Economics

Preface

An apology is needed for adding another to the large number of books that attempt to deal with the whole subject -matter of Economics in a single volume. I offer two pleas in extenuation. The first is that nearly all existing introductions to the subject are intended primarily for the University student. The pious wish is generally expressed that they may be of use also to the general reader ; but the general reader's special needs and opportunities are seldom borne in mind. His needs are different, inasmuch as he has not the guidance of a teacher and the leisure of the student ; on the other hand, his opportunities are some compensation for these disadvantages, since he has usually a practical interest in the economic system and an experience of its working, which the academic student lacks. It seemed, therefore, worth while to try to do for the economic organisation as a whole what Bagehot and Mr. Hartley Withers have done for a part of it, the credit system — to explain the principles of its construction and working in the language of ordinary life, and with reference to the experience and interests of the ordinary man. While it would need a Bagehot to succeed, I hope that the mere viii ECONOMICS

attempt will have done sometliing to make it easier for the general reader to perceive the bearing of economic studies on the political and social problems in which he is interested.

My second plea is that existing introductions to Economics give the student too little help in applying its conclusions, since they give too little attention to the most interesting and important part of the subject, that, namely, where it borders on the allied studies of Politics and Ethics. The instinct which leads the working-man in discussions on economic questions to return constantly to the ethical aspect of them is a sound one, and Economics will gain rather than lose in authority by discarding its Mid- Victorian pose of the one and only science of society. No study of Economics, therefore, it seems to me, is worth making which does not include some consideration of the relation of the economic organisation to political and ethical aims and standards ; which does not, in other words, indicate what light Economics can throw on Euskin's question, " What is Wealth ? " Hitherto economists have tended to confine themselves to explaining how the economic organisation works, postponing indefinitely the consideration of its political and ethical aspects ; moralists, on the other hand, have applied their rules to the criticism of the economic organisation without taking too much trouble to understand it first. The chapters of my book, therefore, deahng with the political and ethical aspects of the economic organisation, which to some may seem irrelevant, seem to me to deal, however inadequately, with the most important

PKEFACE IX

section of economic studies ; at the same time I hope that any moraHst who may take up the book will read the first nineteen chapters first.

I am conscious that my first plea has lost much of its force by the pubhcation of Dr. Cannan's Wealth, and my second by that of Mr. J. A. Hobson's WorJc and Wealth. Unfortunately for me, I did not know that these books were being written ; they were not pubUshed until this book was almost completed, and I did not read them until it was quite completed. I trust that the importance of the subjects, and the differences in my treatment of them, will be considered sufficient to justify another book.

I wish to acknowledge my debt to previous writers. If I do not go beyond a general acknowledgment, it is due not to any wish to conceal an obHgation, but solely to the impossibility, after seven years of teaching, of tracing to their sources all conceptions and arguments that I owe to other writers. It is easier to assess one's indebtedness to friends. Professor D. H. Macgregor has helped me with many difficulties. Mr. K. H. Tawney and Mr. G. H. Thompson read my first draft of Chapters II. to VI. and XII. and XIII., and helped me with their criticisms and suggestions. Mr. H. Sanderson Furniss read the whole of my manuscript with a care for which I cannot thank him sufficiently, and enabled me to remove a great many obscurities, errors, and other imperfections. My wife performed a similar service while the book was being written, and Mr. A. E. Zimmern when it was in proof. My thanks are due to the Tutorial Classes Committee of the

X ECONOMICS

University of Oxford for relieving me of lecturing work, and so enabling me to give the book the revision for whicli it bad been waiting a year. And I tbank, though they are too numerous to mention by name, all the members of my classes, who have allowed me to draw on their wide and diverse industrial experience, and have helped me with their criticisms of the views, my own and other people's, that I have put before them.

