As we saw yesterday, there is a virtually unlimited commercial and industrial frontier that can replace the land frontier and give every child, woman, and man the opportunity to become an owner of productive assets and achieve a level of capital self-sufficiency. The only question is how to do it . . . and it wouldn’t be through government handouts or programs like the New Deal.
|Dr. Harold G. Moulton|
To be blunt, there were not only philosophical, ethical, and legal reasons for opposing the New Deal, there were also economic considerations. The most cogent argument against the Keynesian economics that underpinned the program was that presented by the Brookings Institution under the direction of Dr. Harold Moulton, president of Brookings from 1928 to 1952.
In 1934 and 1935, Brookings published the findings of a study funded by the Maurice and Laura Falk Foundation (1931-1964) of Pittsburgh, Pennsylvania, Distribution of Wealth and Income in Relation to Economic Progress. Moulton “foreshadowed” (his word) the study in a series of articles published in the Journal of Political Economy in 1918, which presented the theoretical framework and tentative analysis.
Results of the study were contained in four volumes, which, without mentioning Say’s Law of Markets, broke it down into its component parts. The first two volumes, America’s Capacity to Produce (Harold G. Moulton, America’s Capacity to Produce. Washington, DC: The Brookings Institution, 1934.) and America’s Capacity to Consume (Harold G. Moulton, America’s Capacity to Consume. Washington, DC: The Brookings Institution, 1934), came out in 1934. The Formation of Capital (Harold G. Moulton, The Formation of Capital. Washington, DC: The Brookings Institution, 1935) and Income and Economic Progress (Harold G. Moulton, Income and Economic Progress. Washington, DC: The Brookings Institution, 1935) followed in 1935.
As Moulton explained, “The purpose of the investigation as a whole is to determine whether the existing distribution of income in the United States among various groups in society tends to impede the efficient functioning of the economic system.” Not limiting the study to the cause of business depressions, Moulton concluded that the fact of such depressions “suggests that there must be some basic maladjustment which seriously impedes the operation of the economic machine by means of which the material wants of society are supplied.” (Moulton, The Formation of Capital, op. cit., 1.)
As the result of an exhaustive study of the productive and consumptive capacity of the United States in the early 1930s, Moulton decided there was sufficient capacity for both to keep the economy in equilibrium. Imbalance had to be due to other factors. As he summarized the issue,
The fact that business enterprises seldom produce at full capacity, and that the greatest problem of business managers appears to be to find adequate markets for their products, has raised in the minds of many business men and economists the question, Is not the primary difficulty a lack of purchasing power among the masses? This leads at once to the correlative question, What is the bearing of the distribution of income upon the demand for the products of industry? Concretely, if a larger percentage of our annual income were somehow made available to the purchasers of consumption goods, would not business managers find it profitable to utilize existing capital equipment more fully, thereby giving to the masses of people higher standards of living, and at the same time promoting a steadier and more rapid rate of economic progress? (Ibid., 1-2.)
After examining evidence from the early 1830s down to the early 1930s, Moulton decided that the maladjustment between production and consumption had two principal causes. One, how new capital is financed, and, two, how income is distributed.
|John Maynard Keynes|
With respect to how new capital is financed, Moulton noted that mainstream economists, especially Keynes, insisted that new capital can only be financed by restricting consumption below production levels (“saving”). Assuming that new capital formation requires previous reductions in consumption, however, creates an “economic dilemma”:
The dilemma may be summarily stated as follows: In order to accumulate money savings, we must decrease our expenditures for consumption; but in order to expand capital goods profitably, we must increase our expenditures for consumption. . . . [W]hen the managers of modern business corporations contemplate the expansion of capital goods they are forced to consider whether such capital will be profitable. . . . Now the ability to earn interest or profits on new capital depends directly upon the ability to sell the goods which that new capital will produce, and this depends, in the main, upon an expansion in the aggregate demand of the people for consumption goods. . . . if the aggregate capital supply of a nation is to be steadily increased it is necessary that the demand for consumption goods expand in rough proportion to the increase in the supply of capital. (Ibid., 28-29)
In short, no producer will invest in additional capital until and unless there is an increase in consumption to warrant and justify the investment. Instead of a decrease in consumption prior to new investment in order to provide the financing, what Moulton found for the preceding century was an increase in consumption accompanying every period of significant investment in new capital. As he concluded,
The traditional theory that an expansion of capital construction and consumptive output occur alternatively . . . finds no support whatever in the facts of our industrial history. . . . We find no support whatsoever for the view that capital expansion and the extension of the roundabout process of production may be carried on for years at a time when consumption is declining. The growth of capital and the expansion of consumption are virtually concurrent phenomena. (Ibid., 47-48.)
|John Law, somewhat checkered Banking Principle pioneer.|
This finding raised another question. If periods of rapid capital expansion are not preceded by periods of saving to finance new capital instruments, but instead by dissaving to finance the increase in consumption, how is new capital financed, especially on such a vast scale? The answer is, By the proper use of the commercial banking system (invented for just that purpose) backed up with a central bank:
Funds with which to finance new capital formation may be procured from the expansion of commercial bank loans and investments. In fact, new flotations of securities are not uncommonly financed — for considerable periods of time, pending their absorption by ultimate investors — by means of an expansion of commercial bank credit.” (Ibid., 104.)
If, therefore, all current income is used either for consumption purposes, or to retire loans made out of expanded commercial bank credit for capital formation, production and consumption will be in balance, and there will always be enough effective demand to purchase all production. If, however, income that should be spent on consumption is diverted to reinvestment, there will be insufficient demand to clear all the goods and services produced.
|Louis Kelso: had a possible solution.|
Keynes’s solution of backing new money with non-productive government debt in order to stimulate demand artificially only made the imbalance worse. This is because the price level rose in response to the addition of new money not backed either by new productive capacity or existing inventories. This cut consumption even more and required further stimulus in a fruitless effort to catch up and bring the economy back into equilibrium.
Moulton had partially solved the problem of insufficient demand by recognizing that current income should be used for current consumption, not set aside to increase future production, and that financing for new capital formation should come out of new money specifically created for that purpose. That potentially removed one cause of imbalance in the economy but left the second: the problem of income distribution. The income existed in the form of production, but how could that income be gotten into the hands of people who would use it for consumption instead of for reinvestment?
That is the question Louis Kelso set out to answer, and that we will look at next week.