THE following theory of crises, more correctly of recurrent business fluctuations, has still less claim to be considered a satisfactory representation of its subject-matter than the theories of the entrepreneurial function, of credit, capital, the money market, profit, and interest which have already been expounded. A satisfactory theory would require, to-day more than ever, a comprehensive treatment of the tremendously increased material, the working out of the numerous individual theories based upon different indices of business conditions and of their relation to one another. My work in this direction is a torso; the promise of exhaustive treatment has remained unfulfilled,1 and according to my programme of work must long remain so. Nevertheless, I submit this chapter again without any alteration except in exposition, not only because it now has its place in the investigation of crises but also because I still hold it to be true; not only because I believe that it contains the contribution of the argument of this book to the topic but also because this contribution gives the essence of the matter. Hence I am ready to accept criticism on the basis of this chapter.
The study of the objections which have come to my notice has confirmed me in my conviction. I shall mention only two. First there is the criticism that my theory is merely a “psychology of crises.” This objection has been made so urbanely by a most competent authority, and one most highly esteemed by me, that I myself must formulate its true content more sharply if the reader is to see what it really means. “Psychology of crises” means something quite definite, and is different from “psychology of value” for example: it means insisting on those tragi-comic aberrations of the frightened business world which we notice and specially have noticed in the past in every crisis. As a theory of crises, therefore, it would mean the basing of a scientific explanation either upon obvious accompanying and consequent phenomena (panic, pessimism, and so on) or, only a degree less bad, upon previous bullish tendencies, promotion fever, and so forth. Such a theory is barren; such an explanation explains nothing. But this is not my position. Not only do I always discuss external conduct, so that psychology can only be found in my argument in the sense in which it would be implied in every statement, even the most objective, about economic events, but I explain the phenomenon of business fluctuations — whether actually occurring now or not — solely by an objective chain of causation which runs its course automatically, that is by the effect of the appearance of new enterprises upon the conditions of the existing ones, a chain of causation which follows from the facts explained in the second chapter.
Then there is the objection formulated by Loewe: my theory does not explain the periodicity of crises.2 I do not understand this. Two things may be meant by periodicity. First, the mere fact that every boom is followed by a depression, every depression by a boom. But this my theory explains. Or secondly, the actual length of the cycle may be meant. But this no theory can explain numerically because it obviously depends upon the concrete data of the individual case. Yet my theory gives a general answer: the boom ends and the depression begins after the passage of the time which must elapse before the products of the new enterprises can appear on the market. And a new boom succeeds the depression when the process of resorption of the innovations is ended.
But Loewe means something else, which has been formulated as follows by Emil Lederer.3 My treatment is said to be “not satisfactory because it does not try at all to explain why the entrepreneurs appear periodically in swarms as it were, what the conditions are under which they can appear and whether they will always appear and why, if the conditions are favorable for them.” Now one may assert that I have explained inconclusively the swarm-like appearance of entrepreneurs, which, with its consequential phenomena, constitutes the only cause of periods of boom. But that I have not tried at all to explain it — when my whole argument aimed at this — seems to me to be untenable. The conditions under which entrepreneurs may appear — neglecting the general economic and social conditions of the competitive economy — are shown in the second chapter and may be briefly and incompletely formulated as the existence of new possibilities more advantageous from the private economic standpoint — a condition which must always be fulfilled; the limited accessibility of these possibilities because of the personal qualifications and external circumstances which are necessary;4 and an economic situation which allows tolerably reliable calculation. Why the entrepreneurs appear under these conditions is no more problematical if one adheres to the assumptions implied in our entrepreneurial concept than the fact that anyone seizes a gain when it is immediately before his eyes.
I should now like, without any critical design and solely in order to allow the ideas to stand out more clearly, to compare my theory with by far the most thorough effort in this field, that of Spiethoff5 — little as it is capable of comparison with the latter in thoroughness and perfection. The point of view — deriving from Juglar — according to which the wave-like fluctuation in business and not the crisis itself appears to be the fundamental thing to be explained, is common to both. We agree in the conception — which is established by me not in this chapter alone but also in the second — that the alternating situations (Wechsellagen — Spiethoff) are the form economic development takes in the era of capitalism. Hence we also agree in the view that completely developed capitalism is to be dated historically only from the time when such alternating situations first unmistakably occur (that is in England, according to Spiethoff, only from 1821, in Germany from the forties of the nineteenth century). Further, we agree that the figure for the consumption of iron is the best index of business conditions; that is, this index which Spiethoff discovered and worked out — I have no effort in this direction to exhibit — is also recognised by me as the right one from the standpoint of my theory. We agree that the causal nexus begins first of all with the means of production which are bought with capital and that the boom materialises first of all in the production of industrial plant (factories, mines, ships, railways, and so forth). Finally, we agree with the conception that the boom arises, as Spiethoff puts it, because “more capital is invested,” is fixed in new businesses, and that the impulse then spreads over the markets for raw materials, labor, equipment, and so forth. We also understand the same by capital in the sense which is here significant, with the exception that the creation of purchasing power plays a fundamental part in my argument which it does not in Spiethoff's. So far I should only have to add one thing, that capital investment is not distributed evenly in time but appears en masse at intervals. This is obviously a very fundamental fact, and for this I offer an explanation not offered by Spiethoff. I accept Spiethoff's conception of the standard cycle (Musterkreislauf).
The difference between us lies in the explanation of the circumstance which cuts short the boom and brings about the depression. For Spiethoff this circumstance is the overproduction of capital goods relative on the one hand to the existing capital and on the other hand to the effective demand. As a description of the actual facts I could also accept this. But while Spiethoff's theory stops at this element and tries to make us understand what circumstances induce the producers of factory equipment, of building materials, and so forth periodically to produce more than their markets are capable of absorbing at the time, my theory tries to explain the state of affairs in the manner to be found in this chapter, which may be summarised as follows. The effect of the appearance of new enterprises en masse upon the old firms and upon the established economic situation, having regard to the fact established in the second chapter that as a rule the new does not grow out of the old but appears alongside of it and eliminates it competitively, is so to change all the conditions that a special process of adaptation becomes necessary. This difference between us would be still further reduced by more detailed discussion.
It was impossible to keep my old exposition short and yet to make it invulnerable. Nevertheless I have cut it down still further in order to let the fundamental idea stand out more clearly. For the same reason I shall number the steps of the argument.
§ 1. Our question is: does this whole development which we have been describing proceed in unbroken continuity, is it similar to the gradual organic growth of a tree? Experience answers in the negative. It is a fact that the economic system does not move along continually and smoothly. Counter-movements, setbacks, incidents of the most various kinds, occur which obstruct the path of development; there are breakdowns in the economic value system which interrupt it. Why is this? Here we meet with a new problem.
If these deviations of the economic system from a smooth line of development were rare, they would hardly constitute a problem with a special claim upon the theorist's attention. In an economy without development the individual may meet with misfortunes which are very serious for him without there being any reason for theory to go into such phenomena. Likewise, events which might perhaps destroy the economic development of a whole nation would require no general investigation if they were rare, if they could be conceived as isolated mishaps. But the counter-movements and setbacks of which we are speaking here are frequent, so frequent that upon first consideration something like a necessary periodicity seems to suggest itself. This makes it impossible, practically at all events if not logically, to abstract from this class of phenomena.
Further, if it were the case that after such a setback is overcome the earlier development begins again at the point reached before it was interrupted, then the significance of the setback would not in principle be very great. We might say that we had taken account of all the fundamental facts of development even if we could not explain these disturbing incidents themselves or had simply abstracted from them. However, this is not the case. The counter-movements do not merely obstruct development, they put an end to it. A great many values are annihilated; the fundamental conditions and presuppositions of the plans of the leading men in the economic system are changed. The economic system needs rallying before it can go forward again; its value system needs reorganising. And the development which then starts again is a new one, not simply the continuation of the old. It is true, experience teaches that it will move more or less in a similar direction to the earlier, but the continuity of the “plan” is interrupted.6 The new development proceeds from different conditions and in part from the action of different people; many old hopes and values are buried forever, wholly new ones arise. Empirically it may happen that the main lines of all these partial developments, which lie between the setbacks, coincide with the broad outlines of the total development, but theoretically we cannot merely consider the contours of the total. Entrepreneurs cannot skip the setback phase and carry their plans over intact into the next phase of development, and scientific explanation cannot do so either without completely losing touch with the facts.
We have now to investigate this class of phenomena, which stand out so sharply against, apparently in a certain opposition to, other phenomena of development. At the outset the following possibilities exist. First, crises may or may not be a uniform phenomenon. The peculiar breakdowns of development which we know from experience and describe as crises always appear even to the naive mind as forms of one and the same phenomenon. However, this homogeneity of crises certainly does not go far. On the contrary, it exists chiefly only in a similarity of the effects upon the economic system and upon individuals, and in the fact that certain events are in the habit of occurring in most crises. Such effects and such events, however, would appear with the most various external and internal disturbances of economic life and are not enough to prove that crises are always the same phenomenon. Actually, different kinds and causes of crises are distinguished. And nothing justifies us in assuming beforehand that crises have more in common with one another than the element from which we started, namely that they are all events which call a halt on the preceding economic development.
