Since Irving Fisher and John Maynard Keynes were writing in the 1930s, there have been two prevailing orthodoxies in mainstream economics:
1. That deflation is an unalloyed negative.1
2. That consumer-led economic growth must be our top economic priority.2
In this article, using British macroeconomic data from the nineteenth, twentieth, and twenty-first centuries as well as praxeological reasoning, I will seek to challenge this received wisdom by showing that growth has come at the expense of net national savings, which is not sustainable in the long run.
First, on deflation, if we study the following table (figure 1) showing average wheat and bread prices versus average labor wages and total population for the 1800s,3 we can see immediately that average prices fell as wages and population rose. The basic claim that deflation is always a bad thing thus fails to explain the entirety of the nineteenth century, especially after 1846 when laissez-faire hero Richard Cobden finally persuaded Sir Robert Peel to repeal the Corn Laws after a decade of political activism and agitation.
FIGURE 1
This set of figures not only dispels myths about deflation emanating from the 1930s, but also the myths of the protectionists of the early 1800s, who had opposed Say’s Law and argued in favor of maintaining the Corn Laws.4 Thomas Malthus — Keynes’s avowed economic hero — argued that wages are inextricably tied to the price of wheat. David Ricardo followed him basing his argument on a convoluted set of assumptions including his differential Theory of Rent and the homogeneity of wage rates.5 The “wheat” theory of wages is demonstrably untrue, which can be shown empirically and using the praxeological method.
William D. Grampp showed it empirically simply by dividing annual average wages by average wheat prices to produce “wheat wages” from 1815 to 1846.6 If Malthus and Ricardo were correct “wheat wages” would be fairly constant for fifteen-or-twenty-year periods, but this is not observed because they fluctuate wildly. In some years, wheat is as much as 36.1 percent higher than wages (1817), and in other years as much as 44.2% lower (1835). Still, this argument cannot be won by empiricism. As Grampp himself notes, supporters of Ricardo such as Mark Blaug have simply questioned the validity of the data. However, the eagle-eyed Ricardian could simply pick a twenty-year range — let us say 1816 to 1836 — and average the “wheat wages” together to find only a +0.6 percent difference between wages and wheat, and only a -0.5 percent difference for the entire period. While this does not show year-to-year consistency, they might reason it demonstrates that prices nonetheless on average oscillate around their “natural rate.” Games of statistics like this can always be played, so we need to expose the error in the underlying reasoning.
Ricardo’s contemporary, Nassau William Senior put his finger on the problem: “Corn does not become dear because a portion is raised at a great expense, but a portion is raised at a great expense because corn has already become dear.”7 Here Senior seems to anticipate Carl Menger in recognizing that the value of a good is determined by the preferences of the consumers and that capital investment in production of that good is a recognition of this fact. The costs of the factors of production are determined with the final price of the consumer good (and possible projected earnings) already in mind.8 In fact, as Ludwig von Mises went on to argue, economic calculation is only made possible by this price structure.9 Individual entrepreneur-capitalists appraise the prevailing market conditions and decide to allocate their resources to farming wheat or to establishing a coal mine, or to opening a factory manufacturing textiles, or perhaps an ironworks. They anticipate future market demand for this or that good and then invest in capital and labor accordingly, costing it against projected future returns. If they are correct, they will make some profit, if they are incorrect, they will make losses and eventually be forced to close the venture. This obvious reality of nineteenth-century life (indeed, of life at any time where markets are allowed to operate) is completely ignored by Ricardo, who “totally leaves out the entrepreneur.”10 One entrepreneur in this period, John Bennet Lawes, developed a new fertilizer product which led to a 37 percent increase in per acre wheat yields in the 1840s which not only made him rich but also translated into a near 29 percent increase in average returns for tenant farmers.11 This blindness to innovation in Ricardo’s thinking ensured that, despite his reading of Jean-Baptiste Say, he could see how the different parts of an economy might affect each other.
One example of this blind spot in Ricardian thinking is that rent is not determined by the quality of land alone but by the many factors which affect demand for it, including its location and connectivity: “Railways affected rent by opening up distant markets to farmers and by cheapening the cost of farm inputs such as seeds, fertilisers, machinery and coal as transport costs fell.”12 The role of fixed capital investment also goes missing as a factor in Ricardo’s theory. As George Stigler noted, “Ricardo assumes … that all capital in agriculture is circulating capital.”13 For example, one technological innovation in the 1870s was the “tackle,” a steam-powered tractor and plough which greatly increased productivity. As with all automation, such contraptions reduced the need for labor while increasing output. They cost around £645, which for most tenant farmers (and their landlords) would have required some savings and investments — those early adopters would enjoy some competitive advantage over those who did not or could not invest. Ricardo’s static analysis could not foresee the effects of these sorts of changes which ultimately broke the Malthusian trap. In 2019, agriculture is around 0.59 percent of the UK economy and 1.6 percent of its workforce, while providing 50 percent of the food supply.14 Neither Malthus nor Ricardo foresaw technological advancement on this level. The Malthusian Trap was thus broken.
However, we have not yet freed ourselves from the Keynesian Trap of Malthus’s spiritual successor. In the table below (figure 2),15 I have compiled various decade-average statistics for the UK economy from the 1840s to the present day. GDP figures are given in 2015 £billions. Population is given in millions of people. I have derived the Gross Domestic Private Product (GDPP16 ) by subtracting Government Consumption from GDP. GDPP is used here to distinguish genuine growth from government bloat.