H. C.

Chapter I. — Introbttctory PAGE

1. The Scope and Subject-matter of Economics . . 1

2. The Relation of Economic Study to Business Experi-

3. The Method of Economics . . . . . 9

4. The Limits of Economics . . . . .16

Chapter II. — The Division of Labour

1. The Economy of Specialisation . . , .22

.S. The Localisation of Industries . . . .29

4. Large-scale Production, and the Limits of Specialisa-

5. The Evils of Specialisation . . . 41

Chapter III.— The Organisation or Production

1. The Co-ordination of Specialists .

2. The Functions op the " Middleman " .

3. Methods of appointing the Organisers of Production

4. Merits and Defects of the System of " Free Enter

prise " . . ■ .

Chapter IV. — Speculation and Insurance 49 51

1. Production as a whole carried on in Anticipation of

2. Speculative Dealing ...... 71

3. The Use of Contracts to shift Speculatu/e Risks on to

THE Shoulders of Dealers . . . .78

xi xii ECONOMICS

PAGE

4. Tbkminal Markets for dealing in Futures . . 83

5. Illegitimate Speculation . . . . .89

6. Insurance and other Methods of meeting Risks . 94

Chapter V. — Capital and its Organisation

1. Functions of Capital in Modern Industry and Com-

2. Conditions requisite for the Accumulation of Capital 101

3. Different Types of Organisation for applying Capital :

THE Private Firm, the Joint Stock Company, Co-operative and Public Enterprise . . .103

4. The Market for Capital . . . . .112

1. Money and Coinage ....•• 163

2. The Single Standard . . . . c . 168

CONTENTS xiii

PAGE

4. Paper CuEREKcy . . . . . .174

Chapter X.— Banking and Credit

1. The Cancelling of Indebtedness by the Use of Credit

Instruments . . . . . .180

2. The Creation of Credit by Banks . . .188

3. The Cash Reserve . . . . . .192

4. The Social Utility of the Credit System . . 199

Chapter XI. — The Level of Prices and Foreign Exchanges

1. The Measurement of Changes in the Level of Prices 207

2. Causes of Changes in the Level of Prices . . 210

3. The Law of Comparative Cost .... 216

4. Imports paid for by Exports . . . . 220

5. The Balance of Trade and the Level of Prices . 222

Chapter XII.^The Circulation of Wealth

1. Wealth and Production ..... 227

2 Income and Capital ...... 231

3. Spending and Saving ...... 234

4. The National Dp/idend or Income . . . 237

Chapter XIII. — Unemployment and Over-Production

1. Imperfect Co-operation between Specialists . , 244

2. Imperfect Anticipation of Demand . . 248

3. Cyclical Trade Fluctuations .... 252

Chapter XIV. — Value ^

1. Value and Price ...... 258

2. The Labour Theory of Vai.ue .... 261

3. The Cost of Production Theory of Value . . 266

4. Decreasing, Increasing, and Constant Cost . . 273

5. Influence of Competition and Monopoly on Value . 279 xiv ECONOMICS

PAGE

Chapter. XV. — Value (continued)

1. Relation op Utility to Value .... 284

2. The Marginal Utility Theory of Valxje . . 287

3. The Law of Supply akd Demand .... 292

Chaptee XVT. - -Wages

1. Wages and Income ...... 297

2. Wages and Labour Cost ..... 302

3. Wages and Trade Unionism^ .... 304

Chapter XVII. — Wages (continued) L The Subsistence Theory of Wages . . . 308

2. The Wages Fund Theory of Wages . . . 310

3. Productivity Theories of Wages .... 313

4. The Influence on Wages of the Standard of Life . 321

5. The Influence on Wages of the Volume of the

National Dividend ..... 328

6. The Influence on Wages of Inequality of Opportunity 330

1. Private Property and Freedom of Enterprise . 379

2. State Regulation and Supersession of Freedom of

Enterprise ....... 384

Chapter XXII. — The State and the Economic Organisation (confimied)