Secondly, whether homogeneous or heterogeneous phenomena, crises may or may not be capable of a purely economic explanation. Of course it cannot be doubted that crises belong essentially in the economic sphere. But it is by no means certain that they belong to the nature of the economic system or even to any one kind of system in the sense that they would necessarily result from the operation of economic factors left to themselves. On the contrary, it would be quite possible for the real causes of crises to exist outside the purely economic sphere, that is for them to be consequences of disturbances which act upon the latter from outside. The frequency and even the often asserted regularity of crises would be in itself no conclusive argument, since it can be readily conceived that such disturbances must often occur in practical life. A crisis would then simply be the process by which economic life adapts itself to new conditions.
As regards the first point we can at the outset say one thing. If we speak of crises wherever large disturbances are met with, then there is no general attribute beyond the fact of disturbance. For the moment, it is as well to conceive of crises in this broad sense. Economic processes are accordingly divisible into three different classes: into the processes of the circular flow, into those of development, and into those which impede the latter's undisturbed course. This arrangement is by no means remote from reality. We can clearly keep all three classes separate in real life. Only more detailed analysis will show whether one of them comes under one of the other two.
The absence of a general attribute in the disturbances is proved by the history of crises. Such disturbances have already broken out in every conceivable place in the economic body, and moreover in very different ways in different places. Sometimes they appear on the supply side, sometimes on the demand side: in the former case sometimes in technical production, sometimes in the market or in credit relations; in the latter case, sometimes through changes in the direction of demand (for example changes in fashion), sometimes through changes in the purchasing power of consumers. For the most part the various industrial groups do not suffer in the same way, but first one industry suffers more, then another. Sometimes the crisis is characterised by a breakdown of the credit system which especially affects capitalists, sometimes the workers or landowners suffer most. Entrepreneurs may also be involved in very different ways.
At first sight the attempt to seek the common element in crises in the form of their appearance seems to be more promising. Actually it is this element that has led to the popular and scientific conviction that crises are always one and the same phenomenon. However, it is easy to see that these external characteristics which may be seized upon superficially are neither common to nor essential for all crises in so far as they go beyond the one element of the disturbance of development. The element of panic, for example, is very obvious. It was a striking feature of earlier crises. But there are also panics without a crisis. And further there are crises without real panics. The intensity of the panic does not in any case bear a necessary relation to the importance of the crisis. Finally, panics are much more the consequences than the causes of the outbreak of crises. This is also true of catchwords like “speculative fever,” “overproduction,”7 and so forth. Once a crisis has broken out and changed the whole economic situation, a great deal of speculation may appear senseless and almost every quantity of goods produced too large, although both were perfectly appropriate to the state of affairs before the outbreak of the crisis. Similarly, the breakdown of individual concerns, the lack of the proper relation between the individual branches of production, the incongruence of production with consumption, and other such elements are effects rather than causes. That there is no satisfactory criterion of crises in this sense is indicated by the fact that although in the descriptive literature of the subject a certain number of crises invariably recur, yet beyond this the individual enumerations of crises do not agree with one another.
We now come to the other question, whether all crises are not at least purely economic phenomena, that is whether they and all their causes and effects are capable of being understood by explanatory factors resulting from studying the economic system. It is clear that this is not always and not necessarily the case. It will be admitted at once that the outbreak of war, for example, may cause disturbances big enough for a crisis to be spoken of. To be sure, this is by no means the rule. The great wars of the nineteenth century, for example, did not for the most part lead immediately to crises. But the case is conceivable. Let us assume that an insular nation, which has an active trade with other nations and whose economic system may be conceived as in full development in our sense, is cut off from the outside world by an enemy fleet. Imports and exports alike are obstructed, the price and value system is shattered, obligations cannot be kept, the anchor chain of credit snaps — all this is conceivable, has actually occurred, and certainly represents a crisis. And this crisis is incapable of being explained purely economically since the cause, the war, is an element foreign to the economic system. By the operation of this foreign body in the economic sphere the crisis arose and is at the same time explained. Such external factors very frequently explain crises.8 An important example is bad harvests, which may evidently evoke crises and, as is well known, have become even the basis of a general theory of crises.
But even circumstances which do not act from without on the economic system as strikingly as wars or meteorological conditions must be seen from the standpoint of pure theory as effects of external causes of disturbance and hence in principle as accidental. To take an example, the sudden abolishment of protective tariffs may cause a crisis. Such a commercial measure is certainly an economic event. But we can assert nothing accurate about its appearance; we can only investigate its effects. From the standpoint of the laws of economic life it is simply an influence from without. Thus, there are crises which are not purely economic phenomena in our sense. And because they are not, we can say nothing in general, from the purely economic standpoint, about their causes. With us, they must pass for unfortunate accidents.
The question now arises: are there any purely economic crises in our sense, crises which would appear without the outside impulses of which we have just given examples? In fact the view is conceivable, and has been actually held, that crises are always effects of external circumstances. And it is undoubtedly very plausible. If it is correct, then there is no real economic theory of crises, and we can do nothing but simply establish these facts or at most try to classify those external causes of crises.
Before we answer our question we must get rid of a special kind of crisis. If the industry of a country is financed by another country and if a wave of prosperity sweeps over the latter, which offers capital more profitable employment than it has found hitherto in the former country, then there will exist a tendency to withdraw capital from its previous investments. If this happens quickly and inconsiderately it can clearly result in a crisis in the first country. This example should show that purely economic causes in one economic area may give rise to crises in another. The phenomenon is frequent and generally recognised. Obviously this can happen not only between two different countries but also between different parts of one country and finally, under certain circumstances, within one economic area between the different branches of industry. When a crisis has once broken out in one place it usually involves other places. Now the question is, are such phenomena purely economic, of the kind we are seeking? The answer is in the negative. The economic conditions of other regions are data for any given economic system and can only play the part of non-economic elements in explaining phenomena within it. For the economic system under consideration they are accidents, and it would be idle to try to find a general law for such crises.
Finally, after discarding all extraneous causes of crises, we find still others which are of a purely economic character in the sense that they arise from within the economic system, but which nevertheless do not present a new theoretic problem. Every new combination, to use our old expression, is exposed to an obvious danger of turning out a failure. Although cases in which whole branches of industry commit fatal mistakes will be rare, yet they happen, and if the industry in question is of sufficient importance, most of the symptoms of a crisis may be produced by them. But again, events of this class are merely mishaps, to be individually explained in each case and not inherent in the economic process in the sense of being the result of any element or factor essential to it.
If we consider this list of possible causes of disturbance, it may well become doubtful whether there will be anything left if we abstract from all its items, and whether, therefore, anything more can be said about the causation of crises than that they happen if, in consequence of outside or inside accidents, anything of sufficient importance goes wrong. History would not contradict this theory. For there are in almost every historical case so very many “accidents,” which may without any glaring absurdity be held responsible for the crisis actually occurring, that the necessity of any search for more general and fundamental causes is less obvious than some of us seem to believe. It may be remarked in passing that, however we may decide this question, the individual setting of most of the great crises in history is more important for the explanation of the actual happenings observed in each case than anything which enters into a general theory — supposing such theory to be possible — which can therefore never be expected to yield more than a contribution to either diagnosis or remedial policy in any actual case. If businessmen nearly always try to account for any crisis by circumstances special to the case in hand, they are not entirely wrong. Nor is the “empiricist's” antagonism towards any attempt to construct a general theory without foundation — although it is not antagonism that is called for in this case but a clear distinction between two entirely different tasks.
The decisive discovery, which settled our question and at the same time shifted our problem onto somewhat different ground, consisted in establishing the fact that there is, at all events, one class of crises, which are elements, or at any rate regular if not necessary incidents, of a wave-like movement of alternating periods of prosperity and depression, which have pervaded economic life ever since the capitalist era began.9 This phenomenon, then, emerges from the mass of multifarious and heterogeneous facts which may account for setbacks or breakdowns of all sorts. These great peripeteias of economic life are what we have primarily to explain. As soon as we seize upon this problem we are, for the purposes of theoretic analysis, not only justified but forced to assume the absence of all the other — external and internal — disturbances to which industrial life is exposed, in order to isolate the only question interesting from the point of view of theory. In so doing, we must never forget, however, that what we discard is not on that account of inferior importance, and that our theory, if kept within the narrow limits of our question, must become incommensurable with all analytic endeavors of wider scope which aim at providing an apparatus for the full understanding of the actual course of things.
That question may now be formulated as follows: why is it that economic development in our sense does not proceed evenly as a tree grows, but as it were jerkily; why does it display those characteristic ups and downs?
§ 2. The answer cannot be short and precise enough: exclusively because the new combinations are not, as one would expect according to general principles of probability, evenly distributed through time — in such a way that equal intervals of time could be chosen, in each of which the carrying out of one new combination would fall — but appear, if at all, discontinuously in groups or swarms.
This answer is now (a) to be interpreted, this appearance in groups is then (b) to be explained, whereupon (c) the consequences of this fact and the course of the causal nexus called forth by them are to be analysed (in § 3 of this chapter). The third point contains a new problem without the solution of which the theory would be incomplete. Although we accept Juglar's statement that “the only cause of the depression is prosperity” — which means that depression is nothing more than the economic system's reaction to the boom, or the adaptation to the situation into which the boom brings the system, so that its explanation is also rooted in the explanation of the boom — yet the manner in which the boom leads to the depression remains a thing by itself, as the reader can see at once in the difference on this point existing between Spiethoff and me. It will also be seen immediately that this question is answered — without difficulty and without the aid of new facts or theoretical instruments — by our argument.
