by Mario Rizzo
I have been on an enforced vacation by the failure of my previous laptop. Now that I have access to my old files, permit me to begin where I left off at the beginning of April. The topic is of “eternal” significance.
In an April 1st (print edition) opinion article Paul Krugman complained about the revival of so-called Mellonism. This is the idea that liquidation of over-expanded industry and a fall in prices and wages will somehow re-generate economic activity after a recession has begun.As Krugman duly notes, it is unclear that President Herbert Hoover’s Secretary of the Treasury Andrew Mellon had anything to do with this vague idea and even what his putative rationale was. Nevertheless, Krugman believes that Mellonism is still with us, some eighty years later.
But one thing is clear to any informed economist. The issue in pre-Keynesian economics was not whether prices and wages in general should fall or whether a large number of enterprises should fail. Keynes liked to summarize the “classical” position as allowing (encouraging?) the general fall in wages and prices to revive economic activity. While there was a basis for the view in the work of A.C. Pigou and some others, this was not representative of the major tradition.
What many contemporary economists do not see is that pre-Keynesian economics was not macro-economics in the current sense. The largest school of thought based on the traditional understanding of Say’s Law was that business cycles were characterized by sectoral disproportionality. (Austrians should note that the Mises-Hayek-Wicksell theory was not unique in that respect.)
Wesley Clair Mitchell made this point in Business Cycles: The Problem and Its Setting (1927) in connection with the classical rejection of theories of general overproduction or general insufficient demand.
To most of the classical economists, the theory of general overproduction was a heresy, which they sought to extirpate by demonstrating that the supply of goods of one sort necessarily constitutes demand for goods of other sorts. But maladjusted production they allowed to be possible, and their brief references to crises usually aimed to show how production becomes maladjusted through the sinking of capital in unremunerative investments. They often held that such misuse of capital was one result of “the tendency of profits to a minimum.” When the current rate of profits has fallen to an unaccustomed level, the less sagacious capitalists, become dissatisfied and embark on ill-considered schemes. There result the production of goods for which no market can be found, business failures, and loss of confidence—in short, a crisis which extends over all lines of trade. (p. 8, emphasis added)
The Harvard economist Frank W. Taussig who wrote a widely used economics textbook in the pre-Keynesian era was clear that the nature of crises was to be found in sectoral maladjustment. In the 1921 edition of his textbook, Principles of Economics, he says:
We have already noted the successive division of labor: the marshaling of different stages in the processes of production. Thence ensues an interval, often long, between the first stages of production and the final emergence of the consumable commodity. Thence comes the possibility of mistake and maladjustment, and also the possibility that themaladjustment will not be promptly ascertained. Here is one great cause of the industrial crisis, – ill-adjusted production. (vol.1, p.403, emphasis added)
The upshot of all of this is the Mellonism is not a serious economic doctrine held by the majority of the “classical” economists (in either in the nineteenth century or in the early twentieth century). It functions in Krugman’s world view as a useful caricature – shall I say a strawman? – to draw attention away from the allocation problems in recessions and to emphasize the promiscuous fiscal-stimulus approach to solving current economic problems. Why else bring it up?
The truth is that pre-Keynesian economics was, in most ways, more sophisticated than the aggregate demand framework bequeathed to us by Keynes and his official interpreters.
Therefore, it is wrong to infer that before Keynes economists believed in widespread liquidation of enterprises and general reductions in prices and wages as a “cure” for depressions. However, the reasonable implication of the then-dominant view was that some industries were, in fact, over-expanded as a result of the boom period’s excesses. And wages and prices in those affected sectors would have to fall in relative terms. This, however, is nothing strange from the economic point of view. If there are sectoral imbalances, how else can they be remedied?