the depreciable life of the machines. And expenditures for construction
materials and the services of construction equipment will not show up as
equivalent costs deducted from sales revenues for several decades, in
accordance with the still longer depreciable lives of buildings and other
highly durable assets.
Because of these considerations, if a sum such as $100
billion, say, could be shifted away from wage payments in the economic system
and to the purchase of machinery and plant, profits in the economic system
might well increase on the order of $90 to $95 billion dollars in the year in
which this shift of spending occurred. This is because the $100 billion of
spending for capital goods that would now take place would represent fully as
much spending for goods, and thus fully as much business sales revenues, as the
$100 billion of spending for consumers' goods that the wage earners would
otherwise have made. At the same time, while $100 billion of wage payments
would have shown up in the same year as $100 billion of costs to be deducted
from sales revenues, $100 billion of spending for capital goods with a
depreciable life ranging from several years to several decades, may well show
up perhaps as a mere $5 to $10 billion of depreciation cost in any given year.
The replacement of $100 billion in wage costs with $5 to $10 billion of
depreciation cost implies a rise in economy-wide profits of $90 to $95 billion.
Spending for Capital Goods Can Rise at the Same
Time that Spending for Consumers' Goods Falls
Some readers may wonder how it is possible for more to
be spent for capital goods at the same time that less is spent for consumers'
goods. Less spending for consumers' goods, it would seem, should imply less
spending for the capital goods required to produce the consumers' goods. The
answer lies in the fact that while this may well be true, the spending for
capital goods to produce consumers' goods declines in a lesser degree than does
the spending to buy consumers' goods. This means that it now stands in a higher
proportion to the spending for consumers' goods. In turn, the spending to buy
the capital goods to produce those capital goods comes to stand in a compounded higher proportion to the spending for
consumers' goods, and so on, with the spending for capital goods further
compounded at every succeeding stage of production.
The following series of numbers will help to
illustrate what is involved. Thus imagine that initially spending for
consumers' goods in the economic system was 500 units of money, the spending
for the capital goods to produce those consumers' goods was 250 units of money,
the spending for the capital goods to produce those capital goods, 125 units of
money, and so on, with each succeeding amount of spending for capital goods
being half of the spending for the capital goods it helps to produce.
Now imagine that spending for consumers' goods falls
from 500 to 400 units of money. Here is how at the same time spending for
capital goods can increase from 500 (i.e., the sum of 250 + 125 + 62.50 +…) to
600 units of money. The mechanism is that the spending for the capital goods
required to produce consumers' goods falls from .5 x 500 to .6 x 400, i.e.,
from 250 to 240. The spending to produce the capital goods required to produce
those capital goods will now be .6 x 240 rather than .5 times 250. Inasmuch as
.6 x 240 = 144, while .5 x 250 = 125, the spending for capital goods at this
stage has actually risen. Its rise will be relatively greater at each
succeeding stage, e.g., 86.4 versus 62.50, 51.84 versus 31.25, and so on.
Hoarding and the Rate of Profit
Finally, it should also be realized that the effect
even of a decline in total wage payments that was not accompanied
by any increase in spending for capital goods, would soon be very positive for
profits. It would not increase profits in absolute amount, but it would
increase them as a percentage of sales revenues and costs.
Here it must be kept in mind that wage payments are
not only a source of funds for wage earners to spend in buying consumers goods,
but they also show up equivalently as business costs, which must be deducted
from sales revenues in computing profits, and do so fairly soon. Thus a decline
in wage payments would quickly result in equal reductions in sales
revenues and costs. To whatever extent sales revenues were greater
than costs to begin with, the amount of that excess would remain unchanged,
because equals subtracted from unequals do not affect the amount of the
inequality. However, the same amount of inequality, i.e., of profit, would now
represent a larger percentage of the reduced sales revenues and costs.
The same amount of profit in the economic system would
also represent a rise in the rate of return on capital invested in the economic
system. This would be the result not only of the monetary value of the capital
invested shrinking in consequence of reduced spending for labor (and capital
goods), but also, and far more immediately, of the write-down of the value of
existing capital assets to correspond with their lower level of replacement
costs made possible by widespread declines in wage rates and prices. In addition,
purchases of assets at fire-sale prices following bankruptcies contribute to
the same result.
What this implies is that to the extent that savings
in the economic system might be unduly held in the form of cash, i.e.,
"hoarded," the effect is to raise the rate of return on capital
invested and thus to provide a greater incentive for savings being invested
rather than being hoarded. In other words, "hoarding" is always a
self-limiting phenomenon.
