Current Theories of Crises
TWO POINTS OF AGREEMENT
[233]Wide divergences of opinion continue to exist among competent writers upon crises; but in recent years substantial agreement has been reached upon two points of fundamental importance.
Crises are no longer treated as sudden catastrophes which interrupt the "normal" course of business, as episodes which can be understood without investigation of the intervening years. On the contrary, the crisis is regarded as but the most dramatic and the briefest of the three phases of a business cycle—prosperity, crisis, and depression.[234] Modern discussions endeavor to show why a crisis is followed by depression, and depression by prosperity, quite as much as to show why prosperity is followed by a crisis. In a word, the theory of crises has grown into the theory of business cycles.[235]
This wider grasp of the problem has discredited the view that crises are due to abnormal conditions which tempt industry and trade to forsake their beaten paths and temporarily befog the judgment of business men and investors, or to misguided legislation, unsound business practices, imperfect banking organization, and the like.[236] As business cycles have continued to run their round decade after decade in all nations of highly developed business organization, the idea that each crisis may be accounted for by some special cause has become less tenable. On the contrary, the explanations in favor to-day ascribe the recurrence of crises after periods of prosperity to some inherent characteristic of economic organization or activity. The complex processes which make up business life are analyzed to discover why they inevitably work out a change from good times to bad and from bad times to good. The influence of special conditions is admitted, of course, but rather as a factor which complicates the process than as the leading cause of crises.
BEVERIDGE'S "COMPETITION THEORY"
Among these theories which seek to account not for crises but for the cyclical fluctuations of economic activity, the "competition theory" tentatively advanced by Beveridge is one of the simplest.
In most instances, he begins, production is carried on by several or many establishments, each acting independently, and each seeking to do as large a share of the business as possible. Whenever the demand for their wares increases, each competitor tries to engross a larger portion of the market. "Inevitably, therefore, all the producers together tend to overshoot the demand and to glut the market for a time. This is a result not of wild speculation nor of miscalculation of the total demand; it must be a normal incident wherever competition has a place at all." Such activity among producers constitutes the period of prosperity. But sooner or later the glutting of the market becomes apparent, and then the crisis comes, because the goods cannot all be sold at a profit. Prices fall, production is checked, and a period of depression ensues. Gradually, however, the slackened rate of production allows the accumulated stocks to be cleared, perhaps below cost price, perhaps by waiting until demand grows up to supply. When this excess of demand over supply has once again become patent, business recovers. Depression yields to prosperity, competitors again vie with each other to increase their shares in the output, after a few years the market is glutted again, and a new crisis comes, to be followed once more by depression. Thus business cycles are due in the last resort to "the simple and well nigh universal fact of industrial competition."[237]
MAY'S THEORY OF THE DISCREPANCY BETWEEN WAGES AND PRODUCTIVITY
Like Beveridge, May conceives crises to result immediately from the glutting of markets for industrial products. But May offers a quite different analysis of the cause of gluts. The continually growing productivity of industry makes necessary a corresponding growth of the market, if disaster is to be avoided. But to enable producers to sell their growing output promptly prices must be reduced and wages must be raised in proportion as the supply of goods increases. For it is only by combining an increase in the money income of the mass of the population with a decrease in the cost of commodities that a country's home markets can be kept expanding with the progress of industrial methods. Periods of prosperity attended by rising prices necessarily violate this condition of business hygiene and inevitably end by glutting markets. Then come crises, which restore the body politic to health by forcing down prices to the point where consumers can purchase the supplies which are offered. The germ of the trouble, then, is the tendency of prices to rise during periods of increasing productivity. Accordingly, May urges as remedy a legal limitation of the rate of profits, in order that producers may be forced to reduce prices as they increase output.[238]
HOBSON'S THEORY OF OVER-SAVING
A third explanation of how markets come to be glutted periodically is offered by Hobson's theory of over-saving. Hobson holds that at any given time "there is an exact proportion of the current income which, in accordance with existing arts of production and existing foresight, is required to set up new capital so as to make provision for the maximum consumption throughout the near future." Now, if in a period of prosperity the rate of consumption should rise pari passu with the rate of production, there is no inherent reason why the prosperity might not continue indefinitely. But in modern societies, a considerable portion of the wealth produced belongs to a small class. In active times their incomes rise more rapidly than their consumption and the surplus income is perforce saved. There results for the community as a whole a slight deficiency of spending and a