5. Don’t Predict Postwar Deflation—Prevent It!*

The country is swamped with predictions about Postwar Business. They run all the way from lasting prosperity to hopeless depression. How much weight should be attached to these predictions?

In this author’s opinion their value is very limited. All estimates about how many millions of workers will be released and how many can be reabsorbed by industry after the end of the war must be considered highly questionable. The respect they command in this country—more than elsewhere—is not justified. Unlike communist and Fascist economies, a free economy is directed not by government orders but by the calculations, hopes, and fears of millions of people; the objective conditions with which these people will have to reckon, and—even more—the subjective reactions are as unpredictable as the future in general. Therefore, estimates of future billions of working hours, of the national income, and of the goods to be produced are nothing but a toying with figures. There is little that is scientific about such estimates. All calculations of the so-called deflationary gap—the gap between the purchasing power needed for the maintenance of full employment and the purchasing power to be counted on—will prove to be fallacious; as fallacious as all the calculations of the inflationary gap during World War II have proved to be; and postwar planning based on such specific calculations will turn out to be impractical.

During the last few months the proponents of the pessimistic school of thought—which predicts depression and deflation—seem to have gained in popularity. This line has been adopted by an important group of economists here as well as abroad. Lately it has been propagated by the distinguished Swedish economist, Gunnar Myrdal, in the Swedish, Swiss, and American press.

This school of thought is not only pessimistic—it is fatalistic. It describes postwar mass unemployment as something that follows more or less perforce from the working of the capitalist system. Such an approach has obvious dangers. Let us, therefore, examine the validity of its arguments a little more closely:

The arguments seem to be threefold. They are: (1) The Argument of Increased Population; (2) The Argument of Increased Productivity, and (3) The Argument of the Delayed Rising of the Standard of Living, generally known as the Oversavings Argument. They are based, at least in part, on certain factual assumptions made in S. Morris Livingston’s well-known study, Markets After the War.

THE ARGUMENT OF INCREASED POPULATION

According to Livingston, around 10,000,000 more people will be seeking jobs in 1946 than in 1940. How can these 10,000,000 people be employed? The question sounds rather distressing. It seems quite impossible to provide jobs for all these newcomers, even if the labor market absorbs the supply which existed before. However, the question in itself only shows how far the thinking of some economists, even if thoroughly acquainted with the classicists of economics, deviates from the orthodox lines of economic thinking and disregards certain basic truths.

Orthodox thinking precludes unemployment as a consequence of an increase in population. For every newcomer is not only a potential producer, but also a potential consumer. According to classical economic thinking, production and consumption equal each other. Growth of population can be the reason for unemployment only under very exceptional conditions, the most important one being lack of capital necessary for the productivity of the new labor forces. This condition certainly does not exist in our times of very low interest rates.

Unless compelling reasons to the contrary are put forward, an increase in population can never lead to unemployment.

THE ARGUMENT OF INCREASED PRODUCTIVITY

Productivity, according to Livingston, is increasing at a rate of 2½ per cent or even 3 per cent yearly. Where will the purchasing power and the demand come from to absorb the output increased by the higher productivity of labor, once the government no longer requires more than half of the national production? Will the management of industry suggest a huge rise in wages in order to create sufficient purchasing power to absorb the output under full employment?

Let us put aside the highly controversial question whether productivity really is increasing at the presumed rate—there are authors who reach entirely different conclusions—and let us assume that the productivity of labor will have increased at the rate of 2½ to 3 per cent during the war; does this mean that unemployment is inevitable? Again, this question in itself implies the disregard of basic economic truths; it is based on a fallacy.

High productivity of labor means that labor produces more units of goods per unit of labor. Generally speaking, wages increase with the units of goods produced per hours of labor, for the simple reason that competition in industry is likely to raise wages until the extra profit of the increased productivity has disappeared. At least this is the case if the adjustment does not take place through declining prices with unchanged wages, i.e., with rising real wages, an eventuality not probable in the inflationary atmosphere of the postwar world. In no case can higher productivity result in a deficit of purchasing power. What has been paid out, chiefly in the form of wages, will be sufficient to buy the output of labor, whether large or small, because increased productivity will either force wages to rise or prices to fall. To assume that productivity of labor rises while wages remain low—or prices high—at the same time is to make two assumptions incompatible with each other; at least, this is so in a static world in which maladjustments are leveled out.

Of course, in a dynamic reality, wages can remain too low relative to labor productivity. But this would cause a boom and not unemployment, as every cost alleviation does. For new enterprises would appear profitable and would absorb elements so far unemployed. Also, wages could be too high relative to labor productivity. But this would not cause full employment—rather a depression and declining employment, as certain enterprises would be forced to close down because of too high costs of production. In a static world with which the Increased Productivity argument primarily deals, wages must be considered as adjusted to productivity. There is no reason to worry where the purchasing power for the increased product is to come from; purchasing power creates itself.

Higher productivity means higher potential wealth of the country; and a country does not suffer because of increased wealth. Therefore, the pessimistic attitude concerning the postwar economy must be considered as unjustified on this basis.