It follows that even if a decline in wage rates was
initially accompanied not only by a fall in total wage payments but also by a
fall in total business spending for labor and capital goods combined, the
subsequent rise in the rate of return on capital would operate to restore total
wage payments and the spending for capital goods. Consequently, once the
underlying aspects of a process of financial contraction have come to an end, a
fall in wage rates operates at least fairly soon to increase the quantity of
labor demanded.
100 Percent Hoarding and an Infinite Rate of
Profit
An implication of this discussion that may appear
startling to many readers is that if it were ever the case that people kept all
of their savings in the form of cash holdings and spent absolutely nothing for
labor or capital goods, the rate of profit and interest in the economic system
would become infinitely high. This is because while there would still be some
amount of sales revenues in the economic system, resulting from consumption
expenditures by those who possessed money, there would be no money costs of
production to deduct from those sales revenues, since no expenditures giving
rise to money costs would have been made. Thus the amount of profit in the
economic system would equal 100 percent of the sales revenues generated by
whatever consumer spending existed. At the same time it would equal an infinite
percentage of the zero money costs of production and an infinite percentage of
the zero money value of capital invested.
These conclusions are confirmed by the fact that the
rate of profit and interest is far higher in countries that lack the security
of property and developed financial markets and institutions and where, as a
result, a far larger portion of savings takes the form of precious metals and
gems rather than investments in business.
More on Hoarding and the Rate of Profit
"Hoarding," or more precisely an increase in
the demand for money for cash holding, has two effects on
the rate of profit. One is its longer-run effect, which can take place within a
period as short as a few months, and which is to raise the rate of profit, as I
have just shown.
Its other, more immediate effect, however, is to
reduce the rate of profit, even to the point of wiping it out entirely and
replacing profits with losses throughout the economic system. This is the
effect with which everyone is familiar and in the name of which they desire to
do everything possible to avoid reductions in spending of any kind.
The reason that hoarding first reduces profits is
merely the fact that reductions in spending for labor and capital goods exert
their effect on business sales revenues to a more or less substantial extent
before they exert their effect on the business costs deducted from sales
revenues in arriving at profits. Business sales revenues decline immediately
when spending for capital goods declines: for example, less spending for steel
sheet by an automobile company is less sales revenue for steel companies at the
very same moment. Sales revenues decline almost immediately when spending to
employ labor declines, i.e., as soon as reduced wage payments show up in
reduced consumer spending.
Now some costs deducted from sales revenues also
decline immediately in response to reduced business spending, notably, such
costs as typically come under the heading of selling, general, or
administrative expenses. But other costs, namely, those which come under the
headings of "cost of goods sold" and "depreciation cost"
are not immediately affected by declines in current business spending. They are
determined historically, that is, by business
spending for inventories and plant and equipment that has taken place in the
past, and which cannot retroactively be reduced.
Current spending on account of inventories and plant
and equipment shows up as costs to be deducted from sales revenues only in the
future, a future that ranges from days to decades. Of course, in a major
recession or depression, long-term investment spending falls to a far greater
extent than spending required to carry on current operations, and as a result,
further declines in business spending, notably for labor and materials, almost
all show up fairly quickly as declines in costs deducted from sales revenues.
Long-term investment spending falls disproportionately
in large part because the wage rates of construction workers and of workers
producing construction materials and the various kinds of machinery have not
fallen or have not fallen to the point to which it is believed they will fall.
In that case, it pays to postpone such investments and hold cash instead,
because they would be at a major disadvantage in competition with investments made
in the future. And when these wage rates and prices do finally fall, permitting
current long-term investment to be worthwhile once again, the monetary value of
existing plant and equipment can be written down commensurately, as previously
indicated. The effect of the write-downs is to reduce depreciation cost on
existing plant and equipment. (For example, the annual depreciation charge on
plant with an asset value of $1 billion and a remaining depreciable life of 20
years is $50 million. But if the value of that plant and equipment were written
down to $500 million, the annual depreciation charge incurred would also fall
by half, to $25 million.)
Along with a fall in wage rates and prices, an
essential condition of economic recovery from a major recession or depression
is simply the end of further financial contraction, i.e., further economy-wide
declines in spending. Further financial contraction stops when bank failures
and their accompanying declines in the quantity of money stop (or, better
still, do not start in the first place) and when the demand for money for cash
holding has risen sufficiently to satisfy the need to operate without access to
loans created on a foundation of credit expansion.
The additional demand for money for cash holding also
includes whatever temporary further component may be necessary to allow for a
failure of wage rates and prices to fall and the consequent postponement of
long-term investments. At this point, the short-run negative effect of less
spending on the amount and rate of profit begins to come to an end. Its final
end is greatly accelerated by the write-downs of assets that accompany
reductions in wage rates and prices and hence in the replacement cost of
existing business assets. (As indicated, purchases of assets at fire-sale
prices following bankruptcies contribute to the same result.)
