§ 18. The Effects of Crises and Cycles

Under trade-cycle policy we understand the totality of all measures by means of which it is sought to remove, or at least to mitigate, crises and cycles. There are here two questions involved. The first is, should we combat crises and cycles? and the second, can we combat them? It is evident that the first question must be answered before the second, and the answer to this question depends on how we judge the effects exerted by crises and cycles in the economic, social, and financial sphere.

It will seem to many strange, and will be considered sheer academic pedantry, that we should even raise the question whether we ought to counteract the phenomena of economic fluctuations by suitable means, at a time when not so long ago the recovery from the depression with its ever-growing destruction stood unchallenged on the peak of all desires and endeavours. In fact, it is very widely held to be a proposition needing no further proof that economic fluctuations are to be regarded as an evil which should in all circumstances be combated. But this attitude tends to overlook the fact that the boom belongs to the cycle just as much as the crisis and depression, and it ignores, moreover, the fact that the boom constitutes the fertile soil on which the crisis and depression are raised. If we think that the crisis and depression should be combated, then we must be prepared to sacrifice the boom in the same measure as we want to modify the later reaction. Thus, instead of its being a matter of course, we are obviously faced with a serious problem of weighing up against each other the assets and liabilities of the whole cyclical process.

The discussion finally reduces itself to the philosophical resignation that a price must be paid for everything in this world. If we want to have the acceleration of economic development which takes place during the boom, we must be ready to pay the price of the later reaction with its losses and social misery, and if, conversely, we want to avoid this reaction (crisis and depression), then we must renounce the period of accelerated economic advance. The ultimate dilemma is this: Do we prefer calm and steadiness or a quick tempo of economic progress? Comfortable stability or discontinuous outbursts of energy? It is just the same as with our own mortality and other things which we cannot change: we must face the fact that we have to decide between stability and expansion and that we cannot attain both at once. The final decision is a political one, that is, it is dependent on valuations which are subjective and have no universal validity. The task of science is to bring together all the considerations which are indispensable in making a final judgment.

In commencing with the positive functions of the cyclical movement, we may recall that we have already described it in a previous section as the form in which, in the capitalist economy, the economic development towards the perfection of the technique and organization of the apparatus of production and exchange typically takes place (see § 14). If—to vary slightly the celebrated words of the “Communist Manifesto” of Marx and Engels—“capitalism has first shown what human activity can accomplish,” if “it has achieved miracles altogether different from Egyptian pyramids, Roman aqueducts, and Gothic cathedrals, and has carried out other expeditions than migrations and crusades,” then it is the spasmodic outburst of the ardent spirit of entrepreneurship and its financing by a periodic credit expansion which has made capitalism capable of this incomparable historical feat. If, for example, we had waited for the construction of the modern railway network until the necessary means had been scraped together without a temporary speeding up of the economic process by inflation, then a railway journey would undoubtedly still be for us just as much a sensation as it was for our grandfathers fifty years ago. And what is true of railways is true also of all the other advances in technique and organization of the last hundred years: their swift diffusion always takes place in the framework of a boom on which a reaction invariably follows. The boom may be described as a period in which all the reserves of power of the economic system are mobilized for the purpose of accelerated economic progress. It is, so to speak, a periodic “Five Year Plan,” and for a hundred years past it has anticipated the fundamental ideas of the concentration of investment underlying the Russian Five Year Plan.¹ The cyclical movement is, therefore, not the senseless consequence of capitalist libertinism, but a process with a quite definite positive function.

This positive function is somewhat concealed by negative effects which are representative in their totality of the price we have to pay for the speeding up of economic development. These negative effects cumulate in the crisis, or at any rate the depression, which actually takes its origin from the positive function of the boom. The latter thus brings in its train a period of economic losses all round, a shrinkage of the volume of production and trade inflicting on the majority of the population a grievous diminution of their general welfare. The diminution of wealth can, as the present depression very forcibly shows, reach such proportions that the impoverishment of large classes of the population shakes the foundations of the economic and political structure.

In the forefront of these unfavourable effects of cyclical fluctuations comes the effect on unemployment. Even the most zealous eulogist of the positive functions of the cyclical movement must admit that the alternation from over-work in the boom period to unemployment in the depression is a social evil of the worst kind. The trade cycle is, if not the sole, at least the main source of unemployment, that scourge of modern industrial countries.² How pernicious this is is only recognized to the full when we realize that it is not so much the average level of wages as the danger of unemployment and the uncertainty that it introduces into the economic future of the wage-earner, which is the real social problem of our time. In so far as a dampening down of cyclical fluctuations promises the diminution of unemployment, trade-cycle policy becomes one of the most important measures of social policy. This includes such measures as are intended, without influencing the cycle itself, to alleviate the economic, social, and moral effects of unemployment. These will be dealt with separately in a later section.

