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BUSINESS CYCLES

A Theoretical, Historical,
and Statistical Analysis of the
Capitalist Process

JOSEPH A. SCHUMPETER

Professor of Economics, Harvard University

Volume I

McGRAW-HnX BOOK COMPANY, Inc.

NEW YOEK AND LONDON
1939

printed in the united states of AMERICA

AU rights reserved. This book, or
parts thereof, may not he reproduced
in any form without permission of
the publishers.

Preface

Analyzing business cycles means neither more nor less than analyzing
the economic process of the capitalist era. Most of us discover this
truth which at once reveals the nature of the task and also its formidable
dimensions. Cycles are not, like tonsils, separable things that might be
treated by themselves, but are, like the beat of the heart, of the essence
of the organism that displays them. I have called this book ‘‘Business
Cycles’^ in order to indicate succinctly what the reader is to expect, but
the subtitle really renders what I have tried to do.

This attitude to our subject is anything but novel, though I may
have made it stand out more conspicuously than other economists have
done. Nor do I think that there is anything novel in my combination of
historical, statistical, and theoretical analysis — as far as that goes I have
merely moved with the general tendency toward their mutual peaceful
penetration. But the exolanatory principles are my own. The profes-
sional reader will have no difficiilty in seeing their relation to the scaffold-
ing which I published nearly thirty years ago. The beginner or non-
professional reader should not bother about this — and still less about how
my exposition differs from doctrinal tradition — but accept in a common-
sense spirit what I believe to be fundamentally nothing but very practical
common sense.

It took longer than I thought to turn that scaffolding into a house,
to embody the results of my later work, to present the historical and
statistical complement, to expand old horizons. Nevertheless I doubt
whether the result warrants that simile. The house is certainly not a
finished and furnished one — ^there are too many glaring lacunae and too
many unfulfilled desiderata. The restriction to the historical and sta-
tistical material of the United States, England, and Germany, though
serious, is not the most serious of all the shortcomings. The younger
generation of economists should look upon this book merely as some-
thing to shoot at and to start from — as a motivated program for further
research. Nothing, at any rate, could please me more.

The reader will find the structure of the argument complex. To his
justifiable groan I have nothing to oppose but the question whether he

Preface

expected to jBnd it easy. The book cannot be glanced through for sweep-
ing results. It must be worked with. But I will make bold to say that
if this be done, all the repetitions, qualifications of qualifications, doubts,
apparent contradictions, all the details and case studies, will justify
themselves. Eeaders who do the work, master the method, follow up
the suggestions, answer the questions left to them will at the end of their
labor be able to feel that they have really come to grips with what goes
under the heading of Business Cycles.

To that there is no royal road. But I have done what I could to
make sure that the general reader who is willing to take the trouble will
be able to travel the one mapped out in this book. Insertion of an intro-
ductory chapter, constant attention to the common-sense meaning of
technicalities, utmost simplification throughout were the chief means
to that end.

I recommend no policy and propose no plan. Eeaders who care for
nothing else should lay this book aside. But I do not admit that this
convicts me of indifference to the social duty of science or makes this
book — ^including its historical parts — ^irrelevant to the burning questions
of the day. What our time needs most and lacks most is the understand-
ing of the process which people are passionately resolved to control.
To supply this understanding is to implement that resolve and to rational-
ize it. This is the only service the scientific worker is, as such, qualified
to render. As soon as it is rendered everyone can draw for himself the
practical conclusions appropriate to his individual interests or ideals.
And it will be seen (and often pointed out) that my analysis can in fact
be used to derive practical conclusions of the most conservative as well
as the most radical complexion, exactly as one and the same body of
engineering or medical knowledge can be used for the most varied
purposes.

But scientific analysis of an organic process easily creates the impres-
sion that the analyst advocates’^ letting that process alone. Such an
impression would have been another psychic barrier between myself and
most of my readers, additional to the inevitable ones that arise in, the
course of an argument which in important points challenges old-estab-
lished habits of mind. In order to remove it and to make it clear that
my analysis lends no support to any general principle of laisser fairSy I
have sometimes indicated valuations of my own, though I do not think
them interesting or relevant in themselves.

I had my own tale to tell. In doing so I have derived much benefit
from the work of a long list of writers — ^there is in fact little in the work
done by economists during the last two or three decades that does not
bear upon problems of economic cycles in one way or another. It has
been my endeavor to weave into my argument all that seemed appropri-

Preface

Vll

ate to the level of approximation I had to be content with and to add,
though not a bibliography, sufficient references for further study of what
has been done in what I believe to be the most important lines of advance.^
But I cannot say the same for the literature that comes under the heading
of general theories of business cycles. The facts and ideas presented in
that sector until about 1934 have, of course, been dealt with. But the
general schemata of the individual authors have not, and many names of
authors whom I highly respect are hence absent from my pages. Most
readers, however, will miss still more comment upon several important
treatises of this type which have been published since, in particular those
of Mr. Keynes, Professor Haberler, and Mr. Harrod. The plan and aim
of my book account for that. Systematic comparison of my analytic
scheme with others is one of the things that I leave to the reader whose
judgment and choice I do not wish to influence except by expounding
my case. He needs no urging in order to refer to those authors. And I
can assure him that lack of admiration was not among the motives which
prompted me to leave unchanged all that I had written or planned to
write when those three books appeared. Nor did I wish to criticize them,
which it is necessary to add because, in the nature of things, some passages
will read exactly like attacks on them.

The work partly summed up in this book has been made possible by
a series of grants from the Harvard Committee on Research in the Social
Sciences.

Much of the charting and calculating work has been done in that
Committee’s statistical laboratory. I wish to express my thanks to its
staff and in particular to its head, Mrs. E. W. Gilboy.

I had the help of three research assistants whose cooperation I
remember with gratitude. Dr. M. J. Fields assisted in the beginnings
and did many an irksome job of digging. Dr. Edgar M. Hoover, Jr.,
now Professor at the University of Michigan, succeeded him to continue
the digging and to nurse the growing child, contributing several inde-
pendent pieces of research as well as valuable criticisms. And Dr.
Alice Bourneuf, now of Rosemont College, Pennsylvania, attended to the
last stages. Dr. Carl E. Thomas, though working with me mainly on
other lines, has lent his aid on many individual points pertaining to the
sphere of monetary and banking statistics.

I have used a wide variety of material produced by, or published in,
private sources. The requisite permissions have always been most

1 Some omissions are explained by the length of the time it took to prepare this book for
press. I regret particularly that the latest books by Professors Hansen and Tinbergen,
Professor Marget’s book on the theory of prices, and Dr. Macaulay's book on bond yields,
interest rates, and stock prices appeared after what was a dead-line for me.

Vlll

Pkeface

readily granted and are in every individual case acknowledged in the
Appendix, in which I have assembled the description of the material that
went into the charts. I wish to avail myself of this opportunity to thank
all the authors, institutes, and publishing firms who so generously facili-
tated my task.

This acknowledgment fails, however, to convey adequately my sense
of obligation in several cases. Individual endeavors like mine are so
dependent on the splendid work which has been done by several great
organizations and which proffers to all of us possibilities nobody would
have dreamed of twenty years ago, that these organizations almost
have to share in the responsibility for the publication of a book such as
this whether they like it or not. Far beyond anything that quotation
on particular points, however careful, can express, reaches my obligation
to the pioneer work of the Harvard Economic Society, to the National
Bureau of Economic Research, to the Research Divisions of the Federal
Reserve Board and the Federal Reserve Bank of New York, to Professor
Ernst Wagemann and his creation, the Institut fiir Konjunkturforschung,
to Professors Bernhard Harms and Andreas Predohl and the Institut fiir
Weltwirtschaft, to the London and Cambridge Economic Service, and
to several others.

More debts to one’s environment than it is possible to mention or
even to remember accumulate in the course of such protracted work,
especially if one teaches the subject to small and active groups of gradu-
ate students. Help and advice generously given by Professors Crum
and Harris of Harvard, Professor Gordon, now of the University of
California, and Dr. Clausing of the University of Bonn should, however,
be particularly acknowledged.

Joseph A, Schumpeter.

Taconic, Connecticut,

July^ 1939 .

Contents

VOLUME I

Fags

Preface v

CHAPTER I

Introductory S

A. Business Situations and the Businessman’s Normal 3

B. External Factors 6

C. Importance of External Factors. 11

D. Common-sense Semeiology 14

E. Elementary Critique and Treatment of Series Representing the

Symptoms 17

F. Empirical Linking of Factors or Symptoms 25

CHAPTER II

Equilibrium and the Theoretical Norm of Economic Quantities. . . 30

A. The Meaning of a Model . 30

B. The Fundamental Question about Cycles 33

C. The Stationary Flow 35

D. Equilibrium and the Theoretical Norm 38

E. Complications and Clarifications. 45

F. Imperfect Competition 56

1. Bilateral monopoly 57

2. Oligopoly 60

S. Monopolistic competition. . . 63

G. Equilibrium Economics and the Study of Business Fluctuations . . 68

CHAPTER III

How THE Economic System Generates Evolution 72

A. Internal Factors of Change 72

1. Changes in consumers’ tastes . - 73

2. Changes in quantities of factors of production; saving and investing in an otherwise

stationary process . . . . . . . 74

8. Changes in the methods of supplying commodities; innovation and invention; the

concept of economic evolution. .... 84

B. The Theory of Innovation 87

C. The Entrepreneur and His Profit 102

1. Who, in a given case, is the entrepreneur? . . . 103

2. The entrepreneurial function as distinguished from that of supplying capital, risk-

bearing and others. ....... 103

Contents

Page

8. The emergence of entrepreneurs* profits 104

4. The struggle for shares in functional profits 106

5. Decreasing importance of the entrepreneurial function 108

D, The Role of Money and Banking in the Process of Evolution ... 109

1. The place of credit creation in our schema . . 110

2. The meaning of credit creation illustrated ... ... . Ill

8. Forms of credit creation; the commercial and the investment theories of banking; the

true function of banking . . i . . . . . . ... ^ .113

4, Types of ‘‘deposits”; redemption of deposits in legal tender; theoretical limits to the

creation of deposits . . . 118

E. Interest a Premium on Present over Future Balances (Money

Market; Capital) 123

CHAPTER IV

The CoNTOtJRs of Economic Evolution 130

A. The Working of the Model; First Approximation ISO

The modus operandi of enterprise under simplified conditions; behavior of volume of

transactions, costs, and total output in the process of innovation ISO

The two phases of each unit of the process; reaction by old firms; the “turn” . . 13S

Autodeflation and readjustment . 136

B. Looking at the Skeleton 138

The element of innovation sufficient to produce a logical sequence of “prosperities and
recessions” (two-phase cycle); commonsense of the thesis that “progress” unstabilizes

the economic world. . 138

The place of errors and anticipations; relation of this analysis to other explanations of

cycles. . , s 140

The welfare connotation of prosperity and recession . . . 142

The “rhythm*’. . : 143

Partial and general disequilibria . v v ■? . . . ... 144

The institutional character of our model. ? ; r . ... . 144

C. The Secondary Wave; Second Approximation 145

Secondary effects induced by the fundamental process; depression and the four-phase cycle 145

1. The “ahnormahty” of depression . .... . . 150

2. The theory of the recovery point . . ...151

8. The cycUcal unit and its phases . , . .. . 155

4. Introduction of additional facts that complete the second approximation .... 157

D. Many Simultaneous Cycles; Third Approximation 161

The historical development of the problem of cycles; Juglar and the single-cycle hypothe-
sis; the “discovery” of long and of short waves , . 162

Derivation of the three-cycle schema 166

1. The three-cycle schema not another hypothesis . 169

2. Motives of the decision to work with three cycles 170

5. Relations between the Kondratieffs, Juglars, and Kitchins 171

E. Other Fluctuations 174

1. “Waves” produced by external factors, in particular by wars, chance variations in gold

production, and in crops (special cycles) 175

2. Waves of adaptation or oscillations; the Slutsky effect; cumulation, acceleration, and 179

self-reinforcement; an illustrative example .

5. Hesitations and vibrations; fluctuations m aggregates (macrodynamics); Mr. ICalecki’s 188

theory and other models 138

4. Replacement waves and cognate topics 189

CHAPTER V

Time Series and Their Normal 193

A. Introduction (The Nature of Time Variables and the Task of Time
Series Analysis) 193

Contents

B. Various Meanings of the Term Trend 5200

Formal definition of ‘‘Trend** and “Cycle** 5200

1. Descriptive trends

2. Eeal trends gQg

S. Reference trends. . ; 2 Q 4

4. Special trends g ()5

5. Kondratieff movements often taken as trends 5205

C. A Single Cyclical Movement 205

The statistical normal and the concept of “result trend’* 5205

The solution of the trend problem for two-phase cycles . . 207

The solution for four-phase cycles; R. Frisch’s method of normal points, s 7 207

D. Many Simultaneous Waves 212

A composite of three cycles 212

Problems incident to the method of normal points 215

The comparison of time series . 219

CHAPTEE VI

Historical Outlines I: Introduction; 1787-1842 220

A. The Fundamental Importance of the Historical Approach to the

Problems of the Cyclical Process of Evolution 220

B. Questions of Principle 223

1. The definition of capitalism, s 2523

2. How old is capitalism?. . 224

S, Continuity and revolution in economic change; the “rise of capitalism”; “original

accumulation”; spurious problems, yssv .... . 226

C. Conditions and Processes in the 300 Years Preceding the Epoch

Usually Studied for the Purpose of Business Cycle Analysis .... 231

The background; infiuence of the increase in precious metals; of mercantilist policies;

and of public expenditure 5231

Some features of English economic evolution, s s .> r 5236

1. Agricultural enterprise 5237

2. Innovations in the woolen textile industry 240

8. Other industrial developments; the conquest of the home market 5241

4. Forms of resistance by the environment 243

5 . Monopolies . 5244

6. Commercial and colonial enterprise . 5245

7. The role of government finance; external factors, crises, and the problem of the

presence of cycles . . y i 5248

8. A note on John Law 5250

D. The Long Wave from 1787 to 1842 252

1. The meaning of the term Industrial Revolution s = 253

2. External factors, the Napoleonic wars in particular . . 255

8. American protectionism 258

4. “Inflation,” “deflation,” and “reckless banking’*. 260

5. Agrarian developments 266

6. English industrial and commercial developments ? = ? 270

7. German developments. ..yy .. 280

8. Developments in the United States 285

9. The role of credit creation and of monetary policy 292

10. The dating of Juglar cycles; discussion of the major crises ... . . . . 296

CHAPTER Vn

Historical Outlines II: 1843-1913 303

A. The Period 1843-1897 Considered as a Unit of the “Long Cycle”
(Second Kondratiej0F) 303

1. Social atmosphere of the “bourgeois** Kondratieff 304

2. Nature of institutional change and of the policies of the period 306

Contents

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Page

8. External disturbances y 311

4. The American Civil War, and the prosperity at falling prices after it 314

5. Sliver strategy syyevsyrv 317

B. The Agricultural Situations of the Period (and the Agricultural

Depression) 319

C. Raiboadization 325

1, The early stages and general features of the railroadization of the United States . 325

8. Problems of financing; the Illinois Central as an example 327

3. The crisis of 1857 in the United States . . ; - SSI

4. The end of the second and the third Juglar; the boom 1869-1872 and the crisis of 1873 S33

5. The depression 1874-1877, changing character of railroad enterprise . 337

6. Railroad development in England; the crisis of 1848 .rs Sil

7. The role and features of railroad development in Germany; the industrial or promotion

banks 346

D. Some Features of the Development of Manufactures in Our Three

Countries 351

1. German industrial evolution; the course of Juglar phases.* y y v y ; 351

2. English industrial and commercial evolution; finance; the course of Juglar phases . 366

3. Industrial evolution in the United States; cyclical calendar ? y 383

E. The First Sixteen Years of the Third Kondratieff (1898-1915) . . 397

A new industrial revolution yyyy .... . 397

1. Social changes and policies during the Neomercantilist Kondratieff; the shadows

of the War; various disturbances yssyyp 898

2. Agricultural developments until 1914 t ? 401

3. The last instalment of railroad construction » s . . . 402

4. The merger movement, mainly in the United States; its financial complement . . 403

5. The theory and practice of industrial mergers; the U. S. Steel Corporation as an

example 408

6. Electrification in the United States 411

7. The rise of the automobile industry and its subsidiaries; other industrial develop-
ments in the United States, y . y s 414

8. Discussion of the course of cyclical phases; the question of dating; the crisis of 1907

in the United States, yyyyy . 424

9. Features and contours of English developments to 1914; cychcal phases . . . 429

10. Features and contours of German developments to 1914; cyclical phases .... 436

VOLUME II

CHAPTER Vm

The Price Level 449

A. A Preliminary Warning Concerning the Causal and the Sympto-
matic Importance of Variations in Price Level 449

B. The Theory of the Price Level 452

C. The Practical Question 458

D. Analysis of the Behavior of Price-level Series; the Pulse Charts; the

Gold Factor 461

E. Group Prices; the Salient Fact of Covariation 475

CHAPTER IX

Physical Quantities. Employment 483

A. Individual and Composite Quantities; Three Methods of Indicating

Variations in Total Output 483

B. The Analysis of the Trend in Total Industrial Output; the Problem

of Retardation 491

Contents

xiii

C. The Cyclical Behavior of the Physical Volume of Production . . . ^500

Belaavior of output and price level compared 506

D. Employment of Labor

Discussion of the English unemployment series; absorption of cyclical unemployment at
rising wage rates; cyclical behavior . . , 510

CHAPTER X

Prices and Quantities of Individual Commodities

A. Prices and Quantities of Individual Commodities (Including

feervices)

1. Expectation for infinite variety of responses to cyclical situations ...

The competitive case; the “nominal” effect of cyclical variations in expenditure . .

S. Reaction of competitive industries to “real” changes in receipts

4. Illustrative discussion of various types of behavior

B. Special Cases

Recent work on price analysis

The case of coffee

The hog cycle and other “animal cycles” . r .

C- The Cycle in Shipbuilding; Professor Tinbergen’s Model

D. Entrepreneurial Price Policies

The case of entrepreneurs confronted by a demand of infinite elasticity

The imperfectly competitive situation; oligopoly in particular

Rigidity or stabihty of price

520

521

522

524

525

528

529

530

533

535

536
538

CHAPTER XI

Expenditure, Wages, Customers’ Balances 544

A. Some Propositions about Money 544

B. System Expenditure (Outside Clearings); the Cyclical Behavior of

Producers’ and Consumers’ Expenditure 548

C. National Income and Wages 561

1. The behavior of national income as to trend and cyclical variations, comparison with

other series; the profit item . 561

2. Factual and conceptual dijQSculties about wages, various definitions^ 564

S. Analysis of trends in, and cyclical variations of, wage bills and wage rates, r ? ; ; . 567

4. The question of lags 572

5. A diflScuIty in theoretical interpretation; sss??; 574

D. Deposits and Loans 578

1. Possible ways of financing an act of expenditure; . 578

2 . The relation between (outside) deposits, loans, and clearings 581

S. Qualifications of the expectation for parallelism 584

4. On underspending, nonborrowing, and the role of saving in the cycle. . . . 587

5. Customers’ balances and bank loans in detail; behavior of various monetary ratios . 594

6. Real and monetary investment 598

CHAPTER XII

The Rate of Interest 602

A. Earlier Argument Resumed 602

1. The concepts of a demand for balances and of an equilibrium rate of interest; the

adapted rate . .... . . . . 602

2. The secondary wave and the cyclical shifts in the demand for balances; the lag of

interest 604

3. The “supply” of balances* y ? ; . r ? . . ... 606

4. The position of interest in the cyclical process; capitalization of quasirents .... 607

5. The pricing of titles to future balances .yyvysr.,.. 611

XIV

Contents

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B. Discussion of Various Bates 614

The iiistorical course of interest rates 614

1. Factual difficulties 615

3. The mortgage rate. 618

S. Bond yields 671

4. The rates of the open market 622

5 . The rates of the Bank of England and of the Eeichsbank 625

C. Discussion of the Time Shape of Interest Bate 626

1. The absence of trend in the series . 627

3. The cyclical behavior of interest 628

S. Interest and profits, pig iron production, total output, and price level 632

4. The consequential character of interest and Professor von Hayek’s theory; the lag in

short and long rates 634

CHAPTEB XIII

The Central Maeket and the Stock Exchange 639

A. Banks and the Pulse of Industry 639

1. Limitations to the initiative of banks; banks are normally not “loaned up” ... 639

2. Member banks’ operations in the open market; their secondary reserves, investments,

and loans ... 643

3. Other factors affecting banks’ investments; the investments of industrial or promotion

banks ... . ... . 646

B. The Central Market (in an Isolated Domain) 648

Position and influence of bankers’ banks, their behavior with respect to cyclical situations 651

C. The Cyclical Aspects of International Belations 666

1. Exports and imports under the influence of cyclical fluctuations; the role of central

banks . . . . . . . 666

2. Capital movements and central bank policy; the English case; pivotal importance of

short claims on foreign countries . . . 668

3. The London gold market; the gold policy of the Bank of England; gold stock, bank rate,

and price level ... . . . . , 675

D. Stock Exchange Series 678

1. Cyclical nature and cyclical effects of the trade in stocks and bonds; peculiarities of the

pricing of stocks . .... ... 679

2. Theory of stock-market “tendencies” . . . 682

3. Analysis of the behavior of stock prices, various covariations 684

4. Banks and stock speculation 689

CHAPTER XIV

1919-1929 692

A. Postwar Events and Postwar Problems (Introduction) 692

B. Comments on Postwar Patterns 695

1. Some factors and symptoms of change in the social structure 697

2. The world war and its consequences as external factors . . 700

8. Survey of postwar foreign policies and economic relations; reasons for the failure of the

provisional arrangements arrived at 702

4. Various other types of war effects exemplified . . 704

5. Postwar protectionism and the refusal of this country “to accept its creditor position” 705

C. Further Comments on Postwar Conditions in Our Three Countries 708

1. The United States; mentality of the country and its fiscal policy. . ....... 708

2. Digression on the effects of taxation . . . . . . 710

3. Germany; the postwar situation and the social atmosphere; expenditure and fiscal policy 714

4. Facts and theory of the German “capital imports”. 718

5. England; the postwar situation; monetary policy; the social atmosphere; fiscal policy 722

Contents

D. Outlines of Economic History from 1919 to 1929

1. Agrarian developments; diagnosis of the agrarian depressions in the United States,

England, and Germany

2. The building booms of the twenties in the United States, Germany, and England •

E. The “Industrial He volution’^ of the Twenties

General features

1. English developments; external factors; motorcars; iron and steel; electricity; the

expanding industries; cycles and phases

2. German developments; “rationalization”; public enterprise; mergers, the “crisis of

concerns”; the potash problem; iron and steel; organizational innovations; the chem-
ical industry; rayon in particular; cycles and phases ....