These write-downs not only serve to reduce costs
deducted from sales revenues earned with existing assets, thereby increasing
current profits, but also serve to reduce the money value of the capital
invested, thereby further increasing the rate of profit on existing assets in
the economic system. In effect, they serve to increase the size of the profit
numerator while reducing the size of the capital-invested denominator. More
profit earned on less capital is a two-sided increase in the rate of return on
capital.
In this environment, reductions in wage rates not yet
accompanied by the employment of more workers or by the purchase of more
capital goods quickly result in improvement in the rate of profit. They do so
not only by reducing costs as much as sales revenues, but by reducing them by
more than sales revenues when the effect of write-downs is taken into account.
The write-downs, as just shown, also raise the rate of profit by reducing the
money value of the capital invested in the economic system.
This rise in the rate of profit, and consequently also
in the rate of interest, operates to reduce the demand
for money for cash holding, by virtue of making the investment
of money relatively more attractive in comparison with the holding of money. The reduction in the demand for money for cash
holding is greatly furthered by the restoration of the profitability of
long-term investment that accompanies the necessary fall in wage rates and
prices and also by the rise in the rate of profit that takes place pursuant to
the putting of funds into longer-term investments.
The net upshot is that the necessary fall in wage
rates and prices serves to increase the quantity of labor demanded disproportionately, by virtue of calling back into the
market funds that had been withheld in anticipation of the fall in wage rates
and prices. At the same time, the increase in the quantity of labor demanded
and the corresponding movement of the economic system toward "full
employment" is accompanied by a rise in the rate of profit in the economic
system.
The Keynesian IS-LM Doctrine
The doctrine of Keynes himself is far more complex
than the popular variant. It is so complex that it calls to mind a popular song
from years ago called "Dem Bones" that described the connection of
one bone to another, from toe to head. The song went,
Toe bone connected to the foot bone,
Foot bone connected to the ankle bone,
Ankle bone connected to the shin bone,
Shin bone connected to the knee bone.…
Neck bone connected to the head bone.
Foot bone connected to the ankle bone,
Ankle bone connected to the shin bone,
Shin bone connected to the knee bone.…
Neck bone connected to the head bone.
My reason for associating Keynesian economics with
this song is that just as one bone is connected to another in the song, so in
textbooks expounding the Keynesian system, each separate but connected piece of
the anatomy of that system — a bone, if you will — is presented in a series of
successively connected diagrams totaling as many as eleven in all. Each one of
the diagrams repeats an axis of the one before it. Thus, in the Keynesian
system, the "production function" is connected to the "IS
curve"; the "IS curve" is connected to the "saving
function"; the "saving function" is connected to the
"saving-equals-investment line"; the "saving-equals-investment
line" is connected to the "marginal efficiency of capital
schedule"; the "marginal efficiency of capital schedule" is
connected back to the "IS curve"; the "IS curve" is
connected to the "aggregate demand curve…" The diagram below, which
is from the first edition of Joseph P. McKenna's Aggregate Economic Analysis, depicts all the various
relationships involved.
Anatomy of the Keynesian System
Just as in the case of the highly simplified
labor-union version, the ultimate conclusion drawn from this extensive series
of connections is that full employment cannot be achieved in a free market,
because, once again, a fall in wage rates allegedly turns out to be incapable
of increasing the quantity of labor demanded.
Even though the two versions of Keynesianism reach the
same conclusion, they differ profoundly in the complexity of their
explanations. And as a result, they require separate critiques.
