This contradiction is played out in the conflicts between labor and business, both inside and outside the factory. Inside, these conflicts take the form of direct confrontation, sabotage, grievances, absenteeism and collective bargaining. Outside, conflict is usually indirect and sometimes proceeds through the mediation of the government. For example, the demands by workers without jobs for unemployment compensation or welfare are commonly directed at the government, even though the workers may also desire these costs to be paid by business, rather than by other workers. Sometimes, workers make it very clear that they are demanding that business pay. One example has been the demand for business contributions to pensions and social security. Another, more recent example, has been the demand by women in the "wages for housework" campaign that they be paid by business, through the government, for the work they do. Those women have argued that in a business society what appears to be simply family life, really involves a lot of work for business. What work? The work, they say, of procreating, raising and disciplining the next generation of workers, as well as the work of patching up, comforting and consoling the present generation (husbands, boyfriends and selves) so they will be able and willing to return to work everyday.
For reasons such as these, the ability of business to invest, and therefore to generate growth, has always been in question. It has always had this problem because there have always been conflicts over consumption and investment. I have already mentioned the history of conflict over work time. There has been an equally long history of conflict over wages and other benefits. What I want to examine now is one of the results of these conflicts, a result which turns out to also have been one of the mechanisms through which these conflicts were regulated: cyclical crisis. This history begins before the 19th Century but it ends, more or less, with the crisis of the 1930s, the Great Depression. We will look briefly at one pattern of events during that period.
Before the Great Depression, business sought to limit workers' struggles by many means. Partly they used brute force. The use of physical violence was commonplace. Sometimes they even massacred groups of workers demanding increased wages, etc. For this, they used either their own private armies (e.g., the infamous Pinkertons) or they used their leverage with government to bring in police or national guards.
Partly business used the state legally by getting laws passed forbidding unions, or strikes, or setting maximum wages laws --yes, maximum rather than minimum wage laws. It was a long time before workers organized themselves enough to force the state to act in their interests, rather than in those of business.
When business failed to control rising wages through violence or through the state, it still had one more tactic: economic crisis. In this case business would simply go on strike. Businessmen who were upset about the rate of return on their investment would refuse to invest. This refusal might involve an unwillingness to hire new workers, or, more dramatically, it might involve a refusal to continue producing at the going rate of profit. Then it would shut down plants and lay off workers. By throwing workers out into the streets, this business strike would put pressure on them to accept lower wages --a move that would tend to restore business profits to a level it found more acceptable.
Let's look at the pattern of growth produced by this kind of action. Suppose we begin with a period of growth, or a boom as they used to say, when the economy is expanding rapidly, more goods and services are being produced and employment is rising as workers are being hired. Under such conditions, the desire of business to expand output may outstrip the growth of available labor Ñso that the demand for labor grows faster than the supply. As this happens the labor markets become "tight," that is to say, there is a tendency for businesses to compete among themselves for available workers by offering better wages. In such situations, workers use their improved situation to fight for wage increases or other benefits Ñsuch as a reduction in the working day or week.
If the workers are successful, the cost of labor rises for business. If the cost rises fast enough, then it may begin to eat into profits. Supposing, furthermore, that business is unsuccessful in countering or offsetting these struggles, then it may respond by cutting back on investment.
In effect, capital would be going on strike. The spokesmen for business might say "We are not going to do what we normally do any more. We are not going to invest. We are going to sit on our profits, keep them in cash or short term securities, but buy no more plant and equipment and hire no more workers." When that happens, the expansion of output slows down. Sufficient cutback can even reduce the level of output, throwing the economy into a crisis --a recession or a depression.
How long and how deep the downturn would be depends on circumstances. The years during the latter half of the 19th and early 20th Century, during the long, rapid development of modern industrial capitalism, were characterized by many of these downturns. Between June 1857 and August 1929, according to the Department of Commerce dating of cycles, there were 19 downturns that set off cycles (peak to trough to peak) of an average length of 3.8 years. They were fairly regular, right up to the Great Depression.