FIGURE 2
GDP = Decade average in 2015 £billions; Population = decade average in millions of people; GDPP = Gross Domestic Private Product = GDP minus Government Consumption
Looking at this, several things should become starkly apparent. In the 1800s, despite sustained population growth and genuine economic growth as measured by GDPP, combined public and private saving consistently managed to stay above 8.7 percent and well over 10 percent in most decades until 1910. The generations of Victorians during this period maintained a genuinely farsighted economic policy of leaving the country in a more financially secure state than they had been born into. Sometimes this meant sacrificing some economic growth in the short term for long-term sustainability, in other words, they delayed consumption to produce net national savings — money that could be used for the capital investments necessary to produce the next round of innovation and growth. This was an orientation which, in effect, put their children’s future ahead of their own present consumption. It was a policy which induced a low time preference. Such was their fiscal prudence that even the disaster of World War I, which negatively affected real growth did not reduce savings to less than 7.18 percent for the whole decade. However, as interventionist policies took root in the years of depression after the war, savings reduced in the 20s and 30s. The catastrophe of World War II saw a 3.5 percent dent in national savings. What we see, in effect, in the period from 1910 to 1950 is the abject squandering of eighty years of capital accumulation. In the post-war consensus that followed, we can see that despite a brief return to nineteenth-century style saving in the 1960s, national savings have since been in total free fall. To the extent that in the 2010s, they are now scarcely above zero. A glance at the following two graphs should make this more explicit.
FIGURE 3
FIGURE 4
Figure 3 shows Government Consumption as a Percentage of GDP, Figure 4 shows Net National Saving as a Percentage of GDP. The economic growth of the period from the 1950s to the 2010s may look more impressive on paper than that of the nineteenth century, even when using GDPP instead of GDP, but this masks the fact that this growth is something of a sugar rush. In effect, the economic policies of this period have reversed the mantra of the Victorians. It has sacrificed long-term sustainability for short-term growth. It has substituted delaying consumption to produce net national savings for present consumption at the expense of any savings at all. This is an orientation which, in effect, puts our present consumption ahead of our children’s future. It is a policy which induces a high time preference. It is a policy which, looking at the data above, as well as negative interest rates around Europe,17 is surely reaching the end of the line.
- 1Irving Fisher, “The Debt-Deflation Theory of Great Depression,” Econometrica 1, no. 4 (October 1933): 337–57.
- 2John Maynard Keynes, The General Theory of Employment, Interest, and Money (London: Macmillan, 1936).
- 3B.R. Mitchell, British Historical Statistics (1988; Cambridge: Cambridge University Press, 2011), pp. 756–57, 769–70, 165, 452–53, 9. Note that the prices for bread are average for London.
- 4See William D. Grampp, The Manchester School of Economics (Oxford: Oxford University Press, 1960); Thomas Sowell, Say’s Law: An Historical Analysis (Princeton, NJ: Princeton University Press, 1972), pp. 115û41; and W.H. Hutt, A Rehabilitation of Say’s Law (Athens: Ohio University Press, 1974), pp. 24–25.
- 5David Ricardo, “On the Principles of Political Economy and Taxation” (1817), in The Works and Correspondence of David Ricardo, ed. Piero Sraffa, 11 vols. (1951; Indianapolis, IN: Liberty Fund, 2004), vol. 1, especially pp. 95–109.
- 6Grampp, The Manchester School of Economics, p. 32.
- 7Nassau William Senior, “Report — On the State of Agriculture,” Quarterly Review 25, no. 2 (July 1821): 476.
- 8Carl Menger, The Principles of Economics, trans. James Dingwell and Bert F. Hoselitz (1871; Auburn, AL: Mises Institute, 2007), pp. 149–74.
- 9Ludwig von Mises, Socialism: An Economic and Sociological Analysis (1922; Mansfield Centre, CT: Martino Publishing, 2012), pp. 114–22.
- 10Murray N. Rothbard, An Austrian Perspective on the History of Economic Thought, 2 vols (1995; Auburn, AL: Mises Institute, 2006), vol 2: Classical Economics, p. 86.
- 11Mitchell, British Historical Statistics, pp. 756–57, 195
- 12Stephen John Pam, Essex Agriculture: Landowners’ and Farmers’ Responses to Economic Change, 1850–1914, PhD diss (London: London School of Economics, 2004), p. 43.
- 13George Stigler, Production and Distribution Theories: The Formative Period (New York: Macmillan, 1941), p. 285.
- 14“Food Statistics in Your Pocket 2017 — Global and UK Supply,” Department for Environment, Food and Rural Affairs (9 October 2018), available at: https://www.gov.uk/government/publications/food-statistics-pocketbook-2017/food-statistics-in-your-pocket-2017-global-and-uk-supply.
- 15Data adapted from Bank of England, “A Millennium of Economic Data” (2016), available at: https://www.bankofengland.co.uk/-/media/boe/files/statistics/research-datasets/a-millennium-of-macroeconomic-data-for-the-uk.xlsx.
- 16See Robert Higgs, “Government Bloat is Not Growth: Real Gross Domestic Private Product, 2000–2011,” Mises Wire (December 20, 2012), available at: https://mises.org/library/government-bloat-not-growth-real-gross-domestic-private-product-2000%E2%80%932011.
- 17Thorsten Polleit, “The ECB’s Renewed Attack on Free Markets,” Mises Wire (June 25, 2019), available at: https://mises.org/wire/ecbs-renewed-attack-free-markets.
