The Theory of Modern Welfare
Before business principles came to dominate everyday life the common welfare, when it was not a question of peace and war, turned on the ease and certainty with which enough of the means of life could be supplied. Since business has become the central and controlling interest, the question of welfare has become a question of price. Under the old regime of handicraft and petty trade, dearth (high prices) meant privation and might mean famine and pestilence; under the new regime low prices commonly mean privation and may on occasion mean famine. Under the old regime the question was whether the community's work was adequate to supply the community's needs; under the new regime that question is not seriously entertained.
But the common welfare is in no less precarious a case. The productive efficiency of modern industry has not done away with the recurrence of hard times, or of privation for those classes whose assured pecuniary position does not place them above the chances of hard times. Distress may not be so extreme in modern industrial communities, it does not readily reach the famine mark; but such a degree of privation as is implied in the term "hard times" recurs quite as freely in modern civilized countries as among the industrially less efficient peoples on a lower level of culture. The oscillation between good times and bad is as wide and as frequent as ever, although the average level of material well−being runs at a higher mark than was the case before the machine industry came in.
This visible difference between the old order and the new is closely dependent on the difference between the purposes that guide the older scheme of economic life and those of the new. Under the old order, industry, and even such trade as there was, was a quest of livelihood; under the new order industry is directed by the quest of profits. Formerly, therefore, times were good or bad according as the industrial processes yielded a sufficient or an insufficient output of the means of life. Latterly times are good or bad according as the process of business yields an adequate or inadequate rate of profits. The controlling end is different in the present, and the question of welfare turns on the degree of success with which this different ulterior end is achieved. Prosperity now means, primarily, business prosperity; whereas it used to mean industrial sufficiency.
A theory of welfare which shall account for the phenomena of prosperity and adversity under the modern economic order must, accordingly, proceed on the circumstances which condition the modern situation, and need not greatly concern itself with the range of circumstances that made or marred the common welfare under the older regime, before the age of machine industry and business enterprise.(1*) Under the old order, when those in whose hands lay the discretion in economic affairs looked to a livelihood as the end of their endeavors, the welfare of the community was regulated "by the skill, dexterity, and judgment with which its labor was generally applied."(2*) What would mar this common welfare was the occasionally disastrous act of God in the way of unpropitious seasons and the like, or the act of man in the way of war and untoward governmental exactions. Price variations, except as conditioned by these untoward intrusive agencies, had commonly neither a wide nor a profound effect upon the even course of the community's welfare. This holds true, in a general way, even after resort to the market had come to be a fact of great importance in the life of large classes, both as an outlet for their products and as a base of supplies of consumable goods or of raw materials, − as in the better days of the handicraft system.
Until the machine industry came forward, commerce (with its handmaiden, banking) was the only branch of economic activity that was in any sensible degree organized in a close and comprehensive system of business relations. "Business" would then mean "commerce," and little else. This was the only field in which men habitually took account of their own economic circumstances in terms of price rather than in terms of livelihood. Price disturbances, even when they were of considerable magnitude, seem to have had grave consequences only in commerce, and to have passed over without being transmitted much beyond the commercial houses and the fringe of occupations immediately subsidiary to commercial business.
Crises, depressions, hard times, dull times, brisk times, periods of speculative advance, "eras of prosperity," are primarily phenomena of business; they are, in their origin and primary incidence, phenomena of price disturbance, either of decline or advance. It is only secondarily, through the mediation of business traffic, that these matters involve the industrial process or the livelihood of the community. They affect industry because industry is managed on a business footing, in terms of price and for the sake of profits. So long as business enterprise habitually ran its course within commercial traffic proper, apart from the industrial process as such, so long these recurring periods of depression and exaltation began and ended within the domain of commerce.(3*) The greatest field for business profits is now afforded, not by commercial traffic in the stricter sense, but by the industries engaged in producing goods and services for the market. And the close−knit, far−reaching articulation of the industrial processes in a balanced system, in which the interstitial adjustments are made and kept in terms of price, enables price disturbances to be transmitted throughout the industrial community with such celerity and effect that a wave of depression or exaltation passes over the whole community and touches every class employed in industry within a few weeks. And somewhat in the same measure as the several modern industrial peoples are bound together by the business ties of the world market, do these peoples also share in common any wave of prosperity or depression which may initially fall upon any one member of this business community of nations. Exceptions from this rule, of course, are such periods of prosperity or depression as result from local (material) accidents of the seasons and the like, − accidents that may inflict upon one community hardships which through the mediation of prices are transmuted into gain for the other communities that are not touched by the calamitous act of God to which the disturbance is due.