It was the regularity of these crises which led economists to call them "business cycles." The pattern seemed to repeat itself over and over, always passing through the same four phases: expansion, peak (the highest point reached by an expansion), downturn, trough (the bottoming out point of a recession).
These terms are somewhat calmer ones than those often used by the press. Instead of expansion and downturn, it was common to speak of boom and bust (or panic). In the 19th Century such language was certainly warranted by the rapid and dramatic evolution of the phases. A boom was often just that: a sudden, explosive expansion of economic activity full of new investment and often wild speculation. Because "busts" or "panics" sometimes began with the collapse of some financial speculation, or the failure of some overestimated new market, the peak was often followed by a sudden crash.
At this point, I want to emphasize that there are many reasons for cyclical patterns of growth. There have been many theories put forward to explain these patterns. In a later chapter, when we return to examine these cycles, we will spend more time examining these alternative views. Here, I am focusing on one particular set of relationships Ñthe conflict between labor and businessÑ because it is important and because it has considerable relevance to the present situation.
What happened when the capitalists went on strike? When they cut back production and investment and laid off workers? In these circumstances, of course, unemployment would expand, the more so as the population and labor force were growing. This expansion of unemployment would increase the number of workers looking for jobs. It would result in increased competition for jobs and greater fear of losing jobs. These pressures would reduce demands for wage increases and even make it possible for the capitalists to reduce wages. As the downturn deepened, the average level of wages would often fall. If this fall were more rapid than the fall in total output, the result would be a shift in the proportion of output available as surplus and profits Ña shift in favor of business. Once business was convinced that the "business climate" was improving, it would begin to invest again, using profits to buy means of production and to expand employment Ñto put more people to work again. Production would thus start rising and the whole cycle set off on an upturn again.
By insisting on a certain rate of profit as a prerequisite to investment, business is demanding some minimally acceptable portion of total output be given over to it as plant and equipment (to put more people to work). This is simultaneously a demand by business to retain its traditional role in society Ña dominant one.
What we are also seeing is how the cycle was both the outgrowth of conflict over the growth process and, at the same time, a fundamental mechanism for regulating the relationship between wages and profits. Rarely seeing that both profits and wages could rise together, business generally thought that any increase in wages was a threat deserving retaliation. Refusing to invest and throwing the economy into a crisis of high unemployment and reduced production was a powerful weapon to regain what it saw as its rightful share of output.
Thus crisis was either a problem or a solution depending on the point of view. From the point of view of business, wage increases that ate into profits constituted a crisis. From the point of view of workers, rising wages were no crisis but rather a solution to their problem of achieving higher standards of living. Therefore, what was a crisis for business was a solution for labor. When the economy turned down, although everyone called it a crisis, or "bust," or "slump," the real crisis was more for workers than for business. High unemployment was a real crisis for workers, but for business, it was a solution to the problem of rising wages and falling profits Ñdifferent points of view for different classes of people in society.
Classical theorists postulated that all resources were being fully used. They thought this because they felt there were various mechanisms at work in a market economy tending to generate full utilization of resources and hence maximum output. Most importantly, they thought that the labor market would function in such a way as to guarantee the "full employment" of labor --which is to say that everyone willing to work at going wages could find a job.
The basis of this argument lay in their belief that the labor market, like other markets, was self-adjusting. In terms of the diagram below, representing the supply and demand for labor, they felt that the market would always adjust the price of labor (the wage) such that all workers who wanted to be employed at that wage would be. Thus there could be no "involuntary unemployment." They did admit the possibility of "voluntary" unemployment Ñthat there might be some who would refuse jobs at going wage ratesÑ but that was the workers' problem and their perversity did not trouble the classical economists. Let's see how the mechanism worked.
