Destructive competition, corporatism, industrial policy, and the new economic role of the state: 1927-1928

From 1926 through the publication of Britain's Industrial Future by the Liberal [Party] Industrial Inquiry in 1928, Keynes was deeply engrossed in a detailed study of the structural and competitive impediments to the achievement of sustained full employment and industrial efficiency in Britain.

His writings on the failures of unregulated competition in this era are of two kinds. The first kind consists of concrete studies of the troubled coal and cotton industries, which had been such important exporters before the war. These industries were populated by large numbers of small ffrms. Keynes emphasized the destructive nature of intense competition in such industries. "The day of the small unit is over," he said (CW 19-II, p. 642). The second kind represents an analysis of major industries dominated by a small number of giant ffrms in an era of increasing returns to scale and the rise of monopoly or oligopoly capitalism.

He addressed these issues in a speech to Liberal Party candidates in January 1927 called "Liberalism and Industry." The subject of the lecture is "the arrival of a new industrial revolution, a new economic transition,"

The new economic role of the state 85 which needs guidance by the state if it is to lead to "an economically effi­cient and just society" (CW 19-II, p. 638).

Keynes situated his analysis in the context of Britain's long-term structural economic malaise. He emphasized the effect of stagnation on the buoyancy of business confidence or "animal spirits." We have seen that Keynes believed that "prosperity is cumulative" - an extended period of prosperity creates confidence in the economic future, which in turn makes future prosperity more likely. Here, he warned us that stag­nation is also cumulative, and politically and economically dangerous as well because the working class had grown increasingly restless in this period.

The optimistic Zeitgeist of the nineteenth century has given way to a pessimistic Zeitgeist. The spirit of the age is not as optimistic as it used to be. We are disappointed with the results of our existing method of carrying on. We used to think that private ambition and compound interest would between them carry us on to paradise. Our material conditions seemed to be steadily on the upgrade [in the nineteenth century]. Now we are fully content if we can prevent them from deteriorating; which means the working classes no longer have suffi­cient hopes in the general trend of things to divert their attention from other grievances. We no longer have sufficient confidence in the future to be satisfied with the present.

(CW 19-II, p. 641)

One of the central failings of "free" competition in the context of the 1920s, Keynes said, was that it was incapable of efficiently coordinating the downsizing of Britain's declining export industries that suffered from chronically large excess capacity. Though in decline, they still collectively generated the lion's share of Britain's exports.

Methods which were well adapted to continually expanding business are ill adapted to stationary or declining industries. You can increase the scale of industries by small additions arranged by individuals. If there comes a need to shift from one industry to another, to cur­tail particular industries by small decrements, just as they have been expanded by small increments, no corresponding method is available to isolated, unorganised, individual effort.

(CW 19-II, pp. 642-643)

Combination in the business world, just as much as in the labour world, is the order of the day; it would be useless as well as foolish to try to combat it. Our task is to take advantage of it, to regulate it, to turn it into the right channels.

(CW 19-II, p. 643)

British industry needed more combination, cartelization, and amalgam­ation. Keynes told a story about how very few guards are needed to con­trol a large number of "dangerous lunatics" in an asylum because "lunatics never combine" (CW 19-II, p. 643).

Keynes argued that it is the responsibility of the government to try to assist those industries that suffer from excessive competition to create collusion and cooperation under government regulation. The "remedy," as he argued in "Liberalism and Labour," is to move "onwards toward order, towards society taking intelligent control of its own affairs" (CW 19-II, p. 643). What is needed is neither cut-throat competition nor the detailed central planning favored by the Labour Party, but "regulated competition" (CW 19-II, p. 643).

The government:

must also be prepared to experiment with all kinds of new sorts of partnership between the state and private enterprise.

(CW 19-II, p. 645)

The Liberal Party had historically been associated with strong opposition to trusts and combinations. But this is:

a wrong policy in modern conditions. It should be not discourage­ment, but encouragement for [trusts and combines] to live and exist in right conditions conducive to the general welfare. So far from there being any natural incompatibility between [combination and the general welfare], I believe that these great concerns run by salaried persons with a sufficient degree of decentralisation may, if they are handled by politicians and statesmen in the right manner, become a pattern and model of the way in which the world of the future will get the best both of large units and of the advantages that might be expected of nationalisation, whilst maintaining the advantages of pri­vate enterprise and decentralised control.