The true, or what may be called the normal, crises, depressions, and exaltations in the business world are not the result of accidents, such as the failure of a crop. They come in the regular course of business. The depression and the exaltation are in a measure bound together. In the recent past, since depression and exaltation have been normal features of the situation, every strongly marked period of exaltation (prosperity) has had its attendant period of depression; although it does not seem to follow in the nature of things that a wave of depression necessarily has its attendant reaction in the way of a period of business exaltation. In the recent past − the last twenty years or so − it has been by no means anomalous to have a period of hard times, or even a fairly pronounced crisis, without a wave of marked exaltation either preceding or following it in such close sequence as conveniently to connect the two as action and reaction.
But it would be a matter of some perplexity to a student of this class of phenomena to come upon a wave of marked business exaltation (prosperity) that was not promptly followed by a crisis or by a period of depression more or less pronounced and prolonged. Indeed, as the organization of business has approached more and more nearly to the relatively consummate situation of to−day, − say during the last twenty years of the nineteenth century, − periods of exaltation have, on the whole, grown less pronounced and less frequent, whereas periods of depression or "hard times" have grown more frequent and prolonged, if not more pronounced. It might even be a tenable generalization, though perhaps unnecessarily broad, to say that for a couple of decades past the normal condition of industrial business has been a mild but chronic state of depression, and that any marked departure from commonplace dull times has attracted attention as a particular case calling for a particular explanation. The causes which have given rise to any one of the more pronounced intervals of prosperity during the past two decades are commonly not very difficult to trace; but it would be a bootless quest to go out in search of special causes to which to trace back each of the several periods of dull times that account for the greater portion of the past quarter of a century. Under the more fully developed business system as it has stood during the close of the century dull times are, in a way, the course of nature; whereas brisk times are an exceptional invention of man or a rare bounty of Providence.
What current economic theory has to say on the common welfare is more frequently found under the caption of crisis and depression than in any other one connection. And the theory of crisis and depression has, as is well known, been one of the less happy passages in the economists' repertory of doctrines. It has been customary to approach the problem from the side of the industrial phenomena involved − the mechanical facts of production and consumption; rather than from the side of business enterprise − the phenomena of price, earnings, and capitalization. This untoward accident of a false start is probably accountable for the fact that no tenable theory of these phenomena has yet been offered. The solutions attempted have commonly proceeded by an analysis of industrial life apart from business enterprise; that is to say, they have sought to explain the occurrence of crises under that old−fashioned "natural economy" or "money economy" under which crises did not normally occur.(4*)
Taking as a point of departure the patent fact that crises, depressions, and brisk times are in their first incidence phenomena of business, of prices and capitalization, an explanation of their appearance and disappearance, and of their bearing upon the common welfare, may be sought by harking back to those business principles that underlie modern capitalistic enterprise. An analysis of the current, common−sense business views of price and investment should indicate the genesis and manner of growth of these mass movements of the business community, as well as the character of those circumstances which may further or inhibit such movements. Business depression and exaltation are, at least in their first incidence, of the nature of psychological fact, just as price movements are a psychological phenomenon.
The everyday circumstances which condition the modern business management of industry are sufficiently well known, and they have already been reviewed in some detail in earlier chapters; but they may perhaps advantageously be outlined again in so far as they bear immediately on the question in hand.
(1) Industry is carried on by means of investment, which is made with a view to pecuniary gain (the earnings). The business man's endeavors in managing the affairs of the concern in which investment has been made look to the same end. The gains are kept account of as a percentage on the investment, and both they and the industrial plant or process through the management of which they are procured are counted in terms of money, and, indeed, in no other terms. The plant or process (or the investment, whatever form it takes) is capitalized on the basis of the gains which accrue from it, and this capitalization proceeds on the ground afforded by the current rate of interest, weighted by consideration of any prospective change in the earning−capacity of the concern. The management of the concern is effected by a more or less intricate and multifarious sequence of bargains. The decisive consideration at every point in this traffic of investment and administration is the consideration of price in one relation or another.