The rationale for the labor supply curve is simply that individuals acting alone and in combination will be willing to work more if they are paid more, but will work less if wages are reduced. The labor supply curve can be taken as representing the behavior of an individual, or, as the sum of the patterns of all individuals. This can be graphed in two-space as an upward sloping curve where the vertical axis measures the wage rate (W ) and the horizontal axis measures the quantity of labor -- either the number of hours workers are willing to work, or the number of workers willing to work a given 8 hour day, or some such.
The demand curve for labor slopes down because business firms will want to hire more labor if that labor is cheap, but will hire less if its price rises. Again there could be such a demand curve for a given firm, or the individual curves could be aggregated into an industry or economy wide curve.
Given these two curves, the labor market will clear where the two curves intersect, at wage rate W(e) , which is called the equilibrium wage, and labor quantity L(e) or the equilibrium quantity of labor. Market clearing means the quantity of labor business wants to hire at wage W(e) is just equal to the number of workers who want to work at that wage. The wage and quantity of labor are said to be in EQUILIBRIUM because it is thought that if for any reason there is a deviation from these magnitudes, forces will be set in motion which will tend to restore these conditions.
Suppose that the supply of labor offered exceeded the quantity demanded at a given wage. At that wage the number of workers willing to work is greater than the number business is willing to hire -- clearly there will be competition among the workers for the limited number of jobs. The classical economists argued that workers competing for jobs would accept lower wages. At lower wages business would hire more workers and the market would gravitate toward the equilibrium wage rate, where the quantity of labor desired = quantity of labor offered.
If, on the other hand, the demand for labor is grater than the supply, say at wage rate, then firms, rather than workers, will compete, each trying to hire the limited number of workers available at the low wage, and one means they will use to compete is to raise wages. So, again, the wage rate will tend to change, this time upward.
You should note that there is a very strange notion of "full employment" in this theory. More labor is hired at the equilibrium wage rate than at a higher wage, yet we know that fewer are working than were willing to work at the higher wages. Here, those who would work at the higher wage are not considered to be unemployed just because they refused the lower wage rate!
Despite this, the classical economists assumed that there would always be "full employment" and the economy would be operating at its full capacity. We have seen this with respect to labor and similar reasoning was applied to other resources.
In general, classical theorists were very optimistic about the ability of markets to allocate resources and to guarantee their full utilization in such a way as to sustain growth. Moreover, they were optimistic about the ability of markets to distribute final goods produced by putting labor and other resources to work. They based that optimism on what is known as SAY'S LAW after the economist J. B. Say.
Say's Law asserted that any act of production increases the supply of goods and the demand for goods by equal amounts, so that, aggregate demand always equals aggregate supply. In other words, total production will always be equal to the demand for consumption goods plus the demand for investment goods. Or, total output will always be equal to the demand for consumption goods plus the investment of the surplus. Everything that is produced will be bought; there will be no stagnation, no overproduction that the market cannot handle quickly and effectively in the short term.
In a barter economy, the workings of this "law" seem evident. The offer of a good is always simultaneously a demand for another good. At worst, if someone produces something others do not want, or want less of today than yesterday, that producer will shift to producing something else.
But in a money economy, such as modern business society, Say's Law will hold only if all money income (wages plus profits) are spent on actual production (C + MP). The classical economists, observing the general poverty of their time, never doubted that workers would spend all of their wages on consumption goods. The only problem appeared to be whether all profits would be invested.
This was perceived to be a problem because while large numbers of firms may earn some profit, not all firms will invest in new plant and equipment during a given period. The solution to this problem was provided by the existence of financial markets. Financial markets are, first of all, what are known as "financial intermediaries." Their purpose is to pool small amounts of cash, e.g., deposits of profits (we will ignore personal savings here because most workers in those days had none and even today such savings account for only 25 percent of the surplus available for investment) to create a large mass adequate for financing several investment projects. Financial intermediaries such as banks or the stock market make this mass available to those firms desiring to invest. Banks pay interest for deposits (stocks pay dividends) and charge interest on loans -- they make their own profits out of the difference. The financial market thus consists of a supply of loanable funds (from various firms' profits) which will be larger at higher interest rates, and a demand for such loanable funds which will grow as the interest cost of borrowing them declines. This structure of financial markets, or capital markets as they are sometimes called, can be seen to be similar to that of labor markets.