3. Developments in the United States; the general pattern; aviation; power production,

electrical equipment; motorcars, oil and rubber; the chemical industry, rayon and
textiles; iron and steel, aluminum, copper; value added and value added divided by
payroll in industries, whose value added was 50 millions or more in 1929; detailed
discussion of cyclical fluctuations through 1929

F. The Behavior of Systematic Series from 1919 to 1929

I. Output (a), prices (6), interest rates (c)

a, 1. Total industrial output and output per employee .

2. Producers’ and consumers’ goods; eqmpment goods; “overproduction” and

\ “excess capacity” ...

3. Employment and the absorption of unemployment . .

5. Price levels as shaped by the evolutionary process and by reaction to war inflation

1. Analysis of variations in the American price level

2. The English case

3. The German case.

c. Interest rates

1. The behavior of interest rates in the United States

2. The German case

3. The English case . . . .

II. a. Debits outside New York, national income, and payroll m the United States

h. Corporate accumulation in the United States .

c- Total realized income and consumers’ expenditure, households’ borrowings, infer-
ence about households’ savings . ... . . • .

d. German and British national incomes, wage bills, consumers’ expenditures, and

savings

e. The behavior of profits in the United States • •

/. The behavior of wage rates

1. American wage rates during the twenties . .

2. Their relation to the amount of unemployment and to prosperities

8. German wage rates during the twenties

4. Wage rates in the United Kingdom during the twenties . ...

III. Series descriptive of processes in the sphere of money and member bank credit, mainly

in the United States

a. The nature of time deposits. . . . •

5, Outside deposits and loans and the structural change in assets

c. Banks’ investments and general business practice

d. German and English banking developments .... . ....

IV. Stock speculation and the monetary investment process mainly in the United States

a. The theory of brokers’ loans .... . .

h. The speculative outburst, call rate; minor points, issues for real investment .
c. Stock exchange and investment processes in Germany and in England . ...

V. Central banking in the United States and England • -

a. The American postwar situation

6, The mechanics of Federal reserve credit ... •

c. The reserve system’s postwar policy, conclusions; its “failure to prevent the

depression”. ... • •

d. Comments on the policy of the Bank of England ...... ....

CHAPTEE XV

The Wohld Ckisis and After

A. Th? World Crisis aad the Cyclical Schema

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B. 19S0 911

1. The United States 911

2. England 917

3 Germany 920

C. 1931 and 1932 924

1. Physical Production, on the downgrade and at the bottom 924

2. Incidents, Accidents, and Policy in Germany . 930

8. Incidents, Accidents, and Policy in the United States 936

4. The behavior of other American and German time series around the bottom of the

depression 944

D. The United Kingdom, 1931-1938 954

1. The abandonment of the Gold Standard 955

2. The subsequent management of money and credit 958

3. Some effects of abandonment and cognate policies 959

а. The relief to exports 960

б. England’s conversion to protectionism and the Ottawa achievement ...... 961

4. England’s industrial processes; the great building boom in particular 963

5. The testimony of time senes, especially of output, unemployment, prices, wages, in-
come, clearings, issues, stock prices 966

E. The State-Directed Economy of Germany, 1933-1938 971

Employment and production 971

Efforts toward autarky 973

Pohey in the recovery phase 974

Government expenditure in the prosperity phase 976

Prices, wages, incomes, consumption . . . 977

Monetary management and the behavior of monetary and banking series 979

F. Recovery and Recovery Policy in the United States from 1933-1935 983

The problem 983

1. **Mmor” measures surveyed 986

2. Recovery and the AAA 988

3. Recovery and the NRA 992

4. Monetary policy 996

5. Income-generating expenditure, facts and theory 1001

6. The statistical picture 1006

G. The Disappointing Juglar 1011

The problem raised by American developments since 1935. 1011

1. Time series contours 1013

2. The money market and the banking sphere; behavior of price level 1016

S. The industrial process 1020

4. The reciprocal trade agreements; monetary “restriction” and “expansion”; the

stoppage of income generation . , 1026

5. Stagnation of the capitalist process 1032

а. The theory of vanishing investment opportunity , . 1032

б. Its inadequacy . . . 1036

c* The alternative explanation by means of the social atmosphere resulting from cap-
italist evolution . . . 1038

d. Reasons for believing this explanation to be adequate 1044

Appendix: Description op the Statistical Material Embodied in

Charts I-LX 1051

Index

CHAPTER I

Introductory

A. Business Situations and the Businessman's Normal. — ^Every busi-
nessman knows that his success or failure depends not merely on the
degree of efficiency with which he manages his firm and on the fortunes
of the particular branch of industry in which he works, but also on a set
of conditions over which neither he nor that branch as a whole has any
control. These conditions made up what he calls the General Business
Situation, which he readily distinguishes from that group of factors mak-
ing for success or failure within his own concern: the quality of his plant,
the vigor of his management or of his advertising campaigns, his skill
in buying raw materials, or his smooth cooperation with his employees.
He also distinguishes it from another group of factors which affect the
prosperity of his particular branch of industry: its competitive position,
the rate of change of its total productive capacity, the state of its cus-
tomers" demand, its labor conditions or raw-material supply. He knows
that there is something else which affects the fortunes of all individual
concerns and of all industries, and which is not simply the sum total of
the factors acting within each concern or each branch of industry, but a
general background for all individual endeavors in the nation or even in
the whole industrial world that sometimes makes for their success and
sometimes for their failure, irrespective, as it seems to him, of their
individual merits : something, finally, the elements of which weld into one
connected whole capable of being described in terms of comparatively
few strong contour lines. Price structures and price levels, the state of
credit, consumers" expenditure, employment, and other such well-known
factors form at any time a set of data which the individual firm has to
accept and to which it must try to adapt itself. Waiving for the moment
the question of the precise nature of that general pattern of economic life,
which it is the aim of this book to interpret, and the further question
whether its changes display any significant regularities, we may well take
that common sense idea of Business Situations as a starting point. From
everyday experience, from the contents of the business page of every
newspaper, and from what the various forecasting services report, we
know sufficiently well what they are. If our idea is not yet quite clear

4 Business Cycles

or definite, it has the compensating advantage of being saturated with
practical fact.

Next let us observe that businessmen, when, for example, they are
writing their yearly reports to their shareholders, seldom fail to describe
business as having been normal or above or below normal. Everybody
understands this. A firm has had a normal year if it has succeeded in
earning enough to cover current expenditure, depreciation, contractual
interest on its debt, plus such remuneration of the owners’ services and
capital as is sufficient and not more than sufficient to induce them to go
on without either increasing or decreasing their investment.^ The
general business situation will be called normal if it allows all firms not
working under advantages or disadvantages peculiar to them, to earn
about that much. Later on we shall link up this concept of normal busi-
ness with two others which are related to it, though not identical with it:
the concept of the Statistical Normal that has grown out of that analysis
of time series with which the reader is familiar from the charts in his
newspaper or his statistical service; and the concept of Equilibrium which,
though less familiar, is an indispensable tool of scientific analysis of the
chronic disequilibria of economic life.

For the moment, however, we are content with the rough common-
sense of the matter. All that is important to note is that businessmen
actually compare any actual situation with that kind of normal. Both
their talk and their actions testify to a feeling they have that in the long
run things have a way of conforming to it, and that, barring special
circumstances, situations much above and situations much below it are
not likely to last. Both these habits, embodying as they do long, even
ancestral, business experience, deserve notice. The habit of comparing
actual results as presented by a profit-and-loss account with what the
executive considers normal, supplies a sufficient answer to all those who
say that the idea of normal business has no importance because business
never is normal, and who go on to draw the conclusion that the concept of
economic equilibrium is useless. We shall see later on that business
situations sometimes approach and sometimes draw away from these
normals in a characteristic way. But we see already that even if real
life were always equally far removed from equilibrium, our concept would
still be indispensable as a standard by which to diagnose and, if possible,
to measure actual states of the economic organism. The habit of

1 Tliat is not, of course, offered as a satisfactory definition. Still less is the next sentence
to be so interpreted. Nevertheless, it may seem to the reader that we are not justified in
imputing even as much as that to the unscientific mind. This impression will, however,
vanish if it be remembered that the above definition does not mean anything more than
that each firm gets what the noanagement considers to be adequate and not more than
adequate.

Inteoductoky

expecting return to normal (which explains why a certain state of profit-
and-loss accounts is called normal) shows that businessmen have a very
full idea of that logic which is inherent in economic things and which it
is the task of scientific economics to formulate somewhat more rigorously.^

With reference to their idea of normal business they identify pros-
perities or booms and depressions or slumps. If they feel sufBciently
uncomfortable, they speak of a crisis. Not only in everyday parlance
but also as they are used by economists and historians those terms,
although not actually lacking meaning, yet do lack precise meaning. In
particular, the term crisis is quite loosely used in the literature of our
subject, and so are its specifications, commercial crisis, financial crisis,
agrarian crisis, and so on. This is, in fact, the main reason why the
historical lists of crises which have been drawn up differ — ^beyond a
number of standard cases which everybody includes — so considerably.
We shall not give any technical meaning to the term crisis but only to
prosperity and depression. The word cycle did not originate in the busi-
ness community and does not concern us just now.

We can learn more than that from our businessman and his perception
of what with him we call the General Business Situation. He tries, from
his standpoint and for his purposes, to diagnose and to prognosticate it.
This he often does subconsciously, sometimes even deprecating anything
that would look like 'HheoreticaP’ analysis. There is common sense in
this: sometimes the unanalyzed impression of an experienced man is
likely to be a safer guide to correct action than is analysis, which by its
nature stresses a limited number of measurable elements and thereby
misses other factors so as to lose the intimate flavor of things.

This, of course, is especially true for short-time considerations, such
as those which occur in trying to forecast the events on a stock market
from day to day, for here knowledge of the technical position and of the
temperament and motives of leading groups often counts for much more

1 The concept of a normal business situation is, therefore, no mere “figment,” although
it is an abstraction— one of the many which practical life imposes upon us. It implies,
moreover, no circular reasoning, as we might think when we reflect that normal business
implies normal profits (in the bookkeeping sense) and that normal profits are sometimes
defined with reference to a normal situation. It is, finally, directly gleaned from observa-
tion. But that it is not so obviously present in the American businessman’s mind as it is
in the minds of his European brethren, must be admitted. Here we strike for the first time
a note which xmavoidably sounds each time our subject requires reference to sociopsycho-
logical attitudes. The spirit of pioneer times has in America not died out as yet from under
an uncongenial superstructure, and asserts itself in an impulsive belief in increasing rates of
growth, particularly of capital values. This in less sober minds often blurs the picture of
the plain facts embodied in our concept. The same spirit manifests itself in the naive
enjoyment of prosperities and “new eras” and in corresponding dejection if the shocking
disaster of depression occurs. It is a real factor in shaping those secondary phenomena,
which we have a right to attribute to “psychology.”

Business Cycles

than does the understanding of the deeper forces which underlie the cur-
rents of the day or the week. But it also applies to attempts at long-
range prognosis and even to analysis carried out by scientific methods for
purely scientific purposes. As a doctor at the bedside sees and under-
stands more than he would be able to prove by exact test, so every econo-
mist who is at all worthy of this name acquires by lifelong familiarity
with contemporaneous and historical fact a vision or an understanding
of the intimate necessities in the life of the organism he deals with which
carries him much further than the exact tools at his command and may
count for more in remedial advice than provable theorems.

There is no warrant for the view that what we cannot measure does,
therefore, not exist. This, by the way, partly explains the fact that the
problems of applied economics are seldom handled satisfactorily by the
mere technician, and that even competent economists who agree per-
fectly about the scientific basis of a diagnosis may yet differ as to advice,
just as doctors do. Whether or not to operate on the patient is no mere
question of better or inferior knowledge of a given state of things, but
also of temperament; as far, however, as it is a question of knowledge,
it is not wholly a question of provable, still less of quantitative, knowledge.

Yet our businessman analyzes whenever new situations arise. He
does so himself in a manner which is unscientific but often shrewd, or
other people do it for him — ^his banker, his newspaper, or any of the
services which present current business facts and inferences therefrom
by methods which vary as to scientific value from zero up to anything
that can be fairly asked in the present state of our knowledge. There
always have been, probably, some rules by which businessmen formed
their judgment about existing business situations and the changes to be
expected, ever since business operations extending over time and space
came into existence; but with increasing wealth of, and with improving
methods of treating, statistical facts an ever-expanding number of
‘‘indices,” which look objective and sometimes are, have come to the
assistance of even the untutored mind. We shall presently draw up a
list of those symptoms which are more attentively observed than others.
But now we want to learn from, and incidentally improve upon, a certain
mental attitude or method which we observe that our businessman
applies to the material before him. In trying to diagnose economic
change, he forms an idea about its causes. And these he classifies by
means of a distinction which is fundamental also for us.

B. External Factors. — ^Everyone is conscious of the fact that, for
example, political events, while not business phenomena themselves, are
very important elements to take account of in diagnosing a business
situation or forecasting the economic future. Every conversation, every
circular from a bank or investment house to its customers, every speech

Inteodxjctoby

at a shareholders’ meeting, every newspaper’s commercial page touches
on this subject. But businessmen would also readily agree to the follow-
ing generalization and further distinction. Among the factors which
determine any given business situation there are some which act from
within and some which act from without the economic sphere. Economic
consideration can fully account for the former only; the latter must be
accepted as data and all we can do about them in economic analysis is to
explain their effects on economic life. Hence we arrive at the very
important concept of factors acting from without (let us call them
External Factors), which it stands to reason we must try to abstract from
when working out an explanation of the causation of economic fluctua-
tions properly so called, that is, of those economic changes which are
inherent in the working of the economic organism itself.^ We will group
them into two classes, the first of which contains instances which are, and
the second instances which are not, readily recognizable as extra-economic
disturbers of the flow of economic life.

1. The best examples of what we mean by an external factor are
offered by such events as the great Tokyo earthquake, the virtue of which
from our standpoint consists in the fact that, so far at least, no one has
thought of attributing responsibility for them to our industrial system.
Whenever a disturbance is the product of social processes, the difficult
question arises whether it is not as much a consequence as a cause of
economic events and situations and hence whether we are within our
rights if we speak of it as ^‘acting from without the economic sphere.”
In a deeper sense, and especially for those of us who accept the Marxian
theory of the social process, the answer is undoubtedly in the negative.
But for our purpose^ it is yet permissible to draw a line between the
phenomena directly incident to the working of the economic system and
the phenomena produced by other socialagencies acting on the economic
system, however obviously this action may be conditioned by economic

^ The effects of these external factors will be called the external irregularities of our
material, as distinguished from its internal irregularities, to be defined later. The distinc-
tion between external and internal factors is related to, though not always synonymous
with, the distinction widely used in classifying ‘‘theories” of the cycle, between exogenous
and endogenous factors (on which see, for example, Spiethoff, art. on Krisen in Hand-
wi5rterbuch der Staatswissenschaften). Neither is it synonymous with the distinction
between economic and extra-economic factors as usually understood. The factors that are
clearly extra-economic in origin are merely the most obvious instances of external factors.
But the principle of analysis underlying all these and similar distinctions is the same. They
are all meant to express the fact that what we are faced with is an economic process dis-
turbed by events not inherent in it. What precisely is looked upon as inherent in it will,
of course, depend on how we deli m it it and which facts and relations we decide to treat as
data, and which as variables.

* It is readily admitted that, in a sense, this purpose limits us to the surface of things.

Business Ctcues

situations or propelled by economic aim or class interest. In a sense,
therefore, we may within the limited range of our investigation look upon
wars, danger of war, revolutions, and social unrest as external factors.
Changes in the tariff policy of a country or in its system of taxation,
measures of social betterment, and government regulations of all kinds
we include in the same class. After all, there is probably little that could
be objected to in our recognition of the fact that it would not help us
much, for instance in an analysis of the problems of foreign exchange, to
deal indiscriminately with cases in which exchanges are determined by
commercial factors alone and cases in which they are ‘‘pegged’’ as the
French exchange was during the war.^ And this is all that our distinction
amounts to so far. But for obvious reasons it is less easy to carry
out the distinction in other cases, and great care — carried even to the
extent of hairsplitting — ^is required in order to do justice to the endless
variety of the social patterns we encounter.

2, Variations of crops due to natural causes, such as weather condi-
tions or plagues, raise a problem only because of the difficulty of separat-
ing them from variations due to other causes. But for this, we could class
them with the effects of earthquakes.^ Gold discoveries also could be
listed in the same category as far as they may be considered, from the
standpoint of the business organism, to be chance events. But it is a
fact that variations in the total supply of gold often come about in response
to business situations and in exactly the same way as variations in the
supply of any other commodity. The variations in the monetary supply
of gold are never conditioned by chance discoveries alone. Hence we
have here a case of mixed character not always easy to interpret.

S. This, however, raises the question of discoveries of new countries
and of what is readily seen to be for our purposes similar in character
and effect, inventions. Both create new possibilities and are no doubt
among the most important causes of economic and social change. But
are they external factors in our sense? Our answer will best be given by
way of examples. If we scrutinize the motives and methods of Colum-
bus’s venture, we find that it would be by no means absurd to call it a
business venture. In this case it would be just as much an element of
the business situation as is any other enterprise. But if we refuse to

^Example: There cannot be any doubt, of course, that England’s policy of free trade
grew out of a definite business situation, and that every explanation of the former must run
in terms of the latter. It still remains true that from the standpoint of the industrial and
commercial organism the repeal of protective duties came about as an outside event and was
not evolved by its working: something else, another mechanism, stood between the two.

* Meteorological conditions acting not through crops but through human behavior would
be ideal external factors if we accepted Dr. G. Mata’s theory. Quarterly Journal of Eco-
nomics^ November 1934, which is an excellent example of a rigorously exogenous theory of
the business cycle.

Introductory

do this, the discovery of America does not thereby become an external
factor, for it was not directly relevant to the course of the economic
process at alL It acquired relevance only as and when the new possi-
bilities were turned into commercial and industrial reality, and then the
individual acts of realization and not the possibilities themselves are
what concern us. Those acts, the formation of companies for the exploi-
tation of the new opportunities, the settling of the new countries, the
exports into and the imports from them, are part of the economic process,
as they are part of economic history, and not outside of it. Again, the
invention of, say, the Montgolfier balloon was not an external factor of
the business situation of its time; it was, indeed, no factor at all. The
same is true of all inventions as such, witness the inventions of the antique
world and the middle ages which for centuries failed to affect the current
of life. As soon, however, as an invention is put into business practice,
we have a process which arises from, and is an element of, the economic
life of its time, and not something that acts on it from without. In no
case, therefore, is invention an external factor. All this may sound
strange. We do not mean to say that the social and cultural importance
of the discovery of America consists in the business transactions to which
it led, or that the point of view we adopt does justice to the broader conse-
quences of the growth of knowledge. We formulate as we do merely for
the purposes of a study of economic fluctuations and for it, as in fact
our businessman would agree, things acquire proportions very different
from those they would have in a general sociology.

We shall return to the subject in Chap. Ill, Sec. A and in Chap. IX,
Sec. B, but two examples will show at once that this is no play with words.
We sometimes read that in the nineteenth century the opening up of new
countries was the background on which economic evolution achieved
what it did. In a sense this statement is true. But if the inference is
that this circumstance was, in our parlance, an external factor, that is,
something distinct from that very economic evolution and independently
acting upon it, then the statement ceases to be true: our vision of the
evolution of capitalism must precisely include the opening up of new
countries as one of its elements and as a result of the same process which
also produced all the other economic features of that epoch. Among
them is the mechanization of industry. Again, we read a statement made
by a high authority in our field, to the effect that it is not ^^capitalistic
enterprise” hut technological progress (invention, machinery) which
accounts for the rate of increase in total output during the nineteenth
century. Obviously it is not a matter of indifference whether we accept
the theory underlying that statement, namely that the mechanization
of industry was a phenomenon distinct from “capitalistic enterprise” and
independently influencing it — a phenomenon which could and would have

Business Cycles

come about in substantially the same way whatever the social organiza-
tion — or whether we hold as we do (in this respect entirely agreeing with
Marx) that technological progress was of the very essence of capitalistic
enterprise and hence cannot be divorced from it. This view will be
developed as we go along and is mentioned here only for the purpose of
illustrating our terminology.