(CW 19-II, p. 649)

The regulation of monopolies, oligopolies, and industry associations, though it represented an enormous increase in the economic role of

The new economic role of the state 87 government, was far from the only additional state responsibility in the new era. The state must also: regulate wages, hours, and working conditions; oversee labor education and training; arrange the transfer of labor from industries and areas where it is in surplus to those where it is needed; and allocate credit to high-priority uses. Keynes's enthusiastic and consistent support for state control of most large-scale capital invest­ment is not the only "radical" policy position overlooked by mainstream "Keynesian" economists; his support of detailed industrial and labor­market policy has escaped their attention as well.

It is not only in the direction of the regulation of capital that the state must be prepared for new functions. It must be prepared to regard the regulation of wages of great industrial groups as being not merely of private concern, and it must quite deliberately in its wages and hours policy treat the gradual betterment of the workers as the first charge on the national wealth... The problem of the education and the mobility of labour is going to be at least as important. It is not so much that there is no work to be done, but that men drop into occupations with no knowledge, by mere accident of circumstance and parentage and locality, often finding themselves in the wrong market, trained for something for which there is no demand, or not trained at all. There is no remedy for that by unregulated private action. It must be the concern of the state to know and have a policy as to where labour is required, what sort of training is wanted; and then where there are maladjustments, as there are in the coal industry, to work out plans for the transfer of labour from localities and trades where there is not demand to localities and other trades which are expanding and not declining. That is one example of the general policy which the Government has to be prepared for - namely, the deliberate regulation from the centre in all kinds of spheres of action where the individual is absolutely powerless left to himself. I have given several examples of that, and as the machinery gets built up and the policy is developed, not a year will pass without an important addition to [these] spheres.

(CW 19-II, pp. 646-647)

Keynes was so committed to this new direction that he threatened to leave the Liberal Party if it failed to support his ambitious policy initiatives. Unless the Liberal Party is willing to undertake this task, Keynes said, he and others will not be able to sustain "any live interest in party pol­itics." Fortunately, "an attempt is now being made to work out some first outlines of such a policy by the Liberal Industrial Committee, initiated by the Liberal Summer School and encouraged and supported by Mr.

A brief description of labor-management-state relations in the coal industry would be useful background to a discussion of the problems that 88 The Economic Consequences... to The General Theory faced the industry in the mid-1920s. The General Strike of May 1926 sheds light on important aspects of Keynes's approach to the economics and pol­itics of labor relations in this era.

There had been bitter conflict in the depressed coal mining industry between owners and the miners' union for several years over how to restore prosperity to the industry. This conflict was put on hold in 1925 via wage and profit subsidies while a Royal Commission studied the problem, but the subsidies were allowed to expire in April 1926. The owners locked out the miners on May 1, leading to the ill-fated General Strike from May 3 to May 12, a strike that was met with a ferocious response by both mine owners and the armed might of the state. The miners stayed out after the General Strike collapsed, but in the fall, "starvation forced them back on the owners' terms" (Skidelsky 1992, p. 251).

These events created a split in the Liberal Party between Lloyd George, who sympathized with the miners, and Lord Asquith and others, who believed that the workers' movement had committed treason and "feared that a General Strike would pave the way to revolution" (Skidelsky 1992, p. 252). Keynes supported the Lloyd George faction. The "split has come about in such a way that any radical, who is not ready to subordinate his political ideas entirely to personalities, has absolutely no choice," Keynes wrote to his sister. "I find a unanimous - astonishingly unanimous - feeling that this is so amongst every single leftish Liberal whom I have spoken to this week" (Skidelsky 1992, p. 255). Keynes believed that the miners were forced into their position by events they neither understood nor controlled.