Unemployment is a reflection of the monetary and material losses and the general contraction of economic activity which characterize the crisis and depression. Corresponding to the dismissed workmen, there are the closed workshops, the rusting machines, a mass of failures and bankruptcies with all the human tragedies bound up with them, the redistributions of incomes and wealth (in proportion to the dimensions of the boom) which take place irrespective of guilt or merit. Finally, there is a series of more remote effects among which special attention may be drawn to the decline in the figures of marriages and births, the rise in the death-rate, the fall in the standard of living, the increase in criminality, and, lastly, the intensification of social and political unrest. The net result of all these phenomena of the crisis and depression is that a large part of the economic ground gained in the boom has to be given up in the depression. Indeed, it may even happen, as the present depression bears witness, that through the convergence of all the most unfavourable circumstances the general economic level falls far below the position that had been reached before the commencement of the last boom.

The cycle has especially important effects on national budgets.³ It will be obvious that the boom must tend to increase exchequer receipts (particularly the yield of taxes that are especially sensitive to the cyclical movement) corresponding to the increase in the volume of production, trade, and income, while in the crisis and depression they fall. The expenditure side also is not unaffected by cyclical fluctuations. During the boom there is a steady fall in certain classes of expenditure, especially social expenditure, but this is counterbalanced by other expenditure and by the fact that in this period of increasing national income, increasing exchequer receipts and optimistic public feeling, the Government and Parliament usually manifest a very liberal spending mood which leads not only to the using up of the original surpluses but often even to State borrowing. We shall later show that this inflation of expenditure by State borrowing during the boom is just the opposite of a rational cycle policy.

In the depression the reverse takes place: on the expenditure side the slight tendency to an automatic fall through the reduction in the prices of materials bought by the Government is very much more than surpassed by such increases in expenditure as arise from the tasks falling to the lot of the State in the depression (unemployment relief, assistance to the banks, &c.). But since exchequer receipts fall off in the depression, the Government now seeks to maintain budgetary equilibrium by reducing any expenditure that can possibly be dispensed with, and so far as the reduction in expenditure is insufficient, it tries to tighten up the tax screw. The reduction of expenditure and increase in the burden of taxation are, however, elements which accentuate the depression so that the budgetary policy during the depression sets up a vicious circle in which the budgetary crisis and the economic crisis become increasingly intermingled especially as the budgetary crisis is a new source of pessimism and lack of confidence. Eventually a point is reached when even the severest retrenchment and the most vigorous screwing up of taxation can no longer ward off a deficit and, despite the canons of budgetary equilibrium, recourse must be had even for ordinary regular items of expenditure, to State loans, or, where even this is no longer possible, to the printing press. This point approaches nearer with the progressive growth in the difficulties of maintaining exchequer receipts in face of the general economic contraction. The development in most countries during the present depression gives abundant proof of this, the most conspicuous example at the present moment being the case of France, Holland, and Switzerland.

The fatal interaction between financial crisis and economic crisis has been particularly noticeable in Germany. It is to-day generally acknowledged that it was an unpardonable mistake to allow the expenditure of the Reich as well as the States and municipalities to rise so high in the boom years (1927-1929) that the budgetary surplus after the stabilization of the mark was almost immediately transformed into a deficit, of which the chief danger lay in the increase in the floating debt. The way in which, from the point of view of financial technique, this to-day simply incomprehensible budget deficit in the main came about was that the expenditure in the extraordinary budget (public works programme) was enormously increased and it was not found possible to cover this expenditure out of the proceeds of loans. Thus Germany entered the depression with a budgetary position that was already undermined and from which the necessary consequences of a vigorous reduction of expenditure and an increase in taxation had not been drawn in time.

The continued difficulties of the Treasury put an excessively heavy burden on the money market while the political and psychological reactions of the financial crisis, which in spite of the ever-optimistic declarations of the Government could no longer be concealed, contributed their part also to the aggravation of the economic crisis. It should not be forgotten that it was the German financial confusion that determined the fatal political development of 1930, ending in the election of the 14th September 1930, which was so destructive of business confidence. In the later phase of the depression the Brüning Government made repeated and temporarily successful attempts—by emergency decrees of increasing drasticness—to maintain the budget equilibrium by retrenchment and the tightening up of the tax screw. But here also the fatal interaction between financial contraction and economic contraction manifested itself. And since under the German system of unemployment relief the increasing length of the period of unemployment threw a constantly growing section of the unemployed on to the local authorities for poor relief, the financial needs of the local authorities also rose to an ever more threatening scale. Despite positively heroic efforts to preserve budgetary equilibrium, it proved an altogether impossible task to avoid a total budget deficit (of the Reich, the States, and the municipalities) running into billions.

It is difficult to see what more could have been done in Germany by way of retrenchments and tax-raising, and yet the result was that after a while a new budget deficit presented itself. It may be likened to the battle with the Hydra, two ghastly heads always growing in the place of the one cut off. It is a well-known fact that the drastic financial policy of the Brüning era—honest to be sure, and passively courageous but none too ingenious—paved the way for Hitler. Thus the ultimate outcome was that what—namely, an expansionist economic policy—should have been done wisely and with a skilled hand, was now done under political and economic conditions which were liable to exclude any chance of lasting success. This should be a lesson to all other countries, which, like France, Switzerland, and Holland, are at the present moment following more or less the same policy as Brüning, though it is to be conceded that the general economic and political conditions in these countries are different.