4. We need not stay to explain why, for any country, business fluctua-
tions in another country should be looked upon as external factors. But
to treat in this way variations in the number and age distribution of
populations is less easy to justify. Migrations in particular are so obvi-
ously conditioned by business fluctuations that no description of the
mechanism of cycles can claim to be complete without including them,
and including them — at least some of them — as internal factors.^ How-
ever, as we shall not deal with this group of problems in this volume —
although the writer is alive to the seriousness of this breach in our wall —
it will be convenient to consider migration over the frontiers of the
territories to which our statistics refer, provisionally, as an external
factor, while migration within those territories, which it would be impossi-
ble so to consider, will be noticed but incidentally. Changes in numbers
and age distributions due to other causes than migration sometimes are
in fact external factors or consequences of external factors, such as wars.
Sometimes they are not, as we may see from the cyclical component in
marriage rates. But as it is impossible to accept a minimum-of-existence
theory of wages — ^which it would be necessary to do in order to make the
relation between the rate of change of population and economic situations
stringent — and as nativity and mortality display substantive independ-
ence of economic fluctuations — ^however much their historic changes have
to do with the ulterior cultural effects of the working of the capitalist
machine — ^it has seemed best to class them with external factors^ (see
Chap. Ill, Sec. A).

5. Finally, we have had examples (changes in tariff policy, taxation,
and so on) of what we may term changes in the institutional framework.
They range from fundamental social reconstruction, such as occurred in

^ There are some, however — e,g,, emigrations because of religious oppression — which are
external factors in the full meaning of the term.

2 Readers will see that om arrangements about the element of population are partly
motivated by factual propositions and partly by considerations of expository convenience
arising out of the purposes of this book. It is not, of course, held that those arrangements
would be satisfactory outside of these purposes or that the subject of population has no
claim to other treatment than is given to it here. Work done by Dr. A. LSsch, Bev<5l-
kerungsweUen und Wechsellagen, 1936, has even shaken the writer's conviction, which used
to be strong, that changes in population, although they certainly are among the most
important conditions of capitalist evolution and also among its most important ulterior
effects, have no place among the causal factors of economic cycles.

Introductory

Russia after 1917, down to changes of detail in social behavior or habits,
such as keeping one’s liquid resources in the form of a demand deposit
rather than in the form of cash at home or contracting collectively rather
than individually. It is entirely immaterial whether or not such changes
are embodied in, or recognized by, legislation. In any case they alter
the rules of the economic game and hence the significance of indices and
the systematic relations of the elements which form the economic world.
In some cases, however, they so directly act by means of business behavior
that it may become difficult to recognize them as external factors. The
Owen-Glass reform is readily recognized as a rearrangement by political
means of part of the setting within which business works. But change
of practice by the Federal Reserve System or by any Central Bank in
Europe may be itself an act of business behavior and an element of the
mechanism of cycles, as well as an external factor; and so may collective
measures taken by the business world itself. Every such case must be
treated on its merits, and decision may be difficult indeed. Our dis-
tinction must be kept in mind even in such cases, but it works with
increasing difficulty the more frequent they become. This is but a
consequence of the fact that our economic system is not a pure one but in
full transition toward something else, and, therefore, not always describ-
able in terms of a logically consistent analytic model. But for the com-
mon sense of the principle we may again appeal to our businessman, who
as a matter of fact does distinguish each time between the elements of the
business situation, and the elements acting on the business situation —
while to possible sociological criticism we again reply that it would be
quite justified if this were a book on, say, the rise of American civilization,
but that it is not justified if aimed at the purpose in hand.^

C. The Importance of External Factors. — ^Now, it is obvious that the
external factors of economic change are so numerous and important that
if we beheld a complete list of them we might be set wondering whether
there was anything left in business fluctuations to be accounted for in
other ways. This impression is much intensified by the fact that the
impact of external factors would of itself account for wavelike alternation
of states of prosperity and of depression, both because some disturbances
occur at almost regular intervals and because most of them induce a
process of adaptation in the system which will produce the picture of a
wavelike oscillation in every individual case.

^ Changes of the “rules of the game” and changes brought about in the data of business
action, if of more than passing importance, might be called dructural changes. This con-
cept, as used by Harms, L5we, Wagemann, and others, is handy for some purposes. But
we will avoid it, because it includes also some of the more durable effects of the process that
we wish to investigate and hence tends to obliterate what it is important for us to keep
distinct.

Business Cycles

We shall return to this subject (see Chap. IV, Sec. D), but really do
not need any theory or apparatus in order to realize this much. In fact,
it would be possible to write, without any glaring absurdity, a history of
business fluctuations exclusively in terms of external factors,^ and such a
history would probably miss a smaller amount of relevant fact than one
which attempts to do without them. Consequently, a theory of business
fluctuations to the effect that they are caused by external factors would
not lack verifying evidence; indeed, it might be the first to suggest itself
to an unprejudiced mind.

There are instances covering considerable stretches of our material,
in which effects of external factors entirely overshadow everything else,
either in the behavior of individual elements of business situations or
in the behavior of business situations as a whole. The fall of greenback
prices during the greenback ‘‘deflation’’ after 1866, which even the
prosperity of 1872 was powerless to reverse (although it did arrest it)
is an instance of the first class. The whole course of economic events
from 1914 to about 1920 may be cited as an instance of the second. There
is no perfectly satisfactory remedy for this. We shall, indeed, exclude
from the facts on which we are to base fundamental conclusions, material
which is obviously vitiated by such things as the World War, “wild”
inflations, and so on. This is the reason why we shall deal with postwar
cycles separately and try, as far as possible, to work out fundamentals
from prewar material, although sources of facts and figures flow much
more freely since 1919 than they did before 1914.2 We cannot, however,
go very far in this direction without losing too much of our material. But
the infliuence of external factors is never absent. And never are they of
such a nature that we could dispose of them according to the schema of,
say, a pendulum continually exposed to numerous small and independent
shocks. We shall see that the power of the economic machine is great
enough to hold its own to an astonishing degree, even as it shows its
working in the worst material and the most faultily constructed indices.
But it never works entirely true to design, although at some times more

^ The reader who wishes to use this book as an instrument for professional training is
urgently advised to make the experiment. This can be done with little trouble by reading,
for example, W. Thorp’s Business Annals and interpreting, by means of the outside factors
mentioned there, some business index, e.g,, that of Col. Ayres, published by the Cleveland
Trust Company.

* Among leading students of the business cycle we may cite, in support of the above
procedure. Professor Spiethoiff. The reason why we do not treat the Napoleonic Wars and
their aftermath similarly is that the World War not only spelled much greater disturbance
and exhausted the industrial system much more but also was, though not the cause, yet
the catalyzer of a different attitude toward business activity which affected the functioning
of the economic machine much more than its more obvious consequences did (see Chap.
XIV).

so than at others. Several conclusions of great, if sinister, importance
follow from this.

In the first place, it is absurd to think that we can derive the contour
lines of our phenomena from our statistical material only. All that we
could ever prove from it is that no regular contour lines exist. We must
put our trust in bold and unsafe mental experiments or else give up all
hope. Here also we strike one of the fundamental difficulties about
economic forecasting — one which goes far to explain and even to excuse
some of the failures of predictions to come true. At almost any point of
time statistical contour lines bear uncomfortable resemblance to the sky-
line of a city after an earthquake. Hence it is as unreasonable to expect
the economist to forecast correctly what will actually happen as it would
be to expect a doctor to prognosticate when his patient will be the victim
of a railroad accident and how this will affect his state of health.

Second, it is important to keep in mind that what we know from
experience is not the working of capitalism as such, but of a distorted
capitalism which is covered with the scars of past injuries inflicted on its
organism. This is true not only of the way in which our business organ-
ism functions but also of its structure. The very fundaments of the
industrial organisms of all nations have been politically shaped. Every-
where we find industries which would not exist at all but for protection,
subsidies, and other political stimuli, and others which are overgrown or
otherwise in an unhealthy state because of them, such as the beet-sugar
industry in Europe and shipbuilding all over the world. Such industries
are assets of doubtful value, in any case a source of weakness and often
the immediate cause of breakdowns or depressive symptoms. This
type of economic waste and maladjustment may well be more important
than any other.

Third, in some cases we may gather enough information about the
nature, range and duration of a big disturbance to know more or less
precisely which of our figures are vitiated by it. Then we can either
drop these items or try to correct them — as we sometimes do, for instance,
in the case of prices during an inflation. But whether we do this or
something else or nothing at all, it is always of the utmost importance
for us to be thoroughly masters of the economic history of the time, the
country or the industry, sometimes even of the individual firm in ques-
tion, before we draw any inference at all from the behavior of time series.
We cannot stress this point sufficiently. General history (social, politi-
cal, and cultural), economic history, and more particularly industrial
history are not only indispensable but really the most important con-
tributors to the understanding of our problem. All other materials and
methods, statistical and theoretical, are only subservient to them and
worse than useless without them.

Business Cycles

D. Common-sense Semeiology. — After having tried to identify and
appraise external factors, either actually present in any business situation
or expected, our businessman generally takes it for granted that there are
other things to be taken into consideration. Questioned, he — and, in
fact, everyone who ever came under the writer’s observation — can readily
be made to testify to a belief or impression that there would be economic
change even in the absence of any external factor or, to put it diflPerently ,
that, besides factors acting on the business situation, there also are
factors in it which make for what we may call autonomous change. Accord-
ingly, he takes a second step in analysis and attempts to diagnose this
class of facts also. It is hazardous to say more, because beyond this, as
we observed above, the businessman’s own contribution to his diagnosis
becomes indistinguishably merged in a heterogeneous mass of all sorts of
information, ‘theories,” and advices that come to him from various
sources. But as a result of the mixture certain practical recipes emerge
which in turn reveal a definite, if rough, method of analyzing business
situations that does not differ in principle, however much it may differ in
technique, from what we want to do.

Perhaps the most generally useful of these practical rules is not to
trust to any single symptom nor to trust hastily to any combination of a
few, but to survey as many as possible. This will tend to eliminate the
influence of errors about the significance or importance of any single
element, and to give a more lifelike picture. Another piece of advice is to
prefer ‘"sensitive indices.” In acting upon it one must, however, bear
in mind that indices which fluctuate violently are apt to give an exag-
gerated picture of economic movements and so may be misleading for
some purposes. Still another rule is to try to pick out symptoms of
causal significance in preference to indices which reveal only the conse-
quences of the action of initiating factors. There is no doubt about the
wisdom of this advice if it be addressed to the investigator who analyzes
for scientific purposes. But for practical purposes it is inapplicable, first
because it presupposes a rational opinion about the causation of industrial
fluctuations, and second because, if we may express ourselves thus
paradoxically, in our field causes do not always precede effects. Of course
there is no real paradox in this: we merely mean to refer to the fact that
anticipation of coming events sometimes produces the same effect on the
behavior of business communities as do these events themselves, and that
symptoms sometimes lag behind the events to which they refer. This
may occur, for instance, in the case of a credit expansion and its relation
to a rise in prices: the credit expansion may be the “cause” or condition
of the rise in prices, but if the commodities in question are paid for, say,
six months after date, the rise in their price will be registered before the
increase in firms’ borrowing, which, of course, need not take place before

Introductory

the date of payment. Among the innumerable types of a more concrete
kind of advice given by practical men to practical men/ we wish to quote
but one because of both its usefulness and its neatness. At the beginning
of 1907 somebody asked M. Yves Guyot whether he thought that a crisis
was likely to occur in the United States. He answered very emphatically
in the affirmative. To the further question as to the signs by which its
approach could be foretold, his answer was: ^"Observe the railways, the
orders of the United States Steel Corporation, and the prices of metals.”

The interpretation and coordination of such symptoms are what we
call Semeiology. At its highest this is not a branch of economics, but
really the whole of economics — ^for all the acquirements of our science, all
its statistical, historical, and theoretical tools are relevant to it and can
be brought to bear upon it; in fact, it is here that they meet their ultimate
test and that we become conscious of what we can and cannot do. Thus,
semeiological work is not confined to the analysis of business fluctuations;
its primary task is really the diagnosis of the economic state of a country.^
The method simply consists in observing facts — ^if possible, figures —
concerning phenomena which are by experience known to be important
either in themselves or as symptoms; in the most favorable cases, impor-
tance attaches to a figure on both counts. At least by rough estimation,
each figure must be linked to a reference magnitude — ^to what it would be
were the business situation normal. Also each symptom must be judged
in the light of the corresponding (not necessarily exactly contemporaneous)
states of some of the others, which precisely means judging it in the light
of the whole business situation. From businessmen’s discussions, the
business pages of the daily press, circulars of banks and other concerns,
trade journals, and so on, a list has been compiled of what most people
agree are relevant facts illustrative of business situations, although not
all people would admit the amount of theorizing unavoidably implied in
calling them so. Nothing has been done to the list beyond clearing it
of the most obvious duplications :

1. Profits and expected 'profits.

Consumers’ (household) demand for consumers’ goods — ‘‘con-
sumers’ purchasing power,”

3. Producers’ demand for producers’ goods — “producers’ purchasing
power.”

^ Some of them have grown into proverbs, for instance: Quand le bdtiment va, tout va.

2 In the seventeenth century, the analysis of given economic situations in individual
countries was the foremost task to which not only ‘‘Political Arithmetick,” but economics
in general applied itself. This tradition, both sound and promising, was practically lost in
the eighteenth century, notably after A. Smith and largely through his fault. It was for
more than a century pushed back into the role of a statistical specialty, and only in com-
paratively recent times have economists again become aware of its importance and of the
fact that a new, more realistic, and more quantitative theory might evolve from it.

Business Cycles

4. Commodity prices at wholesale and at retail. No rational con-
cept of price level has been offered although an effort to elicit it was made
whenever possible. ‘‘Slope of prices in general” was the best definition
heard. Of particular levels, the level of “basic commodities” has been
most frequently mentioned, of individual prices wheat and pig-iron
prices, and also the price of electrolytic copper.

5 . Money rates, bond yields.

6. Bank rate (mentioned only by Englishmen).

7. Employment.

8. Bank clearings and debits, New York and outside (attended to
only by Americans, excepting the case of a Hamburg merchant who was,
however, thoroughly familiar with the usual methods of business-cycle
analysis). Often mentioned in reply to the request to give precision to
such terms as “business activity” or “volume of business.”

9. U. S. Steel Corporation — unfilled orders (mentioned at least as
frequently by Europeans as it was by Americans).

10. Business failures. Amount of liabilities of bankrupt concerns.
Bank failures.

11. Exports and imports, both quantities and values.

12. Building permits or contracts awarded.

13. Securities issued. On reflection this was readily reduced to
“issues of domestic business corporations.”

14. Stock prices. Number of shares traded.

15. Production: Total; finished goods; finished equipment goods;
finished consumers’ goods; semifinished metal products; iron and steel;
“materials ”; electric power.

16. Consumption: similar divisions. Also shifts of consumption as
between consumers’ goods,

17. Sum total of money incomes. Several times also changes in the
distribution of this sum as between classes of income receivers were
mentioned, but there was suspicion of scientific or ideological influence in
each case.

18. Stocks of finished products or staple commodities. Visible
supplies. Also, whether they are accumulating with producers or mer-
chants or other manufacturers.

19. Sales by chain stores, department stores, mail-order houses
(mainly emphasized in this country, but retail traders’ receipts also
mentioned in Europe).

20. Eeserve ratio of banks, especially central banks. New York
banks’ loans. Outside banks’ loans. “All other loans.” Discounts.
Deposits, particularly Demand Deposits. Lawful money outside of
banks. Commercial bills drawn (Germany: “Wechselziehungen”),
Once any one of these was mentioned, it was easy to elicit the whole list

Introductoey

of figures which compose bank statements and the usual banking ratios.
To these it was always possible to reduce such terms as ‘‘easy” or “tight
money,” “soundness of credit position,” “tension,” and so on,

£1. Brokers’ loans (U. S.).

££. Motor car sales (U. S.). Sales of beer (Germany).

£3. Cost of production, mostly identified with wage rates, which
were also frequently mentioned by themselves as symptoms or even
causes of a prosperous or depressed state of things.

£4. New firms founded, new incorporations. Per contra: liquidations.

£5. Urgency of creditors and promptness or otherwise of debtors.

£6. Fussiness of customers over quality and so on of deliveries.

£7. Temper of banking community, as evidenced by “reasonable-
ness” and courtesy or otherwise in their dealings with customers. Their
“running after” or “riding high horses.”

£8. Gold production. Gold flows in and out of country.

£9. Freight cars active. Freight-car loadings. Basic material
transported. Miscellaneous merchandize transported. Less-than-car-
load-lots. Passenger traflSc receipts. Railroad earnings. While the
last mentioned and the figure of idle cars were universally given attention,
the finer analysis implied in the other headings is predominantly American.

30. Condition of the real estate market.

31. Public finance, chiefly receipts from excise, stamp duties, and
turnover taxes, but also from income taxes.

3£. Foreign exchange rates.

33. Percentage of industrial capacity active.

34. Dividends declared.

35. Marriage rate.

36. Migration to and from industrial centers. Immigration and
emigration.

37. Temper of business community. Confidence. Optimism.

38. Advertising.

39. Competitive position in industry. “Overproduction.”

40. Rate of spending. Velocity of circulation of deposits. “Hoard-
ing.” Once, relation between savings and investment turned up, but a
quotation from Mr. Keynes’ Treatise on Money followed.

41. Attendance at divine service, the implication being of an inverse
relation with the degree of business prosperity.

E. Elementary Critique and Treatment of Series Representing These
S 3 rmptoms. — ^This list could easily have been run to something like £00
items, merely by drawing it up somewhat differently.^ Statistical

^ Much provisional clarification can be derived from classifying our series in various
ways. We may group them in prices, physical quantities and values (price times quan-
tity), or according to whether the series show fluctuations merely* or also a persistent

Business Cycles

series obviously relevant to the fluctuations of business are now available
by hundreds of thousands, if we include also the short and otherwise less
valuable ones, and if we count the series for each individual commodity
separately and as often as it appears in different countries or is within the
same country independently compiled. The first thing to do is to judge
them not only as to reliability of source and method of compilation, but
also as to what it is they really measure and how accurately they reflect
what we want them to indicate. Evidently this kind of critique is of
basic importance and, in spite of the ‘"index credulity’" so frequently
observable, by no means foreign to the mind of the practical man who,
occasionally at least, discovers to his cost the true significance of an index,
the very function of which is to indicate something that cannot be
measured directly. While all of this applies to any material, also to
material which is allowed to retain its natural significance, such as the
price of a commodity of given quality, it holds true with additional force
for what we shall term synthetic series, such as the series of total output,
which, representing the variation of a quantity that is the creation of the
statistician, should never be used without previous critique of the process
of synthesis to which they owe their existence.

This is not all, however. Included in our list are instances of cases, in
which businessmen themselves ask what a certain figure means. Such
instances could be readily multiplied. A series of figures of collateral
loans, for example, is often taken to indicate the amount of resources
engaged in speculation. But however accurate the figure may be, this is
certainly wrong, for loans against collateral are applied for and given for
many other purposes. The series of clearings or debits outside of New
York is sometimes used — and has been so used in the work summed up
in this book — ^in order to give an idea of the course of producers" and con-
sumers’ expenditure on commodities and services. It may, indeed, give
an idea, but in itself it certainly is not the series (or a simple invariant
function of the series) of this expenditure. The less-than-carload figure
is not itself retail trade; pay-roll statistics do not accurately reflect total
wage earners" income; building permits are not building; time deposits are
not savings; and so on.

In all these and innumerable other cases, there is more or less dis-
crepancy between what a set of figures actually measures and the factor or
symptom the behavior of which we wish to infer from it. But in all of

tendency to increase or decrease, or according to whether it is absolute magnitudes or rates
of change of magnitudes which matter, or according to whether the series reflect primarily
events in some particular sector of the economic process, for instance activity of cotton
mills, or like the rate of interest immediately the state of things in the economic process as
a whole. Whoever reads this book in order to learn how to reason on business-cycle facts
should not neglect to carry out what is a very useful if elementary exercise.

Introductoby

them at least the meaning of that factor or symptom is perfectly clear.
Very often, however, that is not so. There are two Hnds of cases in
which this supreme difficulty occurs. The one kind arises from the fact
that even if we know quite well what that factor is, we sometimes find it
difficult to associate a given behavior of it consistently with either good
or bad business: such erratic series sometimes increase and sometimes
decrease, e,g., when business is good and grows better. The other kind
arises from inability to define what the thing is that a given set of figures
represents — ^price level is an instance — and bars, where it occurs, the
way of common-sense semeiology.

Moreover, a series may veil the business situation it is to indicate by
displaying a movement of its own which is out of keeping with the rest
of the symptoms. Nobody will, for example, accept the sales of chain
stores as reflecting the tendencies of retail trade when that particular
form of organization is rapidly gaining ground at the expense of others, or
electric power production in a country which is in pi;ocess of electrifica-
tion as a satisfactory index of the general situation. Everybody will try
to take account of that in some rough "^empiricar^ way.

Certain refinements immediately suggest themselves, however, which
have their roots in the mental attitudes of everyday life, although pro-
fessional work has carried some of them beyond the range of untutored
common sense. They bear both on the material and on the way of
drawing inferences from it. An example of such refinements upon our
factual evidence is the habit of looking separately at, and interpreting
differently, statistics of New York and of outside banks. Another is
splitting up, where we can, the statistics of building activity : it stands to
reason that, while the total figure is what we want if we wish to estimate
the influence of building on a given situation, building as a symptom may
be rendered valueless by the inclusion of building for the account of
public bodies, and is much reduced in value by failure to distinguish
between residential and industrial building. Or, the diagnostic value of
pig-iron production is much reduced by the fact that the industries whose
activity it is to reflect also feed on imported pig iron, while in slack times
reduction of output of pig iron that would otherwise ensue may be
prevented by export, possibly at a loss.^ It has, therefore, been suggested
by Spiethoff that the figure of consumption of pig iron (production plus
imports minus exports) be used instead. The principle, of course, applies
to all commodity series.

