The Idea of Proportionate Flows Applied to Wages: the Great Depression

The Great Depression of the 1930’s has been very thoroughly gone over in the literature and there would be no need to mention it here except that it is necessary to describe it in terms of the concepts presented in these posts and to link it with the present day.

Consider the case of the industrialised nations in the early 1930’s, and fifty years later.

There is an achievable optimum relationship of wages to net-throughput (Tn). Wages rose more slowly than Tn for years after the First World War, so that wages came to be too small a fraction of Tn.

However, a sustained “boom” of rapidly increasing throughput, enabled by new technology whose development had been stimulated by the war, caused rising expectations and a high level of confidence. These factors combined with the wage deficiency to give rise to excessive private borrowing and unsound speculation in an attempt to close the gap between cash income and desired purchasing power.

With too little money flowing through the wages channel, a spurious effect was created where money flowing through the consumer spending channel was more nearly sufficient in proportion to the other channels. The catch was that too much of this money that should have been wages was lent and had to be given back, with interest.

Businesses borrowed excessively too, not because their profits were too low, but because of the other two factors: expectations and confidence.

Eventually a point arrived where business and consumers’ debt was so excessive a fraction of expenditure, and stocks and shares were so hugely overpriced, that the whole distorted structure crashed and collapsed.

A realisation that stocks and shares were grossly overvalued led to a selling panic that could not be stopped before near rock-bottom. Much of this stock had been bought on “margin”, a form of buy now, pay later. This added to the huge load of debt that could not now be paid back.

Over-borrowing had been accompanied by over-lending, caused by the same high expectations and buoyant confidence. So banks found themselves with so much bad debt as to cause the loss of savings and of accumulated profits.

Where did the money go? Much of it didn’t exist. The collapse of 1929 stripped away the spurious apparent proportionate flows of money through the various channels and left the bare reality – too little money in the consumer spending channel, too much idle money not being borrowed or spent.

With people and businesses unwilling and in any case unable to borrow, very much inclined to save, and wages being generally too low compared to the value of work performed in exchange for them, there was downward pressure on prices.

This led to a drop in throughput, due to the operation of other variables that require goods and services to command a certain minimum money price to make their structuring worthwhile.

The falling throughput led to rising unemployment, further reducing aggregate demand and throughput itself. The throughput level is not, as currently believed, the sole determinant of the unemployment rate, but under the conditions of the Great Depression it was a major determinant.

An equilibrium was reached at a high level of unemployment, a low throughput rate not tending to increase, and wages for much of the working population not far above subsistence level.

Meanwhile, too much money had been flowing into the savings channel – not because profits and savings were extraordinarily high, but because the rate of saving and profit accumulation was higher than the rate of lending for business investment, government spending, and private consumption.

“Boom” conditions and high confidence make people more inclined to borrow, and banks more inclined to lend, in the latter case even to a greater extent than their available funds would justify; while in Depression conditions, people are more inclined to save, even if this means scrimping on necessities; and banks are less inclined to lend, even if they are well funded.

Governments were committed to the idea of balanced or surplus budgets as the road to economic health, and were not willing to borrow. Business borrowing for investment was low, in line with the low marginal efficiency of capital.

At that time, there was in conventional terms “under-consumption”. Put another way, there was a mismatch between two links of the throughput chain, between structuring of wealth into goods and services and the subsequent use and degradation of these.

Of course the goods and services were not in general being structured faster than they were being consumed; the point was that the rate of consumption that aggregate demand made possible was lower than the rate of structuring of goods and services that available workforce, technology, loanable funds, and resources wealth made possible.

In the equilibrium state mentioned earlier, purchasing power was just sufficient to buy the goods and services being structured at prices just sufficient to keep them being made.

It was necessary to transfer money across economic channels, to free idle money piled up in banks, and place it in the hands of consumers to set idle hands to work preparing goods and services for market. But this had to be done not by lending the money to consumers as a debt to spend now and pay back later with interest, rather by providing the money as wages to spend as one’s own money.

J.M.Keynes in his “General Theory” suggested that the money tied up in banks could be put in bottles and buried down derelict mines, after which the unemployed could be put to work digging it up.. Their spending it would boost economic activity and lower unemployment.

The bizarre nature of this scheme would make it unacceptable as policy, but in the conditions of the Great Depression it would probably have achieved the desired result.

The task was to find a scheme equivalent in substance and effect, which had a more acceptable form.

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