(a) If the new enterprises in our sense were to appear independently of one another, there would be no boom and no depression as special, distinguishable, striking, regularly recurring phenomena. For their appearance would then be, in general, continuous; they would be evenly distributed in time and the changes which would be effected by them in the circular flow would each of them be relatively small, hence the disturbances would be of only local importance and easily overcome for the economic system as a whole. There would be no considerable disturbances of the circular flow and therefore no disturbances of growth at all. It should be noticed that this is true for any theory of crises with respect to that element which it considers as the cause, in particular for all disproportionality theories; the phenomenon is never made intelligible if it is not explained why the cause, whatever it may be, cannot act in such a way as to allow the consequences to be continuously and currently absorbed.10
Even then there would be good and bad times. Gold or other inflation would still hasten economic growth, deflation would obstruct it; political and social events and economic legislation would still exercise their influence. An event like the World War, for example, with the adjustment of the economic system to war requirements enforced by it, with the necessary liquidation after its conclusion, with its disturbance of all economic relations, its devastations and social upheavals, its destruction of important markets, its alteration of all data, would have taught men what crises and depressions are like even if they had not already known. But there would not be the kind of prosperity and depression which are here under consideration. Such events would not be regular, or necessary in the sense that they emerge from the working of the economic system itself, but would have to be explained by special external causes, as has already been sufficiently emphasised. One favorable circumstance, which always facilitates and partly explains a boom, must be particularly remembered, namely the state of affairs created by every period of depression. As is well known, there are generally masses of unemployed, accumulated stocks of raw materials, machines, buildings, and so forth offered below cost of production, and there is as a rule an abnormally low rate of interest. Indeed these facts play a part in nearly every investigation of the phenomenon, as for example with Spiethoff and Mitchell. But it is clear that we can never explain the phenomenon by these consequences of it if we wish to avoid first deriving the depression from the boom and then the latter from the depression. Therefore here, where it is only a question of the principle of the thing — and not of an exhaustive statement of the circumstances (bad harvests,11 war rumors, and so forth) concretely operative in boom or crisis — we shall completely neglect these consequences.
Three circumstances increase the effect of the swarm-like appearance of new enterprises, yet without being real causes coordinate with it. First, our argument in the second chapter allows us to expect — and experience confirms it — that the vast majority of new combinations will not grow out of the old firms or immediately take their place, but appear side by side, and compete, with them. From the standpoint of our theory this is neither a new nor an independent element; nor is it essential to the existence of booms and depressions, although it is clearly very important in explaining the amplitude of the wave-like movement.
Secondly, the fact that entrepreneurial demand appears en masse signifies a very substantial increase in purchasing power all over the business sphere. This starts a secondary boom, which spreads over the whole economic system and is the vehicle of the phenomenon of general prosperity — which can only be completely understood in this way and cannot be satisfactorily explained otherwise. Only because new purchasing power goes in bulk from the hands of entrepreneurs to the owners of material means of production, to all producers of goods for “reproductive consumption” (Spiethoff), and to the workers, and then oozes into every economic channel, are all existing consumption goods finally sold at ever-rising prices. Retailers thereupon place bigger orders, manufacturers extend operations, and for this purpose increasingly more unfavorable and often already abandoned means of production come into use again. And only on this account do production and trade everywhere temporarily yield a profit, just as in a period of inflation, for example when war expenditure is financed with paper money. Many things float on this “secondary wave,” without any new or direct impulse from the real driving force, and speculative anticipation in the end acquires a causal significance. The symptoms of prosperity themselves finally become, in the well known manner, a factor of prosperity. For the theory of business indices and the understanding of the business situation as a whole, this is of course most important. For our purpose, however, only the division between primary and secondary waves is essential, and it is enough to note that the latter can simply be traced back to the former and that in a theory elaborated upon the basis of our principle everything that was ever observed in the cyclical movement would find its definite place. But in an exposition like the present, justice cannot be done to such things, hence an impression of remoteness from reality may arise which is actually not justified.12
Thirdly, it follows from our argument that errors must play a considerable rôle at the beginning of the boom and during the course of the depression. Most theories of crises in fact use this element in one way or another. Errors, however, do not normally occur to the excessive extent required; production is entered upon by sane men only on the basis of more or less careful investigation of the facts. Although miscalculations may occur on a scale that may well endanger an individual business, in exceptional cases perhaps a whole industry, this is not as a rule enough to endanger the economic system as a whole. How can such general mistakes be made, then, that the whole system is affected, and indeed as an independent cause and not merely as a consequence of the depression which is to be explained? Once it has set in for other reasons, depression certainly upsets many plans which were previously quite reasonable and makes mistakes dangerous which would otherwise have been easily rectified. The initial mistakes require a special explanation, without which nothing is explained. Our analysis supplies this explanation. If the characteristic feature of a period of boom is not merely increased business activity as such, but the carrying out of new and untried combinations, then it is immediately clear, as has already been mentioned in Chapter II, that error must play a special rôle there, qualitatively different from its rôle in the circular flow. Nevertheless, no “error theory” will be found here. On the contrary, in order to avoid any such impression we shall segregate this element. It is indeed a supporting and accentuating circumstance, but not a primary cause necessary to the understanding of the principle. There would still be cyclical movements — though in a milder form — even if no one ever did anything that could be described as “false” from his point of view; even if there were no technical or commercial “error,” or “speculative fever,” or groundless optimism and pessimism; and even if everyone were gifted with wide foresight. The objective situation which the boom necessarily creates explains exclusively the nature of the thing,13 as will be seen.
(b) Why do entrepreneurs appear, not continuously, that is singly in every appropriately chosen interval, but in clusters? Exclusively because the appearance of one or a few entrepreneurs facilitates the appearance of others, and these the appearance of more, in ever-increasing numbers.
This means, first, that for the reasons explained in Chapter II the carrying out of new combinations is difficult and only accessible to people with certain qualities, as is best seen by visualising an example from earlier times or the economic situation in the stage that most resembles an economy without development, viz. the stage of advanced stagnation. Only a few people have these qualities of leadership and only a few in such a situation, that is a situation which is not itself already a boom, can succeed in this direction. However, if one or a few have advanced with success many of the difficulties disappear. Others can then follow these pioneers, as they will clearly do under the stimulus of the success now attainable. Their success again makes it easier, through the increasingly complete removal of the obstacles analysed in the second chapter, for more people to follow suit, until finally the innovation becomes familiar and the acceptance of it a matter of free choice.
Secondly, since as we have seen the entrepreneurial qualification is something which, like many other qualities, is distributed in an ethnically homogeneous group according to the law of error, the number of individuals who satisfy progressively diminishing standards in this respect continually increases. Hence, neglecting exceptional cases — of which the existence of a few Europeans in a negro population would be an example — with the progressive lightening of the task continually more people can and will become entrepreneurs, wherefore the successful appearance of an entrepreneur is followed by the appearance not simply of some others, but of ever greater numbers, though progressively less qualified. This is how it is in practice, the testimony of which we merely interpret. In industries in which there is still competition and a large number of independent people we see first of all the single appearance of an innovation — overwhelmingly in businesses created ad hoc — and then we see how the existing businesses grasp it with varying rapidity and completeness, first a few, then continually more. We have already come across this phenomenon in connection with the process of eliminating entrepreneurial profit. Here it comes into consideration again, though from another standpoint.14
Thirdly, this explains the appearance of entrepreneurs in clusters and indeed up to the point of eliminating entrepreneurial profit, first of all in the branch of industry in which the pioneers appear. Reality also discloses that every normal boom starts in one or a few branches of industry (railway building, electrical, and chemical industries, and so forth), and that it derives its character from the innovations in the industry where it begins. But the pioneers remove the obstacles for the others not only in the branch of production in which they first appear, but, owing to the nature of these obstacles, ipso facto in other branches too. Many things may be copied by the latter; the example as such also acts upon them; and many achievements directly serve other branches too, as for example the opening up of a foreign market, quite apart from the circumstances of secondary importance which soon appear — rising prices and so on. Hence the first leaders are effective beyond their immediate sphere of action and so the group of entrepreneurs increases still further and the economic system is drawn more rapidly and more completely than would otherwise be the case into the process of technological and commercial reorganisation which constitutes the meaning of periods of boom.
Fourthly, the more the process of development becomes familiar and a mere matter of calculation to all concerned, and the weaker the obstacles become in the course of time, the less the “leadership” that will be needed to call forth innovations. Hence the less pronounced will become the swarm-like appearance of entrepreneurs and the milder the cyclical movement. And clearly this consequence of our interpretation is also strikingly confirmed by reality. The progressive trustification of economic life acts in the same direction, even though to-day a great combine with its sales and its financial requirements is still so dependent upon the market situation, which is to a considerable extent determined competitively, that the universally advantageous postponement of its innovations, and especially of construction, to periods of depression — as exemplified in the policy of American railways — is only possible sporadically. In so far as it operates, however, this element also confirms our interpretation.
Fifthly, the swarm-like appearance of new combinations easily and necessarily explains the fundamental features of periods of boom. It explains why increasing capital investment is the very first symptom of the coming boom, why industries producing means of production are the first to show supernormal stimulation, above all why the consumption of iron increases. It explains the appearance of new purchasing power in bulk,15 thereby the characteristic rise in prices during booms, which obviously no reference to increased need or increased costs alone can explain. Further, it explains the decline of unemployment and the rise of wages,16 the rise in the interest rate, the increase in freight, the increasing strain on bank balances and bank reserves, and so forth, and, as we have said, the release of secondary waves — the spread of prosperity over the whole economic system.