In the textbook version, the reason that a fall in
wage rates allegedly cannot reduce unemployment is not that it automatically reduces spending in the
economic system. Keynes is willing to concede that initially spending might
remain the same or even increase and that at the lower wage rates it would in
fact employ additional workers. He writes:
Perhaps it will help to rebut the crude conclusion
that a reduction in money-wages will increase employment "because it
reduces the cost of production", if we follow up the course of events on
the hypothesis most favourable to this view, namely that at the outset
entrepreneurs expect the reduction in
money-wages to have this effect. It is indeed not unlikely that the individual
entrepreneur, seeing his own costs reduced, will overlook at the outset the
repercussions on the demand for his product and will act on the assumption that
he will be able to sell at a profit a larger output than before. (General Theory, p. 261)
The basic problem, Keynes contends, lies in what would
happen next, if the fall in wage rates did in fact manage to increase the
volume of employment. Continuing in the very same paragraph, he argues that the
effect of the greater employment would be a fall in the rate of profit (which
he usually calls "the marginal efficiency of capital") below the
lowest rate that is sufficient to induce investment. This would serve to make
the employment of additional workers no longer worthwhile and result in
employment being pushed back to its previous figure. In his words (to which
I've taken the liberty of adding explanatory comments, which appear in
brackets):
If, then, entrepreneurs generally act on this
expectation, will they in fact succeed in increasing their profits? Only if the
community's marginal propensity to consume is equal to unity, so that there is
no gap between the increment of income and the increment of consumption [i.e.,
there is no additional saving]; or if there is an increase in investment, corresponding
to the gap between the increment of income and the increment of consumption,
which will only occur if the schedule of marginal efficiencies of capital has
increased relatively to the rate of interest [i.e., either the mec schedule must somehow move to the right, which
there is allegedly no reason for its doing, or the rate of interest must fall,
which it can't do, because it is allegedly already at its lowest acceptable
rate, which is usually assumed to be 2 percent]. Thus the proceeds realised from
the increased output will disappoint the entrepreneurs and employment will fall
back again to its previous figure, unless the marginal propensity to consume is
equal to unity [i.e., there is no additional saving] or the reduction in
money-wages has had the effect of increasing the schedule of marginal
efficiencies of capital relatively to the rate of interest and hence the amount
of investment [Keynes means, of course, increase the amount of investment that
is worthwhile — i.e., yields 2 percent or more]. For if entrepreneurs offer employment on a scale which, if they
could sell their output at the expected price, would provide the public with
incomes out of which they would save more than the amount of current
investment, entrepreneurs are bound to make a loss equal to the difference; and
this will be the case absolutely irrespective of the level of money wages.
I have italicized the last sentence because, if any
single sentence of Keynes can express the theoretical substance of his
doctrine, that is the one.
Here is the line of argument Keynes is presenting in
the passage above and which is depicted in the graphical analysis. The
employment of more workers results in more production, which at the same time
means more real income. By a process of equivocation, which I note here, but
will not make a major issue of, real income suddenly becomes interchangeable
with money income, out of which saving and cash hoarding can potentially take
place.
Saving, according to Keynes and his followers, is a
mathematical function of income, such that more income results in more saving,
e.g., 20 percent of each additional dollar of income is saved, while 80 percent
of each additional dollar of income is consumed. The extra saving relative to
extra income is called "the marginal propensity to save," while the
extra consumption relative to extra income is called "the marginal
propensity to consume." The names of the full mathematical functions are
"the saving function" and "the consumption function."
As the quotation indicates, the existence of saving
allegedly creates a problem. If there were no additional saving as employment
and income increased, there would be nothing to stop the additional employment
achieved as the result of a fall in wage rates from being maintained. But saving
creates the potential for cash hoarding.
Cash hoarding, in the Keynesian system need not
automatically and necessarily occur every time there is saving. Potentially,
additional saving might be offset by equivalent additional investment. If it
were, that would put the money saved back into the spending stream. In this
case too, the additional employment achieved as the result of a fall in wage
rates could be maintained.
The problem that arises, according to Keynes and his
followers, is that the additional investment required is the cause of a fall in
the "marginal efficiency of capital," i.e., the rate of profit or
rate of return on capital. The effect of achieving full employment, believe the
Keynesians, would be an increase in the volume of saving to such an extent that
it would require an offsetting increase in the volume of investment of such a
magnitude that the rate of return on capital would allegedly be driven to an
unacceptably low level. (Below 2 percent is the figure usually assumed.)
In response to a rate of return less than the minimum
acceptable rate, funds would be withdrawn from investment and hoarded. This
would reduce spending throughout the economic system and cause the return of
unemployment.
The fundamental problem, say the Keynesians, is that
the existence of full employment would impose an unacceptably low rate of
return on capital and therefore could not be maintained if it were achieved.
The return of unemployment would be necessary because by reducing
output/income, it would reduce the volume of saving, since less income results
in less saving. With saving reduced, less investment is required to offset it
in order to prevent hoarding. And with less investment, the rate of return on
capital will be higher.
Keynes's whole argument depends on the rate of profit
falling as the end result of the increase in employment and output. If the rate
of profit did not fall, if it stayed the same or rose as employment and output
increased on the foundation of a fall in wage rates and prices, there would be
absolutely nothing standing in the way of the achievement of full employment by
means of a fall in wages and prices.
Clearly, it is essential to examine Keynes's argument
that the rate of profit (mec) declines as investment increases. For his whole
analysis depends on it. In explaining it, he writes:
If there is an increased investment in any given type
of capital during any period of time, the marginal efficiency of that type of
capital will diminish as the investment in it is increased, partly because the
prospective yield will fall as the supply of that type of capital is increased,
and partly because, as a rule, pressure on the facilities for producing that
type of capital will cause its supply price to increase.… Thus for each type of
capital we can build up a schedule, showing by how much investment in it will
have to increase within the period, in order that its marginal efficiency
should fall to any given figure. We can then aggregate these schedules for all
the different types of capital, so as to provide a schedule relating the rate
of aggregate investment to the corresponding marginal efficiency of capital in
general which that rate of investment will establish. We shall call this the
investment demand-schedule; or, alternatively, the schedule of the marginal
efficiency of capital. (General Theory, p.
