Deflation, social justice, and class struggle

The government announced the return to gold at prewar par on April 28, 1925. Keynes believed this policy to be profoundly ill-conceived. His most famous intervention in the debate on this issue was "The Economic Consequences of Mr.

After stressing the fact that the rising value of sterling did not create, but only aggravated, the long-term unemployment problem - "we were not free from trouble a year ago" - Keynes reiterated his belief that Britain's export industries, which had dominated world trade for most of the nine­teenth century, now suffered from permanently high excess capacity. They had to shrink substantially before they could return to full capacity and profitability. Britain could only return to prosperity, he argued, by a large increase in public investment that would create jobs for the workers displaced from the shrinking export industries. His position was heret­ical in that the ruling elites were determined to weaken labor and drive down costs in these industries by so much that export dominance would be restored.

It was also probable that certain of our export industries were over­stocked both with plant and with labour, and that some transference of capital and men into home industries was desirable and, in the long run, even inevitable.² Thus we already had an awkward problem; and one of the arguments against raising the international value of ster­ling was the fact that it greatly aggravated, instead of mitigating, an existing disparity between internal and external values, and that, by committing us to a period of deflation, it necessarily postponed active measures of capital expansion at home, such as might facilitate the transference of labour into the home trades.

(CW 9, pp. 210-211)

Keynes thought that the main problem with a $4.86 pound was that it created a mismatch with "relative prices here and abroad" that would take a general real-wage reduction of some 10-12 percent to eliminate (CW 9, p. 207). The only way available under the gold standard and laissez- faire to lower costs by 10 percent in the export industries was to initiate a lengthy, costly, unjust, and potentially disastrous dynamic disequilibrium process whose end result was supposed to be lower real wages.

Keynes's main objective in this pamphlet was to critically evaluate these disequilibrium dynamics so as to make them transparent and, therefore, abhorrent to the public. His analysis of the processes by which the effects of an overvalued pound became "diffused" throughout the economy achieves a level of theoretical sophistication not yet evident in the Tract. He focused on the disastrous disequilibrium processes associated with wage and price deflation and criticized classical theory for its unrealistic treatment of the costs of adjustment.

Keynes made four main points about the serious problems that infected deflationary disequilibrium dynamics in the current British economy. First, the mobility of labor across industries and regions had diminished substantially since the nineteenth century. Among the causes of this change were: the rise of strong unions (which interfere with the "freedom" of unemployed workers to bid down wages); the existence of the "dole"; and the inability of workers to secure adequate housing outside the area in which they currently live. As a result of these changes, it would take much higher unemployment over a much longer period to force a cut in money wages of the required magnitude.

Second, these institutional changes would have significantly raised the adjustment costs involved in the return to gold at par, even if the economy was growing rapidly. But, as we have seen, Keynes believed that Britain had entered a period in which the normal rate of growth was sluggish.

His testimony before the Committee on Industry and Trade in Parliament in July 1925 included the following statement:

[D]uring a considerable part of the nineteenth century we were increasing at a rapid rate: everything was on a general crescendo, just as in the United States now; everything was increasing at the rate of three per cent per annum or something of that kind. That meant that when a given industry was too large and another too small you did not force a man out of the industry that had too much labour into the other, but you just stopped taking new men in for a certain period of time, and with the rapid general progress going on, the slack would be taken up not so much by driving men out of the industry as by simply stopping the intake for a bit. Then it was very much easier to bring your industry into equilibrium by just not taking on new hands - which you can do

The return to gold in 1925 65 when the whole economic machine is stepping forward at a great pace - than by actually discharging men.. [S]acking men.. is much more dif­ficult both practically and humanly than stopping new men coming into the industry. So that the old [classical] assumption about the mobility of labour and about the way in which a fall of wages in one trade would be reflected in others, in my opinion, only holds good in the very long run.

(CW 19-I, pp. 396-397, emphasis added)

Third, the necessary process of deflation would distribute reductions in nominal and real incomes in a manner that violated norms of social justice that required that the distribution of income among the classes reflect their relative contributions to economic output. Therefore, if a deflationary policy is adopted by the state, the state must, in the name of social justice, simultaneously institute an equitable incomes policy.

Fourth, the disequilibrium processes inherent in defense of the pound at par will involve economic and social costs so high they might trigger economic and political class warfare.