§ 3. (c) The swarm-like appearance of entrepreneurs, which is the only cause of the boom, has a qualitatively different effect upon the economic system from that of a continuous appearance evenly distributed in time, in so far as it does not, like the latter, mean a continuous, and even imperceptible, disturbance of the equilibrium position but a jerky disturbance, a disturbance of a different order of magnitude. While the disturbances caused by a continuous appearance of entrepreneurs could be continuously absorbed, the swarm-like appearance necessitates a special and distinguishable process of absorption, of incorporating the new things and of adapting the economic system to them, a process of liquidation or, as I used to say, an approach to a new static state (Statisierung). This process is the essence of periodic depressions, which may therefore be defined from our standpoint as the economic system's struggling towards a new equilibrium position, its adaptation to the data as altered by the disturbance of the boom.
The essence of the matter does not lie in the fact that the individual entrepreneur, interested only in planning his own enterprise, takes no account of the swarm-like following of others, and so comes to grief. It is certainly true that conduct which is correct from the standpoint of the individual business may be mulcted of its fruits by the general effect of the similar conduct of many. We recognised the most important example of this when we explained how producers, in their very striving for the maximum profit, set the mechanism in motion which tends to eliminate surplus value in the system. Similarly, here also the general effect may render false what was correct for the individual, and this element will actually play a part in most crises, for although the swarming after the entrepreneur is known beforehand to the latter and cannot take him unawares, the magnitude and tempo may frequently be estimated wrongly. However, the essence of the disturbance caused by the boom does not lie in the fact that it often upsets entrepreneurs' calculations,17 but in the following three circumstances.
First, the new entrepreneur's demand for means of production, which is based upon new purchasing power — the well known “race for means of production” (Lederer) in a period of prosperity — drives up the prices of these. In reality this tendency is weakened by the fact that at least some of the new enterprises do not appear side by side with the old, but grow out of them, and that the old businesses do not simply work without profit, but may still earn some quasi-rent. We can best elucidate the nature of the operation, however, if we assume that all innovations are embodied in newly established businesses, are financed solely by newly created purchasing power, and take their place beside businesses which belong strictly to the circular flow and work without profit, and which, therefore, in consequence of the increase in their costs, begin to produce at a loss. Reality contradicts this construction less than one would imagine. Actually, only the atmosphere which hangs over the period of boom hides the fact that very soon after its beginning, and as long as it is expressed simply in the increased demand, the boom means distress for many producers, although it is diminished again when the rise in the prices of their products sets in. This distress is a form of the process by which means of production are withdrawn from the old businesses and made available for the new purposes, as explained in Chapter II.
Secondly, the new products come on the market after a few years or sooner and compete with the old; the commodity complement of the previously created purchasing power — theoretically more than counterbalancing the latter — enters into the circular flow. Again the consequences of this process are practically moderated by the causes mentioned in the preceding section, and further by the fact that because some investments are remote from finished products this complement appears only gradually. But this does not touch the nature of the process. At the beginning of the boom costs rise in the old businesses; later their receipts are reduced, first in those businesses with which the innovation competes, but then in all old businesses, in so far as consumers' demand changes in favor of the innovation. Apart from the possibility of profiting — secondarily — from the innovation, their working at a loss is only checked by the buffer quasi-rent, which is merely temporarily effective. And it is only because old businesses are mostly well established and appear as especially deserving of credit that this working at a loss does not lead at once to collapse. Their partial breakdown affects the success of the new undertakings. The breakdown is moderated by the fact, which fits so well into the framework of our interpretation, that the boom is never general at first, but centres in one branch or a few branches of industry, leaving the other areas undisturbed, and subsequently only affects the latter in a different, and secondary, manner. Just as entrepreneurs appear en masse, so do their products, because the former do not do different but very similar things, and hence their products appear on the market almost simultaneously. The average time 18 which must elapse before the new products appear — though of course actually dependent upon many other elements — fundamentally explains the length of the boom. This appearance of the new products causes the fall in prices,19 which on its part terminates the boom, may lead to a crisis, must lead to a depression, and starts all the rest.
Thirdly, the appearance of the results of the new enterprises leads to a credit deflation, because entrepreneurs are now in the position — and have every incentive — to pay off their debts; and since no other borrowers step into their place this leads to a disappearance of the recently created purchasing power just when its complement in goods emerges, and which can henceforth be repeatedly produced in the manner of the circular flow. This thesis requires careful safeguarding. In the first place this deflation must be distinguished from two other kinds. The appearance of the new products must result in deflation, not only as against the price level of the boom period, but theoretically also as against that of the preceding period of depression, even if absolutely no means of payment disappeared in debt repayment by entrepreneurs, for the sum of the prices of the new products must obviously be normally greater than the amount of these debts. This would have the same effect as the liquidation of debts, only to a smaller extent; but we are now thinking of the effect of debt reduction. Deflation also occurs in a depression which is already in being or is expected by the banking world, because the banks endeavor on their own initiative to restrict their credits. This factor is practically very important and frequently starts a real crisis; but it is accessory and not inherent in the process. Here we are not thinking of this factor either, though we deny neither its existence nor its importance, but only its primary causal rôle.20 Then, further, our formulation contains two abstractions which will make the essentials stand out clearly, but which exclude moderating influences of great practical importance. First, it neglects the fact that the new products generally contain only small quotas for depreciation of the investments made in producing them, hence that only a part, mostly only a small part, of the total expenditure in the period of boom comes on the market in saleable form when the new enterprises are ready to produce; therefore the newly created purchasing power only gradually goes out of circulation, in part only when later periods of boom have brought more credit seekers into the money market. The resorption of the new purchasing power by savings alters nothing in this deflationary process — but the fact that many states, municipalities, and agricultural mortgage banks step into the place of the dwindling entrepreneurial demand does make a difference. Apart from this only gradual disappearance of entrepreneurs' debts, it must be borne in mind that, in the modern economic system in which interest has penetrated even into the circular flow, credit may even remain permanently in circulation, in so far as there are now goods produced year after year corresponding to it — which is the second factor moderating the process still further. But the deflationary tendency is operative, for all that, and liquidation of debts by successful enterprises takes place — so that deflation, even though in ever so mild a form, must always appear automatically out of the logic of the objective situation, when the boom has gone on far enough. A noteworthy verification of this theory, which leads to the conclusion that in the course of development the “secular” price level must fall, is in fact given by the history of prices in the nineteenth century. The two periods which were not disturbed by revolutionary monetary changes, that is the period from the Napoleonic Wars to the Californian gold discoveries, and the period 1873-1895, actually exhibit the feature which we should expect from our theory, namely that every periodic trough is deeper than the preceding and that a price curve eliminating cyclical fluctuations moves downwards.
Finally, it must still be explained why other entrepreneurs seeking credit do not always step into the place of those liquidating their indebtedness. There are two reasons, to which in practice others are added which can be described either as consequences of the elements which we call fundamental, or as accidental, or as influences operating from outside, and in this sense as secondary, unessential, or accessory. In the first place, if, under the stimulus of success in the industry in which the boom occurs, so many new enterprises spring up that they would produce, when in full swing, a quantity of product which, through the fall in prices and rise in costs — which occur of course even if the industry in question obeys the so-called law of increasing returns — would eliminate entrepreneurial profit, then the impulse to further advance in this direction is exhausted. In practice, even in a competitive society, the elimination of profit is only approximate and the process excludes neither the survival of some profit nor the immediate realisation of losses. The limit to which the appearance of entrepreneurs in other industries and the phenomena created by secondary waves of development can go is determined analogously. When it is reached, the impulse of this boom is exhausted. The second reason explains why a new boom does not simply follow on: because the action of the group of entrepreneurs has in the meanwhile altered the data of the system, upset its equilibrium, and thus started an apparently irregular movement in the economic system, which we conceive as a struggle towards a new equilibrium position. This makes accurate calculation impossible in general, but especially for the planning of new enterprises. In practice only the latter element — the characteristic uncertainty which results from the new creations of the boom — is always immediately observable; the first-named limit shows itself mostly only at individual points. Both of them, however, are obscured, first, by consequential phenomena which the foresight of many individuals anticipates. Some individuals begin to feel sooner than others either the strain, as is true of the banks, or the rise in costs and other elements, as in the case of many old businesses, and react accordingly — in most cases too late, it is true, but when they do, in panic-stricken fashion, especially the weaker ones. Secondly, they are obscured by fortuitous events, which always occur but which acquire an importance from the uncertainty created by the boom such as they did not have before. This explains why the practical man in almost every crisis thinks he can adduce fortuitous events, unfavorable political rumors for example, as causes, and why the impetus in fact frequently proceeds from these. Thirdly, they are obscured by acts of intervention from without, of which a conscious pull on the reins by the central bank is usually the most important.
§ 4. If the reader thinks through what has been said, and tests it on any factual material or on the arguments of any theory of crises and the business cycle, he must understand how the boom (which is now explained) creates out of itself an objective situation, which, even neglecting all accessory and fortuitous elements, makes an end of the boom, leads easily to a crisis, necessarily to a depression, and hence to a temporary position of relative steadiness and absence of development. The depression as such we may call the “normal” process of resorption and liquidation; the course of events characterised by the outbreak of a crisis — panic, breakdown of the credit system, epidemics of bankruptcies, and its further consequences — we may call the “abnormal process of liquidation.” In completion and in repetition of some points we now have a few more things to say about this process, but only about the normal, since the abnormal presents no fundamental problems.