136)
Keynes's reference to the prospective yield on capital
falling is usually divided into two related aspects: a decline in the
prospective selling prices of products as stepped up investment increases their
supply, and also a decline in the physical amount of additional product
produced per successive equal increment of additional investment. Thus, for
example, each additional $10 billion of investment in the economic system might
be imagined to result in increments of product that would sell for less and
less because of increases in the supply of products and that would also bring
in less and less because the physical size of the increases was smaller and
smaller. Thus the first $10 billion of additional investment might be imagined
to result in 1 million units of additional product that would sell at a price
of $100 each. The second $10 billion, however, would supposedly result only in
an additional 900 thousand units of product, which would sell at a price of,
say, $95 each. By the same token, the third $10 billion of additional
investment might result in only 800 thousand units of additional product that
would sell for $90 per unit, and so on. Clearly, the extra revenue accompanying
equal extra increments of investment would fall under these conditions. And
since that extra revenue is the source of the profit on the investment, it
seems to follow that the rate of profit would decline as investment increased.
In addition, of course, Keynes refers to a rising
"supply price" for the various types of capital goods as their
production expands in response to the additional demand constituted by
additional investment. Thus, in his view, the rate of profit declines as
investment increases because more investment both raises the prices of capital
goods and at the same time operates to reduce their yields in terms of revenue.
Keynes's Bait and Switch
When Keynes's explanation of the falling
"marginal efficiency of capital," just quoted, is taken in conjunction
with his previously quoted explanation of why a fall in wage rates allegedly
cannot succeed in overcoming unemployment, it turns out that what is present is
something similar to the technique of a dishonest salesmen who begins by
appearing to offer something that is very different from what he actually ends
up offering, i.e., the technique known as "bait and switch."
When Keynes tries to explain the alleged impossibility
of full employment being achieved by virtue of a fall in wage rates, he is
clearly talking about the alleged impossibility of a fall in wage rates achieving full employment. But
when all is said and done, what this alleged impossibility turns out to rest
upon is not at all consistent with a fall in wage rates. To the contrary, in
the last analysis Keynes's argument against the ability of a fall in wage rates
to achieve full employment depends on the absence of a
fall in wage rates, indeed, on their rise.
The fall in the "marginal efficiency of
capital"/rate of profit that supposedly results from investment having to
be pushed beyond its worthwhile limit in order to offset all of the saving
taking place out of the level of income resulting from full employment, and
which allegedly prevents full employment from being achieved more than very
temporarily — that fall turns out to depend on wage rates not falling, indeed, rising.
Consider. Why should a fall in the selling prices of
products serve to reduce profitability if that fall has been preceded by a fall
in wage rates and in the prices of existing capital goods, i.e., in the costs
of production, which is the situation under discussion? It would be reasonable
to argue that a fall in selling prices serves to reduce profits if it were not preceded by a fall in wage rates and the
prices of existing capital goods, but not when it is so preceded. What Keynes has done here is to
substitute the effects of a fall in selling prices on the rate of profit in the absence of a preceding fall in wage rates and the
prices of existing capital goods for its alleged effect in the presence of such a preceding fall.
The same point applies even more strongly to the
alleged decline in yields based on declines in physical increments of product
accompanying additional increments of investment. Here Keynes and his followers
take for granted the supply of labor and consider the effects on output merely of
successive equal increments of investment. But this too is a total
contradiction of the situation under discussion.
That situation, recall, is whether or not the
re-employment of masses of previously unemployed workers can be maintained
following a fall in wage rates and the prices of existing capital goods. Keynes
and his followers say no, in part because of alleged diminishing physical
returns to additional increments of capital investment. Here they ignore the
fact that the situation under discussion implies an increase in the supply of labor employed far in excess of any
secondary, derivative increase in the supply of capital goods that might come
about as the result of additional saving taking place as the by-product of full
employment.