1. The Assumptions of the Present System . 395

2. The Assumption op Rational Self-interest . . 397

3. The Assumption that Competition leads to the Sur-

vival of the Fittest ..... 399

4. The Assumption that Wealth will usually be associ-

ated WITH Social Service .... 402

6. The Assumption that Market Value is a Satisfactory

Indicator for Production to follow . . 409

Chapter XXIII.— Wealth and Welfare — the Measurement OF Wealth

1. Wealth as Product ...... 415

2. Wealth as Welfare ...... 420

3. Defects in the Usual Method of Computing the

Country's Wealth ..... 423

Chapter XXIV. — Wealth and Welfare — Economic Influences on Welfare

1. The Influence of Distribution .... 429

2. The Influence of the Use of Wealth and the Kind of

3. The Influence of Work ..... 436

4. The Sacrifice of Producer to Product . . 440

Chapter XXV. — Wealth and Welfare — Business and Morality

1. Welfare regarded as Independent of Wealth in some

Systems of Morality ..... 447 xvi ECONOMICS

PAGE

2. The Economic Obganisation not necessarily a Re-

flection OF Current Moral Standards . . 450

3. Reaction of the Economic Organisation on Moral

4. Materialistic Tendency of Economic Influences

To-day 460

5. How Wealth contributes to Welfare . . . 464

6. " Business is Business," and Economic Laws . . 468

7. The Mobalisation of the Economic Organisation . 473

Chapter I Introductory

The Scope and Subject-matter of Economics

Economics is the study of business in its social aspect ; the word " business " being used in its broadest sense ^ to cover all lawful ways of making a living. It will help us to reach a clear understanding of the scope and objects of the study if we take an example of the simplest kind of business transaction, and remind ourselves of the social "-'•-.ngements which make the transaction possible.

We wiU take the purchase of a woollen shirt, the price of

•jic' is ten shillings. We notice first of all that it is not

.: d' n the home, as it would have been a couple of genera-

ions ago ; it is less trouble to buy it from an outfitter. The

; : Gt- er did not make it ; he bought his stock of shirts

; • - :, shirt manufacturer, or possibly from a warehouse-

'ho bought them from a manufacturer. When we

■ t' ; shirt manufacturer " made " the shirts, however,

. •: (i ' not mean that he made the material of which the

.re made ; he may have done so, but more probably

'■:-' :■ iness was confined to " making up " material which

- • ■;<_ _ght from a piece-merchant or flannel manufacturer.

IS 1 B

From other merchants or manufacturers he would buy the thread, buttons, and material for collar-bands. The flannel manufacturer would use several kinds of yarn in making his flannel, and each of these yarns would be spun from several kinds of wool. The origin of the shirt, then, which we obtained by the simple process of handing a tenshilKng piece over a counter, is to be sought on the Yorkshire hills, the Murray River sheep-runs and the South American plains, where the wools were grown, in the cotton plantations of the United States which supphed the raw material for the thread and collar-band, and in Birmingham where the buttons were made. In the course of its jom-ney from the sheep's back to ours, the wool has probably travelled through three or four factories, through a dozen middlemen's hands and half round the globe. It is one item in the output of an organisation, the woollen industry, the ramifications of which reach most parts of the civihsed world.

The woollen industry was not the only organisation involved in the production of the shirt, and necessa^ry to its production on the modern system. Each of the factories through which the material passed required for its work on the material many machines, which in their turn required power to drive them. Several branches of the machinery and engineering industries were therefore involved in the making of this shirt ; so were the iron and steel industries which supplied the material of these machines ; so wer the oil and leather industries, since they supplied subsidiary materials. The coal industry was involved, because coal is the chief source of power ; the building trades, because modern factories and warehouses have to be built specially for their work. The more important forms of transport were all of them employed in the making of this shirt.