When we portray the supply and demand for loanable funds in the financial market, we see the interest rate on the vertical axis appearing as they price of capital and the amount of loanable funds being supplied or in demand on the horizontal axis. The classical economists felt the interest rate would adjust so that the amount of funds some capitalists wanted to save would just equal the amount others wanted to invest at the same interest rate. As in the case of the labor market, if the price was not at equilibrium, forces would be set in motion to return it to equilibrium. For example, if the interest rate was above the equilibrium rate, an excess supply of loanable funds would lead banks to lower interest rates in order to be able to loan them out. At rates below equilibrium the excessive demand for loanable funds would push rates up. Thus surplus would always be equal to investment via the market adjustment of interest rate.
At this point, having seen why the classical economists thought there would always be full employment of all resources and all the surplus would be invested, you may be wondering what they thought would determine the rate of surplus, or the amount of investment, or the rate of profit, or the position of the supply curve of loanable funds. On this question the classical economists often saw long run problems and were pessimistic about the long run outlook. The early classical economists didn't really have a theory of the direct determination of profit, their profit was a residual after wages and rent were subtracted from total output. But they did have a theory that while wages would remain at subsistence, rent would tend to rise with the demand for land, and therefore the rate of profit would tend to fall. That was why the long term outlook for generating a surplus and investment was poor.
In more recent versions of classical theory, the proportionate division of output between consumption and surplus is explained by the proportionate roles of labor and capital in production measured by their respective contributions to output. This side of the theory, especially in its neo-classical version is a central topic of microeconomics. Suffice it to say, it is not identical with the theory of division via conflict that I have been setting out, even though there is a relation between the two approaches.
Finally, I want to discuss one last aspect of classical theory relevant to current crisis discussions: their theory of the general price level, and hence their theory of inflation and deflation. This was a separate issue for classical economists, and they turned for the most part to what is called THE QUANTITY THEORY OF MONEY AND PRICES. That theory says: for a given quantity of goods in circulation, the price level will be proportionate to the quantity of money in circulation, and inversely proportionate to the velocity of its circulation. Symbolically we can write: M = PQ/V, where M = the quantity of money, Q = total production, P = the price level and V = velocity of circulation of money. (Velocity here refers to the number of times a given monetary unit is used to finance an exchange. In the aggregate one estimate of this value can be obtained by dividing GNP by the money supply.) Assuming Q and V to be fixed in the short term, the classical economists thought that changes in M would result in changes in P. For example, a sudden rapid increase in the money supply, due to the discovery of gold, or the rape of a new land (e.g., Central America), or to the government printing money, would result in a jump in the price level. As long as the increase in M continued, inflation would continue. One variation or another of this theory is still adhered to today by some economists. Because it posits that inflation is only possible if more money enters the system than goods, it concludes that the way to control inflation is by limiting the growth of the supply of money. We will return to this at length in later discussions of monetary policy.
But, suppose that this were not true. Suppose that in some year Americans imported more than they exported -- that they therefore needed more gold to pay for imports than they were receiving in payment for their exports. What would happen in such a situation of imbalance? Hume argued that market forces would be set in motion which would tend to restore balance. In his argument the most important of these forces were mobilized as a result of changes in the price levels of America and its trading partners consequent upon American exports of gold to pay for the excess of imports over exports (the trade "deficit").