The strikers are not red revolutionaries; they are not seeking to over­turn Parliament; they are not executing the first movement of a calculated political manoeuvre. They are caught in a coil, not entirely of their own weaving, in which behaviour, which is futile and may greatly injure themselves and their neighbors, is nevertheless the only way which seems to them to be open for expressing their feelings and sympathies and for maintaining comradeship and keeping faith... But my feelings, as distinct from my judgment, are with the workers. I cannot be stirred so as to feel the T.U.C. [Trades Union Congress] as deliberate enemies of the community, who must be crushed before they are spoken with.

(CW 19-II, p. 532)

Keynes wrote a number of articles dealing with the crisis in coal. The industry had permanently lost a large part of its prewar market and was now burdened with substantial excess capacity, an excessive labor force, and uneconomical mines - problems exacerbated by the return to gold at par. He believed that these problems could never be sorted out by unregu­lated competition, which could only lead to overproduction and perpetu­ally depressed prices. "I should, therefore, put the formation of a cartel of

The new economic role of the state 89 British coal-exporters in the forefront of the remedies" (CW 19-II, pp. 535­536). But "in the absence of a pool or any other concerted action, this overproduction has resulted in a cut-throat competition which has driven down prices, mainly in the export trade, to a level that cannot yield a living wage." Therefore, "the urgent problems of the trade are... to transfer men out of the industry, to curtail production and to raise export prices," and to arrange for "the closing down, temporarily or permanently, of a not inappreciable number of less efficient collieries" through combination and collusion (CW 19-II, p. 536). He suggested that if the owners refused to set up "a pool" through which "a scheme of quotas, of standard prices, and of penalties is drawn up, the industry must disappear or it must accept nationalisation" (CW 19-II, pp. 528-529).

However, if we want to fully understand Keynes's views on indus­trial policy and the role of state planning in the 1920s, we must turn from coal to the cotton industry, for he was intimately and intensely involved in efforts to create a cartel in the American (or low-grade) section of the British cotton industry centered in Lancashire from late 1926 through 1928.

The American section of the industry was divided among "over 300 fiercely competing family firms," some of which were loosely associated through the Federation of Master Cotton Spinners (Skidelsky 1992, p. 261). Keynes became an adviser to and spokesman for a group of mill owners who were attempting to turn the industry into a tightly knit cartel called the Cotton Yarn Association.

Cotton had lost 30 to 40 percent of its prewar export volume. During WWI, many of its former customers had engaged in substantial import substitution, sometimes under the protection of tariffs, and Japan had become a major competitor in coarse cotton, actually surpassing Britain in output in 1926. The industry reacted to the collapse in demand through half-hearted, incomplete, and ineffective cooperation rather than the well- coordinated collusion required to solve the industry's problems. It was a pale reflection of the successful industry "rationalization" movement led by Germany that was sweeping across Europe. In Keynes's view, the reactions of both coal and cotton:

are founded on a belief that, if only the industries hang on, "normal" times will return when they may again hope to employ all their existing plant and labour on profitable terms. Neither industry has attempted what the Germans are calling "rationalization," that is to say, the concentration of demand on the most efficient plants, which are worked at full stretch and the rest closed down.

(CW 19-II, p. 579)

While coal had engaged in massive overproduction and price cutting, cotton had "ruined itself by organised short-term [working hours] extending over five years," which drastically underutilized capital (the 90 The Economic Consequences... to The General Theory spindles) and thus substantially raised production costs (CW 19-II, p. 578). What is needed, Keynes believed, is an industry cartel - a " 'rationalisa­tion' process designed to cut down overhead costs by the amalgamation, grouping or elimination of mills" (CW 19-II, p. 584).²

Keynes's writings on Lancashire cotton contain his clearest concrete or empirical observations about the costs of competition, about the myriad ways in which disequilibrium competitive processes, which may take years or even decades to work themselves out, can reproduce or even exacerbate structural unemployment and reproduce, rather than elim­inate, economic inefficiencies. The clear implication is that such processes are not only costly and lengthy, they are also path dependent: they affect the new equilibrium position.