Going from a state of mass unemployment to full
employment implies a correspondingly large reduction in the ratio of
accumulated capital to labor. The supply of existing capital goods is what it
is. But going from, say, an unemployment rate of 25 percent, such as existed in
the depths of the Great Depression of the 1930s, to full employment, implies in
increase in the supply of labor employed in the ratio of 4:3. This, in turn,
implies a fall in the ratio of capital to labor to ¾ of its previous level. Thus,
if in the state of mass unemployment there were 12 units of capital in
existence for every 3 workers employed, giving a ratio of capital to labor of
4:1, now, with the employment of 4 workers for every 3 previously employed, the
ratio of capital to labor falls to 3:1. With capital now less abundant relative
to labor, i.e., scarcer relative to labor, successive equal increments of
investment should have substantially higher physical
yields than they did in the state of mass unemployment. Thus, if it were the
case that physical increments of output accompanying increments of investment
had a connection with the rate of profit, the rate of profit would have
to be expected to rise as the accompaniment of the economic
system going from a state of mass unemployment to full employment.
Even if at some point, after many years of full
employment and accompanying additional saving, the ratio of capital to labor
ultimately came to surpass what it had been in the period of mass unemployment,
it would still be far less than it would be in the face of fresh mass
unemployment. Always, the employment of more labor serves to reduce the ratio
of capital to labor and to have a correspondingly positive effect on physical
yields to capital, all other things being equal.
The third alleged reason for the rate of profit
falling as employment increases turns out to be no less bizarre and
contradictory. This is Keynes's claim that pressure on the facilities for
producing capital "will cause its supply price to increase." Since
when do the prices of capital goods rise on a foundation of falling wage rates
and costs of production? They would rise in a situation of risingwage rates and costs of production, but not falling wage rates and costs of production. This
is just another aspect of the switch Keynes has pulled off.
Further Problems with Keynesianism
The Keynesian argument is actually absurd on its face.
If one looks at its so-called IS curve, one sees a relationship purporting to
show that as output and, implicitly, employment increase along the horizontal
axis, the "marginal efficiency of capital"/rate of profit falls on
the vertical axis. The economic system is allegedly locked into a state of
permanent mass unemployment because the rate of return is already as low as it
is possible for it to go consistent with investment being worthwhile, while
full employment would result in an even lower rate of return. What this means
is that the economic system cannot achieve full employment and recovery,
because if it did, the rate of profit would be lower in the recovery than it is
in the depths of the depression.
There is another problem. A leading doctrine of the
Keynesians is the "investment multiplier." According to this
doctrine, every additional dollar of investment results in an induced rise in
consumption spending and thus in substantially more than a dollar of additional
spending overall, perhaps $2 or $3. This additional spending is held to be
synonymous with additional national income. While national income is composed
essentially of profits and wages, the Keynesians seem to overlook the fact that
additional national income implies additional profits. If profits were just 10
percent of national income, and the multiplier were just 2, every additional
dollar of investment would imply 20 cents of additional profits in the economic
system. What this in turn implies is that the rate of profit in the economic
system must be rising in the direction of 20 percent, i.e., that more
investment has a powerful positive effect on the rate of profit.
In a Recovery, Investment and Profits Move
Together
The Keynesian claim is that the additional investment
that accompanies additional employment reduces the rate of profit. The
strongest argument against this claim is the fact that in the context of a business
cycle, investment and profits move together, virtually dollar for dollar.
Profit in the economic system is the totality of business sales revenues minus
the totality of the costs deducted from those sales revenues. Net investment is
the totality of business productive expenditure, i.e., wage payments plus
purchases of newly produced capital goods, minus the very same costs that are
deducted from sales revenues in arriving at profits. Since productive
expenditure is the source of the great bulk of the sales revenues of the
economic system, the only difference between net investment and profits in the
economic system is the extent to which sales revenues exceed productive
expenditure.
The reason that net investment equals productive
expenditure minus costs is that productive expenditure represents additions to
the value of accumulated assets, while costs represent subtractions from the
value of accumulated assets. For example, productive expenditures on account of
inventory are added to the value of inventory accounts on the balance sheets of
the firms making the expenditures. Productive expenditures on account of plant
and equipment are added to the gross plant accounts on the balance sheets of
the firms making the expenditures. In these ways, productive expenditures
increase the value of accumulated assets on the books of business firms.
By the same token, when firms make sales out of
inventory, the value of inventory accounts is reduced by the cost value of the
goods sold, which cost value enters into the income statements of firms, under
the heading "cost of goods sold." Similarly, as time passes, plant
and equipment undergo depreciation. Depreciation allowances are accumulated in
depreciation reserves, which are subtracted from the gross plant accounts,
leaving net plant accounts. The same amount of depreciation that is deducted
from gross plant — and thereby reduces net plant — enters into the income
statements of firms as depreciation cost.
If "cost of goods sold," is subtracted from
productive expenditure for inventory, the difference is the net change, i.e.,
the net investment, in inventory. If depreciation cost is subtracted from
productive expenditure on account of plant and equipment, the difference is the
net change, i.e., the net investment, in net plant and equipment.