What has been said leads directly to the understanding of all primary and secondary features of the period of depression, which now appear as parts of a single causal nexus. The boom itself of necessity causes many businesses to run at a loss, causes a fall in prices apart from that due to deflation, and in addition causes deflation through credit contraction — phenomena which all increase secondarily in the course of events. Further, the diminution of capital investment21 and entrepreneurial activity, and hence stagnation in the industries producing means of production, and the fall in the Spiethoff index (iron consumption) and similar barometers, such as the unfilled orders of the United States Steel Corporation, are all explained. With the fall in the demand for means of production, the rate of interest — if the coefficient of risk is removed — and the volume of employment also fall. With the fall in money incomes, which is causally traceable to the deflation, even though it is increased by bankruptcies and so forth, the demand for all other commodities finally falls, and the process has then penetrated the whole economic system. The picture of the depression is complete.
Two reasons, however, prevent these characteristics from appearing in the order in time which would correspond to their position in the causal nexus. First is the fact that they are not only anticipated by the conduct of individuals, but also anticipated in very unequal degrees. This happens especially in markets where professional speculation plays a great part. Thus the stock market sometimes exhibits speculative preliminary crises long before a real turning point arrives, which are then overcome and make room for a further upward movement, which still belongs to the same boom (thus 1873 and 1907). But something else is much more important. Just as in practice the rise in the price of a product often anticipates the increase in costs which is nevertheless its cause, so a similar phenomenon appears here. The decrease in capital investment in the sense just indicated, the parallel decrease in entrepreneurial activity, and the stagnation in the industries for producers' goods, for example, may occur, as far as the logic of the process is concerned, before the boom has attained its external culmination; but it is not necessary that they should. On the contrary, if these symptoms do regularly occur before the end of the boom, it is because they are under the influence of factors which anticipate relatively promptly what is coming. Secondly, however, various circumstances bring it about that in the actual course of events secondary elements often stand out more prominently than the primary. The anxiety of lenders, for example, expresses itself in a rise in the rate of interest, and only late in the depression does the effect appear which in the very nature of things would appear quite early in the normal course of events. The reduction in the demand for labor should be a very early symptom of the change, but just as wages do not rise immediately in prosperity because as a rule there are unemployed workers, so wages and the amount of employment do not usually fall as promptly as one would expect because a series of well known obstacles stands in the way. The business world tries to defend itself against a fall in prices, and where competition is not completely “free” — as is practically nowhere the case — and when the banks lend their support, it resists with temporary success, so that the maximum price level is often later than the turning point. It is a fundamental task of the investigation of crises to establish all these things. But here it is sufficient to state, without further substantiation, that all this no more alters the essence of the matter than the analogous phenomena in other fields, to which I referred above, support objections against the theory of prices.
The course of events in periods of depression presents a picture of uncertainty and irregularity which we interpret from the point of view of a search for a new equilibrium, or of adaptation to a general situation which has been changed relatively quickly and considerably. The uncertainty and irregularity are quite comprehensible. The customary data are altered for every business. The extent and nature of the change, however, can only be learned from experience. There are new competitors: old customers and dealers fail to appear; the right attitude towards new economic facts has to be found; incalculable events — unsuspected refusals of credit — may occur at any moment. The “mere businessman “ faces problems which lie outside his routine, problems to which he is not accustomed and in the face of which he makes mistakes which then become an important secondary cause of further trouble. Speculation is a further cause, through the distress in which it involves speculators as well as through the fact that the latter anticipate a further fall in prices, so that all these well known elements mutually increase one another. Nowhere is the final result clearly in sight; weak points, which in themselves have nothing to do with the crisis, may come to light anywhere. Business contraction or business extension may finally prove to be the correct type of reaction without its being possible at the moment to advance trustworthy reasons for the one or the other. This complication and lack of clarity in the situation, of which theory in my opinion makes an unwarranted use in explaining the causes of depression, really becomes an important factor in the actual events.
The uncertainty of the data and values involved in the new adjustment, the losses which apparently occur irregularly and incalculably, create the characteristic atmosphere of periods of depression. Those speculative elements which make up stock exchange opinion and are commercially and socially so noticeable in prosperity suffer especially. To many people, particularly the speculative class and the producers of luxury goods who are partly dependent on its demand, conditions appear essentially worse than they are — to them the end of all things seems to have come. Subjectively, the turning point appears to producers, especially if they resist the unavoidable fall in prices, as an outbreak of hitherto latent overproduction, and the depression as its consequence. The unsaleableness of commodities already produced, still more of those producible, at prices which cover costs calls forth the well known further phenomenon of the tightness of money, possibly insolvency, which is so typical that every theory of the business cycle must be in a position to explain it. Ours does so, as the reader can see, but it does not employ this typical fact as a primary and independent cause.22 The overproduction is accentuated by that skewness of the boom which we have already noticed and explained. This circumstance on the one hand, and the discrepancy between effective supply and effective demand which must occur in many industries during the depression on the other, make it possible to describe the external form of depressions in the language of the various disproportionality theories. The gist of every such theory lies in the manner in which it tries to explain the appearance of the disproportionality, and in the particular quantities between which disproportionality is held to exist. For us, the disproportionality between quantities and prices of goods, which results at many points because of the loss of equilibrium in the economic system, is an intermediate phenomenon just like overproduction and is not a primary cause. Connected with it there may be disproportionality between incomes in individual industries, but not between the incomes of different economic classes, for entrepreneurial profits bear no normal proportion to the incomes of other people which could be disturbed, and the other incomes, with the exception of those fixed in terms of money, have the tendency to move pari passu and to gain or lose ground at the cost or to the advantage of the fixed incomes, leaving the total consumers' demand undisturbed.
The skewness of the boom has the consequence, amongst others, that strain and danger in the situation are not equally great for all branches of industry. Experience teaches also, as Aftalion23 has already shown, that many branches are hardly disturbed at all, others only relatively little. Within every industry new enterprises are generally implicated considerably more than established businesses, which seems to contradict our interpretation. This is to be explained as follows: an old business has the buffer quasirent, and, what is more important, generally accumulated reserves. It is embedded in protecting relationships, often effectively supported by banking connections of many years' standing. It may be losing ground for years without its creditors becoming uneasy. Therefore it holds out much longer than a new enterprise, which is strictly and suspiciously scrutinised, which has no reserves but at best only overdraft facilities, and which only needs to give a sign of embarrassment to be considered as a bad debtor. Hence, the reaction of the change in all conditions upon new enterprises may become visible earlier and more strikingly than that upon old businesses. And therefore in the former it leads much more easily to the final consequence, bankruptcy, than in the latter, in which it rather initiates a slow decay. This distorts the picture of reality, and is also the reason why a selective process in crises may be spoken of only with an important qualification; for that firm which is well supported, and not the one that is most perfect in itself, has the best chance of surviving a crisis. But this does not affect the nature of the phenomenon.
§ 5. Although it stands to reason that the process of adjustment and resorption which makes up the period of depression causes discomfort to the most vigorous elements in the economic system, those which do most to create the mood of the business world, and although it necessarily annihilates many values and existences even if everything occurs with ideal perfection, yet its nature and effects would be inadequately grasped if it were seen only from the aspect of the cessation of the impulse to prosperity or described merely by negative characteristics. There are more cheerful sides to it which are much more characteristic of it than the things just indicated.
First, the depression leads, as stated already, to a new equilibrium position. To convince ourselves that all that happens in it is really to be understood from this point of view and is only apparently meaningless and unregulated, let us consider once more the behavior of individuals in a period of depression. They must adapt themselves to the disturbance caused by the boom, that is by the swarm-like appearance of new combinations and their products, by the appearance of them alongside of the old businesses and by the one-sidedness of their appearance. The old businesses — that is, theoretically, all existing ones with the exception of those formed in the boom, and with the further exception in practice of those removed from danger by a monopoly position, the possession of peculiar advantages, or lastingly superior technique — are faced by three possibilities: to decay if they are unadaptable for objective or personal reasons; to take in sail and try to survive in a more modest position; finally, with their own resources or with outside help either to change to another industry or to adopt other technical or commercial methods which amount to extending production at lower cost per unit. The new businesses have to undergo their first test, a much more difficult one than they would have to undergo if they appeared continuously and not in swarms. Once established, they must be properly incorporated in the circular flow, and, even if no mistake was made when they were founded, there must in many respects be much to revise. Even though from different, secondary, causes, problems and possibilities confront them similar to those confronting the old businesses; and, as mentioned above, they are in many respects less equal to cope with them than are the old. The characteristic conduct of businessmen in depression consists of measures, correction of measures, and further measures to solve this problem; all the phenomena, apart from panics unfounded in fact and the consequences of errors — which characterise the abnormal course of events in a crisis — may be included in this conception of the situation created by the boom and of businessmen's conduct enforced by it, of the disturbance in equilibrium and the reaction to it, of the change in data and the successful or abortive adaptation to it.