As to the handling of series or their formal treatment, everyone
nowadays appreciates the common-sense virtues of expressing them as
percentages of a fixed base, or as chains, of using semilogarithmic paper,

^ The diagnostic value is further reduced, of course, by the changes that have occurred
in its technological significance. No satisfactory remedy has been found for this.

Business Cycles

smoothing devices, and the like. But our businessman also knows that,
in appraising any change in the factors or symptoms he habitually
watches, it is necessary to form an idea as to how far it really indicates a
change in the underlying condition of business and how far it is merely
seasonal. Professional work only adds precision to this eminently
practical idea. As that problem does not play a major role in the argu-
ment of this book and as no contribution to it is offered here, we may as
well dispose of it once and for all. The problem cannot be said to be
satisfactorily solved. For although the phenomenon presents much
greater regularity, particularly as to period, than the others we have to
deal with, it is unfortunately not independent of these nor without
influence on them. We may overlook this in a first approximation, and
evep eliminate it by suitable conventions about the meaning to be
attributed to ‘‘figures corrected for seasonal variations’’; but we cannot
overlook the other diificulty which consists in the fact that, mainly owing
to persistent efforts (but also to other circumstances), seasonal iBuctua-
tions are not invariant in time. Broadly speaking, they tend to decrease
in amplitude and to become less important: hens have been persuaded to
be more regular in laying eggs, building is not nearly so much interfered
with by winter weather as it used to be, money rates are not nearly so
seasonal as they were in the nineteenth century. Even where the
demand of ultimate consumers remains seasonal in spite of the tendency
of modern life to become independent of part of the factors that account
for seasonal variations, the intermediate demand of dealers in some cases,
such as that of the automobile industry, is schooled by producers to
distribute itself more evenly over the year. This difficulty has been
largely met by a method devised by W. L. Crum^ which consists in
finding, by one of the usual methods, the trend of seasonal variations and
using, for correction, the trend values of every month. It amounts to
using a moving, instead of a fixed, seasonal index.

The work summed up in this book has sometimes used series corrected
by others in various ways.^ Sometimes simple smoothing was used. In
some cases the problem did not arise, because yearly figures had to be
used, while in others it has been deemed advisable to refrain from cor-
rection in order to avoid any tampering with the testimony of facts.
While where we actually use corrected figures we shall have to look out for
seasonal influence not entirely eliminated, or for injury to the material

^ Cf. W. L. Crum, Progressive Variation in Seasonality, Journal of the American Statis-
tical Association, March 1925, and others quoted there. The paper also serves to introduce
the reader to the setting and bearings of the problem.

* For most purposes the writer prefers what is called the median-link-relative method,
which preference derives support, ex visu of 1925 at least, from the authority of Professor
Crum, see the paper quoted.

Introductoey

due to the operation, we shall always argue as if the problem had been
solved in a perfectly successful manner and as if seasonals were inde-
pendent things capable of being taken off as easily as a hat. This is an
important part of the schema of simplifications made both necessary and
permissible by the purpose of this book.^

Although laymen sometimes display a disconcerting habit of referring
magnitudes and relations between magnitudes to the corresponding
magnitudes and relations of some bygone epoch, the last prewar
decade, they mostly realize that the normal business situation itself
changes in time. And they face the problem of how to disentangle from
the figures of each moment that pattern which would be normal at that
moment and with reference to which those figures are to be appraised.
This is the common sense of trend analysis, and statisticians have Kut
come to the aid of business opinion by devising formal methods which are
to accomplish this. We shall deal with this subject later on (Chap. V)
and then find reasons to doubt the validity of the usual procedure and
of the trends, as well as of the fluctuations, produced by it. For the
present it is enough to state that elimination of, or correction for, trend is
as practical an idea as correction for seasonal variation. If, then, we use
the concept of trend and confine ourselves to studying the deviations
from trend, probably the prima-facie most plausible method as yet
devised of expressing these, is to put them in terms of standard deviations
as the Harvard Service does. The fundamental problem which arises
here — ^the problem of the correlations that may exist between trends
and deviations — ^is not disposed of thereby. On the other hand, how-
ever, the method can be used to improve material that displays different
intensity of fluctuation in different epochs. Common sense also suggests
the application to our economic symptoms of a rule which we apply as a
matter of course to the symptoms of temper observed in different men.
We evaluate differently a given manifestation according to whether it
comes from a man we know to be irascible or from a man we know to be
even-tempered. Experience teaches that there are irascible and even-
tempered series. It would not do, as far as diagnosis of a business situa-
tion is concerned, to attach the same importance to a given amount of
deviation in both. When they are expressed in ‘^standard units” their
temper is equalized.

^ In leaving tlie subject, reference should be made to S. Kuznets, Seasonal Variations in
Industry and Trade, also to Donner, Saisonschwankungen als Problem der Konjunktur-
forschimg, Sonderheft 6 of the Vierteljahrshefte zur Konjunkturforschungy and Sender heft 11
of the same periodical, in which the same author analyzes seasonal variations in Germany
since 1924, also to Abraham Wald, Berechnung und Ausschaltung von Saisonschwan-
kungen, Wien, 1936, and to Wisniewski, Seasonal and Cyclical Fluctuations, Econometrica
lor April 1934.

Business Cycles

When a time series^ has been treated thus, that is, when having been
‘‘corrected ’’ for seasonal variation and for trend, its items are expressed in
standard units, we get a remainder displaying a roughly wave-like form.
These “waves” are — as everybody knows — usually referred to as cycles.
The implication is that they represent a distinct element of the historic
reality described by the series which it is possible to separate in that way
from the other two, or rather, since the influence of external factors cannot
be eliminated, that distinct element as disturbed by external factors.
This is the essence of the so-called Harvard method. Its validity and, in
particular, the justification or otherwise of the claim that it in fact suc-
ceeds in isolating the cyclical movement will later engage our attention.
What matters now is that the reader should see the common-sense basis
of that method which it has become the fashion to criticize adversely
without any regard to the historic importance of the progress achieved
by it and to the fact that it taught their business to very many students
of the business cycle, some of its most ferocious critics included.^ It
follows faithfully, improves upon, and gives numerical precision to, ideas
which can be readily seen to arise from the needs and cares of the business-
man — ^which may, of course, be recorded against as well as for it. A simi-
lar statement would hold true of other such methods of treating statistical
fact with a view to making it yield additional information, and in par-
ticular of some of the best of them.^

Moreover the very idea of a business situation implies the impression
based upon partly subconscious experience that the fluctuations in meas-
urable symptoms or factors have a way of roughly moving in step.
What professional effort adds to this is, first, a statistical picture and,

^ Later on, time series will have to be carefully defined. For the moment we rely on
everybody’s familiarity with the term.

^ Criticism of the forecasts based upon that method has been particularly unfair. Tak-
ing due account of what economic forecasting can mean and achieve, results were by no
means had, although judgments must necessarily differ according to the method of meas-
urement of success and failure applied and according to the weight we attach to external
disturbances. On the measures of success which attended the efforts of various forecasters,
see G. V. Cox, An Appraisal of American Business Forecasts, 1930. But what irritated
people against the service in question was not failure but success. Even as people cannot
stand depressions, so they cannot stand unfavorable forecasts.

^ We will mention but two. The one is described in Bulletin 57 for July 1, 1935, of the
National Bureau of Economic Research: Wesley C. Mitchell and Arthur F. Burns, The
National Bureau’s Measures of Cyclical Behavior, used by the National Bureau group
in many important investigations. The other is due to Mr. Frickey, see Review of Economic
Statistics for Nov. 15, 1935. We are not able to give to either contribution the attention it
merits, but the reader is strongly urged to familiarize himself with both. The writer
wishes to express his gratitude to Professor Mitchell for generously permitting him to read a
preliminary draft of chapters one and two of the forthcoming second volume of his great
work.

Introductory

second, a number of refinements. The most primitive, but also the most
straightforward, way of supplying the statistical picture consists in simply
plotting on the same chart as many time series as may be thought useful
or convenient. If before being plotted they are all treated according, say,
to the Harvard method, comparison will in some respects be made easier
and richer. For obvious reasons, everyone will try to reduce the number
of series thus plotted and then arises the question which will be dealt with
in the next section. The Harvard “barometer,” for instance, compresses
into three curves the information it wishes to convey,^ but others,
although they never fail to present by way of illustration a number of
other series, yet try to focus the business situation in a single figure. If
that figure has definite meaning, that is to say, if the single figure index of
business conditions is simply arrived at by choosing one of the many series
available in order to characterize the whole situation, we may indeed
object that such characterization must necessarily be very imperfect, but
there is no other objection. A business index consisting exclusively of a
series of bank debits falls into this category and so do indices which are
constructed for the purpose, but from material which we are in the habit of
combining into indices in any case: of this type are those indices of busi-
ness conditions which merely purport to describe the variation of total
physical output. The difficulties inherent in the latter concept are not
relevant here — ^granted that the concept is admissible at all, we may also
use it for the purposes in hand.^

^ Similarly, Mr. B. B. Smith’s barometer compares an index of business activity (the
American Telephone and Telegraph Company’s and the Cleveland Trust Company’s
indices) with four curves. One is an average of interest rates and bond yields, one is gold
and United States securities held by the Federal Reserve banks, one an inverted twelve-
month trailing regression coejQBcient of yields of securities on time, and one the amount of
new long-term bond flotations.

The Econostat index has three components, representing finance, distribution, and
production.

The Axe-Flinn index of business conditions for Germany has also three curves repre-
senting speculation (stock prices), business (prices, production, etc.), and money (money
rates, bank advances, etc.); see the Review of Economic Statistics for October 1925.

2 The following are some single-figure indices of the type described above. The Amer-
ican Telephone and Telegraph Company Index of General Business since 1922; physical
series; see the Harvard Business Review^ January 1923. The Harvard Economic Service
Sensitive (Ten Commodity) Price Index of Business Cycles; see W. Persons and Coyle,
Review of Economic Statistics^ 1921, pp. S53, S69. Carl Snyder’s Clearings Index of Busi-
ness; see his Business Cycles and Business Measurements. The New York Times Weekly
Index of business; physical series. Edwin Frickey’s Clearings Index of Business; see
Review of Economic Statistics, October 1925. The Babson’s Reports Inc. Index; physical
series. Carl Snyder’s Deposits Turnover Index; see Review of Economic Statistics, 1924,
p. 253. Power production index; see Persons and Mathews, Review of Economic Statis-
tics, 1928, p. 196. Persons’ Index of Trade; since 1915 physical series; see Review of
Econoxf'*^ Statistics, 1923. p. 71.

Business Cycles

But in other cases the single-figure index has no such meaning of its
own, and then the question arises whether it has any meaning at all.
There is, of course, no warrant for assuming that the state of any organism
can be characterized by a single figure. In order to realize the nature of
such an attempt, we need only visualize the analogous idea being applied
to the biological organism. Let us think, for instance, of a doctor trying
to express his diagnosis of a case entrusted to his care by a number, or
the variations in the physical state of his patient by a series of numbers.
That the idea of such an index agrees so well with the index credulity
of our time only makes matters worse. An arithmetical average of such
things as railway operating revenues, value of total merchandise imports,
pig-iron production, cotton consumption, coal production and clearings
is not immediately recognized as meaningless only because of the rough
covariation existing between those and many other series. But the
numerical exactness which is what it adds to the imjpression which in any
case we would get from inspection of the individual graphs, is neverthe-
less entirely spurious and can only mislead.^

Finally, the businessman’s impressions can be refined upon by measur-
ing periods and amplitudes and also the timing of the movements of each
series relatively to the fluctuations of other series. This soil is fertile in
new theoretical problems and its surface only has been scratched so far.
The study of amplitudes, in particular, is as yet in its infancy. The
Harvard method has proved especially useful when brought to bear on
the task of measuring precedences and lags.^

^ The following are some one-figure indices of the type discussed above. The American
Telephone and Telegraph Company Index: before 1922 physical series, prices, clearings
(see the preceding note). The Ogburn-Thomas Index^of Business Cycles: prices, failures,
physical series, employment, clearings; see D. S. Thomas, Social Aspects of the Business
Cycle, p. 57, also the Journal of the American Statistical Association, September 1922, p. 324.
The Economist’s Index of Business Activity: employment, physical series, clearings, postal
receipts; see the Journal of the Royal Statistical Society, 1934, article by Geoffrey Crowther.
B. B. Smith’s Forecasting Index of Business Cycles is a weighted average of the four curves
mentioned in the preceding note (the weights being chosen to give the best correlations
between the forecasting index and business). For this index, however, a case could be
made. Persons’ index of trade: before 1915, clearings, physical series, railroad earnings,
and employment (see preceding note). Miss Thomas’s quarterly index of British business
cycles: physical series, clearings, imemployment, prices; see the Journal of the American
Statistical Association, March 1926. Axe and Houghton index of business activity: clear-
ings, physical series, prices; see the Annalist, Jan. 15, 1926, Carl Snyder’s index of volume
of trade: clearings, physical series, employment, and security issues; see Business Cycle and
Business Measurements. Carl Snyder’s index of business activity, one of the constituents
of the index of the volume of trade; debits, postal receipts, physical series; see Business
Cycles and Business Measurements. The Econostat index (see previous note) combines
the three curves into a one-figure index, including therein physical series, bank deposits,
clearings etc.

2 Beference must, therefore, be made primarily to the work of the Harvard Committee,

Introdxjctoby

F. Empirical Linking of Factors or Symptoms. — When our business-
man surveys the material within his reach, he first makes the discovery
that several series or nonquantitative symptoms frequently measure or
indicate the same or nearly the same thing. Sometimes different series
even lead back to the same, or the same kind of material; but it is more
important that different materials often reflect the same factor or symp-
tom. In most cases this is obvious. Carloads of coal transported by
railroads and coal produced are statistically independent symptoms of
the situation and they do not quite coincide. But they are only two
different measurements of approximately the same thing. The United
States Steel Corporation’s unfilled orders and consumption of pig iron
could for many purposes be interchangeably used and only for very special
purposes measure different things. In a wider sense, pig-iron and copper
consumption, when studied as symptoms of the business situation, may be
said to measure the same thing. And several other cases of this kind
have in our list been lumped into single items.

Next he discovers that some series reflect more directly than others
conditions of the whole of the business organism. We shall call them
systematic series in distinction from individual ones, which are primarily
indicative of conditions in some part of it. Some synthetic series, fore-
most among which are the price level and total production, afford
instances of systematic series, but some natural ones are systematic as
well, foremost among them the clearing-debit, the unemployment, and
the interest series. It should be observed, however, that although some
series, such as price level, can never be anything else but systematic,
others may be considered as either individual or systematic according
to the purpose in hand. Pig-iron consumption is an individual series by
nature; but, looked at as an index of the activity of equipment industries,
it becomes a systematic one.

Two other distinctions may be held to be, in germ at least, present in
any attempt to practice common-sense semeiology. Factors may be
causal or consequentialy and they may be primary or secondary. As
before, causal is used in its obvious meaning in the parlance of everyday.
But it is also used in a relative sense, in which an event may be a cause of
some phenomena and a consequence of others. Primary indicates neither
temporal precedence nor relative importance, but only that the element so
designated will, in the opinion of our semeiologist, be always present in

particularly to the results presented in the Review of Economic Etatistics for 1919 (p. 184
et seq.). The rationale of the idea that the lag for which two corrected series display a
maximum of correlation is revelatory of the fundamental relation in the cyclical process of
the quantities reflected by those series, merits closer examination than has so far been
bestowed on it. For a presentation of the idea see W. M. Persons’ contribution on Time
Series in the Handbook of Mathematical Statistics, ed. H. L. Rietz.

Business Cycles

a boom or a depression, unless suppressed or overshadowed by some
accident. An example will clarify. Inasmuch as it would be difficult to
find any marked business boom or depression without corresponding
movements on the stock exchanges, the latter will by most people be called
a primary phenomenon in our sense. But most people will also agree
that such movements are not causal to business booms but rather conse-
quential, although they may be causal to certain secondary phenomena,
such as a fall in demand for jewelry after a stock-exchange crash. The
example shows also that the two distinctions cross — as a primary element
may be consequential, so a causal one may be secondary.

This modest equipment suffices for many purposes. Even many
scientific descriptions, particularly of the historic sort, need never use any
other. In one respect it works particularly well in the hands of the busi-
nessman, who is more likely than the statistician to know and understand
the industrial process and the situations which underlie the statistical
surface. After having cleared his list of symptoms of both what may be
termed statistical and what may be termed economic duplications, he will
form groups descriptive of the various sectors of the organism (agriculture,
industry and mining, wholesale and retail trade, transportation, and so
on) and link them together in a common-sense way. He will realize, for
instance, the importance of fluctuations in agricultural revenue for the
demand for agricultural machinery and fertilizers and for the condition
of banks in agricultural districts. He will evaluate railway receipts and
employment, both as factors in and as symptoms of the situation. He
will observe building activity in its various branches, the state of the
money market, and so on. In all these cases he will also try to form
estimates of both quantities and tendencies.

The reader is strongly advised to do the same. The success of this
useful exercise depends of course on his ability to divest himself of all
theoretical preconceptions and to listen to the voice of his common sense
as if he never had heard or read anything on the subject.^ In order to

^ It woiild also be useful to make a note of results and to refer to it at such turns of the
argument as may seem to stand in need of support or criticism in the light of everyday
experience, for the writer wants to repeat that he is not aware of anything in the whole of
his analysis that could not be put into terms of plain business fact. Of course, the reader
may, but need not, start from our list. Common-sense interpretation of any of the factual
reports the reader may be in the habit of using would serve equally well, provided he
abstracts from the theoretical suggestions almost invariably implied. Perusal, in the way
alluded to, of the publications of the Standard Statistics Corporation or of Moody’s service,
or again of the facts reported on in the London Economist or Statist, the Annalist or the
Commercial and Financial Chronicle, or the German Wirtschaftsdienst, would be invaluable.
No academic course in business cycles should neglect it.

The author has made an attempt to show how it is possible to lead up from such com-
mon-sense linking of factors and symptoms to more efficient analysis in his paper: Die

Inteoductory

avoid interference with the reader’s judgment, the writer must refrain
from carrying out the operation of ‘^linking up symptoms.” But he
may still be permitted to make his idea of this exercise clearer by an exam-
ple and to offer a few general comments.

It is obvious, for instance, that briskness of sales to consumers (house-
holds) is one of the basic elements of a prosperous business situation,
sluggishness of such sales a basic element of an unfavorable one, both as a
symptom and because of its effects. Now items £, 7, 16, 17, 19, £2, £6,
£9, 81, 85, 40, although most of them will also appear in other connections,
are all more or less, in one way or another, related to actual and prospec-
tive sales to consumers, and may be lumped together and checked against
each other for the purpose of diagnosing and prognosing them. The
various aspects and the different phases of a distinct chain of events may
readily be unraveled and dovetailed into each other. From an attempt
to forecast the variation in ‘"consumers’ taking” in the immediate future
we are led, via money incomes, to producers’ expenditure, and we shall
have no diflGlculty in linking that to expectation of profits, particularly
that part which implies large commitments for a considerable time —
expenditure on construction and equipment — ^thus deriving as a by-prod-
uct an element of a common-sense theory of the role played in the process
of changing business situations by the heavy industries and by building
for business purposes. Profits, carnal so far, in turn depend not on the
price level nor on any absolute prices as such but on relations between
prices, hence one important causal factor will obviously be the presence
or absence of any possibility of changing, for the individual firm, the
relation between expected prices and costs. Since it is not simply profits
that affect the businessman’s decisions but that part of the profits which
will remain for him, we hit upon taxation and interest at exactly
the right point, from which interest appears in its true role, without
acquiring the position of either a necessary or a sufficient condition of the
events to be prognosticated.

Wherever we start on our list, it is possible to establish short links
between the item chosen and others, which carry us much beyond mere
impressions, without using any elaborate statistical or theoretical tech-
nique, solely by our common-sense imderstanding of how things are
related in the business process. The economic world and the mechanism
of change may thus be explored, and two things readily accomplished.
First, it is perfectly possible to arrive at reasonable diagnosis and prog-
nosis from the standpoint and for the purposes of the individual firm.
This is facilitated by the fact that for it most of the economic variables

Wellenbewegung des Wirtschaftslebens, Archw fiir Sozialwissenschaft nnd Sozialpolitik,
19X4

Business Cycles

are data whicii it cannot influence by its own action and the more recon-
dite relations between which do not concern it. To be sure the individual
firm may err, because of the inadequacy of its survey of facts or because
of mistaken inferences from them. But very serviceable judgments
can, nevertheless, be arrived at by taking reasonable care about one’s
facts and inferences. Second, both the fact and the form (in the rough)
of the general interdependence between all the factors or symptoms of the
situation can be established and indeed stand out so as to be unmistakable.
Residential building, for instance, is obviously as much a function of
national income as in turn it is, together with all its subsidiaries, a factor
in shaping national income, and there is no item in our list for which an
analogous statement would not hold true. We may and often do use the
cheap device — unavoidable sometimes, useful often, misleading very
frequently, always doing violence to truth — of either neglecting the
weaker direction of a two-sided or many-sided relation or assuming
that in a particular instance influence is exerted only by A on B, and not
by B on A. Our businessman may have reason to suppose, for instance,
that profits will not substantially vary in the near future but that the
rate of interest will. For his purposes, in this case, interest will in fact
acquire a causal role. The source of some of the gravest errors in prac-
tical judgment and of some of the most vicious theories lies in this method,
which, if used with proper care and without pretensions as to the
generality of results, is really helpful in the common-sense exploration of
the economic cosmos.