There is a third major component of productive
expenditure and costs, namely, productive expenditures that are not additions
to any asset account and which are thus costs deducted from sales revenues in
the very instant in which they are made; selling, general, and administrative
expenses are can be taken as examples. When productive expenditures that
constitute selling, general, or administrative expenses are added to the
productive expenditures on account of inventory and plant, the result is total
productive expenditure. When these productive expenditures are added as costs
to cost of goods sold and depreciation cost, the result is the total costs
deducted from sales revenues in calculating profits. Since this is a matter of
equals being added to unequals, the amount of net investment equals the
totality of productive expenditure minus the totality of business costs.
In the context of recovery from a depression, a rise
in productive expenditure should be expected to constitute a virtually
equivalent rise in business sales revenues. If costs in the economic system
remained the same, profits and net investment would obviously rise to exactly
the same extent. The additional productive expenditure in its capacity as the
source of additional sales revenues would raise profits equivalently. In its
capacity simply as additional productive expenditure, it would raise net
investment equivalently. Thus the rise in profits and the rise in net
investment would be equal.
Insofar as total business costs might increase at the
same time that productive expenditure and sales revenue rose, the rise both in
net investment and profits would be equivalently diminished. In any event
profits and net investment would increase together, dollar for dollar. The implication
of this is that the economy-wide average rate of profit rises in the direction
of 100 percent. This is the ratio found by dividing equal additions to profits
and to capital invested. Capital invested rises to the exact same extent as net
investment and additional net investment.
In the same way, as was shown very early in this
article, if costs in the economic system could be made to fall, say, by virtue
of productive expenditure being shifted from wage payments to purchases of
durable capital goods, profits and net investment would both rise equally.
The upshot is that to the extent that additional net
investment accompanies the additional employment made possible by a fall in
wage rates, the rate of profit increases, and
increases the more, the greater is the increase in net investment. Keynes and
his followers simply could not be more wrong about this subject.
In a Depression, Saving and Net Investment Are
Negative
Closely related to the above, is another major error.
This is the belief of Keynes and his followers that in the depths of depression
and its accompanying mass unemployment, saving and investment are at their
maximum tolerable limits. Allegedly, they are already as great as it is
possible for them to be consistent with the rate of return on capital still
being high enough to make investment worthwhile. The problem, say the
Keynesians, is that full employment would result in still more saving, which
would require still more investment to offset it, and which in turn would drive
the already barely acceptable rate of return still lower, below the minimum
acceptable rate.
Contrary to Keynes and his followers, the truth is
that so far removed are saving and investment from being at their maximum
tolerable limits in the conditions of depression and mass unemployment, that in
reality they are both negative. For
example, in the Great Depression of the 1930s, corporate saving (undistributed
corporate profits) was negative in every year from 1930 to 1936 and again in
1938; personal saving was negative in 1932 and 1933 and barely more than zero
in 1934; net investment was negative in the years 1931 to 1935 and again in
1938.
There should be nothing surprising in this. In a
depression, business firms suffer widespread losses. What they are losing is a
portion of their accumulated savings. Even many firms that manage to earn
profits consume accumulated savings in a depression. This is the case to the
extent that their profits are insufficient to cover the dividends they pay.
Similarly, unemployed wage earners deplete their previously accumulated savings
in consuming without the benefit of wages to provide the necessary funds.
Net investment becomes negative as the result of the
exact same process that wipes out profits, namely, a sharp decline in productive
expenditure, which results from the need to rebuild cash holdings in the
aftermath of the end of the credit expansion of the preceding boom. The decline
in productive expenditure wipes out profits insofar as it serves to reduce
business sales revenues in the face of depreciation costs and costs of goods
sold that reflect the higher levels of productive expenditure of the past. The
decline in productive expenditure in the face of those same depreciation costs
and costs of goods sold equivalently reduces net investment.
As explained previously, the demand for money for cash
holding is also increased by a failure of wage rates to fall. And the decline
in productive expenditure becomes greater still insofar as banks fail and the
quantity of money is reduced. The effect is to further reduce productive
expenditure, sales revenues, profits, and net investment.
In the light of such knowledge, it is difficult to
imagine a theory that is more at odds with economic principles and obvious
facts of reality than Keynesianism.
Conclusion
The essential conclusions to be drawn from this
lengthy analysis is that once the process of financial contraction in a
depression comes to an end, and existing business assets have been re-priced to
reflect the deflationary aftermath of credit expansion — once this has
occurred, a fall in wage rates will in fact serve to achieve the reemployment
of the unemployed. Moreover, it will do so in such way that the increase in
employment is more than proportionate to the fall in wage rates. At the same
time, as part of the same process, the decrease in the demand for money for
cash holding that occurs in response to the necessary fall in wage rates,
manifests itself in a rise in productive expenditure not only for labor but
also for capital goods. As the result of the rise in productive expenditure,
sales revenues, profits, and net investment in the economic system all rise
together.