I INTRODUCTORY 3

since its materials came from so many different quarters, and were shaped and put together in so many different places. The credit system was probably involved, since some of the firms that handled it would be dependent on assistance from banks to carry on their business, and the movement of raw materials is very largely financed by bills of exchange. It would hardly be too much to say that the apparently simple transaction of purchasing a shirt was the completion of a process in which the modern economic system as a whole was involved.

Moreover, when we spoke of the parts of that system, manufacturers and merchants, transport agencies and the credit system, we were referring summarily and simply to things which in themselves are complex. The flannel manufacturer employs eleven or twelve different kinds of worker in four departments, even if he neither spins his own yarn nor dyes his own pieces ; the clothier employs ten different kinds of worker on three or more different machines in five or more departments ; transport agencies vary from the country carrier with a horse and cart to railway companies with 70,000 employees and £100,000,000 capital ; even the merchant, who employs directly only half a dozen clerks in a modest office, may be the meeting-point and support of a network of trade connexions covering a continent ; even the outfitter's business requires an expert. The shirt, then, which we purchase with so little thought, is a product of the most complicated piece of social organisation that mankind has yet devised. Our attempt to get behind the superficial simpHcity of our business transactions has entangled us in a labyrinth, the paths of which lead into every social class, and has involved us in a study of a large part of the activities of the human race.

This system of social arrangements, the existence of whicli is revealed by the analysis of any business transaction, is the subject-matter of Economics ; it is the object of Economics to explain the arrangements in detail and to show how the system works. The example we have taken (and any other would have served as well) justifies the use of the word " system." At first sight the business world offers a spectacle of confusion rather than order. We found however that things did not happen anyhow. The materials of which our shirt was made could not have found their way from the place of origin, through all the processes of manufacture, to the outfitter's hy accident. There was order in the process : the outfitter's shop, the shirt-maker and the other firms concerned were parts of a working system ; our transaction was one of millions which depend on one another. Our glimpse of the working of the system gave the impression of a great automatic machine. The system is not a system like the political system, which has a sovereign directing authority. It is not the work of a single brain or the embodiment of a single purpose ; it is a spontaneous organisation, the outcome of actions which were not consciously directed to establishing or maintaining it. Hence, although we are parts of it, we can study it objectively, like a piece of external nature, and search for the principles of its structure and working as the physiologist searches for the principles of the structure and working of the human body. What points of contact this economic order has with the political order, and how far it harmonises with the moral order, are questions we can ask when we have examined it and ascertained its principles.

The example we took will illustrate also the interest and importance of Economics. Why was the shirt ten shilhngs ? Why did the outfitter charge us no more ? How is it that we could not get it for less ? Who gets our ten shillings

I INTRODUCTOEY 5

and all the otlier sliillings paid for shirts ? In what proportions is the price divided among the difierent firms which handled the goods ? and, within each firm, between operatives and employers ? On what principle does this division take place ? These are questions which every one tries to answer at some time or other, and Economics is only a systematic attempt to answer these and related questions. How do the many firms which contribute to the making of the shirt manage to carry on between the time when they incur the expense of making the shirt and the time when the user pays for it ? How are payments made in America and Australia for goods sent to England, and what difference would a protective duty on all imports into England make on the course of trade ? What would be the effect on the price of shirts of a rise in wages, or a new tax on profits or rents ? What would be the effect of extending the Trade Boards (Minimum Wage) Act to cover all the industries concerned in the making of a shirt ? or of the formation of a " combine " of shirt-makers or flannel manufacturers ? Is a " combine " probable in either of those industries ? Under what conditions is an industry likely to be " trustified " ? These are less obvious problems which our example presents — less obvious, but still the kind of questions that the investor, the trade union official, and every citizen who uses his vote intelligently is constantly being called upon to face ; and all of them fall within one or other of the more important sections of Economics.