This high degree of cyclical sensitiveness of State budgets observed during the present depression, is the result of a rather recent development. If we look back at earlier depressions, it is remarkable how little the public finances have been affected. In England good examples are provided by the severe crisis of 1857, which left almost no trace on the budget, and the long depression of the ’seventies, which was even accompanied by budget surpluses which were so considerable that it was possible steadily to lower the income tax (from 6d. in the £ in 1872 down to 2d. in 1875). The reason for the change from those happier days to the present time is, of course, to be found in the fact that the percentage of the national income claimed by the State has tremendously increased, especially since the Great War, and this, in turn, is an expression of the strikingly increased importance of the State in all its activities and of the growth of interventionism in economic policy. As rough approximations, it may be said that the percentage of the national income claimed by the public authorities rose, from 1913 to 1928, in Great Britain from 12 to 25, in Germany from 16 to 28, in France from 18 to 24, in the United States from 8 to 15, and in Italy from 16 to 31.⁴ It is obvious that the higher the percentage the more the State budget is bound to follow the fluctuations of the national income. The reasons for this are primarily two: firstly, with the growth in the size of the budget, recourse has more and more to be had to taxes with a high degree of cyclical sensitivity (e.g., turnover taxes, income taxes, business taxes, taxes on stock exchange transactions, taxes on luxuries, &c.), and, secondly, with the growth of the economic and social responsibilities of the State an increasing percentage of State expenditure is characterized by a high degree of (inverse) cyclical sensitivity, especially the expenditure on social relief and the like. Summing up, we may say that the growth of Etatism and Inventionism has given to the State budget an increasing degree of cyclical sensitivity, rendering it more and more dependent on the fluctuations of the national income and raising its importance as an integral part of the national economic structure. The gravest consequence of this at present is the fact that the course which the public finances, owing to their high degree of cyclical sensitivity, follow during the depression react in turn very ominously on the shrinkage of the national income on which for good or ill they also depend. Consequently the growth of the State, its power, and its continual interference has added tremendously to the top-heavy sensitivity of our entire economic system. To put it bluntly, capitalism has been made more unstable and more sensitive precisely by something very dear to the hearts of those who never tire of blaming capitalism for this.

We have still not completed the debit side of the account of cycles and crises. There has, finally, to be added the circumstance which was earlier rather neglected, but which has come into the limelight at the present time, that the phenomena of economic contraction of the depression give rise to State intervention which obstructs the economic system for a long time after the recovery from the depression. Thus modern protectionism in particular has resulted in large part out of protective tariff measures seized on in time of depression. It is always in bad times that the cry for separation from abroad and protective tariffs is loudest, and that this cry finds the most willing listeners among the Government, Parliament, and the public. If it is doubtful whether protective duties are the right way for any individual country to alleviate the crisis or at any rate its consequences, there is no doubt at all that if all countries follow this policy it only aggravates the situation. But this is invariably just what actually happens, giving rise to a new vicious circle which is the more thoroughly to be condemned since protective duties, once introduced, tend to have an extraordinarily tenacious existence. For this reason the present splitting up of the world economic system by tariff walls and import regulations which tower sky-high and a barbed-wire entanglement of foreign exchange regulations is perhaps the most dangerous and most serious of all the effects of the depression.

The present economic depression shows in other spheres also, how, under the pressure of necessity, Government intervention is undertaken which changes the structure of the economic system so radically that the traces will still be visible long after the depression itself has been overcome. We need only to think of the important changes which the banking system has experienced under the measures of State support in Germany, Italy, and Austria, and we are still far from certain that the present depression will not call forth still further structural changes which will shake the capitalist system to its foundations. Without doubt the present depression is unique in every respect, but it shows in particularly striking fashion to what cataracts one may be driven if one leaves the cyclical stream to run its course.

If we sum up the result of all these considerations, it might turn out, in spite of due account being taken of the positive function of the cyclical movement as the great motive force of economic development, that so soon as the cyclical fluctuations overstep a certain level the evil far outweighs the good. Since, as things are, we should not raise our hopes of a dampening down of cyclical fluctuations too high, there is no reason why the apprehension that we may possibly destroy the machinery of economic progress should hinder us at the outset from weighing up and recommending measures of trade-cycle policy. The much greater and more pressing care is the opposite: that we may not succeed in finding the correct and effective means of freeing the capitalist system from those disturbances which constantly threaten its existence and hinder the full development of economic welfare of which it is capable. This is the biggest and most difficult task facing economists. We cannot give its solution here, but can only indicate the direction in which with our present-day knowledge this solution is probably to be sought.