This is all, however. And that it is not all we want, and where the
limits of common-sense semeiology lie, is best seen when we attempt to
generalize both in the sense of trying to arrive at statements which will be
true for the whole of the organism and in the sense of trying to arrive
at statements which will always hold true, or if we may use what really
are inadmissible words, when we ask questions about fundamental causes
and effects. Let us try one example. Is a rising price level essential
to, perhaps the lever of, prosperity? Is it a cause, an effect, or a symptom
of prosperity? Are profits and losses windfalls due to the mechanical
effects of variations in the price level? And are these variations in price
level in turn the mechanical effects of changes in the rate of interest and
hence, possibly, of the policy of central banks ? To this class of questions
common-sense semeiology supplies no answer. The associations between
series to which one might look for an answer can be interpreted in many
ways. The voice of unanalyzed business fact repeats, almost mockingly,
the one word Interdependence — at best — for anything more concrete is
more often than not downright wrong, if intended to formulate general
truth. Nor can we fall back upon that stock of experimental results
which public policy has accumulated for us, for its testimony is incon-

Inteoductoby

elusive so long as we have no other means of interpreting it than those
under discussion. All that can be said, from this standpoint, about, for
example, whether or not a cheap money policy is eflfective in stimulating
business, is that it sometimes does and sometimes does not take effect.
And the layman has every reason to cry out in honest bewilderment, “Is it
capitalism which upsets money, or is it money which upsets capitaHsm?”i

^ The sentence quoted is faithfully transcribed from a political and literary periodical.
A much better instance to illustrate what the present writer wishes to convey is vol. IV
of the report of the English Committee on Industry and Trade (Balfour Committee),
entitled Further Factors in Industrial and Commercial Efficiency (H. M. Stationary Office,
1928), which in Chap. VI deals with business fluctuations. Surely there is reason to ti:;y
what other methods can do for us, if that is all that a group of able and experienced prae-
titioners has to say after having completed so careful a survey of industrial facts.

CHAPTER II

Equilibrium and the Theoretical
Norm of Economic Quantities

A. The Meaning of a Model. — ^We have seen that much can be done
by the mere survey of those facts which we designate by the expression
business situation and by the common-sense discussion of them. To make
headway beyond this, it is obviously necessary to collect more facts and to
find more elaborate statistical methods with which to treat and marshal
them. It should be obvious, in particular, that we must go as far as possi-
ble into the past — because we have no other means of observing a large
number of units of fluctuation — ^and that hence historical research must
be of paramount importance even for dealing with the most practical
of contemporaneous problems.

But we have also seen that in any such discussion of economic fact
we run up against a wall which blocks the road toward precise answers to
many of our questions, and which is not likely to crumble before any
amount of fact, however complete, or any statistical method, however
refined. The reason for this is that raw facts are, as such, a meaningless
jumble. Even that amount of information which we have been able to
derive so far was as much due to the application of our common-sense
understanding of the modus operandi of our facts as it was to the facts
themselves. The consequence of this is that we must now try, with a
view to acquiring a more powerful apparatus of analysis, to refine upon
our common-sense methods exactly as we must try to increase our stock
of facts and to improve upon our statistical methods. That is what we
propose to do in this chapter and the two that follow.

Surely this is the most natural, as well as necessary, thing to do. But
since well-known controversies have arisen about it, the following remarks
are submitted in explanation and defense.

1. If we present certain concepts and propositions at the outset and
in a connected argument, this is partly a mere matter of expository con-
venience. Other concepts and propositions will follow later, as the need
for them arises. But this method of exposition carries the danger of a
misunderstanding. It will seem to many readers as though the facts

Equilibrium and the Theoretical Norm

introduced later had no other role to fill than that of verifying a preexist-*
ing theory. We cannot enter here into the epistemological problem of the
relation between ‘theory” and ‘^facts.’’ But it must be emphasized
that what will be said in this chapter and those following is, in part, noth-
ing but generalized formulation of some of the facts presented later.
Therefore, the term verification does not accurately describe that relation,
A much wider claim than it implies — ^the writer entirely agrees in this with
some who profess to be enemies of all theory and never mention it except
in quotation marks — must be made and is here made for the direct study
of historical and statistical fact.

2. It is true, however, that some of our refinements upon common
sense are logically anterior to the facts we wish to study and must be
introduced first, because our factual discussions would be impossible with-
out them. The implications of this will become more acceptable if we
make it clear that what we mean differs from what students of economic
cycles usually understand by a ‘"theory.” Many even of those who do
not look upon theory as “babble,”^ are in the habit of identifying it with
explanatory hypotheses. And it is reckless or dilettantist hypothesis
making which is responsible for, and to a certain extent justifies, both the
discredit into which theory has fallen and the contrast which for some
students exists between factual (or “realistic” or “empirical”) and
theoretic work. But the framing of hypotheses, although sometimes as
necessary in our science as it is in all others, is neither the sole nor the main
function of a theory in the sense in which it is synonymous with “analytic
apparatus.” If we are to speak about price levels and to devise methods
of measuring them, we must know what a price level is. If we are to
observe demand, we must have a precise concept of its elasticity. If we
speak about productivity of labor, we must know what propositions hold
true about total product per man-hour and what other propositions hold
true about the partial differential coeflScient of total product with respect
to man-hours. No hypotheses enter into such concepts, which simply
embody methods of description and measurement, nor into the proposi-
tions defining their relations (so-called theorems)^ and yet their framing
is the chief task of theory, in economics as elsewhere. This is what we
mean by tools of analysis. Obviously, we must have them before we take
hold of the material we wish to measure and to understand. A set of
such analytic tools, if framed to deal with phenomena which form a dis-
tinct process, we call a model or schema of this process. To the question
what it rests on, if it does not rest on the facts of the process to
be described, the only possible answer is that it rests on other facts.

3. Some workers in our field not only neglect the task to which we are
about to turn, but take pride in doing so. They justify this by the claim

^ The expression is Mr. Carl Snyder’s.

Business Cycles

that they are applying to social facts the methods of the physical sciences.
Analogy with the entirely different problems of physics is much more apt
to be misleading than helpful, but for the sake of argument we accept it.
The case of those fellow workers of ours is not in the least improved
thereby, for they entirely overlook the role of theory in physics, which is
precisely the kind of arsenal of tools we have in mind and which even in
hypothesis making goes much beyond anything we shall attempt here.
Those of us who derive any comfort from possible similarities between
our methods and the methods of physics, are invited to look up, for exam-
ple, Corollarium V of Newton’s Principia, or Bohr’s model of the atom,
which may serve to elucidate our meaning. However right, therefore, it
may sometimes be to enter solemn protests against preconceived ideas,
speculation, and metaphysics, no argument of weight can be gained from
the physical analogy for the view that the right way to go about our task
is to assemble statistics, to treat them by formal methods, and to present
the results as the solution of a problem.^ The illusion underlying this
view may be further exposed by an instance of what we may term Non-
sense Induction. 2 In every crisis or depression we observe that com-
modities become unsalable. If on the strength of this we say, ‘"People
produce too much, hence they are, from time to time, unable to sell what
they produce,” we are saying something for which there is really no
warrant in the factual finding itself. Yet we have to make statements of
this kind. If we do so on the finding alone, we are performing an opera-
tion void of sense, although it may be clothed in terms that look exact.

4. We have seen, above, that statistical and historical facts have,
on the one hand, much more important roles to play in the building of
our knowledge of a phenomenon than to verify a theory drawn from other
sources. They induce the theoretical work and determine its pattern.
But now we have to add that, on the other hand, they cannot be said to
fill quite satisfactorily the function that theorists usually assign to them —
the function of verification. Por there is, along with Nonsense Induction,
such a thing as Spurious Verification. An example will best show what
it consists in. Starting from the common-sense impression that the
interest rate is an important factor in business situations, we may jump
to the conclusion that it is the causal factor responsible for booms and
slumps. In fact, almost always a low rate of interest precedes a boom and
a high rate of interest a slump. If this were enough to establish causal
connection, this proposition would be one of the safest of our science.
Yet, it is wrong and could be proved to be so, even if no statistical fact

^ Veblen has somewhere said about as much as that, although he added common sense
to statistics and mathematics. The fallacy of this and the danger of subconscious and
primitive theorizing should not reqxxire further argument. Our choice is not between
theory and no theory but between workmanlike theory and theory that is not workmanlike.

* M, F, Simiand*s book on wages may be cited as particularly fertile in examples.

Equilebrium and the Theoretical Norm

ever contradicted it. Nor is this all. Even if the proposition were
correct, statistics could not prove it to be so, for it stands to reason that
the behavior of our time series which accords so well with it, could also be
explained by another relation or on grounds perfectly free from causal
implication — ^for instance, on the ground that every boom must be pre-
ceded by a state of things which we recognize as being the reverse to
‘‘booming,” that in such nonbooming situations there is little demand for
money and, therefore, a low rate of interest. Hence prosperous business
would always be preceded by low interest, even if this had nothing to do
with bringing it about or if it were an obstacle to it.

The time sequences we observe are, of course, part of our material
from which we have to start and for which we have to account. And
we have to bring every new factual finding into accord with the rest
of the facts of the economic process and not with any poetry of ours.
But no statistical finding can ever either prove or disprove a proposition
which we have reason to believe by virtue of simpler and more funda-
mental facts. It cannot prove such a proposition, because one and the
same behavior of a time series can analytically be accounted for in an
indefinite number of ways. It cannot disprove the proposition, because
a very real relation may be so overlaid by other influences acting on
the statistical material under study as to become entirely lost in the
numerical picture, without thereby losing its importance for our under-
standing of the case. It follows that the claim usually made for statistical
induction and verification must be qualified. Material exposed to so
many disturbances as ours is, does not fulfill the logical requirements of
the process of induction.^

B. The Fundamental Question. — When we behold one of the familiar
graphs of economic time series — such as the graphs of the U. S. Bureau of
Labor price index, the commercial paper rate, bank clearings or debits,
numbers of unemployed — or of one of the business barometers, e.g,^ that
of the American Telephone and Telegraph Company, we undoubtedly
have, as our businessman had, the impression of an “irregular regular-
ity” of fluctuations. Our first and foremost task is to measure them and
to describe their mechanism. It is primarily for this purpose that we
shall now try to provide the analytic tools or a schema or model. But our
mind, functioning in this field as it does in all the others, will never be
content with this. However much wisdom there may be in the warnings
against premature questions about causes,^ they will always be asked

^ Statements from the writings of such leading students of business cycles as W. C.
Mitchell, W. Persons, and A. Spiethoff might readily be quoted in support of the assertion,
that the above is not more than what either is already, or is fast becoming, commonly
accepted opinion.

2 There is, of course, a strong argument against using that questionable term at all.
We shall speak of causes in a common-sense way, which, it is believed, is not subject to

Business Cycles

until they are answered. Moreover, our mind will never be at rest until
all our measurements and descriptions of mechanisms and propositions
about relations are linked to the causes indicated in such a way that they
may be understood to follow from them or, to put the same thing in our
language, until we have assembled in one model causes, mechanisms, and
effects, and can show how it works. And in this sense, whatever we may
object, the question of causation is the Fundamental Question, although
it is neither the only one nor the first to be asked.

Now if we do ask this question quite generally about all the fluctua-
tions, crises, booms, depressions that have ever been observed, the only
answer is that there is no single cause or prime mover ^ which accounts for
them. Nor is there even any set of causes which account for all of them
equally well. For each one is a historic individual and never like any
other, either in the way it comes about or in the picture it presents. To
get at the causation of each we must analyze the facts of each and its
individual background. Any answer in terms of a single cause is sure to
be wrong.

But an entirely different question emerges behind this one. If we
succeed in describing the economic system by means of a general schema
embodying certain properties of it, there is obviously some point and
much practical utility in asking the question whether the system, as thus
depicted, will hy its own working produce booms or crises or depressions,
and, if so, under what circumstances. Similarly, there is no sense in
looking for a single reason why men die, for there is obviously a great
variety of reasons. But there is both sense and interest in the question
whether and why death would come about, in the absence of all lesions,
by virtue of the working of the human organism or the cells of which it
consists. This is the truly fascinating problem, although it hardly ever
enters into the ordinary mental operations of medical practice, which are
always concerned with one or another of the innumerable patterns of the
actual occurrence of death. To put the same thing in a general form, if
we have a set of “reaT’ phenomena, X, which we try, for some purpose, to
handle by a conceptual schema, X', then if an event Y occurs in X, it
will not necessarily have meaning to search X for a single cause of F ; but
there is always meaning to the question, whether X' implies or not
the occurrence of F, and which of the properties of X' are responsible
for it.

epistemological indictment. If a definition be thought desirable, we may say that we
mean by causes of a phenomenon a set of circumstances w'ithout which it would not present
itself. We might define them as “necessary and sufficient conditions,” but the greater
precision only opens up new difficulties.

^ So far, with the qualification which is to follow, the present writer entirely agrees with
Professor Wesley C. Mitchell.

Equilibrium and the Theoretical Norm

Having formulated the question as we wish it to be understood, we
have to admit that the answer may still be negative. We have seen
before, that external factors certainly account for much in economic
fluctuations, and that they might even account for everything. This
would amount to a theory of the cycle which may be very simply stated:
a crisis or depression occurs whenever there is an unfavorable event of
sufficient importance. For reasons glanced at in the first chapter, we
cannot dismiss this view a priori. Moreover, it derives some support
from traditional economics. Where economic life is not treated as
stationary, it is, by the best authorities, treated as a process of organic
growth which simply adapts itself to changing data. Barring the waves
which can easily be shown to result from the properties of the adaptive
mechanism, this does not point to any internal cause of cycles. Some
have frankly held the cycle to be a *‘sham” or a random fluctuation.^

No doubt, the testimony of facts might be such as to make the exist-
ence or absence of a cyclical component inherent in the economic process a
practical certainty. But actually they do not speak with a certain voice
— especially, though not exclusively, because prima-facie adequate exter-
nal factors are always with us — ^and however we may treat them by
formal methods, they leave the Fundamental Question unanswered.
Nothing remains, therefore, but to construct a model of the economic
process and to see how it works in the study of time series. It also follows
that in doing so we cannot take for granted that there is a cyclical move-
ment inherent in the economic process, as we could if this were an
indubitable fact of economic experience.

C. The Stationary Flow. — ^The analytic treatment of the facts of
autonomous change in a closed domain of which it is our task to give
account, begins conveniently with the construction of the model of an
unchanging economic process which flows on at constant rates in time

1 Any of tliese views may be right, of course, while it is certain that some supporters of
the contrary view are guilty of faulty reasoning or have otherwise failed to establish the
claim they make for the cycle as a distinct phenomenon. In part, also, final decision
will simply rest on fertility in results and satisfactory fit to facts. Just here, however, it is
important to emphasize that even straight negation of the existence of the cycle may mean
very different things. Mr. Carl Snyder, for example, seems to mean no more than that the
importance of the business cycle, taken by itself, has often been exaggerated — wHch is
quite true. Professor Irving Fisher, in Econometrica^ October 1933, p. 338, however, says
that “the notion of the business cycle as a single simple self-generating cycle” is a myth.
We quite agree, as the reader will see, that the business cycle does not consist of a single
wavelike movement and that it is not “simple.” It is very difficult to say whether the
passage quoted means more than that. Other authors, again, when they deny the existence
of the cycle, mean only to deny exact periodicity in the sense of constancy of period. In
any case, in order to deny anything we have expressly or by implication claimed so far,
it would be necessary to deny that business is sometimes good and sometimes bad.

Business Cycles

and merely reproduces itself.^ Obviously, such a model will present the
fundamental facts and relations of economic life in their simplest form,
and it is hardly possible to bring them out satisfactorily without it.
Implicitly and in a rudimentary form it has, therefore, always been
present in the minds of absolutely all economists of all schools at all times,
although most of them were not aware of it. Some even displayed hos-
tility to it as soon as it was rigorously defined and made to stand out in
all the gauntness of its abstractions. This was attempted by the physio-
crats and definitively achieved by Leon Walras. The Marshallian struc-
ture is based upon the same conception, which it is important to emphasize
in view of the fact that Marshall did not like it and almost made it dis-
appear from the surface of his exposition.

The commonsense of this tool of analysis, its nature and factual basis,
may be formulated as follows : first, if we deal with, say, the organism of a
dog, the interpretation of what we observe divides readily into two
branches. We may be interested in the processes of life going on in the
dog, such as the circulation of the blood, its relation to the digestive
mechanism, and so on. But however completely we master all their
details, and however satisfactorily we succeed in linking them up with
each other, this will not help us to describe or understand how such things
as dogs have come to exist at all. Obviously, we have here a different
process before us, involving different facts and concepts such as selection
or mutation or, generally, evolution. Incidentally, it may be observed
that it is impossible to proceed from the dog backward to, say, a fish, in
the hope that we might thereby add to our understanding of the processes

1 The nonprofessional reader who in economic subjects is not so patient of the rigors of
scientific apparatus as he is in a subject like physics, where he accepts unfamiliar ideas as a
matter of course, will find this section, and perhaps others, d iffi cult to absorb. And so it is,
although the writer has simplified to the point of risking incorrectness of statement.
The professional reader, in turn, will take offense at this simplification. In particular, he
will find that some tools used by the wnriter are antiquated and that in many points recent
progress of analysis has not been sufficiently taken into account. This will be done in
another book which, in a wider frame, will among other things overhaul the purely theoretic
parts of the present argument. Here, no other course seemed open to the writer than the
one he has taken.

The first two tools we have just introduced — the idea of the closed domain and the
stationary process — ^although absolutely necessary for straight thinking, already call for
apologies. The first, while imexceptionable in itself, becomes very doubtful when applied
to countries linked to each other and the rest of the world by a multitude of economic rela-
tions, of which we shall take but the most superficial account. This is a very serious imper-
fection, not only because we miss and relegate to the realm of disturbing factors what is
part of the real process of economic change, but also because the most urgent task in the
field of the theory of international trade is obviously its reconstruction from the standpoint
of the theory of cycles. The second tool meets with objections even from specialists.
We want it in order to bring out, by contrast, the contours of the phenomena of economic
evolution.

Equilibrium and the Theoretical Norm

in the dog as it is: these processes as such go on in a logically endless
circular flow and always presuppose previous turnings of the wheel similar
to the one under study — and we run up against hen-and-egg problems
exactly analogous to the one which confronts us when analyzing the model
of an invariant flow of economic life. In the case of biological organisms
nobody takes offense at the distinction we are trying to make clear.
There is nothing artificial or unreal about it and it comes naturally to
us; the facts indeed impose it on us. As a matter of history, it is to
physiology and zoology — and not to mechanics — ^that our science is
indebted for an analogous distinction which is at the threshold of all clear
thinking about economic matters.

Second, our distinction is by no means foreign to the ways of thinking
of practical business. Every businessman realizes that running his
plant in the customary way, going through all the motions of daily busi-
ness routine, is one thing and that setting up the plant or changing its
setup is another. He approaches these tasks with attitudes which differ
characteristically from each other. There would be no object in trying
to fuse into one schema the things to be done and the behavioristic types
encountered in the two cases, merely because ‘^real life’’ hardly ever
presents one of them without the other, or because the real world is always
‘^dynamic.” The answer to any unwillingness to accept our distinction
on the score of its being too theoretical is simply that everybody actually
works with it, both in practical life and in analysis, although in a sub-
conscious and inexact way — and that it is just as well to put logical
definiteness into this universal practice. We shall see, moreover, that
this is one of the most important means of understanding the mechanism
of the business cycle.

The degrees of rigor to be applied in constructing this model are as
numerous as the purposes for which we construct it. When trying to
impart to a group of beginners a first idea of the relations constituting an
economic system, the best way probably is to admit the whole range of
ordinary occurrences and relax considerably on the various implications
of the assumption of perfect invariance. The habit of doing this, however
defensible it may be pedagogically, easily leads us into the error of over-
estimating the amount of facts which we really explain: we drift into the
belief that if we only make the construction in a sufficiently compre-
hensive manner we shall account for everything there is to consider in a
purely economic investigation. If then we slur over the logical diffi-
culties which do not fail to arise, by replacing absence of change by
‘‘balanced” or “equilibrated progress,” we arrive at a picture which really
deserves to be called the more unrealistic, the more it presents the
misleading appearance of lifelikeness. This applies with special force to
the Marshallian model, which, precisely because of the virtues of its more

Business Cycles

exact parts and the efficiency of some of the tools it provides, becomes
particularly misleading when applied to the problems clustering around
what Marshall calls ‘"the element of time/* The same is true of Professor
G. Cassels* “steadily progressing society** and similar concepts.

D. Equilibrium and the Theoretical Norm. — For ourpresent argument
we may thus visualize an economic process which merely reproduces itself
at constant rates: a given population, not changing in either numbers or
age distribution, organized for purposes of consumption in households
and for purposes of production and trade in firms, lives and works in an
unchanging physical and social (institutional) environment. The tastes
(wants) of households are given and do not change. The ways of produc-
tion and usances of commerce are optimal from the standpoint of the
firms’ interest and with respect to existing horizons and possibilities, hence
do not change either, unless some datum changes or some chance event
intrudes upon this world.

