In his Principles of Economics (8th Edition, London: Macmillan, 1920), Alfred Marshall perhaps says about “depressions” everything that needs to be said – in just a few paragraphs.
Look in Book VI (“The Distribution of National Income”), Chap. XIII (actually the last one of the book, entitled “Progress in relation to standards of life”, available at http://www.econlib.org/library/Marshall/marP55.html#aa167). After discussing some advantages of “the Common Rule” (the imposition by trade unions of “the standard wage to be paid for an hour’s work of a given class”), Marshall explains that problems appear when “the real value of money changes”. When “inflation of credit subsides, and is followed by a depression”, he explains, “prices fall, and the purchasing power of money rises”. Then, the real wage increases. “The more such a policy is persisted in by trade unions generally, the deeper and the more sustained is the injury caused to the national dividend; and the less is the aggregate of employment and good wages throughout the country.” He argues for “a more general and clear appreciation of the fact that high wages gained by means that hinder production in any branch of industry, necessarily increase unemployment in other branches”.
Marshall explains that, “indeed, the only effective remedy for unemployment is a continuous adjustment of means to ends, in such a way that credit can be based on the solid foundation of fairly accurate forecasts; and that reckless inflations of credit – the chief cause of all economic malaise – may be kept within narrower limits”. Marshall seems to say, depressions are caused by “reckless inflations of credit” during the expansion phase of the business cycle, and can be resolved by a downward adjustment of wages which will bring back profits and credit to businesses.
Then, he goes on to explain in luminous terms both Say’s law and why a lack of confidence can prevent its application:
“This matter cannot be argued here: but a few words may be said in further explanation. Mill well observed that ‘What constitutes the means of payment for commodities is simply commodities. Each person’s means of paying for the productions of other people consist of those which he himself possesses. All sellers are inevitably, and by the meaning of the word, buyers. Could we suddenly double the productive powers of the country, we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply; everybody would be able to buy twice as much to offer in exchange.’”
“But though men have the power to purchase”, Marshall continues, “they may not choose to use it. For when confidence has been shaken by failures, capital cannot be got to start new companies or extend old ones. Projects for new railways meet with no favour, ships lie idle, and there are no orders for new ships. There is scarcely any demand for the work of navvies, and not much for the work of the building and the engine-making trades. In short there is but little occupation in any of the trades which make fixed capital. Those whose skill and capital is specialized in these trades are earning little, and therefore buying little of the produce of other trades. Other trades, finding a poor market for their goods, produce less; they earn less, and therefore they buy less: the diminution of the demand for their wares makes them demand less of other trades. Thus commercial disorganization spreads: the disorganization of one trade throws others out of gear, and they react on it and increase its disorganization.”
“The chief cause of the evil is a want of confidence. The greater part of it could be removed almost in an instant if confidence could return, touch all industries with her magic wand, and make them continue their production and their demand for the wares of others. If all trades which make goods for direct consumption agreed to work on, and to buy each other’s goods as in ordinary times, they would supply one another with the means of earning a moderate rate of profits and of wages. The trades which make fixed capital might have to wait a little longer: but they too would get employment when confidence had revived so far that those who had capital to invest had made up their minds how to invest it. Confidence by growing would cause itself to grow; credit would give increased means of purchase, and thus prices would recover. Those in trade already would make good profits, new companies would be started, old businesses would be extended; and soon there would be a good demand even for the work of those who make fixed capital. There is of course no formal agreement between the different trades to begin again to work full time, and so make a market for each other's wares. But the revival of industry comes about through the gradual and often simultaneous growth of confidence among many various trades; it begins as soon as traders think that prices will not continue to fall: and with a revival of industry prices rise.”
Marshall’s adds a footnote, which provides an antedated reply to Keynes. “The quotation from Mill and the two paragraphs which follow it are reproduced from The Economics of Industry, III. I. 4, published by my wife and myself in 1879. They indicate the attitude which most of those, who follow in the traditions of the classical economists, hold as to the relations between consumption and production. It is true that in times of depression the disorganization of consumption is a contributory cause to the continuance of the disorganization of credit and of production. But a remedy is not to be got by a study of consumption, as has been alleged by some hasty writers. No doubt there is good work to be done by a study of the influence of arbitrary changes in fashion on employment. But the main study needed is that of the organization of production and of credit. And, though economists have not yet succeeded in bringing that study to a successful issue, the cause of their failure lies in the profound obscurity and ever-changing form of the problem; it does not lie in any indifference on their part to its supreme importance. Economics from beginning to end is a study of the mutual adjustments of consumption and production: when the one is under discussion, the other is never out of mind.”
Posted on The Barstool Economists, September 2, 2009