We begin with the first problem. The gold standard has no automatic and no equitable process to achieve a new equilibrium at par, Keynes said. This process exists only in "the imaginary academic world, peopled by City editors, members of the Cunliffe and Currency Committees... where the necessary adjustments follow 'automatically' from a 'sound' policy by the Bank of England" (CW 9, pp. 214-215). The actual adjustment pro­cess is initiated by an increase in the interest rate that causes a rise in the value of sterling. This triggers a "depression in the export industries." This depression and the requisite tightening of credit to attract and keep foreign money in Britain are supposed to "diffuse themselves evenly and fairly rapidly throughout the whole community. But the professors who defend this theory do not tell us in plain language how the diffusion takes place" (CW 9, p. 214, emphasis in original). Keynes suggested an explan­ation in the following plain language:

To begin with, there will be a great depression in the export indus­tries. This, in itself, will be helpful, since it will produce an atmos­phere favourable to the reduction of wages. The cost of living will fall somewhat. This will be helpful too, because it will give you a good argument in favour of reducing wages. Nevertheless, the cost of living will not fall sufficiently and, consequently, the export industries will not be able to reduce their prices sufficiently, until wages have fallen in the sheltered industries [that produce non-tradable goods]. Now, wages will not fall in the sheltered industries, merely because there is unemployment in the unsheltered industries. Therefore, you will have to see to it that there is unemployment in the unsheltered industries

also.

(CW 9, pp. 214-215, emphasis in original)

The "great question now before the country is by what process of adjust­ment the sheltered prices can be brought down to the level of the unshel­tered prices" (CW 19-I, p. 385). The rise in the pound itself will create unemployment in the export industries and in those industries that must compete with imports whose prices are lowered by the appreciation of sterling. But these industries, on average, buy most of their inputs from industries that are sheltered from the direct effects of trade and there­fore are under no pressure to lower their prices, and workers in unshel­tered industries buy a high percentage of their consumption goods from sheltered industries as well. Trade-sector costs will not be reduced by nearly as much as their prices have been cut. Therefore, it becomes essen­tial that the authorities use tight money to deliberately create unemploy­ment and excess capacity in the sheltered industries as well in order to force down their prices, which will then be transmitted as lower costs to the unsheltered industries.³

The key assumption of supporters of the return to gold at par is that "labour is free to move from industry to industry and place to place, and that an unemployed man can get himself occupation by offering to work for a lower wage than the standard wage in one of the prosperous indus­tries" (CW 19-I, p. 385). Keynes used the problems in the declining coal industry to show how out of touch with current reality this assumption is.

That theory has no relation to the facts at all, however. It is impossible of course for a collier to offer himself as a baker below the standard wages of bakers, that cannot in fact happen, partly because of the power of the trade unions in preventing the cutting of rates by compe­tition of unemployed labour from other industries, partly because the dole has reduced the extreme pressure to find employment elsewhere, and partly because labour for two reasons is very much less mobile between places and industries. The reason it is less mobile between places is due partly to the condition of housing. A man has a house in the place where he has been employed, and it is a rash and dangerous thing for him to give up that house to go and seek employment in another part of the country where very likely he will not be able to get a house.

(CW 19-I, p. 396)

Keynes said that actual disequilibrium adjustment processes in current- day Britain are an inefficient and destructive kind of "war" in which the economically and politically strong can protect themselves while the weak are beaten down and the economy flounders. His argument here anticipated key insights into these disequilibrium dynamics of wage and price deflation in The General Theory. The adjustment process creates:

a struggle with each separate group in turn, with no prospect that the final result will be fair, and no guarantee that the stronger groups will not gain at the expense of the weaker. The working classes cannot be expected to understand better than Cabinet Ministers what is happening. Those who are attacked first are faced with a depression in their standard of life, because the cost of living will not fall until all the others have been successfully attacked too; and, therefore, they are justified in defending themselves. Nor can the classes, which are first subjected to a reduction of money wages, be guaranteed that this will be compensated later by a corresponding fall in the cost of living, and will not accrue to the benefit of some other class. Therefore, they are bound to resist so long as they can; and it must be war, until those who are economically weakest are beaten to the ground.

(CW 9, p. 211, emphasis added)⁴

Keynes positions on these issues led him to side with the coal miners in their desperate effort to protect themselves from vicious attacks by mine owners and the government in the general strike in 1926. This war on the miners to deliberately drive down their wages, Keynes believed, had to be opposed not only because it was economically inefficient, but also because it violated a core principal of social justice.