Technological data may be expressed, for every firm, by a function
which links quantities of factors, such as labor, services of natural agents
and means of production that are themselves produced (“intermediate
products”: raw material, equipment, and so on) to the quantity of the
product which it is possible to produce by each of the infinite number of
ways in which they can be combined for this productive task, techno-
logical practice and the whole environment being what they are. This
function, known as the production function,^ tells us all we need to know
for purposes of economic analysis about the technological processes of
production. To the uninitiated it is strongly recommended to become
familiar with the idea that production, in the sense relevant to economics,
is nothing but combining quantities of factors and that it is, for economic
purposes, exhaustively described by such a combination (productive
combination). We can do little to facilitate understanding of this piece
of apparatus beyond saying that while the production function itself, in
the case of a stationary economy, is a datum and invariant in form, the
actual combinations of factors, as measured, for example, by coefficients
of production (see note), are among the variables of the problem, and

There is by now a rich literature discussing this fundamental tool of economic analysis
and its properties. Into these problems we cannot enter here, but a few important concepts
may be mentioned. Tor this purpose we designate any product by P, the factors used in its
production by a, 6, c, • • * , and write P = /(a, 6, c • • • )• PA is then the quantity of
product per unit of factor a, say man-hour, a/P the coefficient of production or the quantity
of factor a that enters into a unit of product, dP/da the marginal degree of physical produce-

iivity of factor a. p ‘ ^ is called by H. L. Moore the partial relative efficiency of organization

but had better be called product elasticity with respect to factor a. The difference, so invari-
ably overlooked by statisticians and engineers, between, say, in the case of labor, product
per man-hour and productivity of a man-hour, should be particularly kept in mind.

Equilibrium and the Theoretical Norm

must be determined by economic considerations. If these coefficients
were all fixed, that is, if in order to produce, say, a bushel of wheat it were
necessary to combine land, labor, seed, fertilizers, and so on, in given and
unalterable proportions, there would be no economic problem of produc-
tion beyond deciding whether to produce the bushel or not. If, however,
there is some freedom of choice between combinations, which means that
it is possible to produce the bushel of wheat either with, say, a certain
quantity of land and a certain quantity of labor or with more land and less
labor or less land and more labor, other factors remaining constant, then
the economic problem emerges in the shape of considerations about costs
and values. This is what is usually referred to as Substitutability of
Factors. Inasmuch as that freedom of choice is not absolute and substi-
tution is possible only according to certain rules and within certain limits,
the production function which embodies these rules and limits may be
looked upon as a condition or constraint imposed by the technological
horizon and the structure of the economic environment on economic
decision or on the maxima of economic advantage or profitableness which
economic decision strives to attain. So far as substitution is not possible
at all, analytic difficulties arise which need not detain us here.

But another point calls for notice. If all factors were infinitely divisi-
ble, the production function would be continuous and we could move
about on it by infinitesimal steps. Many factors, however, are not
infinitely divisible but available only in such large minimum units —
think, for example, of a railroad track or even a steel plant — ^that product
responds to addition of a unit not by a small variation but by a jump,
which means that the production function is discontinuous in such points.
Such factors we call lumpy (the term is Mr. Robertson^s, the writer
believes; at all events, it sounds like him). Now in the presence of a
lumpy factor it will very often happen that production below a certain
quantity of output will entirely have to do without that factor. An
instance is the small-scale production of the artisan type, in which it
would not pay to use costly machinery. In this case, mere increase in
output within the technological horizon of the producers and along one
and the same production function may spell change in what is usually
referred to by the ill-defined term Method of Production. The same
effect, not however contingent upon lumpiness, may be brought about by
change in the relative prices of factors: an increase in wages may induce
agriculture to proceed from intensive to extensive methods of cultivation,
or industry to replace labor by machinery which may involve complete
change of technological processes or principles. Yet both classes of cases
may come about within one and the same production function.

In view of much that is to follow, it is as important as it is difficult
to distinguish those classes of cases from others — which could also be

Business Cycles

described as changes in method of production but which do, while those do
not, imply changes in the production function. The criterion is whether
or not the change occurs within the given horizon of businessmen. Or, to
put it in another way, whether or not firms would have from the outset
adopted the method which they actually adopt when their output has
increased sufficiently, had the output been at that figure from the outset,
or whether or not firms would have adopted production by, say, machin-
ery from the outset, had wages also stood at their higher figure from the
outset. In general, though not universally, this is equivalent to saying
that we move on an invariant production function as long as variations
in the quantity of product either can be decomposed into infinitesimal
steps or cannot he so decomposed exclmively because of lumpiness in factors.
No other than ordinary routine work has to be done in this stationary
society, either by workmen or managers. Beyond this there is, in fact,
no managerial function — ^nothing that calls for the special type of activity
which we associate with the entrepreneur. Nothing is foreseen but
repetition of orders and operations, and this foresight is ideally borne out
by events.^ The productive process is entirely ‘^synchronized,’^ which
means that there is no waiting for the results of production, all of which
present and replace themselves at the moment they are wanted according
to a plan to which everything is perfectly adapted. Everything is
financed by current receipts. When dealing with the pure logic of the
process, it is convenient to exclude savings — unless we define savings so as
to cover replacement — since the man who saves obviously does something
either to change his economic situation or to provide for a change in it
which he foresees; and these cases violate, if we take the strictest view,
the assumptions defining the stationary process. The income stream,
constant if we neglect such things as seasonal variation, consists of wages
— ^payments for productive and consumptive services rendered by human
beings, managers included — and rents — ^payments for services of natural
agents. There may be monopoly gains, but they must be entirely con-
sumed either by the monopolists themselves or by some agency which
takes them away from the monopolists, for otherwise they would change
the stationary flow. As far as monopoly gains are due to the peculiar
quality of some factor or to a monopolistic organization of those who own
the factor, these gains will simply appear as wages or rents and may be
entered into the appropriate category. If there are appliances, which

1 The reader may pause for a moment to reflect on the nature of such statements. Is it
not useful to distinguish, for the sake of clarity, phenomena which would present themselves
under such assumptions from those which are contingent upon failure of a foreseen course of
events to come true? And is the above statement really quite so imrealistic as it sounds?
Why should the businessman be surprised when his foresight fails, if there were not a great
mass of routine things which actually do conform to expectation?

Equilibriijm and the Theoretical Norm

are themselves products but infinitely durable ones, we may also list
the return from them under the Marshallian title quasi-rent. But no
other cases of quasi-rent would exist in so perfectly balanced a state of
things. Readers who hold any theory of interest according to which that
phenomenon would be present also in a perfectly stationary state (which
the writer does not believe) are free to insert here also interest as a pay-
ment for the productive service which the particular theory chosen holds
to be responsible for it.

Such a process would turn out, year after year, the same kinds, quali-
ties, and quantities of consumers’ and producers’ goods; every firm would
employ the same kind and quantities of productive goods and services;
finally, all these goods would be bought and sold at the same prices year
after year. Yet all these prices and quantities are ‘^variables” in the
sense that they are not uniquely determined by extra-economic constraint
but may, ordinarily, vary within wide limits imposed by the physical
and social environment. If in the stationary state they do not vary as
they could within those limits, this is a purely economic fact which is to
be accounted for by purely economic reasoning. We know from experi-
ence what kind of relations subsist between prices and quantities, by
virtue of which they influence each other. This we express by saying
that prices and quantities of all goods and services are interdependent
and form a system. The quantities are really rates per element of time,
but for some purposes it is more convenient to eliminate the time factor
and to speak of absolute quantities. This is always possible if flows are
constant, when any period of account may be arbitrarily chosen, or if
they are strictly periodic, when the period of account would have to be a
common multiple of all the periods.

The first and foremost task of economic analysis is to explore the
properties of that system. The method of doing this is analogous to
the method known in mechanics as the method of virtual displacements.
What we want to learn before anything else is whether or not the relations
known to subsist between the elements of the system are, together with
the data, sufficient to determine these elements, prices and quantities,
uniquely. For our system is logically selfcontained only if this is the
case: we can be sure that we understand the nature of economic phenom-
ena only if it is possible to deduce prices and quantities from the data by
means of those relations and to prove that no other set of prices and
physical quantities is compatible with both the data and the relations.
The proof that this is so is the magna charta of economic theory as an
autonomous science, assuring us that its subject matter is a cosmos and
not a chaos. It is the rationale of the idea of variables that do not vary,
the justification of the schema of a stationary economic process. The
values of prices and quantities which are the only ones, the data being

Business Cycles

what they are in each case, to satisfy those relations, we call equilibrium
values. The state of the system which obtains if all prices and quantities
take their equilibrium values we call the state of equilibrium.^ Should
there be more than one set of values of variables satisfying these condi-
tions, we speak of a multiple equilibrium. The terms stable, neuter (or
indifferent), and unstable equilibrium are self-explanatory. Equilibrium
that is unique and stable is, of course, the only perfectly satisfactory case.

So far we have been using the concept of general or Walrasian equilib-
rium. It implies that every household and every firm in the domain is,
taken by itself, in equilibrium. For the households, this means that,
under the existing circumstances, tastes and economic horizon included, no
household feels able to improve its situation by transferring any element
of its money income from the commodity on which it is actually spent to
any other commodity. For the firms this means that, under existing
circumstances, technological and commercial knowledge and economic
horizon included, no firm feels able to increase its revenue by transferring
any element of its monetary resources (“capital”) from the factor it is
actually spent on, to any other factor. More simply and yet somewhat
more generally, all households and all firms must believe that, under the
circumstances and considering those elements of their economic situation
which it is in their power to change, they cannot improve their position
by altering their behavior — ^that is to say that their pattern of consump-
tion (consumers’ budget) and production (producers’ budget or combina-
tion of factors) is trimmed to perfection. Mathematically, of course,
this is expressed by maximum and minimum theorems. Prices and
quantities must also fulfill the following conditions if Walrasian equilib-
rium is to prevail. Every household’s and every firm’s budget must
exactly balance. All quantities of all commodities produced by firms
must be bought by households or other firms. All existing factors must

^ Friction may keep stationary an economic process that is not in equilibrium. This
case is of considerable importance for any study of business situations and their changes,
particularly for a study of their reactions to any impulse to change. It divides up into the
subcase in which there is no equilibrium position and the subcase in which the system dis-
plays no tendency to move toward an equilibrium position, which may, nevertheless, be
proved to exist. For the rough purposes of our volume, we shall not have to go into this
matter except incidentally. Let us, however, settle on a term by which to identify the
case, and call it inactive. Whenever it obtains, we do not “xmderstand’' the particular
prices and quantities which exist, in the sense mentioned above. They could, so far as the
relations embodied in our theory are concerned, just as well be different from what they are.
But in all cases in which there is an economic rationale for unchanging prices and quantities
(to these we will henceforth confine the term stationary), this rationale is afforded by the
concept of equilibrium. Hence, in these cases, stationary flow and equilibrium are analyt-
ically equivalent and, describing the same mass of facts, have the same empirical basis,
the statistical part of which consists primarily in the well-known findings about the great
stability in time of the pattern of consumption.

Equilibrium akd the Theoretical Norm

be used as far as their owners wish to see them used at the prices they can
get, and no demand, effective at those prices, must go unsatisfied. The
last condition affords the basis of a rigorous definition of unemployment.

Let us, however, note in passing two more concepts of economic
equilibrium, which we shall designate by the terms 'partial or Marshallian^
and aggregative equilibrium. If general equilibrium prevails, every firm
and every industry is individually in equilibrium; but an individual firm
or an individual industry may be in equilibrium while there is no general
equilibrium. And for some purposes, an individual industry may,
in an obvious sense, be said to be in a state of equilibrium while the
firms composing it are not. This concept is appropriate to the Mar-
shallian type of analysis, and recommends itself for many purposes by
its simplicity and ‘‘handiness.” But the concept which, barring such
special purposes, matters to us and which is the only strictly correct one,
is the Walrasian equilibrium.

Whoever works with partial equilibria soon discovers the necessity of
an instrument that will enable him to handle processes going on in the
system as a whole which escape his “partial” tools. He is then likely,
especially if trained in the Marshallian tradition, to complement his
apparatus by a system of relations between social aggregates — such as
total output,^ total income, net total of profits — and to reason on these,
together with elements of outstanding importance for the system as a
whole — such as quantity of money (whatever that may mean), rate of
interest, and price level. If these elements are so adjusted that there is
no tendency to change arising from their relations to each other ^ we may
speak of aggregative equilibrium and formulate certain propositions about
it. This is the equilibrium concept msed, for example, in Mr. Keynes’
Treatise on Money. Its usefulness for some purposes we do not deny.
But it is obvious that this kind of equilibrium is compatible with most
violent disequilibria in every other sense. And these disequilibria will
assert themselves by changing the given situation, including the aggre-
gative quantities themselves. It is, therefore, misleading to reason on
aggregative equilibrium as if it displayed the factors which initiate change
and as if disturbance in the economic system as a whole could arise only
from those aggregates.^ Such reasoning is at the bottom of much faulty

^It shoTild be observed that an industry singled out for “partial’^ investigation by
means of the Marshallian apparatus must be, strictly speaking, a small one, i.e.y so small
that what happens in it does not materially affect what goes on without it. Transition
from this to ‘‘total output’’ is by no means plain sailing. See, however, Mrs. Robinson’s
article in the first number of the Review of Economic Studies for a highly interesting view
on that problem.

2 Cf . infra. Chap. IV, Sec. B, “ sixth.” As an instance of the attitude referred to in the
text, we may quote Mr, Harrod’s statement (Doctrines of Imperfect Competition, Quarterly
Journal of Economics, 1934, p. 465): “Ultimately trade cycle theory is concerned with the

Business Cycles

analysis of business cycles. It keeps analysis on the surface of things and
prevents it from penetrating into the industrial processes below, which are
what really matters. It invites a mechanistic and formalistic treatment
of a few isolated contour lines and attributes to aggregates a life of their
own and a causal significance that they do not possess. If we consider
what those aggregates are, we understand immediately how easy it is,
once this starting point is chosen, to slide off into all the superficialities of
monetary theories of cycles. It should, however, be noticed that,
for a point of equilibrium, one of the relations subsisting between
aggregative quantities may be expressed by what is known as the equation
of exchange or even in terms of the ‘"quantity theory of money,’’ which is
formally correct for such points and only for such points. In fact, it is
simply a condition of equilibrium. We shall refer to it as the monetary
ligamen.

Another distinction may be introduced here which applies to all of
the three concepts of equilibrium but is of special importance in the case
of general equilibrium. If the elements of the economic system exactly
satisfy all the relations, conditions, or ligamina constitutive of the system,
we shall say that the system is in perfect equilibrium. If we find that a
system, without satisfying ligamina exactly, is as near to perfect equilib-
rium as it will go, and that it will not move from that position unless some
event impinges upon it, we shall say that it is in imperfect equilibrium^
An equilibrium the imperfection of which consists exclusively in the facts
that firms use more factors and keep larger stocks and balances than
would be the case if they were organized according to the highest standard
of efl&ciency possible under the circumstances and that there is unem-
ployment of resources from indolence of owners we shall, with apologies
to readers of refined taste, call sloppy.

conditions wHch determine the equilibrium of the level of output as a whole in contradis-
tinction to the particular equilibria of each industry which are determined by the demand
and cost conditions of each” — one of those statements which, while not actually untrue,
yet effectively bar the way to the core of the matter. Mutatis mutandis ^ the same applies
to the “partial aggregative” concepts noticed in the previous paragraph of the text, such
as the concept of an industry which, as such, is in equilibrium without (in the limiting case)
any of its firms being in equilibrium.

^ There are, of course, many reasons for the prevalence of such imperfections besides
the fundamental one that no part of the world of real phenomena ever lives up to its con-
ceptual picture. But our distinction is not intended to express the mere fact that schemata
never fit reality exactly. This we could dispose of by saying that the theoretical schema of
perfect equilibrium is simply our tool by which to express some aspects of what in reality
is always but imperfect equilibrium. The distinction is not between schema and reality,
but between two schemata designed to take account of differences in factual situations
which are not negligible but important and productive of consequences, which deserve
separate theoretical treatment.

Equilibkium and the Theoretical Norm

We have not had to make any reference to time since we replaced rates
by absolute quantities. This is as we should expect in dealing with a
system which links its elements by relations that must be satisfied simul-
taneously, and into which we have not yet had the opportunity of
introducing relations between quantities referring to different points or
intervals of time. But now it is convenient, although it is not quite
satisfactory in logic, to follow Marshallian tradition and to make use of
time in order to define another type of imperfection of equilibrium. What
was meant above was the case of a system so circumstanced as never to
reach perfect equilibrium. But in other cases we find that, while the
system is not, as it were, constitutionally incapable of reaching perfect
equilibrium, changing conditions or disturbing events require adaptations
which can be made only in time. In such cases there may be equilibrium
as far as rapidly changing elements are concerned and disequilibrium in
elements of slower adaptation, such as contracts and equipment. These
“momentary’’ or “provisional” or “short-time” or, to use H. L. Moore’s
phrase, “tentative” equilibria may usefully be contrasted with “defini-
tive” or with “long-time” equilibria.

There is some danger in associating a certain state of the system with
a lajtse of time during which changes will unavoidably occur that will
substitute a set of prices and quantities entirely different from the one
which would have satisfied equilibrium conditions before and toward
which the system was conceived to be drifting. What matters here, how-
ever, is only that Marshallian readers should realize that our concept of
perfect Walrasian equilibrium is akin to what Marshallian theory means
by the long-time equilibrium, if the conditions thus designated are satis-
fied for every individual element of the economic system. The values
which elements must take to satisfy those conditions, Marshall’s Normal
Values, we call their Theoretical Norms. And that state of the system
in which every element conforms to its theoretical norm, however distant
it may be from actual life, is what renders to the theorist the service
which to the businessman is rendered by the idea of a normal business
situation. Logically purified, the latter concept merges into the former.

E. Complications and Clarifications. — Before going on, we must
pause to glance for a moment at our magna charta. Is it satisfactory in

^ The writer wishes to repeat a warning uttered in a previous note. This section con-
tains arguments which will be found difficult precisely because all technical apparatus has
been left out. Possibly the best advice to give the general reader is that he skip this section ;
but the writer hesitates to give that advice because the contents of the section are essential
to the understanding of some of the phenomena which are the object of our study. Every
reader should peruse Sec. G. To the theorist apology is again due for brevity of statement
amounting to dogmatism, for failmre to supply proofs, and for simplification verging on
incorrectness.

Business Cycles

every respect, t.e., has it been satisfactorily proved that for each set of
data there is a unique set of prices and physical quantities? No; nor
is, for that matter, the magna charta of any other science entirely satis-
factory, for everywhere a keener spirit of criticism and more powerful
tools of observation and analysis have destroyed the primitive simplicity
and comfortable determinateness of earlier stages. It is, however, pos-
sible to prove beyond reasonable doubt and with but unimportant qualifi-
cations that there exists a uniquely determined equilibrium state of the
economic system in the special case which, following usage, we shall call
the case of perfect competition. This case is defined by the conditions
(a) that no seller or buyer is able to influence the price of any commodity
or factor by his own action and that there is no concerted action, and (6)
that there is perfect mobility of commodities and factors all over the
economic field (i.e., among all possible uses). L4on Walras has built
the relations subsisting between the elements of the economic system
into equations, and has shown that they sufiSce to determine unique
values of variables. His proof left much to be desired in technique
and details,^ but later analysis still retains the principle. However,
several comments are called for, even in the case of perfect equilibrium
in perfect competition,^

^It must be admitted that, matbematically, otir proof is even now imperfect and
becomes convincing only when supplemented, step by step, by economic considerations.
The original method of counting equations, showing that they are linearly independent and
in the same number as the variables is, of course, inadequate. Considerable progress
achieved mainly by Amoroso and Wald (the latter a member of K. Monger’s mathematical
seminar in Vienna, in the reports of which for 1935 the contribution has first been pub-
lished) has not quite overcome the difficulty. But critics forget (besides the fact that our
proof is no worse than many currently used in physics) that the proof does not rest on
mathematics alone.

* The importance of the case does not, of course, rest with the frequency of its occurrence
in actual life. A system satisfying its conditions in all its parts has probably never existed.
For individual industries the case may be illustrated by farmers who can, within their
individual possibilities, sell any amoimt of product they please at the current price which,
individually, they are powerless to alter. The mass effect of their actions produces then
the consequences characteristic of perfect competition. But even if there were no practical
instances of the case, it would still retain scientific importance as an instrument for proving
that purely economic logic is capable of determining uniquely purely economic variables,
and that the case in which this holds true is endowed with interesting properties — such as
zero profits, optimum output in the sense of output up to the point of minimum unit cost,
equality of factor prices and physical marginal product times price of product, and so on.
But in this book the concept would not have been mentioned if it were to serve a purpose
no more concrete. The case does serve primarily as a steppingstone from which to proceed
to more lifelike patterns. But it is also held that within the period covered by our material
it affords a sufficiently close approximation to reality in many cases and that in others the
actual patterns, although not fulfilling requirements, yet work in a way not fundamentally
differing from the working of perfect competition.

Equilibrium and the Theoretical Norm

1. The proof, were it even perfectly satisfactory in logic, that, given
certain data and certain relations, there is one and only one set of values
of the variables that will satisfy the latter and, at the same time, be
compatible with the former, does not imply that firms and households will
actually behave in such a way as to arrive at that set of values or return
to such a set when some disturbance has driven them from it. Yet, we
cannot rest content with a mere existence theorem of the former sort.
What matters to us is precisely the presence or absence of an actual
tendency in the system to move toward a state of equilibrium: if this
concept is to be useful as a tool of business^cycle analysis, the economic
system must strive to reestablish equilibrium whenever it has been
disturbed or, to put the same thing in the language of a principle asso-
ciated in physics with the name of Le Chdtelier, it must tend to move, in
reaction to every disturbance, in such a way as to absorb the change.