THE OVERSAVINGS ARGUMENT

Even if the Increased Population argument and the Increased Productivity argument are fallacious—that is, if the purchasing power in the hands of labor would always be sufficient to buy the whole output of the economy—even then, according to the pessimists, full employment could not be maintained: the purchasing power, although sufficient, would remain partly unspent, because the standard of living (i.e., consumption) would rise neither so rapidly nor to the same degree as is necessary to maintain full employment. This, clearly, is the well-known Oversavings argument. In our time it has been used by J. M. Keynes and his school to explain unemployment of a secular character. According to this school, modern economy has reached a state of maturity in which new possibilities for profitable investments are scarce. The economy therefore is in a chronic state of underinvestment which prevents savings from being readily absorbed; thus the resulting oversaving must lead to a deficit in purchasing power—or, as it is commonly expressed, in effective demand.

It is not possible to deal here with the highly controversial question of the validity of the oversaving-underinvestment theory; the following remarks are merely designed to show that this theory can hardly be used as a basis for such vital matters as our diagnosis of and planning for the postwar world. The factual as well as the theoretical foundation of the theory is too weak for this purpose.

The conception that the higher output of labor does not lead to a correspondingly higher consumption by labor cannot be proved to be valid over a longer period of time. Indeed, labor’s fight for higher wages can be considered as the fight for a higher standard of living. As far as the period immediately after the war is concerned, it can happen that the average person will spend more than he earns, not less, because the high cash reserves accumulated during the war allow for many an extra outlay.

However, even if we assume that underconsumption and consequently excessive savings will be a feature of the postwar period, does this necessarily mean that these savings will lead to underinvestment followed by underemployment? Here, too, it must be realized how far such an assumption deviates from the classical one—and, by the way, from common sense also. Larger savings mean a greater supply of credit to industry, therefore expansion of industry and consequently higher employment.

Quite apart from this, the assumption that our economy is mature and unable to provide new opportunities for investment has never really been proved. The phenomenon of underemployment and underinvestment before the war proves only that enterprise was averse to expanding, but it does not explain the psychological and factual reasons for this behavior. As Professor Schumpeter in his criticism of Harold L. Laski’s Reflections on the Revolution of Our Time¹ has stated quite correctly, the theory of the mature economy is nothing but the reflection of the group interest of the modern intellectual. One writer after another repeats this theory, without any one of them giving valid proofs of it.

But even if it could be proved that there are no opportunities for profitable new investments, unemployment would not necessarily follow. Professor Pigou proved this convincingly.² Even if the investment of new capital should prove to be unprofitable, the employment of additional labor could still be profitable, provided the cost of labor is not too high relative to the price of the finished product. Thus, low profitability of capital could lead to underinvestment, but not necessarily to underemployment. The number of workmen an entrepreneur can employ—capital being ample and cheap—depends on what he has to pay for labor rather than for the use of capital.

PROFITS CREATE PURCHASING POWER AND EMPLOYMENT

Does all this mean that everything will be for the best in the postwar economy? Not at all. It simply means that there is nothing inherent in the capitalist system that inevitably creates unemployment. Neither growth of population, nor increase of productivity, nor larger savings necessarily lead to depressions. A free economy does not work like a machine at a given speed. It is a living organism in which cells are born and die continually. The fact that more cells are born than die, or vice versa, influences the effective demand so greatly that all other factors are only of secondary importance. This is why—and herein we agree with the pessimists—the importance of the great demand for goods and the large amount of cash that will exist at the end of the war should not be overrated. In a free economy demand must come from money paid for the cost of production, money which eventually flows back to buy the output; an economy relying for any length of time on pent-up demand is doomed to failure anyway.

On what will it depend whether more economic cells are born than die; in other words, whether the economy will expand or contract? It will depend on whether the entrepreneur feels that the returns in new or expanded enterprises will be greater than the costs; in short, on whether new business will seem profitable. If this is the case, a boom and high employment will ensue; if not, the result will be a depression and low employment.

Profitability or nonprofitability of business will depend on the many different factors which are now so widely discussed. It will be of great importance to what extent the future corporation tax will mitigate the double taxation of the investor, existing under the present corporation tax law and deterring him from putting new money into enterprises. It will also be of fundamental importance whether wages rise at a quicker rate than productivity of labor.

Problems in this field will certainly be difficult to solve; but it should not be forgotten that the economic difficulties in the United States do not have their origin in natural conditions (as is the case in Europe with the problems she had to face after World War I and will have to face, to an even greater extent, after the second war), but rather are created by man and can therefore also be overcome by man. It is true, they must be handled with understanding, care, and (most important of all) common sense rather than with conceptions based on unproved theories. If this is accomplished, American business will prosper. If not, it will face depression.

^* Appeared first in The Commercial and Financial Chronicle, Jan. 25, 1945.

¹American Economic Review, March 1944, p. 163.

²Economic Journal, 1943, p. 351.