The entry point to his argument is the assumption that real capital accumulation is a substantially irreversible process. This assumption dra­matically changes the character of theory. Modern neoclassical theory typically assumes that capital investment is a reversible process; if investment projects fail, you can resell the capital goods for what you paid minus depreciation. You can then repay any debt involved out of the sale proceedings. This makes capital accumulation a relatively safe investment, one subject to minimal risk. But in the real world, once a firm or industry has been built, the current system "includes no provision whatever for reversing the process, except the slow and dragging cure which time brings at last by decay and obsolescence" (CW 19-II, p. 590). Once financial capital is transformed into a concrete industrial plant and equipment and put in place in a specific production process in a specific plant in a specific location, it normally cannot be reconverted back into money form without substantial loss if and when it becomes unprofit­able. Irreversible investment is a key component of what I have called destructive competition.³

Suppose that, after industry capacity is built to a high level, there is a permanent drop in demand that creates a condition of substantial excess capacity. Each firm will be forced to cut prices in an attempt to maintain some reasonable degree of capacity utilization so that fixed cost per unit and therefore total cost per unit are minimized. Given no substantial increase in industry demand in depressed markets, competition will drive prices down until they hit variable cost, leaving little if any revenue to cover fixed costs.

What will happen in an unorganised industry? Competition between the owners... will drive down prices towards the point at which no contribution at all is left towards overhead [i.e. fixed] expenses. Each individual will accept not the price which yields him a normal return, but the price which is preferable to abandoning his plant altogether and closing down his organisation.

Economists usually assume that in a price war, the least efficient pro­ducers are the first to be driven out of business, but this will often not be the case in what Keynes, in the Tract, referred to as the modern "regime of money contract." It may be the most financially fragile or indebted firms - not the least technically efficient ones - that are first into bankruptcy, for debt is often incurred to finance new capital equipment designed to put a firm on the cutting edge in terms of cost structure. "If this [price war] goes on for long, the mills which are financially weaker, though not perhaps technically inefficient, will become bankrupt."

But even bankruptcy will not necessarily solve the problem of excess capacity [and thus will not eliminate the downward price pressure] because the firms still in business [who hope to survive until the price war is over and profits are normal again] will buy the spindles from the bankrupt firms when the price is low enough. Thus, the spindles of the bankrupt mills will not cease to exist. They will be sold at a low price and thus transferred into stronger hands on terms which will enable the competition to persist in conditions too severe for other businesses to earn their interest charges. And so the losses will con­tinue until the gradual growth of demand over a long period or the obsolescence of the older mills restores the equilibrium at last.

(CW 19-II, p. 590)

The problems created by "the forces of disorganised and beggar-my- neighbor competition" are, to again borrow Keynes's characterization of prosperity, cumulative (CW 19-II, p. 593). The drive to stay in business on the part of these family firms led them to finance losses through new debt and the run-down of working capital, which put them in yet more des­perate straits. Though not stressed here, the same destructive dimensions of competition in periods of inadequate demand, as Schumpeter (1942) demonstrated, afflict industries dominated by a small number of very large firms.⁴

Excessive competition, resulting from excess capacity, has, in many cases, brought down the level of profits below that of interest charges and other unavoidable outgoings. The resulting losses have been provided out of bank loans and other resources which ought only have used as current working capital. The consequence is that the normal borrowing capacity of the industry has been exhausted in meeting losses, and is not available for new capital. In short, the spinners as a class, are frightfully hard-up, which leads to the pest of what is known as "weak selling" [in which the need to pay back the bank plus the need to get revenue just to obtain new raw materials] carries the trouble a stage further and leads to prices which are worse than closing down.

(CW 19-II, pp. 597-598)

Keynes argued that this "involuntary selling by financially necessitous mills" carries competitive pressure on price to totally irrational and destructive levels.

What then should be done? Disempower destructive competition and “rationalize" industry through inter-firm cooperation guided by the state. The only rational solution to the problem of secular excess capacity and the need to shift production from the less efficient to the more efficient mills, especially in a debt-laden industry organized anarch­ically, is: the cartel, the holding company, and the amalgamation... By these means, and by these means only, can the surplus capacity be withdrawn from competition and held in reserve against future requirements, so that the rest of the industry can return normal profits meanwhile.