This problem has first been seen by Walras, although some critics do
not seem to be aware of the fact. His solution starts from the observation
that disequilibrium, which means deviation of at least one price or quan-
tity from its equilibrium value, necessarily spells profits or losses to
somebody at the spot or spots in which it occurs. And the argument is
that this somebody can, under conditions of perfect competition, get out
of that loss or fully reap that profit in no other way than by decreasing
or increasing the quantity of his commodity. This will drive him toward
equilibrium, and if all firms and households simultaneously react in the
same manner, it will eventually bring the whole system to equilibrium,
provided that all actions and reactions are performed within the bounds of
familiar practice that has evolved from long experience and frequent repeti-
tion. Common sense tells us that this mechanism for establishing or
reestablishing equilibrium is not a figment devised as an exercise in the
pure logic of economics but actually operative in the reality around us.
Yet it also tells us that the Walrasian or, for that matter, Paretian or
Marshallian description constitutes but a first approximation which
stops far short of what we need for an analysis of processes in an
incessantly disturbed economic world, and leaves out of account many
facts that may practically, if not logically, be just as important as those it
includes and even go far toward producing exactly opposite results.

£. Later on we shall, of course, often meet with patterns of reality
which require qualification, improvement, or even abandonment of that
Walrasian model. Here, by way of development of some remarks
previously made and in order to complete this preparatory discussion,
we will notice a few points that seem particularly relevant to the question
of principle. All, or nearly all, of the difficulties we encounter will be
seen to be amenable to reduction, directly or indirectly, to the one fact
that economic behavior cannot be satisfactorily expressed in terms of the

Business Cycles

values whicli our variables assume at any single point of time.^ For
instance, quantity demanded or supplied at any time is not merely a func-
tion of the price that prevails at the same time, but also of past and
(expected) future values of that price: we are, therefore, driven to include
in our functions values of variables which belong to different points of
time. Theorems which do this we call, in deference to Professor Frisch,
dynamic.

The simplest case in point arises from technological lags which, in a
world in which disturbances never cease to occur for any considerable
length of time, would in themselves suffice to account for the fact that in
practice we never observe any but those provisional or short-time
equilibria mentioned above. There are always elements in the setup of a
firm, as well as in the economic system^ which for technological reasons
cannot be adapted quickly, while others can. Now the importance of
this for our present discussion does not lie in the obvious fact that full
or perfect equilibrium, since it takes so much time to come about, may
fail to come about at all and that, therefore, new disturbances always
impinge on an imperfectly equilibrated system. For this fact does not
^er se negative the existence of a tendency toward perfect equilibrium
which will assert itself in spite of it and serve to explain many actual
processes, even if it never reaches its goal — ^which is all we want. In
order to produce new phenomena and to impair seriously the usefulness
of the Walras-Marshall description, reaction to the intermediate situa-
tions created by such partial adaptation would have to counteract or
to reverse that tendency and to lead away from instead of toward full
equilibrium.

This is not in general so: necessity for intermediate adaptation and for
reaction to measures of intermediate adaptation, of course, alters the path
the system takes and thereby almost unavoidably also the particular set
of values which will eventually be reached, but does not in itself bar
the way to some equilibrium. Technological facts which entail this are
data. The perfect equilibrium we can still visualize in this case is rela-
tive to them and different from what it would be if they were different.
In the general case, however, this is all. We shall meet exceptions, but
they must be recognized as such and treated on their merits and with due
regard to their particular causes. Nothing is gained by overstressing
them, as has become the fashion of late, or by attributing to them what

^ As far as the writer know's, Maffeo Pantaleoni was the first to see this problem and to
use the phrase that was to acquire such prominence in the thought of our own time, “phe-
nomena which go on indefinitely” (che si yerpetuano indefinitamente) . The paper, an
address given in 1909, is reprinted in his collected essays (Erotemi di Economia, vol. II,
third essay). The second essay is also relevant to our subject. It was first published in
the Giornale degli Economisti for October 1901.

Equilibrium and the Theoretical Norm 49

is really due to anotker process: a practice responsible for certain ‘‘endog-
enous’’ theories of the business cycle which, however useful they may be
in elucidating certain properties of the adaptive apparatus, only obscure
the fundamental problem we face.

3. As an instance which, though somewhat different from the cases
just envisaged, yet enters into the class of lag effects and which will call
for attention at later stages of our analysis, we will mention the cases in
which producers’ reactions to changes in price do not take effect at all
for some time — say, in the case of many agricultural commodities, not
until the next harvest — and then all take effect at once. In such cases
supply does not work up to equilibrium point by small steps and stop
there, but outruns it in one jerk. Price then in turn reacts with a
corresponding jerk, and the process repeats itself in the opposite direction.
It is theoretically conceivable that it will never stop and that prices and
quantities will, without any new disturbance and under conditions of
perfect competition, fluctuate indefinitely around equilibrium values
without ever hitting them. Whether these fluctuations display increas-
ing or decreasing or constant amplitudes — ^whether they are explosive^
damped or stationary — depends on the constants of the demand and supply
functions. This is the Cobweb Problem of recent fame, previously dubbed
the run-around by agricultural economists, which first attracted wide-
spread attention in the shape of the so-called Hog Cycle. ^ Just now we
will merely notice, first, that it is obviously not the lag alone which
produces the phenomenon and, second, that damped fluctuations of this
sort are, of course, movements toward equilibrium. Stationary fluctua-
tions would have to take the place of the equilibrium point but would not
otherwise affect our argument.

4. Not only the lags envisaged in but any kind of provisional
equilibria, however conditioned, may create that difficulty .2 In any
market which is not organized in a very peculiar manner or concentrated
in a single point of time, ultimate equilibrium, even if reached and even
if nothing has occurred to change the situation, will in general depend
on the path by which it is reached, i.^., on the whole series of transactions
that are usually carried out at varying prices as the situation unfolds. In
this sense the outcome is indeterminate. Walras arrived at his unique

1 The Hog and similar cycles will come in for discussion. The theoretical problem
involved in these fluctuations of prices and quantities which suggest the picture of a spider
web, has been, after earlier suggestions (H. L. Moore, U. Hicci, and others), treated by
O. lUnge, Formen der Anpassung imd wirtschaftliches Gleichgewicht, Zeitschrift fur
NationdLohono'mie, 1935, and W. W. Leontief, Verzogerte Angebotsanpassung und partielles
Gleichgewicht, ibid., 1934.

^ See Mr. P, N, Hosenstein-Hodan, Has Zeitmoment in der mathematischen Xheorie
des wirtschaftlichen Gleichgewichts, Zeitschrift fur Nafionalokonomie vol. I, no. 1. Pareto
spoke of a “curve of pursuit.”

Busmiass Cycles

equilibrium by starting from a prix crie par hazard and allowing people
to say what quantities they would be willing to demand and to supply
at that price without actually buying or selling until that initial price is —
par tdtonnement — so adjusted as to equate quantity supplied and quantity
demanded. Edgeworth for the same purpose admitted ‘‘recontracting.”
But if the tdtonnement consists in people’s actually buying and selling
at the initial price, this will absorb part of the supply and satisfy part
of the demand and the equilibrium price for the rest will be different from
what the equilibrium price for the whole would have been, which argu-
ment can be repeated for any subsequent price that is not yet an equilib-
rium price. Some equilibrium, however, will be reached: barring the case
to be noticed below (6), reaction to the various intermediate situations
that arise is corrective and not disruptive. Moreover, experience
acquired in dealing with other people and the possibility of profiting in
each market period from the lessons taught by the preceding ones, tend to
reduce the practical importance of the pattern under consideration and
to make results approach those of the Walras-Edgeworth schema. It is
incessant change in the data of the situations, rather than the inadequacy
of the data of any given situation, which creates what looks like indeter-
minateness of pricing. We conclude, on the one hand, that we must
take account of this pattern when dealing with the process of change
which it is our task to analyze in this book and which must be expected to
create precisely such situations, and, on the other hand, that it does not
paralyze the tendency toward equilibrium.^

5. As provisional equilibria may result from causes other than lags, so
lags may result from causes other than technological. Friction is an
example. The reader may think of costs incident to change of occupation
or to any shift from the production of one kind or quality of commodity to
the production of another kind or quality, or to the exchange, by means
of selling and buying, of one asset for another, or of the resistance to
change of some prices or of the difficulty of adapting long-time contracts
or of persuading oneself or other people to act, and so on. The presence
of friction, will, of course, always entail an equilibrium different from
that which would otherwise be reached, as well as slow up progress toward

is believed that the above is substantially compatible with the residts of Mr.
N. Kaldor’s analysis in his Note on the Determinateness of Equilibrium, Review of Economic
Studies for February 1934. The present writer submits thq,t the distinction, so often
stressed in these pages, between phenomena that are incident, or owe their importance, to
the fact that things incessantly change and phenomena inherent to the economic process
irrespective of change, is not idle and cannot be disposed of by saying that, since incessant
change is the fact, it is irrelevant to speculate about what would be if it were absent. The
distinction serves to separate different processes which are equally real and, in particular,
to improve our picture of the mechanism by which economic life reacts to every change
that occurs.

Equilibeium and the Theoretical Norm

equilibrium. Moreover, if different elements or different sectors of the
system work with different amounts of friction, as in general they do, lack
of harmony will ensue, the more slowly and the more quickly adaptable
elements getting out of step with each other. The same question arises
and the same answer suggests itself as in the case of technological lags.
The very existence and length of those periods of adjustment which we
shall study later on, though, of course, not due to the element of friction
alone, testify to the importance of the phenomenon.

It is not superflous to note that the effect of friction on the progress
of the system toward an equilibrium state is not wholly of that negative
kind. Its presence may steady adaptation by making it impossible to
react to every disturbance instantaneously and to the full extent it may
seem to justify at the moment. Some friction may even be said to be
necessary for the economic system to function at all: it is in part due to
friction which slows up the adaptation of supply that the equilibrium
point is not much more frequently outrun. Just as the physical world
would be an uninhabitable chaos if the slightest difference in temperature
sufficed to transfer all heat instantaneously to the region of the minimum,
so the economic world could not function if, for example, the slightest
variation in a rate of exchange sufficed to set all gold flowing at once.
Where modern technique approximates this state of things, cases of
instability arise, carrying with them well-known measures of defense
which abundantly illustrate our point.

6. Many cases of frictional resistance to change, especially in prices
of commodities and factors of production, are frequently referred to as
Stickiness or Rigidity. In view of the role these terms play in modern
discussions of economic policy and in arguments about business cycles, it
is necessary to point out that they are nontechnical and cover many
different patterns. And to the difficulty of defining — ^we might facilitate
the task by considering Rigidity as the limiting case of Stickiness —
corresponds the difficulty of measuring them.^ There are, of course,
numbers of reasons why some prices should move more slowly or less
strongly than others or all of them more slowly or less strongly than other
elements of the system, and nothing can be inferred from the statistical
fact alone. The latter may even mean no more than that demand and
cost conditions are more stable in some sectors than in others, or that
a price holds place behind others in the time sequence of e vents. ^ But

^ See Professor Mills’s method of measuring variability in his Behavior of Prices, passim.
Number of relative changes weighted by their amplitudes, per suitably chosen unit of time,
gives perhaps as serviceable a measure as we can hope for.

2 That distinction between sequence and lag which is introduced by our turn of phrase
is often difficult to carry out. Its reality is, nevertheless, beyond question. In a statistical
sense consumption of the dessert “lags” behind the consumption of the soup, yet this simply

Business Cycles

there is, nevertheless, a distinct group of facts which has some claim to a
name of its own, ms., what we might call willful stickiness. If a price be
‘‘regulated’’ either by public authority or by the individual or group in
control of supply, this need not either in intention or in fact imply that
it will move less often or less strongly than it would if its determination
were left to the competitive pricing process. Even if it does, this may be
due to friction only, for instance to the friction incident to a public author-
ity’s producing a new decision. But it is also possible that the policy
of that public authority or that private group is to “stabilize” the price in
question. Then we have before us a phenomenon sui generis, to which
we shall have to return more than once.

For the moment it is enough, first, to point out that our definition turns
on the comparison of the actual behavior of a price with what it would
do under perfect competition. While it is recognized that this criterion is
extremely difficult to handle, it is not admitted that this constitutes an
objection if criteria that are easier to apply lack either precise meaning or
relevance. Second, it should be noticed that occurrence of stickiness or
rigidity in our sense — as distinguished especially from the frictional type
— presupposes absence of perfect competition, although this is not in
itself sufficient to produce it. A perfectly competitive system cannot
display stickiness in that sense, however sluggish it may be to react.

If a value other than the equilibrium value be imposed by public
authority upon an element — a price, for instance — of a perfectly
competitive system otherwise in equilibrium, we have a particular
case of imperfection. The system will adapt itself to this condition but,
when it has done so, will no longer fulfill all the other conditions of
perfect equilibrium. Since inserting a new condition into a determinate
system spells overdeterminateness, some other condition has to be
dropped. Which one it will be is quaestio facti, the individual firm’s
choice being guided by a principle of minimizing the effects (in terms of
money) of the disturbance. If the element which has been made rigid
is the price of an original or nonproduced factor of production and if that
price is higher than the equilibrium price, the condition violated is that of
full employment of resources in the sense previously defined. For
perfect competition this is the only possible case of underemployment of
resources in a perfect equilibrium. Of course, since we never meet
perfect equilibria in real life, there will in general be many other cases of
it even without rigidity and even without friction, presence of which,
hence, cannot be proved by the fact of underemployment alone.

7. Of course we do not, as Professor F. H. Knight believes (Risk,
Uncertainty, and Profit, 1921, p. 197), attribute omniscience to our firms

follows from the fact that eating one’s meal is a process in time and has nothing to do with
want of promptness in reaction.

Equilibrium and the Theoretical Norm

and households, or any theoretical understanding of the processes in
which they play a part, but simply that amount of information and under-
standing which they actually possess and which varies greatly between
different groups. In the case of an undisturbed stationary process this
question is of little moment, everyone having been taught by experience
to follow the beacon lights which are relevant to him and the meaning of
which he does not need to explore. Since every decision refers to the
future, this implies foresight; and since the fruits of every effort mature
in the future, it also implies caring for the future — aforethought. The
Walrasian men, for instance, keep their durable instruments and their
stocks at least intact. It is, hence, no more justifiable to call the systems
of Walras and Pareto timeless than to charge them with the absurdity of
assuming omniscience. The particular kind and amount of information,
understanding, foresight, or forethought is one of the data of the problem
perfectly on a par with the particular tastes or the particular techno-
logical knowledge of any particular people. And for the static theory
of the competitive case there is no more reason to bother about the
former than there is to bother about the latter. The assumption really
made is that people react to existing prices only,^ and it is from this that
trouble arises as soon as we start analysis from a state of disequilibrium
or investigate the effects of any disturbance that is more than an isolated
interruption of the ordinary routine. It is then that expectation or
anticipation enters the picture, to threaten the existence of our equilib-
rium tendency.^

The first thing to be noticed about expectation is, however, that in
many cases it materially facilitates both the movement toward, and the
preservation of, equilibrium, sometimes to the point of preventing
disequilibria that would without it arise from the working of the Walras
model. The reader has only to survey the points previously touched
upon in order to see that action upon expectations such as can plausibly
be attributed to firms will often tend to smooth out things and to iron out

^ We need not add “in a certain way,” for the way in which people are made to react in
the Walras-Pareto picttire is the only one that can be reasonably attributed to them if they
really think of nothing else but of the prices existing at the moment of each decision. There
is thus nothing indefinite in Walras’s analysis and the complaint that he neglected to state
his assiunptions about foresight is entirely unjustified.

2 We are not himting for paradoxes and cannot go into the case of people acting on what
they expect that other people expect them to expect and so on. That would indeed interest
us greatly if we were dealing with the logical foundations of economic theory. As it is,
we have more pressing business. On Sherlock Holmes and his fiendish enemy Moriarty
chasing each other, see Professor O. Morgenstem in Zeitschrift fur N ationalbkonomie,
vol. VI, p. 343. The case has some, if limited, importance for oligopolistic situations.
But if there are many Sherlock Holmeses and many Moriartys endowed with different
degrees of foresight, the problem need not worry us.

Business Cycles

fluctuations that would otherwise occur. The effects of technological
lags, for instance, will be reduced if the change — ^in adaptation to which
they occur — ^has been expected, and the Hog Cycle, as far as it is really —
we shall see reason to doubt it — due to inability to foresee the mass
effect of ""improvident’’ reaction to a favorable fodder-pork ratio, would
entirely disappear if the time range of farmers’ expectations increased.
Speculation of the type described by classical theory — buying in advance
of a rise in price that is foreseen, selling in advance of a fall — ^works the
same way. In such cases expectations may open up a shortcut toward a
definitive (though possibly different) equilibrium state.

But this is not always so. The source of trouble is not adequately
described by saying that expectations are uncertain or that they have to
be currently revised or that different people form expectations differing in
range and reasonableness. Uncertainty of the future course of events
gives rise, to be sure, to many phenomena that are very important for
any realistic study of business cycles, among them, again, the existence
of prolonged periods of adjustment. It is responsible for an important
type of social losses and of excess capacity.^ It will be seen, however,
that there is no great difficulty of principle — although we have every
reason to lament the lack of reliable factual studies on the subject — in
handling this element, and we may dismiss it here. Nor need we feel
concern about the mere fact, obvious from common experience, that
action on certain types of expectation may be disruptive and help to
drive the system away from equilibrium. These types, instanced by
expectations which simply project into the future the actual rate of change
of some quantity, will, at various turns of our way, come in to complete
the mechanisms of certain phases of economic fluctuations. But although
they may often temporarily counteract it, they do not in themselves
disprove the existence of an equilibrium tendency or the proposition that
at times it prevails in such a way as actually to draw the system toward
equilibrium.

The real trouble to the theorist comes from the fact that introducing
expected values of his variables — ^we will now, on the one hand, assume
that they are expected with certainty and, on the other hand, also include
past values — changes the whole character of his problem and makes it
technically so difficult to handle that he may easily find himself unable to
prove an equilibrium tendency which, nevertheless, may exist, or even
the existence and stability of the equilibrium position itself. Into ques-

^ This has, as far as the writer know's, been most fully seen (though overstated) by
F. Lavington, An Approach to the Theory of Business Risks, Economic Journal for June
1925. The paper, containing much matter that is important for our purpose, is strongly
recommended to the reader.

Equilibrium and the Theoretical Norm

tions of technique we cannot and need not enter here.^ But the nature of
our difficulty may be illustrated as follows. Suppose that any class of
economic agents which have to decide on any economic quantity — con-
sider, for instance, the firms of a competitive industry in the act of
deciding what quantities of their product they are to produce — in so
doing take account of the past, present, and expected future values of
any economic variables they believe to be relevant, weighting those values
by weights that in general rapidly decrease to zero in function of distance
from the time of the decision. Those expectations are data and quite
arbitrary. Given the kind of people they are — ^their disposition to react —
it is, under acceptable assumptions about consistency and so on, possible
to speak of a uniquely determined decision. When it has taken effect,
however, the industry and the whole system may, in consequence of it, be
farther from settling down to a stationary state just as well as they may
be nearer to it. If, now, those firms suddenly began to behave in the
Walrasian way, Walrasian equilibrium would be approached in either
case; but since ex hypothesi they do not do this but, instead, revise their
expectations somehow and then again behave according to their disposi-
tion to react, they may forever travel away from any state that in any
sense could be dubbed equilibrium or else, turning toward it, outrun it
and jump back again until doomsday.

But for our practical purposes — ^the pure logician’s sorrows are not
ours — ^the predicament vanishes as soon as we realize to what it is due:
we have admitted any expectations and we have taken them as given.
As for the first, we have ourselves to blame if with such tremendous
generality we do not get any results. As for the second, we have emptied
the schema of everything that matters. In other words, if we discontinue
the practice of treating expectations as if they were ultimate data, and
treat them as what they are — ^variables which it is our task to explain —
properly linking them up with the business situations that give rise to
them, we shall succeed in restricting expectations to those which we
actually observe and not only reduce their influence to its proper propor-
tions but also understand how the course of events molds them and at
certain times so turns them as to make them work toward equilibrium.
For the moment, however, this question must be left open.

In certain cases in which there is no danger of ambiguity we shall
speak of correct and incorrect expectations. But in this fragment of a
discussion it was not necessary to draw that distinction, which, because of
the interdependence between expectations and outcome, is a difficult one
at best : since most of what is relevant to us applies equally to all expecta-

^ See, for example. Professor Tinbergen on Tbe Notions of Horizon and Expectancy in
Dynamic Economics, Econometrica for July 1932.

Business Cycles

tions, we need not attach any general meaning to it.^ It would certainly
not do to define correctness of expectation by means of congruent event,
or by means of an assumption that correct expectation necessarily works
towards equilibrium. On the general proposition, often recklessly stated,
that expectations tend to make themselves true, see Professor Pigou’s
Industrial Fluctuations, p. 77.

F. Imperfect Competition.^ — ^From our discussion of the case of
perfect competition we emerge with the result that — subject, it is true, to
serious qualifications and reservations — ^there is a real tendency toward
equilibrium states in a perfectly competitive world. Those qualifications
and reservations do not materially impair our tool. They rather improve,
although they also complicate, it by supplying us with a rich menu card
of possible cases, the theory of which comes in usefully at many cross-
roads of any study of cycles. But many readers who admit this will
question whether this is still so when we leave the precincts of the per-
fectly competitive case. It is necessary to present at least the sketch
of an answer, which may be omitted by those who feel convinced already.