The system works ; and even if we take its working for granted without enquiring how it works, its defects compel study. Unemployment, speculative gambling, waste and poverty, are results of it obvious to the most superficial observer. Are these evils inevitable ? If they are, what advantages does the system ofier to counterbalance them ? if not, why are they there ? Above all, what is one's personal responsibility in the face of these evils ? Economics is the systematic study of these questions. Some study of Economics is at once a practical necessity and a moral obligation. And as a matter of fact everybody makes some such study, everybody at some time or other is a student of Economics, an economist ; like M. Jourdain, who was surprised to learn that he spoke prose, the general reader may not have realised that he was an economist.

II Relation of Economic Study to Business Experience

Every one, then, makes some study, more or less casual or systematic, of the subject-matter of Economics ; and every adult has one important qualification for such study, namely experience. It is on the basis of their experience of the present economic system that people form their judgment on its problems ; it is in their experience that they find the materials for answering such questions as arose from the example we took of an economic transaction.

Experience, however, while it is a qualification, and an essential qualification, for the study of economic problems, cannot be an adequate substitute for that specialised and systematic study of them which constitutes the science of Economics. It is easy to be familiar with a thing, and even to work with it, without understanding it. The engine-driver can do his work excellently without knowing anything of the science of thermo-dynamics, and most of us succeed in spending a lifetime with our bodies without acquiring any considerable knowledge of tlie science of

I INTEODUCTORY 7

human physiology ; similarly a man may be a good business man and yet a bad economist. The experience which any one man, or even any one social class, gains of the economic system in the course of everyday life and work is limited. So far as it goes, it is a sound basis for economic judgments ; but a thorough practical acquaintance with banking would not help a man much to understand the organisation of a colliery, an intimate knowledge of the building trade would not fit a man to understand, either in their private or their social aspect, the operations of a Liverpool cotton-broker. To find a secure basis for an understanding of the economic system it is necessary to bring together the experiences of all trades and occupations, of manual worker and industrial organiser, of private industry and government service, of housewife and producer ; the experience of any individual or class is too limited to give by itself anything but a hmited and partial insight into the system as a whole.

Moreover, the understanding of the system that a man gains from the experience of being a part of it is more of the nature of instinct than knowledge. It enables a man to judge and act ; it does not enable him to explain always how he judges and why he acts. If forced to give an explanation, the explanation may be a wrong one ; copybook maxims about industry and early rising have a suspiciously large place in the explanations given by self-made men of their success ; luck and a lack of scruple, though at least as important, are never mentioned. Thus the experience of people actually engaged in industry has to be subjected to their own reflection and studied from outside, to be analysed, before it can add anything to the body of knowledge which all may share who are willing to study ; treated in that way it becomes the most valuable of all sources of knowledge.

Individual experience is limited and unconscious ; it lias to be supplemented by Economics for a more important reason. Its point of view is that of the individual, the point of view of Economics is that of society. Every business transaction has more than one aspect. The individuals who are parties to it are interested chiefly in its private aspect ; Economics is concerned with its social aspect, which may be a different thing. From the point of view of the individual^ profits are the difference between his expenses and his receipts ; from the point of view of society, they are the incentive to, and the payment for, organising work ; the individual is concerned only with their amount, society with their origin and the extent to which they elicit and represent services to society. Speculation, from the point of view of the individual, is the act of buying at one time and selling at another, and is justified if the seUing price exceeds the buying price ; from the point of view of society^ it is the process by which fluctuating supplies are adjusted to a fluctuating demand, and is justified (or the reverse) by its influence on price fluctuations. To the individual it may make little difference whether he increases his profits by higher prices on a smaller output or by a larger output at lower prices ; society is keenly interested to learn under what circumstances the former method is Hkely to be adopted and under what circumstances the latter. There is the same difference between the two views as there is between the view of a town which a man gets from his street-door and the view he would get from an air-ship. No one, unfortunately, can lift himself into a position to take an " air-ship " view of society ; so that the economist, and other students of society, have to construct their " air-ship " view of society by collecting, comparing and relating a large number of street-door views.