corresponding excess of saving. The wealthy class seeks to invest its new savings in productive enterprises—thereby increasing the supply of goods and also increasing the incomes from which further savings will be made. This process runs cumulatively during the years of prosperity until finally the markets become congested with goods which cannot be sold at a profit. Then prices fall, liquidation ensues, capital is written down, and the incomes of the wealthy class are so reduced that savings fall below the proper proportion to spending. During this period of depression the glut of goods weighing upon the market is gradually worked off, and the prospect of profitable investment slowly returns. Saving rises again to the right proportion to spending and good times prevail for a season. But after a while the chronic impulse towards over-saving becomes fully operative once more, and soon or late begets another congestion of the markets and this congestion begets another depression. Proximately, then, the cause of alternating prosperity and depression is the tendency toward over-saving; ultimately it is the existence of the surplus incomes which lead to over-saving.[239]
HULL'S THEORY OF THE CHANGING COSTS OF CONSTRUCTION
An American business man, George H. Hull, has recently drawn from his experience of practical affairs conclusions which resemble those drawn by In demonstrating the thesis, Hull contends that agriculture, commerce, and finance fluctuate within relatively narrow limits. Agriculture provides the necessities of life, commerce distributes them, and finance adjusts the bills. The volume of all this business is fairly constant, because the demand for necessities is incapable of sudden expansion or contraction. Industry, on the contrary, may expand or contract indefinitely—especially that part of industry devoted to construction work. For the sources of "booms" and depressions, therefore, we must look to the enterprises which build and equip houses, stores, factories, railways, docks, and the like. Of the huge total of construction, which Hull believes to make over three-quarters of all industrial operations, at least two-thirds, even in the busiest of years, consists of repairs, replacements, and such extensions as are required by the growth of population. This portion of construction is necessary and must be executed every year. But the remaining portion is "optional construction," and is undertaken or not according as investors see a liberal or a meagre profit in providing new equipment. Now, when the costs of construction fall low enough to arouse "the bargain-counter instinct," many of "the far-seeing ones who hold the purse-strings of the country" let heavy contracts, and their example is followed by the less shrewd. The addition of the resulting new business to the regular volume of "necessity construction" plus the provision of ordinary consumers' goods creates a "boom." But, after a year or two, contractors discover that their order books call for more work than they can get labor and materials to finish on contract time. When this oversold condition of the contracting trades is realized, the prices of labor and of raw materials rise rapidly. The estimated cost of construction on new contracts then becomes excessive. Shrewd investors therefore begin to defer the execution of their plans for extending permanent equipment, and the letting of fresh contracts declines apace. As they gradually complete work on their old contracts, all the enterprises making iron, steel, lumber, cement, brick, stone, etc., then face a serious shrinkage of business. Just as the execution of the large contracts for "optional construction," let in the low-priced period, brought on prosperity, so the smallness of such contracts, let in the high-price period, now brings on depression. Then the prices of construction fall until they arouse "the bargain-counter instinct" of investors once more, and the cycle begins afresh. While Hull grants that panics are often caused by strictly financial disorders, he holds that all industrial depressions are caused by high prices of construction, and foreshadowed by high prices of iron. Consequently he believes that depressions could be prevented from occurring if the Government would collect and publish monthly "all pertinent information in relation to the existing volume of construction under contract for future months, and all pertinent information in relation to the capacity of the country to produce construction materials to meet the demand thus indicated."[240] Sombart, like many of the recent German writers, finds ill-proportioned production the chief cause of crises; but he thinks it inaccurate to say that the overproduction is in industrial equipment. For during the German "boom" which collapsed in 1900-01, overproduction was quite as marked in industries making equipment for electric lighting systems, telephone plants, street railways, dwellings, bicycles, etc., as in industries making machines. The real lack of proportion he sees in the unlike degree of expansion in industries using organic and inorganic materials. The inorganic industries, typified by steel, can expand to an enormous extent within a brief period without being seriously hampered by scarcity of raw materials. The organic industries, typified by cotton-spinning, on the contrary, are always in precarious dependence upon the year's harvests. In the organic industries, one may say, the condition of business is determined by the harvests; in the inorganic industries the condition of business determines the production of raw materials. The modern crisis, then, following upon a period of prosperity, is substantially the result of the different rhythm of production in the organic and inorganic realms. The organic industries dependent upon harvests cannot keep pace with the inorganic when the latter are being rapidly extended by heavy investments of capital.