(2) The industry to which the business men in this way resort as the ways and means of gain is of the nature of a mechanical process, or it is some employment (as commerce or banking) that is closely bound up with the mechanical industries. Broadly, it is such industry as lies under the dominion of the machine, in that it is involved in that comprehensive quasi−mechanical process of modern industrial life that has been discussed in an earlier chapter. This implication of each industry in a comprehensive system, or this articulation with other branches of industry, is of such a nature as to place each industrial concern in dependence on one or more other branches of industry, from which it draws its materials, appliances, etc., and to which it disposes of its output; and these relations of dependence and articulation form an endless sequence. That is to say, the interindustrial relations into which any branch of industry necessarily enters do not run to a final term in any direction; within the process of industry at large there is no member that stands in the relation of an initial term to any sequence of processes. The ramification of industrial dependence is without limits. The method of these relations of one concern to another, or of one branch of industry to another, is that of bargaining, contracts of purchase and sale. It is a pecuniary relation, in the last resort a price relation, and the balance of this system of interstitial relations is a price balance.
(3) These interstitial pecuniary relations, between the several concerns or branches of industry that make up the comprehensive industrial system at large, involve credit relations of greater or less duration. The bargaining, by means of which industry is managed and the interstitial relations adjusted, takes the form of contracts for future performance. All industrial concerns of appreciable size are constantly involved in such contracts, which are, on an average, of considerable magnitude and duration, and commonly extend in several directions. These contracts may be of the nature of loans, advances, outstanding accounts, engagements for future delivery or future acceptance, but in the nature of the case they involve credit obligations. Credit, whether under that name or under the name of orders, contracts, accounts, and the like, is inseparable from the management of modern industry in all that concerns the working relations between businesses that are not under one ownership, or between which the relations resting on separate ownership have not been placed in abeyance by some such expedient as lease, pool, syndicate, trust agreement, and the like. Credit relations of one kind and another are also found expedient and profitable at many points where their employment is not precisely unavoidable. These extended credit relations are requisite to the most expeditious and profitable conduct of business, and so to the highest degree of success of the business. Under the regime of the machine industry and modern business methods it is probably fair to say that the use of credit, apart from loan capital and leases, unavoidably goes to the extent required to cover all goods in process of elaboration, from the raw material to the finished goods, in so far as the goods change hands (in point of ownership) during the process.
(4) The conduct of industry by competing business concerns involves an extensive use of loan credit, as spoken of in Chapter V above.
The four conditions recited are characteristic features of that recent past during which brisk times, crises, and depressions followed one another with some regularity as incidents of the normal course of business.(5*) Certain qualifications of this characterization are necessary to fit the immediate present. These will be indicated presently.
In brisk times the use of credit is large; it may be as a cause or an effect of the acceleration of business; most commonly it seems to be both a cause and an effect. No appreciable business acceleration takes place without an extension of credit, at least in the form of contracts of purchase and sale for future performance, if not also in the form of loans. In times of protracted depression the use of credit seems on the whole to be somewhat restricted, at least such is the current apprehension of the case among business men.
Still, it cannot confidently be said that seasons of protracted depression are due solely to an absence of credit relations or to an unwillingness to enter into credit relations. A comparison of the course of interest rates, e.g., does not warrant the generalization that the readiness with which loans can be negotiated need be appreciably different in brisk and in dull times.(6*) The readiness with which contracts of purchase and sale are negotiated is appreciably greater in brisk times than in times of depression; that, indeed, is the obvious difference between the two.
Of the three phases of business activity, depression, exaltation, and crisis, the last named has claimed the larger and livelier attention from students, as it is also the more picturesque phenomenon. An industrial crisis is a period of liquidation, cancelment of credits, high discount rates, falling prices and "forced sales," and shrinkage of values. It has as a sequel, both severe and lasting, a shrinkage of capitalization throughout the field affected by it. It leaves the business men collectively poorer, in terms of money value; but the property which they hold between them may not be appreciably smaller in point of physical magnitude or of mechanical efficiency than it was before the liquidation set in. It commonly also involves an appreciable curtailment of industry, more severe than lasting; but the effects which a crisis has in industry proper are commonly not commensurate with its consequences in business or with the importance attached to a crisis by the business community. It does not commonly involve an appreciable destruction of property or a large waste of the material articles of wealth. It leaves the community at large poorer in point of market values, but not necessarily in terms of the material means of life. The shrinkage incident to a crisis is chiefly a pecuniary, not a material, shrinkage; it takes place primarily in the intangible items of wealth, secondarily in the price rating of the tangible items. Apart from such rerating of wealth, the most substantial immediate effect of a crisis is an extensive redistribution of the ownership of the industrial equipment, as noted in speaking of the use of credit.