I INTRODUCTORY 9

Economics, we have said, is the study of business in its social aspect, and the point of view is fundamental to the study. Business in its private aspect is so much a matter of personal character and accidental circumstances, that only a very small part of it can be reduced to rule or stated in systematic form. University courses and even degrees in " Commerce " can now be taken, but the study of Economics, as defined above, can help the futvire business man only by making him more interested in business and therefore more hkely to devote his undivided energies to it. From the point of view of society's interests, however, it is very desirable that business men should study Economics, since it is to society's interest that they should reflect on and realise the social effects of their private actions. For the same reason, that the private and the social aspects of business are so often different, a " government of business men " — if the phrase is intended to be understood in a narrow sense — would be a bad government. It would apply to the work of government standards and tests derived from private industry that are not apphcable to public services ; it might forget that it often " pays " a government to rim a public service (such as sanitation or education) " at a loss."

Ill

The Method of Economics

The study, then, of our subject-matter, in which every one at some time or another engages, can be supplemented with advantage by the specialised and systematic study of it, which we call Economics. The latter grows out of the former, the former is the best preparation for the latter. And the method of the unconscious and unsystematic study is the metliod, used deliberately and consciously, by which the systematic study reaches its conclusions. That method is — to reflect ; to generalise on the basis of the known facts ; in the light of the generalisation to collect further facts with which to test it ; and by this process of testing, and by comparison with other generalisations reached by the same process, to reach a generalisation which exactly fits the facts. By this method any one who is forced by circumstances to frame an answer to some economic problem brings his experience and casually accumulated knowledge to bear upon it ; by this method Economics seeks to reach and to state the principles of the present economic system.

Economic Theory is the body of generalisations so reached. The practical man is suspicious of " theory." His suspicion is justified, if " theory " is used as a substitute for ascertainable facts. But generahsation, the making of theories, is unavoidable. Facts do not explain themselves. In some problems, the causes of trade fluctuations for example, the multitude of facts is so great that we cannot even begin to collect them unless we collect on some plan ; we shall be overwhelmed if we do not take with us to the facts some co-ordinating idea, in other words if we do not frame a theory and take it to the facts to test it by them. On some important questions we cannot hope to enumerate all the ascertainable facts ; if we wait to form our judgment on the influences that fix wages until we have examined all the ascertainable facts, we shall never form a judgment, their number is so great. On other problems some decision has to be reached for purposes of action, although facts are scarce or imobtainable ; taxes are often based on theories which it has been impossible to verify, the collection of the taxes sub-

I INTKODUCTORY 11

seqiiently eliciting the facts that are needed to verify the theories.

Again facts may be contradictory, at any rate on the surface : it is a fact that the introduction of labour-saving machinery has on many occasions displaced labour ; it is also a fact that the amount of labour-saving machinery in use has steadily increased for generations without being accompanied by any corresponding increase in the proportion of the population unemployed. Or the facts may bear more than one interpretation. There are several conflicting theories of wages, all of them " based on facts " : for example, according to the theory on which English Poor Law policy is based, any subsidy to the wage-earner from the State wiU force wages down; according to the theory on which the feeding of school-children and old age pensions are based, State subsidies have no effect, or only a negligible effect ; some facts can be found to support either theory. On the same foundation of facts different statesmen have based two entirely different fiscal policies in regard to foreign trade. Facts are seldom simple and usually complicated ; theoretical analysis is needed to unravel the complications and interpret the facts before we can understand them.

The practical man's objection to " theory " is a valuable protest against hasty generalisation on an insufficient basis of fact or on an inadequate survey of available facts. But the opposition of " facts " and " theory " is a false one ; their true relation is complementary. We cannot in practice consider a fact without relating it to other facts, and the relation is a theory. Facts by themselves are dumb ; before they will tell us anything we have to arrange them, and the arrangement is a theory. Theory is simply the unavoidable arrangement and interpretation of facts,