Just as the struggle towards a new equilibrium position, which will embody the innovations and give expression to their effects upon the old firms, is the real meaning of a period of depression as we know it from experience, so it may likewise be shown that this struggle must actually lead to a close approach to an equilibrium position: on the one hand, the driving impulse of the process of depression cannot theoretically stop until it has done its work, has really brought about the equilibrium position; on the other hand, no new disturbance in the form of a new boom can arise out of the economic system itself until then. Businessmen's conduct in the period of depression is clearly ruled by the element of actual or impending loss. But losses occur or are imminent — not necessarily in the whole economic system but in the parts exposed to danger — as long as all businesses, and hence the system as a whole, are not in stable equilibrium, which is as much as to say in practice until they again produce at prices approximately covering costs. Consequently there is, theoretically, depression as long as no such equilibrium is approximately attained. Nor will this process be interrupted by a new boom before it has done its work in this sense. For until then, there is necessarily uncertainty about what the new data will be, which makes the calculation of new combinations impossible and makes it difficult to obtain the cooperation of the requisite factors. Both conclusions fit the facts if the following qualifications are kept in view. A knowledge of the cyclical movement and its mechanism, which is peculiar to the modern business world, allows businessmen, whenever the worst is over, to anticipate the coming boom and especially its secondary phenomena; the adaptation of many individuals and hence of many values to the new equilibrium is frequently retarded or prevented by the expectation that if they can only hold out — which it is often in the interest of their creditors to facilitate — they will be able to liquidate on favorable terms in the next boom or will not find it necessary to liquidate at all — which is especially important in predominantly prosperous epochs and saves many firms really not fit to live as well as many that are, but in any case retards or prevents the attainment of a settled equilibrium position.
The progressive trustification of economic life facilitates the permanent continuance of maladjustments in the great combines themselves and hence outside of them, for practically there can only be complete equilibrium if there is free competition in all branches of production. Furthermore, in consequence of the financial strength of some firms, especially the older ones, the adjustment is not always very urgent, not an immediate question of life or death. There is also the practice of outside support being extended to firms or whole industries in difficulties, for example government subsidies, given upon the bona or mala fide assumption that the difficulty is only a temporary one, created by extraneous circumstances. In times of depression there is also frequently an outcry for protective duties. All this acts in the same way as the financial strength of old businesses. Furthermore, there is the element of chance — for example a good harvest occurring at the right moment. Finally, abnormalities in the course of the depression sometimes have the effect of producing over-compensations; if, for example, an unjustified panic has unduly depreciated the shares of a business and in consequence a corrective upward movement in them begins, this upward movement may in its turn overshoot the mark, maintain the shares at a quotation which is inappropriately high, and lead to a small pseudo-boom which may last under certain circumstances until a real one begins.
Of course the position reached in the end never completely corresponds to the theoretical picture of a system without development, in which there would no longer be income in the form of interest. The relatively short duration of depressions alone prevents this. Nevertheless, an approximation to a position without development always occurs, and this, being relatively steady, may again be a starting point for the carrying out of new combinations. In this sense, therefore, we come to the conclusion that according to our theory there must always be a process of absorption between two booms, ending in a position approaching equilibrium, the bringing about of which is its function. This is important for us, not only because such an intermediate position actually exists and the explanation of it is incumbent upon every theory of the cycle, but also because only the proof of the necessity of such a periodic quasi-equilibrium position completes our argument. For we started from such a position, out of which the wave of development first arises — without regard to whether or when this was the case historically. We might even merely assume an initial “static” state in order to let the nature of the wave stand out clearly. But for our theory to explain the essence of the phenomenon it is not enough that a trough actually follows every crest of the wave: it must do so necessarily — which cannot be simply assumed, nor may a proof be replaced by pointing to the fact. For this reason a certain amount of pedantry seemed to be required in this section.
Secondly, apart from the digestion of the innovations which has just occupied our attention, the period of depression does something else, which indeed comes less to the fore than those phenomena to which it owes its name: it fulfils what the boom promised. And this effect is lasting, while the phenomena felt to be unpleasant are temporary. The stream of goods is enriched, production is partly reorganised, costs of production are diminished,24 and what at first appears as entrepreneurial profit finally increases the permanent real incomes of other classes.
This conclusion which emerges from our theory (cf. also the fourth chapter) is justified, in spite of the various obstacles which these effects meet with at first, by the fact that the economic picture of a normal period of depression 25 is throughout not so black as the mood pervading it would lead one to suspect. Apart from the fact that a great part of economic life remains almost untouched as a rule, the physical volume of total transactions in most cases falls only insignificantly. How exaggerated the popular conceptions of the ravages caused by a depression are, is shown by any official investigation of crises.26 This is true not only of analysis in terms of goods but also of that in terms of money, in spite of the fact that the cyclical movement, with its inflation in prosperity and deflation in depression, must be especially strongly marked in the money expression. Total incomes rise in the boom and fall in the depression not more than 8 to 12 per cent as compared with the figures for average years, even in America (Mitchell), where the intensity of development presumably makes the fluctuations more strongly marked than in Europe. Aftalion has already shown that the fall in prices during depression only constitutes a low percentage on the average, and that really great fluctuations have their causes in the special conditions of the individual articles and have little to do with the cyclical movement. The same thing may be shown for all really large general movements, as for example the post-war period. When the phenomena of the abnormal course of events (panics, epidemics of bankruptcies, and so forth), which are continually becoming weaker, and with them anxiety about incalculable danger, disappear, public opinion will also judge of depressions differently.
We see the true character of a period of depression if we consider what it brings to and takes from different categories of individuals — always abstracting from the phenomena of the abnormal course of events, which is of no concern here. From entrepreneurs and all their followers, especially from those who fortuitously or speculatively enjoy the fruits of the rise in prices during the boom, it takes away the possibility of profit — which especially in the case of speculation is only very imperfectly replaced by bear possibilities which appear in the slump. The entrepreneur has in the normal case made his profit and embodied it in the now established and adjusted business; but he makes no further profits, on the contrary he is threatened with losses. In the general case his entrepreneurial profit would dry up, his other entrepreneurial income would be at a minimum, even in the ideal course of events. In the real course of events many adverse influences supervene, although mitigated by some factors already mentioned. The existences connected with the old businesses, which are now being competitively vanquished, of course suffer. People with fixed money incomes or incomes only alterable after a long time, such as pensioners, rentiers, officials, and landlords who have rented their land for a long term, are the typical beneficiaries of the depression. The commodity content of their money incomes, which is compressed in prosperity, now expands, and indeed in principle it must expand more than it was compressed before, as has already been shown (cf. above, § 3, “thirdly”). Capitalists with short-term investments gain from the increased purchasing power of the unit of income and capital, and lose by the lower interest rate; theoretically, they must lose more than they gain, but numerous secondary circumstances — on the one hand danger of loss, on the other hand high risk premiums and panic demand — deprive this theorem of its practical importance. Those landowners whose rents are not fixed in money by long-term contracts — hence above all the landowning farmer — are fundamentally in exactly the same position as workers, so that what is now to be argued of the workers is also true of them. The practically important, theoretically inconsiderable, differences are so generally familiar that we shall not go into them.27
In the boom wages must rise. For the new demand, first of entrepreneurs and then of all those who extend operations as the secondary wave rises, is, directly and indirectly, chiefly a demand for labor. Therefore employment must first increase and with it the sum total of wages of labor, then the rate of pay and with it the income of the individual worker. It is from this rise in wages that the increased demand for consumption goods proceeds which results in the rise in the general price level. And because part of the incomes of landowners, who are theoretically coordinate (Chapter I) with the workers, does not rise with wages for the reasons mentioned, and fixed incomes do not increase at all, the rise in total wages is not merely nominal, but is equivalent to a greater real income of labor, and this again to a greater share in the social product which has not as yet increased. This is a special case of a general truth: no inflation can be immediately prejudicial to the workers' interests if, and in so far as, the newly created purchasing power must first operate upon wages before it can affect the prices of consumption goods. Only in so far as this is not the case or as the rise in wages meets external obstacles (as for example in the World War) can wages lag behind28 in the manner so frequently depicted. If, indeed, the inflation is the vehicle of an excess in consumption, as for example if a war is financed by inflation, the consequent impoverishment29 of the economic system must also react upon the workers' position, even though not so severely as upon the position of other groups of individuals. But in our case clearly the opposite happens.
In a depression the purchasing power of the unit of wages rises. On the other hand the money expression of the effective demand for labor falls in consequence of the automatic deflation which the boom starts. In so far as only this occurs, the effective real demand 30 for labor could remain undisturbed. The real income of labor would then still be higher, not only than in the previous approximate equilibrium position, but also than in the boom. For what was previously entrepreneurial profit flows — theoretically and according to our conception wholly, but practically only gradually and incompletely — to the services of labor and land, in so far as it is not absorbed by the fall in the price of the product (Chapter IV). But the following circumstances prevent this temporarily and cause the temporary fall in real income which is actually shown by statistics, while the rise finally to be expected in conformity with our theory is usually overshadowed in reality by the appearance of the next boom.
(a) First, the facts which we have called the uncertainty and apparent irregularity of the data and events in the period of depression, still more the panics and errors of the abnormal course of events, upset many firms and reduce others to idleness for a time. This must result amongst other things in unemployment, the essentially temporary character of which does not alter the fact that it is a great and under certain circumstances annihilating misfortune for those concerned, and that the fear of it — simply because of the incalculableness of its occurrence—contributes substantially to the atmosphere of depression. This unemployment is typical of periods of depression and the source of panic offers of labor, thus resulting in the loss of much ground previously gained by trade-union action and sometimes, though not necessarily, in a severe pressure on wages, the effect of which may be greater than might be thought from the number unemployed.