The play of business exigencies which lead to such a period of liquidation seems to run somewhat as follows: Many firms have large bills payable falling due at near dates, at the same time that they hold bills receivable also in large amounts. To meet the demand of their creditors they call upon their debtors, who may in their turn have bills receivable or may hold loans on collateral. The initial move in the sequence of liquidation may be the calling in of a call loan, or a call for additional collateral on a call loan. At some point, earlier or later, in the sequence of liabilities the demand falls upon the holder of a loan on collateral which is, in the apprehension of his creditor, insufficient to secure ready liquidation, either by a shifting of the loan or by a sale of the collateral. The collateral is commonly a block of securities representing capitalized wealth, and the apprehension of the creator may be formulated as a doubt of the conservative character of the effective capitalization on which it rests. In other words, there is an apprehension that the property represented by the collateral is over−capitalized, as tested by the current quotations, or by the apprehended future quotations, of the securities in question. The market capitalization of the collateral has taken place on the basis of high prices and brisk trade which prevail in such a period of business exaltation as always precedes an acute crisis. When such a call comes upon a given debtor, the call is passed along to the debtors farther along in the sequence of liabilities, and the sequence of liquidations thereby gets under way, with the effect, notorious through unbroken experience, that the collateral all along the line declines in the market. The crisis is thereby in action, and the further consequences follow as a wellknown matter of course. All this is familiar matter, known to business men and students by common notoriety.
The immediate occasion of such a crisis, then, is that there arises a practical discrepancy between the earlier effective capitalization on which the collateral has been accepted by the creditors, and the subsequent effective capitalization of the same collateral shown by quotations and sales of the securities on the market. But since the earlier capitalization commonly, in the normal case, comes out of a period of business prosperity, the point of inquiry is as to the ground and method of this effective capitalization of collateral during the period of prosperity that goes before a crisis, and this, in turn, involves the question of the nature and causes of a period of prosperity.
The manner in which the capitalization of collateral, and thereby the discrepancy between the putative and actual earning−capacity of capital, is increased by loan credit during an era of prosperity has been indicated in some detail in Chapter V above. But it may serve to enforce the view there taken, if it can be shown on similar lines that a period of prosperity will bring on a like discrepancy between putative and actual earning−capacity, and therefore between putative and eventual capitalization of collateral, even independently of the expansion effected by loan credit.
A period of prosperity is no more a matter of course than a crisis. It has its beginning in some specific combination of circumstances. It takes its rise from some traceable favorable disturbance of the course of business. In such a period the potent fact which serves as incentive to the acceleration of business is a rise of prices. This rise of prices presently becomes general as prosperity progresses and becomes an habitual fact, but it takes its start from some specific initial disturbance of prices. That is to say, prices rise first in some one industry or line of industries.(7*)
By new investments, as well as by extending the operations of the plants already employed, business men forthwith endeavor to take advantage of such a rise. The endeavor to market an increased supply of the things for which there is an enlarged demand, brings on an increased demand and an advance of prices in those lines of industry from which the concerns that had the initial advantage draw their supplies. In part by actual increase of demand and in part through a lively anticipation of an advanced demand, aggressive business enterprise extends its ventures and pushes up prices in remoter lines of industry. This transmission of the favorable disturbance of business (substantially a psychological phenomenon) follows very promptly under modern conditions, so that any differential advantage that accrues at the outset to the particular line of industry upon which the initial disturbance falls is presently lost or greatly lessened. In the meantime extensive contracts for future performance are entered into in all directions, and this extensive implication of the various lines of industry serves, of itself, to maintain the prosperity for the time being. If the original favorable disturbance of demand and prices, to which the prosperity owes its rise, falls off to the earlier level of demand, the era of prosperity has thereby a term set to its run; although the date of its termination is always at some distance in the future, beyond the time when the original demand has ceased to act. The reason for this retardation, whereby the close of an era of prosperity is always delayed, other things equal, beyond the lapse of the cause from which it has arisen, is (1) the habit of buoyancy, or speculative recklessness, which grows up in any business community under such circumstances, (2) the continued life of a considerable body of contracts for future performance, which acts to keep up the demand for such things as are required in order to fill these contracts and thereby keeps up prices in so far. In general it may be said that after the failure of the favorable price disturbance to which it is due, an era of prosperity will continue for that (indefinite) further period during which the fringe of outstanding contracts continues to dominate the business situation. Some further, new contracts will always continue to be made during this period, and some unfilled contracts will always be left standing over when the liquidation sets in; but, broadly speaking, the wind−up comes, not when this body of outstanding contracts have run out or been filled, but when the business of filling them and of filling the orders to which they give rise no longer occupies the attention of the business community in greater measure than the rest of current business.