According to the Quantity Theory Hume pointed out, the export of gold would result in a fall in the price level within the United States (assuming, of course that the velocity of money and total output remained unchanged in the short run). This drop in the price level of American goods (a "deflation" of the price level" would be complimented by a rise (an "inflation") in the price level of British goods as gold imports raised the money supply (and V and Q changed little). These two price level changes would then induce the following changes as market forces responded: with American goods cheaper and British goods more expensive, consumers in America would tend to import less and buy more domestic goods; Britishers by contrast would tend to buy fewer of the now more expensive local goods and would import more from the United States because those goods would now be relatively less expensive. As a result of these changes, American exports would tend to rise, American imports would tend to fall and the balance of trade would tend to be restored. In this way the Gold Standard would tend to result in an automatic adjustment toward equilibrium. In addition to this price mechanism that Hume emphasized, the classical economists also argued that changes in the gold/money stock caused by an imbalance in foreign trade accounts would result in changes in interest rates which would cause changes in investment and thus on the demand for imports (assuming some investment spending goes to imports). For example, suppose, once again an American trade deficit with an excess of imports over exports. The resultant gold outflow and drop in the money supply could, in part, take the form of a drop in the supply of loanable funds in financial markets. To the degree that this occurred, the backward shift in the supply curve would result in a rise in interest rates and lower levels of borrowing for investment, which in turn would mean lower demand for imports. As with the drop in demand due to price rises, this would have the effect of correcting the trade imbalance, especially when combined with the opposite effect in Britain (an increase in the money supply, a drop in interest rates and an increased demand for American investment goods).
More generally, the classical economists buttressed their faith in the Gold Standard with an equally fervent belief in the virtues of free trade. Here both Adam Smith and Daivd Ricardo are well known for developing arguments as to the advantages of free trade. In times of crisis, however, it was often very difficult for governments to maintain the Gold Standard against demands for protection against foreign goods. If a country was going through a crisis with rising unemployment, industries whose sales were falling would often point to imports as the cause of their woes and exhort their workers and others to demand protection from those imports in the form of tariffs and quotas. If the government gave in to such demands the Gold Standard could not work properly because imports and exports could not adjust in response to changes in relative prices, etc. Moreover, the imposition of tariffs in one country that stemmed imports from a second would often provoke that second country to impose tariffs to protect its industries and free trade and the Gold Standard would break down. Thus, the classical theory of the advantages and workings of the Gold Standard were relevant only to the degree that governments had the power to maintain the basic acceptance of these mechanisms and the conditions under which they would work. In the 1930s when these broke down, classical economics would itself fall into crisis.
In short, in classical economics crisis can only be very temporary because the market will adjust in the ways described above to iron out any difficulties. Prolonged depression and unemployment could only be due to external shocks (war, etc.) or to a refusal to accept market adjustments, e.g., the refusal by workers to accept wage reductions, or to government actions which prevented the markets from functioning properly.
1. Discuss the conflict between labor and business over the payment for work. What forms does it take? What examples of this conflict have you seen in recent press reports? In what sense are these conflicts over the division of the economic pie?
2. What is meant by a "business strike"? Why would such an action occur? Under what circumstances? Have you seen any evidence in recent press reports or elsewhere that such a strike exists in this period? What evidence?
3. Explain how a crisis can be both a problem for business and a solution. What kinds of tactics might business try to avoid a crisis? Why might those tactics fail? How might the use of a crisis fail?
4. In the analysis of a downturn, the argument was made that rising unemployment would put pressure on workers to accept wage freezes or wage cuts. Examine this issue and discuss exactly how such a mechanism might work. Who would feel such pressures most directly? Who would feel them less directly? What might offset such pressure?
5. Explain the operation of the labor market. What determines the supply of labor, the demand for labor? What might cause the supply to shift to the right, to the left? What kinds of tactics might labor use to raise wages? What determines the demand for labor? Why might it shift right, or left? What do you think happens in a crisis to the supply and demand? Show this with graphs. What kind of tactics might business use to try to reduce wages?
6. Suppose we added personal savings to business profits as elements of the supply of loanable funds. What would happen to the supply curve? What would happen to interest rates if people started saving more? What would happen to the amount of money invested? Answer these questions using the diagram of the capital market.