(b) From these things we must distinguish the fact that the new enterprises either completely eliminate the old businesses or else force them to restrict their operations. As against the unemployment so caused there is, to be sure, the new demand for the labor which is to carry on the new businesses. How much this demand often outweighs the unemployment created is shown by the example of the railway and the stage-coach. But this is not necessarily so, and even if it is so there may be difficulties and frictions which, with the incomplete functioning of the labor market, weigh disproportionately heavily in the balance.
(c) The new demand for labor mentioned above which springs up when prosperity is under way also loses in importance because of the fact that the entrepreneurs' demand for the labor which has created the new investments eventually ceases.
(d) As a rule the boom finally means a step in the direction of mechanising the productive process and hence necessarily a diminution of the labor required per unit of product; and often, though not necessarily, it also involves a diminution of the quantity of labor demanded in the industry in question in spite of the extension of production which occurs. Technological unemployment is thus shown to be a component part of cyclical unemployment, and should not be contrasted with it as if it had nothing to do with the cycle.
This element of practically every depression spells great and painful, but in the main only transitory, difficulties.31 For the total real demand for labor cannot in general permanently fall, because, neglecting all compensating and all secondary elements, the expenditure of that part of entrepreneurial profit which is not annihilated by the fall in prices necessarily more than prevents any lasting shrinkage. Even if it were expended solely on consumption it must be resolved into wages — and rents, for I repeat that everything said here holds good theoretically for them too. When, and to the extent that, it is invested, an increase in the real demand for labor takes place.
(e) The boom, directly or in its effects, can permanently lower the real demand for labor in only one way: if in the new combinations it shifts the relative marginal significance of labor and land which obtained in the old productive combinations sufficiently to the disadvantage of labor. Then not only the share of labor in the social product but also the absolute amount of its real income may permanently fall. Practically more important than this case — but again not necessarily of a permanent nature — is a shift in the demand in favor of produced means of production already in existence.
With this qualification, then, we return to our conclusion that the economic nature of depression lies in the diffusion of the achievements of the boom over the whole economic system through the mechanism of the struggle for equilibrium; and that only temporary reactions, which are only in part necessary to the system, overshadow this fundamental feature and produce the atmosphere expressed in the word depression as well as the repercussion which even those indices exhibit which do not (or not exclusively) appertain to the sphere of money, credit, and prices, and do not simply reflect the automatic deflation characteristic of periods of depression.
§ 6. The outbreak of a crisis initiates an abnormal course of events or that which is abnormal in the course of the events. As has been mentioned, it raises no new theoretical question. Our analysis shows us that panics, bankruptcies, breakdowns in the credit system, and so on need not but may easily appear at the point where prosperity turns into depression. The danger persists for some time, but it is smaller the more thoroughly the process of depression has done its work.32 If panics occur, then errors, which are first made in such a situation or are merely thrown into relief by it, states of public opinion, and so forth become independent causes, which they could not have been in the normal course of events; they become causes of a depression which exhibits different features and leads to different final results from the normal. The equilibrium that is finally established here is not the same as that which would otherwise have been established. The blunders and destruction cannot in general be corrected and repaired again, and they create situations which in turn have further effects, which must work themselves out; they mean new disturbances, and enforce processes of adaptation which would otherwise be superfluous. This distinction between the normal and abnormal course of events is very important, not only for the understanding of the nature of the thing, but also for the theoretical and practical questions connected with it.
We have seen — in contrast to the doctrine which sees in the business cycle essentially a monetary phenomenon or one which has its root in bank credit, and which is to-day especially associated with the names of Keynes, Fisher, and Hawtrey and with the policy of the Federal Reserve Board — that neither profits in a boom nor losses in a depression are meaningless and functionless. On the contrary, where the private entrepreneur in competition with his equals still plays a part, they are essential elements of the mechanism of economic development and cannot be eliminated without crippling the latter. This economic system cannot do without the ultima ratio of the complete destruction of those existences which are irretrievably associated with the hopelessly unadapted. But the losses and destruction which accompany the abnormal course of events are really meaningless and functionless. Justification of the various proposals for a prophylaxis and therapy of crises chiefly rests with them. The other sound starting point for remedial policy is the fact that even the normal — still more the abnormal — depression implicates individuals who have nothing to do with the cause and the meaning of the cycle, above all the workers.
The most important remedy à la longue, and the only one which is exposed to no objections, is the improvement of business cycle prognosis. The ever-increasing familiarity of businessmen with the cycle is, together with progressive trustification, the chief reason why the real crisis phenomena — events like the World War and times like the post-war period do not belong here — are becoming weaker.33 The postponement of new construction by government enterprises or by great combines to periods of depression appears from our standpoint as a moderation of the consequences of the swarm-like appearance of new combinations and as an attenuation of the inflation of the boom and the deflation of the depression, hence as an effective means of alleviating the cyclical movement and the danger of crises. An indiscriminate and general increase in credit facilities means simply inflation, just as does a régime of government paper money. It may possibly obstruct completely the normal as well as the abnormal process. And it encounters not only the anti-inflationary argument in general, but also the argument that it destroys that measure of selection which can still be ascribed to the depression, and burdens the economic system with the unadapted and with those firms which are unfit to live. In contrast with this, credit restriction, which is usually undertaken by the banks unsystematically and without much foresight, appears in the light of a policy which is at least open to discussion, the policy of curing the evil by letting its acute consequences run their course. This procedure could be supplemented by other measures which would make it difficult for individual producers to resist the necessary fall in prices. But a credit policy is also conceivable — on the part of the individual banks as such, but still more on the part of central banks with their influence upon the private banking world — which would differentiate between the phenomena of the normal process of the depression, which have an economic function, and the phenomena of the abnormal process, which destroy without function. It is true, such a policy would lead far into a special variety of economic planning which would infinitely increase the influence of political factors upon the fate of individuals and groups. But this involves a political judgment which does not concern us here. The technical prerequisites for such a policy, a comprehensive insight into the facts and possibilities of economic and cultural life, although theoretically obtainable in time, are at present undoubtedly not available. But theoretically, it is of interest to establish that such a policy is not impossible and is not simply to be classed with chimeras or with measures which are by nature unsuited to attain their ends, or finally with measures the reactions to which necessarily more than compensate for their direct effects. The phenomena of the normal and of the abnormal course of events are not merely distinguishable conceptually. They are in reality different things; and with a sufficiently deep insight, concrete cases even to-day may generally be recognised immediately as belonging to the one or the other. Such a policy would have to distinguish, within the mass of businesses threatened by disaster in any given depression, those made technically or commercially obsolete by the boom from those which appeared to be endangered by secondary circumstances, reactions, and accidents; it would leave the former alone, and support the latter by granting credit. And it might be successful in the same sense as that in which a conscious policy of racial hygiene might lead to successes unobtainable as long as things are left to work out automatically. In any case, however, crises will disappear earlier than the capitalist system, whose children they are.
But no therapy can permanently obstruct the great economic and social process by which businesses, individual positions, forms of life, cultural values and ideals, sink in the social scale and finally disappear. In a society with private property and competition, this process is the necessary complement of the continual emergence of new economic and social forms and of continually rising real incomes of all social strata. The process would be milder if there were no cyclical fluctuations, but it is not wholly due to the latter and it is completed independently of them. These changes are theoretically and practically, economically and culturally, much more important than the economic stability upon which all analytical attention has been concentrated for so long. And in their special way both the rise and the fall of families and firms are much more characteristic of the capitalist economic system, of its culture and its results, than any of the things that can be observed in a society which is stationary in the sense that its processes reproduce themselves at a constant rate.
1 I have since published on the subject, apart from the article in the Zeitschrift für Volksw. Sozialpol. und Verw. (1910), the article “Die Wellenbewegung des Wirtschaftslebens,” Archiv für Sozialwissenschaft und Sozialpolitik (1914). To this day my theory of crises is cited chiefly from this article. It was also expounded in 1914 in a lecture at Harvard University when in formulation and in the factual foundation — but without any essential change — a step beyond this chapter was taken. Furthermore, there is an article “Kreditkontrolle” (ibidem, 1925) which was primarily concerned with other things; and “Oude en nieuwe Bankpolitiek” in the Economisch-Statistischen Berichten (1925), which likewise barely touches the fundamental question. I expounded this in detail in a lecture at the Handelshochschule in Rotterdam in 1925. Finally, for a short exposition see “The Explanation of the Business Cycle,” Economica (1928).
2 In the Festschrift for Brentano, 11, 351,
3 Cf. his distinguished work, “Konjunktur und Krisen,” in Grundriss der Sozialökonomik, vol. IV, pt. I, p. 368.
4 The new formulation in Chapter II also clears up Loewe's objection, which he expresses with the concept of the “half-static” businessman.
5 Cf. his more recent expositions, above all the article “Krisen” in the Handwörterbuch der Staatswissenschaften, but also the exposition in the Hamburger Wirtschaftsdienst (1926), Heft 1, and his lecture, “Moderne Konjunkturforschung,” before the “Freunde und Förderer der Universität Bonn.”
6 Always less, of course, the more trustification progresses.
7 By this we do not mean the elaborated overproduction theories but only the popular reference to this element.
8 Not only do the crisis-like phenomena at the outbreak of the World War belong here, but also the post-war crises of all countries, the nature of which, moreover, is not exhaustively rendered by the catch-phrase “stabilisation crisis” or “deflation crisis” as the case may be.
9 This discovery and the full perception of its consequences are due to Clément Juglar.
10 By which I mean that this part of our argument must be simply taken for granted by every theory of crises. For even if otherwise free from objection, none explains precisely this circumstance.