(CW 19-II, p. 591, emphasis added)

The detailed history of the failed attempt to create the Cotton Yarn Association discussed by Keynes need not concern us.⁵ His advice was that all such firms should join an industry association so that collective decisions could be taken about minimum prices, production quotas, the elimination of "weak selling," the redistribution of production from weak to strong mills (through the sale of quotas), a collective "organisation for marketing and merchanting," collective purchasing of raw materials, per­haps even a collective approach to borrowing ("cooperative credit"), and so forth (CW 19-II, p. 621).

In spite of Keynes's many interventions over two years on its behalf, the Cotton Yarn Association, which at one point included about 70 per­cent of the mills, eventually collapsed under the twin burdens of declining demand and free-rider problems. The Bank of England belatedly stepped in to provide assistance to struggling firms, but their actions were too half­hearted and too late to do much good.

We might summarize the most important analytical points stressed by Keynes in his discussion of the coal and cotton industries in the 1920s as follows: he rejected classical theory because its assumption set was so at odds with the new reality that it was a catastrophic guide to policy. In par­ticular, he attacked its assertion that intense or perfect competition will generate economic efficiency and full employment. He again argued that under then-current institutional and economic conditions, disequilibrium processes were destabilizing, of long duration, and path dependent. To the growing list of institutional impediments to efficient disequilibrium processes, Keynes here added the irreversibility both of capital investment and of labor to show that the cutthroat competition celebrated in classical theory can be tremendously destructive, especially in a regime of money contract. It made the adjustment to a new equilibrium in the major export

The new economic role of the state 93 industries very long and very inefficient. The process itself loaded the firms with debt (and the banks with bad debt) that pushed them further away from normal profitability.

As noted above, Keynes's attack on unregulated competition was not limited to industries populated by large numbers of small firms. As we saw in his three Essays in Persuasion, he also argued that economies of scale and scope were already large and getting larger in many important industries, causing oligopoly to become their normal and potentially most efficient state.

The giant firms that dominated these industries, Keynes argued, must operate, to use Schumpeter's word, "corespectively"; they should cooperate as well as compete, and at all costs avoid cutthroat price com­petition. They obviously cannot be efficiently regulated through perfect competition (see Schumpeter 1942, chapters 6-8). Where there are large economies of scale, there are large fixed costs per unit produced, mar­ginal cost is everywhere below total cost per unit, and the gap between the two widens as capacity utilization declines and fixed cost per unit rises. Marginal cost pricing, a hallmark of "perfect" or super-intense competition, would therefore destroy the industry. Firms in such indus­tries have to cooperate to keep price well above marginal cost and must regulate capital investment to avoid the disastrous effects of large excess capacity. Keynes argued that the state should actively help these crucial industries form organized cartels, trusts, and associations to help them efficiently self-regulate. But the state would also have to regulate these industries to prevent them from using their oligopoly power in harmful ways. The fact that many such industries had already implemented procedures for self- regulation would make it easier for the state to control and integrate them into a coherent overall government planning regime designed to create and sustain full employment. This new proposed eco­nomic policy regime is presented in some detail in the Liberal Party's book Britain's Industrial Future published in 1928, which is the subject of the next chapter.

Notes

1 In the 1930s, his interests naturally focused more heavily on how to respond to the British and global depression - a mostly macro issue and, later, how to pre­pare for war.

2 One reason why this had not happened (in addition to the industry's anarchic structure) was that the banks who had loaned money to the now-unprofitable mills, especially in the speculative bubble of 1919-1920, had a vested interest in seeing that they remained in operation, even at a loss, in order to keep some portion of the interest payments flowing to the banks.

3 Chapters 9-11 of Crotty (2017) explain this process and show that it operated in important global industries in the neoliberal era.

4 Once a giant firm has purchased and put into place its vast array of fixed capital goods, it is likely not to exit its business lines even when times are bad because it stands to lose a large proportion of the money it spent on capital when it exits. If bad times look like they may last for many years, there will be little demand to buy these industry-specific capital goods. The firm will thus suffer large losses upon exit. The expected value of remaining in the industry in hard times, but then earning the profit that will be available once good times return, may well exceed the losses sure to be experienced upon exit. For a more detailed treatment of this issue, see Crotty (2017, pp. 244-271).

5 See CW 19-II, chapter7.

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