The fall in wage rates thus serves as an essential
component of a full and complete economic recovery, one that entails full
employment and the achievement of a substantially increased rate of profit that
will be more than sufficient to make investment worthwhile.
The economic policy that is implied by these findings
of economic theory is one of a fully free labor market. That is, a labor market
free of coercive labor-union interference, free of minimum-wage laws, and free
of all other laws that mandate expenditures by employers on behalf of the
workers they employ. All legal obstacles in the way of wage rates falling,
counting as part of wages the cost of so-called fringe benefits, must be swept
aside. This is the policy that will allow the cost of employing labor to fall
and thus the quantity of labor demanded to increase, and will thereby achieve
the employment of everyone able and willing to work, i.e., full employment.
Beyond Keynesianism: Marxism
While essential, the overthrow of Keynesianism is
insufficient for being able to implement the policy of a free labor market. It
is insufficient because Keynesianism constitutes merely the outer ring of the
defenses of the policy of government interference in the labor market. The
inner ring, which Keynesianism has served to protect up to now, is the errors
and contradictions of Marxism.
Marxism holds that a free market in labor is a vehicle
for the exploitation of labor. It claims that in the absence of government
intervention in the form of pro-union and minimum-wage and maximum-hours
legislation, employers would be free to drive wage rates to or even below the
level of minimum subsistence, while lengthening the hours of work beyond the
limits of human endurance, and imposing conditions of work that are
nightmarish.
Because of Keynesianism, the immense majority of
economists have been able to avoid having to confront Marxism. They have been
able to hide behind the Keynesian doctrine that even if a free market in labor
existed, it would not be able to eliminate mass unemployment. And thus they
have been able to believe that there is simply no point in fighting for a free
market in labor.
Being able to believe this, I'm convinced, has been a
source of great comfort and relief for most economists and thus a major source
of their readiness to accept Keynesianism despite the obviously absurd nature
of some of its claims, such as that "Pyramid-building, earthquakes, even
wars may serve to increase wealth, if the education of our statesmen on the
principles of the classical economics stands in the way of anything
better" (General Theory, p. 129). Keynesianism has spared them
from having to do battle with practically the entire rest of the intellectual
world, which has accepted Marxism as constituting a full and accurate
description of what happens under laissez-faire capitalism.
In the absence of Keynesianism, economists who
understood such elementary propositions as that quantity demanded rises as
price falls would be obliged to argue for the repeal of pro-union and
minimum-wage legislation. They would perceive such interferences as causing and
perpetuating mass unemployment. But to do this, they themselves would have to
understand why laissez-faire capitalism does not in fact result in any
exploitation of labor and how, indeed, it is the foundation of progressively
rising real wages, shortening of hours, and improvement in working conditions.
The immense majority of today's economists — and those
of the past several generations — has lacked both this essential knowledge and
any will, or even mere willingness, to acquire it. They lack the will because
they have no philosophical commitment to the value of individual rights and
individual freedom and thus no basis for being prepared to challenge claims
that these must be sacrificed for the sake of avoiding poverty. They are light
years from understanding that it is precisely respect for individual rights and
individual freedom that is the essential foundation of prosperity, including,
as leading examples, full employment and high and progressively rising real
wages.
Keynesianism has been a refuge for masses of
economists badly deficient in understanding of economics and equally lacking in
essential aspects of moral character, namely, in abhorrence of the use of
physical force for any purpose but that of self-defense, and in an equal
abhorrence of blatant irrationalism, such as manifested in Keynes's claims
about the economic value of wars and earthquakes. Content with the unchecked growing
use of physical force by government in all aspect of the life of the
individual, and often taking delight in the ability to confuse the minds of
students by convincing them that the absurd is true, they are completely at
home in Keynesianism.
Hopefully, the overthrow of Keynesianism will set the
stage for the appearance of a body of intellectuals with a far better
understanding of economics than that of today's economists, an understanding
which they will join to a philosophical commitment to the values of Freedom and
Reason. Thus armed, there will be a group of intellectuals able to take on the
rest of the intellectual world and start to overcome the ideas that have made
today's colleges and universities more into centers of civilization-destroying
intellectual disease than centers of knowledge and education.
Notes
[1] In this article "profit" is to be understood as inclusive of any interest paid on borrowed capital, and the rate of profit as reflecting the division of the sum of profits plus interest by the totality of the capital invested, i.e., as the rate of return on capital.
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