11 Good harvests, for example, facilitate and lengthen the boom, or alleviate and shorten the depression. They are often important in explaining an individual situation: so much H. L. Moore has certainly demonstrated. But they are never coordinate with our causal nexus; they only operate through it.
12 In particular, all the circumstances which in other theories of crises act in the capacity of causes find their place within the framework of our theory, as the reader can easily see if he is inclined to think the matter through. In this book, of course, our explanation of the cycle always remains exposed to an objection similar to the one made against the theory of development in Chapter II, namely, that it emphasises one-sidedly and exaggeratedly one element out of many. This objection confuses the problem of explaining the nature and mechanism of the cycle with the problem of a theory of the concrete factors of individual cycles.
13 Which of course does not mean that the practical importance of the element of error is denied, nor that of the elements which are usually designated by speculative fever, fraud, etc. — in which category overproduction also belongs. We assert only that all these things are in part consequential and that even in so far as this is not the case the nature of the phenomenon cannot be understood from them.
14 For the elimination — mostly foreseen — of entrepreneurial profit is not “the” cause in our theory of crises. Cf. § 3, second paragraph.
15 Hence it hardly needs to be emphasised that our theory does not belong to those which seek the cause of the cycle in the money and credit system, however important the element of the creation of purchasing power is in our interpretation. Nevertheless, we do not deny that cyclical movements could be influenced and even prevented by credit policy — with them, indeed, also this kind of economic development in general.
16 In principle rents must also rise. But where land is let on a long lease they cannot do so, and in addition many circumstances prevent the prompt rise of this branch of income.
17 Nor in the fact that the consequent general extension of production proves to be wrong.
18 This time is determined first technically, then by the tempo in which the multitude follow the leaders.
19 This fall in prices is in practice generally postponed through many circumstances. Cf. infra on this. However, the underlying state of affairs is only accentuated, not eliminated, by the postponement of the fall in prices. The only thing eliminated by it is the serviceableness of price indices as symptoms of the cycle.
20 Primary causal rôle, because the credit restriction initiated by the banks is certainly the “cause” of further occurrences which would not otherwise be expected.
21 The phenomenon now under discussion is to be distinguished from the diminished investment involved in the contraction of credit by debt liquidation. The investment for additional new purposes is meant here. And the statistics of the issue of stocks and bonds, which are in practice such a good business index (Spiethoff), reflect mainly, though not only, a third element: the consolidating of bank credit by means of savings.
22 Every theory of crises in which overproduction plays the part of one, or even the primary, cause seems to me to be exposed to the objection of reasoning in a circle (quite apart from the objection already formulated by Say), even if it does not assert “general overproduction.” From this judgment I must exclude Spiethoff's theory. The very short arguments with which he tries to substantiate the periodical overproduction of goods for reproductive consumption allow no final judgment. Moreover, it is to be observed that Spiethoff's aim is a penetrating analysis of all the details of the subject. For such an analysis, the elements governing the external picture — the stagnation in industries producing means of production certainly belongs here — are really much more important in relation to the primary causes than for an exposition such as this. Finally, there is in the emphasis upon industries producing means of production a reference to the factors which in my opinion constitute the nature of the problem, so that it is by no means correct to describe Spiethoff's analysis as simply an overproduction theory; a more detailed exposition of his theory would perhaps show still more far-reaching agreement than I now suspect.
23 Les crises périodiques de surproduction, livre 1. To be sure, the other fact, different from the one we have in view here, that the cyclical movement is always particularly strongly marked in the industries producing new plant, stands out much more clearly. It is likewise intelligible from our standpoint. Of course this does not contradict the interpretation here presented, rather the contrary.
24 We have twice spoken of the boom's effects in increasing costs: first entrepreneurs' demand drives up the prices of production goods, then the following demand of all people who ride on the secondary waves of development do so still further. These increasing costs have nothing to do with the secular rise asserted by the classical economists on the basis of their assumption of the progressive outstripping of the possibilities of producing means of subsistence by the increase in population. Now the decreasing costs in question above are not the complement of these increasing costs in money. They are the consequence of the productive progress realised by the boom, and signify a fall in real costs per unit of product, first in the new enterprises as against the old, then also in the latter, since they must either adapt themselves — for example by reducing their output and confining themselves to the best possibilities — or disappear. After every boom the economic system as such produces the unit of product with less expenditure of labor or land.
25 Of course the post-war depression was not normal. In my opinion it is a mistake to try to read general results of the business cycle theory into the post-war material. But it is a mistake often made. Thus, many a judgment of the modern therapeutists of crises by means of credit policy is explicable by the fact that they assert of the normal cyclical movement what is only true for the post-war crisis.
26 Cf., for example, those of the Verein für Sozialpolitik, or the English reports in the time of predominant depressions before 1895, say the famous Third Report on the Depression of Trade. Accurate investigations are only of more recent date, as for example in the Special Memorandum No. 8 of the London and Cambridge Economic Service (by J. W. F. Rowe), or, for America, the data and estimates in the Report of a Committee of the President's Conference on Unemployment. An interesting method, which leads to the same result for the year 1921, although this was not simply a year of depression (cf. the preceding note), is due to C. Snyder (in Administration, May, 1923).
27 Likewise it is not necessary here to go into the different degrees in which the depression affects different industries — for example luxury industries more than those producing foodstuffs. What there is of theoretical interest in this has already been touched upon in various places in this chapter.
28 The statistical verification of this theory encounters various difficulties. First of all our data on the retail prices of the articles consumed by the workers do not go far enough back with the desirable completeness — and the mere movement of money wages of course means nothing; it would substantiate our thesis, it is true, if one were to be content with it. The measurement of the extent of employment is still less satisfactory, and yet we cannot do without it. As far as I know it was not possible to measure short-time work at all before the war, and complete unemployment only with the help of trade-union data and occasional censuses. To-day the attempt would be more successful, but for reasons already mentioned only pre-war figures come into consideration for our purposes. We now have a work which tries to find just what we need, namely that by G. H. Wood, “Real Wages and the Standard of Comfort since 1850,” Journal of the Roy. Stat. Soc. (March, 1909). It extends to 1902 and confirms our expectation. However, at the turn of the century that non-cyclical and in this sense secular price movement appeared which distorts the picture, and also involves an aberration of the lines of the cyclical movement. According to Professor Bowley's continuation of Wood's work and also according to the work of Mrs. Wood in “The Course of Real Wages in London 1900-1912,” J. Roy. Stat. Soc. (December, 1913), and to A. H. Hansen in “ Factors Affecting the Trend of Real Wages,” Amer. Econ. Review (March, 1925), which are not, it is true, concerned with the extent of employment, the theory does not fit the facts. But it is easy to see that our conclusion would be verified if the secular rise in prices were eliminated. Upon the question of the connection between gold-production and wage level cf. Pigou in the Econ. Journal (June, 1923).
The argument which now follows in the text is adequately supported by the figures. Real wages regularly fall in depression, yet only by a part of the amount which they had gained in the boom. This is exactly what we should expect.
29 Impoverishment and its consequences and hence also, in the case of an approximately constant quantity of means of payment, relative inflation would appear even without the employment of inflationary financial methods. The text refers to that intensification of the effects which paper money or credit inflation carries with it.
30 This new concept means here simply demand expressed in units of an ideal standard which undergoes no cyclical changes of the kind due to changes in the quantity of circulating media; hence it only indicates real changes in the total demand for labor and not those which are merely nominal.
31 Cf. on this my article “Das Grundprinzip der Verteilungslehre,” Archiv für Sozialw. und Sozialp. (Bd. 42).
32 As the depression continues, the danger of a collapse of the economic system and of its credit structure becomes continually slighter. This statement is compatible with the fact that most bankruptcies do not occur exactly at or near the turning point but only later, sometimes only when the danger to the economic system is past. For even the mortal wounding of a firm does not necessarily cause immediate flight to the bankruptcy court. On the contrary, everyone resists it as long as possible. And most firms can for a longer or shorter time. They themselves hope — and with them their creditors — for more favorable times. They deliberate, resort to shifts, seek new supports, sometimes with success, sometimes at least with such success that liquidation by consent is possible — more frequently, it is true, without success, but even then the death struggle results in postponing the bankruptcy or reorganisation, often into the next upward movement so that the drowning takes place in sight of dry land. This is not the result of new disasters, the danger of which actually falls progressively, but is the final consequence of those which happened long ago. Here, as elsewhere, we have to do with primary causes and the characteristic feature of the explanation, not with the question of when causes become visible. This creates an apparent discrepancy between our theory and observation. But every such discrepancy can only become an objection if it is shown that it is not satisfactorily explained.
33 Increasing foresight also weakens the normal cyclical movement. It cannot prevent it, however, as will be recognised if our argument is scrutinised from this point of view. Therefore T. S. Adams goes too far when he states: “To anticipate the cycle is to neutralise it.” It is different with the element mentioned earlier (§ 2, b, “fourthly”) that in the course of time economic development becomes continually more a “matter of calculation” (Rechenstift). This element is something different from the familiarity and foresight of which we are now speaking. It also mitigates the cyclical movement, but for another reason: it tends to eliminate the fundamental cause of the boom and therefore acts much more slowly, but in tendency much more completely, than the mere anticipation of the course of the cyclical movement — which as long as the cause exists is nevertheless unavoidable. It is different again with trustification: this mitigates the normal and abnormal course of events for the same reasons.