The run of business exigencies on which an era of prosperity goes forward may be sketched in its general features somewhat as follows: Increased demand and enhanced prices, with the large contracts which follow from such a state of the market, increase the prospective earnings of the several concerns engaged.
These prospective earnings may eventually be realized in full measure, or they may turn out to have been putative earnings, only. that is largely a question of how far in the future the liquidation lies. The business effect of increased prospective earnings, however, is much the same whether the event proves the expectation of increased earnings to have been well grounded or not. The expectation in either case leads the business men to bid high for equipment and supplies. Thereby the effective (market) capitalization is increased to answer to the increased prospective earnings. This recapitalization of industrial property, on the basis of heightened expectation, increases the value of this property as collateral. The inflated property becomes, in effect, collateral even without a formal extension of credit in the way of loans; because, in effect, the contracts entered into are a credit extension, and because the property of the contracting parties is liable to be drawn into liquidation in case of non−fulfilment of the contracts. But during the free swing of that buoyant enterprise that characterizes an era of prosperity contracts are entered into with a somewhat easy scrutiny of the property values available to secure a contract. So that as regards this point not only is the capitalization of the industrial property inflated on the basis of expectation, but in the making of contracts the margin of security is less closely looked after than it is in the making of loans on collateral. There results a discrepancy between the effective capitalization during prosperity and the capitalization as it stood before the prosperity set in, and the heightened capitalization becomes the basis of an extensive ramification of credit in the way of contracts (orders); at the same time the volume of loan credit, in set form, is also greatly increased during an era of prosperity.(8*)
An era of prosperity is an era of rising prices. When prices cease to rise prosperity is on the wane, although it may not promptly terminate at that juncture. This follows from the fact that the putative increase of earnings on which prosperity rests is in substance an apprehended differential gain in increased selling price of the output over the expenses of production of the output. Only so long as the selling price of the output realizes such a differential gain over the expenses of production, is the putative increased rate of earnings realized; and so soon as such a differential advantage ceases, the era of prosperity enters on its closing phase.
Such a differential advantage arises mainly from two causes: (1) The lines of industry which are remote, industrially speaking, from the point of initial disturbance, − from which, that is to say, the lines of industry first and chiefly affected by the rise draw supplies of one kind or another, − these remote lines of industry are less promptly and less acutely affected by the favorable disturbance of the price level; this retardation of the disturbance affords the industries nearer the seat of disturbance a differential advantage, which grows less the farther removed the given enterprise is from the point of initial disturbance.(9*) (2) The chief and most secure differential advantage in the case is that due to the relatively slow advance in the cost of labor during an era of prosperity. Wages ordinarily are not advanced at all for a considerable period after such an era of prosperity has set in; and so long as the eventual advance of wages does not overtake the advance in prices (which in the common run of cases it never does in full measure), so long, of course, a differential gain in the selling price accrues, other things equal, to virtually all business enterprises engaged in the industries affected by the prosperity.
There are, further, certain (outlying) lines of industry, as, e.g., farming, which may not be drawn into the movement in any appreciable degree, and the price of supplies drawn from these outlying industries need not rise; particularly they need not advance in a degree proportionate to the advance in the prices of the goods into which they enter as an element of their expenses of production. To an uncertain but commonly appreciable extent there is also a progressive cheapening of the processes of production during such an era, and this cheapening, particularly in so far as it affects the production of the goods contracted for, as contrasted with the appliances of production, serves also to maintain the differential advantage between the contracted sale price and the expenses of production of the goods contracted for.
In the ordinary course, however, the necessary expenses of production presently overtake or nearly overtake the prospective selling price of the output. The differential advantage, on which business prosperity rests, then fails; the rate of earnings falls off. the enhanced capitalization based on enhanced putative earnings proves greater than the earnings realized or in prospect on the basis of an enhanced scale of expenses of production; the collateral consequently shrinks to a point where it will not support the credit extension resting on it in the way of outstanding contracts and loans; and liquidation ensues, after the manner frequently set forth by those who have written on these subjects.(10*)
At some point in the system of investment and business extension will be found some branches of industry which have gradually lost what differential advantage they started out with when they entered on the era of prosperity; and if these are involved in large contracts and undertakings which are carried over into the phase of the movement at which this particular branch of industry has ceased to have a differential advantage in the price of its output over the cost of its supplies of material or labor, then what may have been a conservative capitalization of their holdings at an early phase, while their earning−capacity rested on a large differential advantage, will become an excessive capitalization after their earning−capacity has declined through loss of their differential advantage. Some branch or branches and some firms or class of firms necessarily fall into this position in the course of a period of phenomenally bri