On grounds of social justice no case can be made out for reducing the wages of the miners. They are the victims of the economic juggernaut. They represent in the flesh the "fundamental adjustments" engineered by the Treasury and the Bank of England to satisfy the impatience of the City fathers to bridge the "moderate gap" between $4.40 and $4.86. (CW 9, p. 223)

If it is unjust to force the miners to submit to mass unemployment in order to force their wages down in defense of the return to gold at par, then the whole policy is unjust because most workers will eventually be placed in a similar position. So long as the gold standard requires domestic deflation to sustain itself, it is a policy of class warfare waged by the "City" and the ren­tier class against the working class. Keynes clearly sees the process of out- of-equilibrium adjustments as one of class warfare. "The gold standard," Keynes argued, "with its dependence on pure chance, its faith in 'automatic adjustments', and its general regardlessness of social detail, is an essential emblem and idol of those who sit in the top tier of the machine" (CW 9, p. 224). Even the disparity of its effects within the working class is repug­nant. "For the method of economic pressure, since it bears most hardly on the weaker industries where wages are already relatively low, tends to increase the existing disparities between the wages of different industrial groups" (CW 9, pp. 224-225). What, then, should be done? The only sens­ible choice would be to go off gold once again: "it is impossible to recom­mend any truly satisfactory course except its reversal" (CW 9, p. 224). Since this was obviously not in the cards, the next best solution would be the implementation of an incomes policy that would distribute the economic costs of the return to gold more equitably. The government should explain to the labor movement that a reduction of all money wages of some 10 per­cent is needed (under then-current international prices and exchange rates) and to ask for labor's cooperation in an attempt to attain this reduction in a fair and equitable manner - one that would not substantially change relative incomes. "If there were any machinery by which you could reduce all wages simultaneously the objections to the policy that I have been out­lining would not be very serious" (19-I, p. 393). Therefore, if a deflation was to be deliberately caused by state policy - and that would be a mistake - the state was obligated to create new administrative "machinery" to see that it was done efficiently and equitably.

Keynes is here insisting that any policy involving significant deflation must, in the name of social justice, be accompanied by the implementation of what he elsewhere called a "Great National Treaty." Keynes suggested that Prime Minister Baldwin make the following proposal to labor:

Can we not agree, therefore, to have a uniform initial reduction of money wages throughout the whole range of employment, including government and municipal workers, of (say) 5 per cent, which reduction shall not hold good unless after an interval it has been compensated by a fall in the cost of living?

(CW 9, p. 228)

Labor would respond, Keynes suggested, by asking Baldwin "what he intended to do about money payments other than wages - rents, profits, and interest" (CW 9, p. 228). Keynes noted that rentier incomes are the hardest issue to deal with because "it is of the essence of any policy to lower prices that it benefits the receivers of interest at the expense of the rest of the community; this consequence of deflation is deeply embedded in our system of money contracts" (CW 9, p. 229). The only equitable solu­tion is to use the tax system to ensure that non-wage-money income fell in proportion to wages.

On the whole, I do not see how labour's objective can be met except by the rough-and-ready expediency of levying an additional income tax of 1s in the £ [or 10 percent] on all income other than from employments, which should continue until real wages had recovered to their previous level.

(CW 9, p. 229).

Keynes understood that powerful class interests would never allow such an incomes policy to be implemented. He believed that the economic costs of the return to gold at par would be heavy and would be borne mostly by workers. He also believed that workers might not tolerate these costs for long. In October 1925, he wrote:

I sympathize with the working classes in resisting a general reduction in real wages. I am sure that no material reduction is possible without engaging in a social struggle of which no one could foretell the out­come... Indeed another five years of this policy might bring us to the edge of revolution, if revolution is even possible in this country.

(CW 19-I, pp.444-445)

Notes

1 Many of the arguments in this pamphlet are presented in even greater detail in Keynes's testimony before the Committee on Industry and Trade on July 9, 1925 (see CW 19-I, pp. 383-416).

2 The phrase "over-stocked" with plant suggests one reason why the profit rate on capital and thus the incentive to invest in large-scale projects in these indus­tries was so low in the post-WWI era due to excess capacity.

3 Here, Keynes adds that if the politicians told the truth about this process to the electorate, they would not be able to successfully implement it. "The question is how far public opinion will allow such a policy to go. It would be politically impossible for the Government to admit that it was deliberately intensifying unemployment" (CW 9, p. 225).

4 The idea that the needed adjustments can only be achieved through the delib­erate application of force is reflected in the following comment: "We are depending for the reduction of wages on the pressure of unemployment and of strikes and lockouts; and in order to make sure of the result we are deliberately intensifying the unemployment" (CW 9, p. 220).

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