[241] Carver has suggested a way of accounting for business cycles by applying the laws of value which govern producers' goods. He points out that a comparatively small change in a factory's selling prices will cause a much greater change in its profits, if volume of output and expenses remain the same. Since the value of the factory as a going concern is the capitalized value of its prospective profits, a large increase of profits will cause a large increase of the factory's value, provided the high profits are expected to continue long. Hence the law that "the value of producers' goods tends to fluctuate more violently than the value of consumers' goods." It follows that: "A slight rise in the price of consumers' goods will so increase the value of the producers' goods which enter into their production as to lead to larger investments in producers' goods. The resulting larger market for producers' goods again stimulates the production of such goods, and withdraws productive energy from the creation of consumers' goods. This for the time tends to raise the price of consumers' goods still higher, and this again to stimulate still further the creation of producers' goods. There is no check to this tendency until the new stock of producers' goods begin to pour upon the market an increased flow of consumers' goods. This tends to produce a fall in their value, which in turn produces a still greater fall in the value of producers' goods, and so the process goes." Thus, once more, prosperity breeds crisis and depression; but this time the reason is found in the dissimilar fluctuations which the laws of value establish for the goods which people use and the equipment with which they are made.[242] Another interesting suggestion comes from Irving Fisher. By statistics he has shown that when for any reason prices begin to rise, interest rates advance, but not fast enough to offset the decline in the purchasing power of the principal caused by the rise of prices. During such periods, accordingly, borrowers on the whole get the better of lenders and make high profits. Since the borrowers consist largely of active business men, precisely the class of greatest foresight, they grasp the situation more quickly than lenders. As a result of their desire to profit by their opportunity, loans are rapidly extended. This extension is effected largely by the lending of bank credits, that is, by the increasing of deposit currency. The greater volume of the currency combines with more rapid circulation of money and checks to increase prices again, and so to start the whole process anew on a higher level. "There is thus set up a vicious circle, which will continue just as long as the rate of interest fails to make a proper adjustment to put on the brakes and prevent over-borrowing." "But the rise in interest, though belated, is progressive, and, as soon as it overtakes the rate of rise in prices, the whole situation is changed." Borrowers can no longer hope to make great profits, and the demand for loans ceases to expand. Further, the higher rate of interest reduces the price of many of the securities used as collateral for loans. Business men "who have counted on renewing their loans at the former rates and for the former amounts are unable to do so. It follows that some of them are destined to fail." There follow suspicions regarding the solvency of the banks, runs for cash, forced curtailment of loans, and exceedingly high rates of interest—in short, the phenomena of crisis. The contraction of loans is accompanied by a reduction of deposit currency and a slower circulation both of money and of checks. Hence prices decline. Again the rate of interest follows; but just as it was slow to rise so now it is slow to fall. Then the business men who borrow find that the sluggish adjustment of interest reduces their profits. Therefore loans, and the deposits based on loans, contract again. But the shrinking volume of deposit currency causes a further fall of prices, and once more interest lags behind and renews the process. Thus the phase of depressions runs cumulatively until at last the progressive reduction of interest has overtaken the fall of prices. At this point business men find their profits rising to the normal level. Borrowing becomes freer, the volume of deposit currency swells, prices start upward, and the cycle begins afresh.[243] Beveridge ascribes crises to industrial competition, May to the disproportion between the increase in wages and in productivity, Hobson to over-saving,... Hull to high costs of construction, Lescure to declining prospects of profits,... [Seligman] to a discrepancy between anticipated profits and current capitalization, Sombart to the unlike rhythm of production in the organic and inorganic realms, Carver to the dissimilar price fluctuations of producers' and consumers' goods, Fisher to the slowness with which interest rates are adjusted to changes in the price level. One seeking to understand the recurrent ebb and flow of economic activity characteristic of the present day finds these numerous explanations both suggestive and perplexing. All are plausible, but which is valid? None necessarily excludes all the others, but which is the most important? Each may account for certain phenomena; does any one account for all the phenomena? Or can these rival explanations be combined in such a fashion as to make a consistent theory which is wholly adequate?SOMBART'S THEORY OF THE UNEVEN EXPANSION IN THE PRODUCTION OF ORGANIC AND INORGANIC GOODS
CARVER'S THEORY OF THE DISSIMILAR PRICE FLUCTUATIONS OF PRODUCERS' AND CONSUMERS' GOODS
FISHER'S THEORY OF THE LAGGING ADJUSTMENT OF INTEREST