The limiting case of pure monopoly is still plain sailing. If one
individual or combination of individuals (which does not necessarily
imply definite or legally valid agreement or even conscious cooperation)
controls either the supply of, or the demand for, some commodity or
service, we get a determined price and a determined output of that com-
modity or service,^ irrespective even of whether the monopolist sets the
price or offers, as it were for auction, the quantity most advantageous to
him.^ But even in this case we meet with an element, important for all
purposes of analysis but especially for ours, which tends to deprive that
determinateness of the stringency it has in the perfectly competitive case.
In perfect competition, the individual firm is not only powerless to alter
market price, but also under strong compulsion to accept it. The firm

the desirability of avoiding that, the writer has been convinced by Mr. Rollin
Bennett.

2 Professor E. H. Chamberlin’s Theory of Monopolistic Competition, 2d ed., 1936,
and Mrs. Joan Robinson’s Economics of Imperfect Competition, 1933, are the standard
works to which the reader should turn. Since we can only lightly touch upon a subject
which has absorbed the interest of many theorists during the last decade, we will merely
add Dr. Hicks’ excellent survey in Econometrica for January 1935. A few other references
will follow under particular headings.

® At least under carefully delimitated assumptions. On these see P. M. Sweezy’s Note
on the Definition of Monopoly in the Quarterly Journal of Economics for February 1937.

^ We neglect, as of little importance for our purpose, the case of indeterminateness which
may arise from particular shapes of demand and cost functions. If, for example, costs are
zero and the demand curve is a rectangular hyperbola for part or the whole of the useful
interval, many prices — strictly speaking, an infinite number — ^are equally advantageous to
the monopolist.

Equilibiiium and the Theoretical Norm

cannot charge a higher price without losing all its business. It can, of
course, charge a lower price, but will be penalized for doing so by a loss
which, considering the absence of surpluses, will in the long run threaten
its life. If a monopolist charges a higher or lower price than the one
that maximizes his gain, he will also lose but only in the sense that he
will, within limits, gain less than he could. Hence he can, if he should
choose, go on doing so indefinitely, and there may be reasons for it other
than error, indolence, and benevolence. He may have to consider public
opinion, he may wish to maximize not immediate gains but gains over
time and to ''nurse up demand.” He may or may not discriminate.
Generally, there are many courses of action open to him and many ways
in which to react to a disturbance. Each of them, however, yields a
determinate result and supplies an equilibrating mechanism.^

As long as each monopoly position is surrounded by a sufficiently
broad zone of perfect competition, no new difficulty arises about deter-
minateness, even if the system contains a considerable number of them.
Every monopoly then presents an isolated maximum problem with respect
to given buyers’ demand curves and competitively determined factor
prices. But difficulties do arise as soon as those monopolies get near
enough to one another in such a way as to influence one another’s orbits,
or, less figuratively speaking, as to make it necessary for each monopolist
to shape his policy with regard to the policy of one or more of the others.
Let us take at once the limiting case, that in which every commodity and
service, every product and factor, is monopolized. The trouble with this
case, known as Universal Monopoly, is not in any inability of ours to
prove the existence of a case in which determinateness prevails^ but in our
inability to prove that there is any tendency for reality to conform to it.
In general such a system would be what we have called inactive. We
shall not, however, discuss this but merely notice, as far as it is necessary
to do so for our purpose, the three standard instances of imperfect com-
petition: Bilateral Monopoly, Oligopoly, and Monopolistic Competition.

1. We have bilateral monopoly when a monopolist faces a single buyer
(monopsonist) . If exchange between the two is isolated — ^both in the

^ For a more refined ajid at tlie same time more realistic theory of monopoly, see G. C.
Evans, The Dynamics of Monopoly, American Mathematical Monthly, 1924, and G. Tintner,
Die Nachfrage im Monopolgebiet, Zeitschriftfur Nationatokonomie vol. VI, no. 4. A long list
of contributions would have to be quoted were it in our power to do justice to the subject.
We confine ourselves to Professor Zeuthen’s important book on Monopoly and Economic
Warfare, 1930.

2 See E. Schneider, Theorie der monopolistischen Wirtschaftsformen, 1932, Chap. Ill,
where the case is presented and illustrated by a very simple numerical example, and H. von
Stackelberg, Marktform und Gleichgewicht, where the reader finds the argument against it.
Mrs. Robinson in her chapter on A World of Monopolies (in which, however, factors are not
monopolized) agrees with us by taking existence of equilibrium for granted.

Business Cycles

sense that they meet just once and never again, and in the sense that for
the purpose in hand the economic system consists of the two only — ^there
will, of course, be limits between which the exchange ratio must fall, but
no equilibrium exists within this zone, one exchange ratio being as likely
as any other. ^ This case, quite uninteresting in itself, has yet some bear-
ings on situations which actually arise in the course of the phases of busi-
ness cycles: momentary situations emerge that are very imperfectly
understood by the actors on the business stage and often lead to erratic
actions more or less conforming to that type. Selling and buying a going
concern amidst the excesses of a violent boom may serve as an example.
The only thing we can do, even in less extreme instances, is to replace an
equilibrium point by an equilibrium zone. It should be observed (see
above, Sec. E, 4) that under those conditions even perfect competition
would not yield determinate results, particularly if parties have no experi-
ence with each other and if there are experimental transactions at the
beginning of the market. At the other end of the scale of possibilities
stands the case of a monopolist and a monopsonist who deal regularly
with each other, know from experience all about each other's situation
and ways, and desire to arrive at an agreement which will cover the whole
period they envisage so that there are no experimental transactions influ-
encing the terms of later ones. We will also let the freedom of choice be
limited for both parties by the relations in which they stand to the rest
of the system. On these lines we construct the following case: a trade
union so strongly organized as to be perfectly safe from the breaking away
of members and the intrusion into its field of outsiders, deals with a
monopsonist employer. This employer, in turn, is monopolist with
respect to his product, which he sells to a perfectly competitive crowd of
consumers. All the other factors he buys in competitive markets which
he cannot influence by his own action, the industry being too small for
that and also too small to influence the purchasing power of the masses
by the wages it pays.

Now in this particularly favorable case we have at least a determined
demand curve of the monopsonist employer for the services of labor.
This demand curve will shift in the cycle but is exactly known not only to
the employer but also to, say, the secretary of the workmen’s union. The
employer, in turn, knows exactly from long experience with his workmen
what the minimum wage rate is that the secretary can accept for each
total of man-hours. Neither wants to fight,^ which means that neither

^ This is not quite true, hiowever. It is not so likely that one of tlie parties will be able
to reap tbe whole advantage of the bargain as it is that they will somehow divide it. This
fact, possibly reinforced by the introduction of other considerations, may be used for a more
refined theory of the case.

2 Professor Zeuthen has shown, however, that even in the case of “warfare” the range

Equilibrium and the Theoretical Norm

uses the threat of withdrawing the whole supply of labor or of employ-
ment. The whole strategy of both parties consists in varying rate and
quantity by small steps without trying to bluff. Under these conditions
there is a determined wage rate which, together with the associated
amount of man-hours, will be most advantageous to the union and another
determined rate which, together with the associated amount of man-
hours, will be most advantageous to the employer. But those rates
will not, in general, be equal. Between them we have again a zone of
indeterminateness.

Although some of the highest authorities in the field, particularly
Cournot and Wicksell, and many recent writers could be quoted to the
contrary, this is the opinion of the majority of students and particularly
of Professor Bowley. But it is, of course, true for the general case only
and in the absence of any further information. The equilibrating mecha-
nism does not work thus in vacuo^ but within the specific circumstances of
each case. Therefore, that indeterminateness does not necessarily mean,
to use an expression introduced before, that such a system is constitu-
tionally incapable of equilibrium but only that the case divides up into
subcases, for each of which the question must be put separately, as in
fact it must in the case of straight monopoly as well. Among these
subcases there are obviously many determinate ones. If, for instance, it
is the practice that the union asks for a rate and thetemployer simply
replies by taking as many man-hours as it is most advantageous for
him to take at that rate, determinate equilibrium will obviously be
arrived at. Other subcases may be constructed which are indeterminate.
Practically more important for our purpose is the fact that, within the
process for the analysis of which we are now assembling the analytic
tools, situations change so quickly as to make the assumption of perfect
knowledge and invariant reaction inadmissible. The characteristics of
those changing situations may, however, give us to some extent precisely
that information which we need in order to reduce ranges of indetermin-
ateness. But temporary necessity, consciously planned strategy, and
fluctuating anticipation of the general course of events acquire a very
much wider scope than was assumed in the foregoing analysis. We are
then left not only with zones but with shifting zones. Moreover, in many
cases the demand and supply curves are not independent of each other.

Whatever their importance, those subcases in which bilateral monop-
oly yields determined equilibrium may be used — as may, of course, the
case of simple monopoly of owners of resources — ^to show that perfect
equilibrium may, outside of the perfectly competitive case, be com-
patible with the existence of unemployed resources. For it is clear that

of indeterminateness may be considerably reduced. See Problems of Monopoly and
Economic Warfare, Cbap. IV.

Business Cycles

the bargain most advantageous to the workmen in our example will not, in
general, lead to the sale of as many man-hours per workman as each work-
man would individually be willing to sell at that rate. No man need
actually be out of work, of course, but whether some will or not is a
secondary matter to be settled between the secretary and the employer,
so that it is always possible to characterize the situation by associating
with it a certain number of totally unemployed men. It is, in fact, very
probable that the rate which will yield the maximum sum total of real
wages, the maximum being relative to the value put upon leisure and to
length of period envisaged, will generally imply some unemployment.
Even if the unemployed have to be kept out of the earnings of their
comrades, that wage rate will ex definitione remain the most advantageous
one. If the unemployed are partly or wholly kept from other sources, the
proposition applies a fortiori, but the conditions of the maximum are
altered thereby.

£. If supply in a perfect market, i.^., in a market in which there can,
owing to perfect homogeneity of the commodity and perfect mobility and
indiflEerence of buyers, be only one price, is controlled by firms that are
in a position to influence that price by their individual action (oligopoly
or, if there are but two of them, duopoly), it is easy to see that we lose
the conditions which enforce determinateness of behavior in the perfectly
competitive case j,s well as those which account for such determinateness
as there is in the monopoly case. This pattern, implying as it does that
all customers will instantly transfer their allegiance from one firm to
another on the slightest provocation, is of very little interest to us, because
it is another limiting case which in practice must be rare, if not altogether
absent. The obvious thing to do for any firm that finds itself, potentially
or actually, in such a situation, is to try to alter it. The typical courses
that are, in practice, resorted to in order to effect this, therefore, matter
more to us than does the pure logic of oligopoly.^ They may be roughly
grouped under three headings.

^ This is not to say, of course, that oligopoly is not very interesting from the standpoint
of pure theory. The case was first treated by Cournot, whose solution, adversely criticized
by Bertrand and Edgeworth, later on upheld by Wicksell, to this day serves as starting
point of discussion. We will confine ourselves to mentioning the contributions of Harrod
(Equilibrium of Duopoly, Economic Journal for June 1934), von Stackelberg (Marktform
und Gleichwicht, 1934), Leontief (Stackelberg on Monopolistic Competition, Journal of
Political Economy for August 1936) and Mr. Hicks’ summary in the survey quoted before.
On Edgeworth’s treatment of the problem, see A, J. Nichol, Edgeworth’s Theory of Duopoly
Price, Economic Journal for March 1935. The subject owes very much to T. Palander
(Beitrage zur Standortstheorie, 1935) and Professor Frisch (Monopole — Polypole — ^la Notion
de Force dans I’Economie in Tillaegshefte til Nationaloekonomisk Tidsskrift, vol. 71) . The
general statement that oligopolistic prices are indeterminate would be misleading. All
that can be said is that oligopoly divides up into very many cases, some of which are
determinate while others are not.

Equilibrium and the Theoretical Norm

First, a firm may attack to kill or cow. This may result in a monopoly
situation — ^which in most cases will be a precarious one requiring endless
defensive moves — or in a situation which, while stopping short of tech-
nical monopoly, yet gives the aggressor more or less complete control, the
unconquered positions being insignificant or submitting to his leadership
(‘‘follow-the-leader’’ system, which may, however, arise also in other
ways) . Since, as in the case of Dumping, it is poor method to try to cover
a wide variety of different patterns by one term and one argument, we
should avoid speaking simply of cutthroat competition in all cases of such
attacks: the intrusion of a new and superior method of production for
instance, an event of particular importance to the subject of this book,
identifies a special case which should be treated differently and distin-
guished from the genuine case in which there is or may be ‘VastefuF’
competition, overproduction, overcapacity in a sense to which nothing
corresponds in the former, although throats are being actually cut in
both. Whatever the nature of the struggle, while it lasts there cannot be
any equilibrium, of course. But it will, in general, lead to a state which,
though perhaps never fulfilling equilibrium conditions strictly and though
often sloppy or lacking in stability, yet sufl&ces for our purpose and,
indeed, for most practical purposes. We have merely to note once more
that this particular type of ^'equilibrium tendency’’ issues in a set of
equilibrium or quasi-equilibrium values different from that which the
system would otherwise reach. Rare, indeed, are the cases in which a
campaign of this kind can be embarked upon irrespectively of the general
business situation: as a rule, the phase of the cycle will provide us with
determining conditions for the outcome. As common experience teaches,
everything will turn out differently according as such a struggle occurs in
a phase of expansion when demand curves shift upward, or in a phase of
contraction when demand curves shift downward. Typically, it occurs in
the latter, of course, a fact which is of considerable importance to the
picture of the mechanism of business cycles in a society in which big units
prevail.

The same applies to the second course open to firms in oligopolistic
situations — agreement. Whether this be secret or open, tacit or explicit,
complete or restricted to certain regions, products, practices (such as
credit to customers) , whether it is aimed and arrived at directly or after
struggle for shares in the trade, does not affect the principle. The out-
come enters in any case into the category of monopoloids. Creation of
excess capacity as a war reserve or simply for the sake of its nuisance value
is particularly characteristic of this case, for which the cartel is as typical
as is the "trust” of the first case. The former is the most likely outcome
whenever, on the one hand, nothing can be done to alter the homogeneity
of the product and, on the other hand, no firm is, or thinks it is, strong

Business Cycles

enough to venture on a fight to a finish. This is also a hind of equilibrium
tendency, although the resulting set of values will again be different from
any of those that would follow from any other course. The quaint
metaphor by which Edgeworth illustrates the indeterminateness of oligo-
poly but serves to show how very likely combination or some understand-
ing is: Nansen and Johansen, the two explorers who are all that is left of
the personnel of a polar expedition, wishing to drag their only sledge in
different directions (Papers Relating to Political Economy, voL I, p. IM)
may reasonably be assumed not to go on pulling against each other for
ever. It also serves to show that their final course will not be deter-
mined by any automatic result of mere dragging. Dropping metaphor,
we must recognize that the monopoly that emerges, were it even much
more complete and much more durable than as a rule it can be expected
to be, will, save in very exceptional cases, be a compromise that could,
from the standpoint of economic theory, just as well be different. There
is an element in the case, the distribution of the profit, which is theo-
retically indeterminate and has to be settled, say, by fixing cartel quota, in
order to supply the missing datum. The theorist must, hence, deny
himself the comfort of being able to say that, pure monopoly being the
only rational solution, the problem is determinate. For us, however, this
does not matter.

As a third course, firms may try to do away with the homogeneity of
the product or rather to increase, and to take shelter behind, that lack of
homogeneity which already exists in most cases. Though this course
may also be taken for purposes of attack, it is primarily a measure of
defense. It merges oligopoly into the third standard instance of imperfect
competition — ^monopolistic competition. Hence, though we need not
deny the occasional occurrence of pure oligopoly and though we cannot
deny its logical possibility, we are certainly within our rights in denying
the practical importance of the question of its determinateness. Two
things should be added. First, any indeterminate situations that might
arise if ‘‘pure” oligopoly actually persisted for some time, must not be
confused with that indeterminateness which owes its existence to incessant
variation of data that confront a firm in a world full of actual and expected
change and are, at any time, imperfectly known for this very reason. The
latter type of indeterminateness has nothing to do with the former.
Second, such cases of indeterminateness of the first and genuine kind
would also suflice to produce excess capacity, quite independently of the
special reasons we have above seen to expect it. This follows from the
fact that, both in a short-time and in a long-time sense, firms which find
themselves in an indeterminate situation can never plan except for a range
of prices and outputs.

Equilibrium and the Theoretical Norm

S. The term Monopolistic Competition will be used to connote product
diflPerentiation (c/. Professor Chamberlin, op. cit.), and not in Professor
Pigou’s sense. Each firm in any sector of the system in which monop-
olistic competition prevails offers products that differ in some way from
the products of every other firm in the sector, and thus supplies a special
market of its own. This product differentiation must be interpreted with
reference to its rationale, the creation of such a special market, hence very
broadly: it comprises not only “real” but also “putative” differences, not
only differences in the product itself, but also differences in the services
incident to supplying it (atmosphere and location of shops included) and
every device that enables the buyer to associate the thing he buys with
the name of a particular firm. Differences in location^ and other factors
which will induce customers to prefer, rationally or a-rationally,^ one firm
to another, are of course unavoidable, irrespective of any intention to
create them. And there is simply no such thing as a homogeneous
commodity motorcar or liver pill.

At first sight it may appear that the case is covered by the theory of
monopoly and that the questions of the existence of an equilibrium and of
a tendency toward it are disposed of thereby. Some authorities, Mrs.
Robinson in particular, seem in fact to be of this opinion. Otherwise it
would be difficult to understand the confidence they place in their well-
known schema and the equilibrium it yields.^ To a certain extent they

^ This matter, which ought to, but cannot, occupy us here, has, after an interesting
discussion started by a famous paper by Professor Hotelling and valuable contributions by
Professors Zeuthen and Chamberlin, been greatly developed in Mr. Palander’s important
book previously quoted and in the article by A. P. Lerner and H. W. Singer, Some Notes
on Duopoly and Spatial Competition, written several years ago, and at last published in the
Journal of Political Economy for April 1937.

2 It should be observed that here as elsewhere a-rational behavior does not necessarily
mean irrational or antirational behavior. A rational motive may be subconscious. An
antirational conscious motive may cover an interest that could be defended on rational
grounds. And what seems, or even is, antirational in the short run and in the individual
case may still be rational in the long run and as regards results. Theorists of Monopolistic
Competition do not seem to take adequate account of considerations arising out of these
facts when they speak of the irrational behavior of consumers and, in particular, assume
them to be "‘blindfolded.” Two other points are germane to our discussion. First, if the
scientific observer, applying his own private standards, thinks certain product differentia-
tions insignificant and hence wasteful, it does not follow that they are so from the stand-
point of buyers. Second, if monopolistic competition leads to what to the scientific observer
appears to be too great a number of small firms (such as barbers or gasoline stations) he
ought, before concluding that this spells social waste, to consider, among other things,
that many of those who operate them would otherwise be unemployed and that the exist-
ence of such a fringe of small-scale business constitutes the capitalist method of taking care
of a certain type of unemployment.

^ The nonprofessional reader should consult Mrs. Robinson’s and Professor Chamberlin’s

Business Cycles

are rigM. Creation of a special market may be described as a device to
increase the friction that militates against buyers’ transferring their
allegiance from one firm to another. If this friction be strong enough, it
may in the limiting case annihilate, in many other cases materially
reduce, that interrelation of demands for the products of individual firms
which is responsible for the oligopolistic difficulty, and thus, temporarily
at least, create monopoly situations or, at all events, situations which are
acceptable approximations to straight monopoly. The affinity becomes
still more marked when we reflect that there is in real life hardly such
a thing as absolute monopoly and that at least potential competition, to
use John B. Clark’s term, is present in most cases. We note, therefore,
that one corner of business reality is adequately taken care of by this
theory.

In general, however, that is not so. The very essence of monopolistic
competition is in the fact that the price at which a quantity can be sold
at any time is a function of the behavior both of the firm itself (not inde-
pendent of costs to the firm) and of all the other firms in the field. This
might of course be still described as a monopoly with a shifting demand
curve. But when these shifts are no longer external to the behavior of the
individual firm but part of its very mechanism and, moreover, so impor-
tant as to completely overshadow any movements along such a curve,
that way of formulating the case ceases to be useful;^ a demand curve so

books and Mr. Harrod’s article, all of wMcb were quoted before. Tbe following remarks
may, bowever, be offered. Tbe firm is endowed with a U-shaped unit cost curve and a
demand curve for its particular variety of product, the negative inclination of which
expresses the fact that the firm’s individual output will exert influence on price. A ‘‘nor-
mal ” rate of proflt being assumed and included in costs, equilibrium in the industrial sector
under study is determined by the point in which that cost curve is tangent to that demand
curve. This can occur only in the falling interval of the U. For the analysis of short-run
phenomena the validity of this cost curve which then follows from the temporary fixity of
some factors, seems to be beyond question. But in the short run we cannot rely on the
tendency toward equalization of net earnings of firms (the normal “profits” which those
theorists include in costs), which tendency is the only reason why average costs should be
equal to price, as they would have to be if that point of tangency is to indicate equilibrium.
For the long run, the U-shape — the descending part of which can then only be based on
lumpiness and the bottom of which is likely to be very broad — and with it some of the
results of that theory, become less convincing. IMr. Harrod does not insist on the U-shape
as a universally valid long-run form of average costs. He secures similar results about
underutilization of resources by representing the long-run cost curve as the envelope of an
array of short-time cost curves, the minimum of each of which is below the minimum of its
predecessor. Results attributable to this technique only cannot be relied on to reflect
properties of economic processes. Doubts about the demand curve of monopolistic com-
petition will be mentioned in the text. It is not held, however, that the apparatus is
wrong or useless.

^ There seems to be, hence, considerable merit in Mr. P. M. Sweezy’s strict definition of
pionopoly which stresses that distinction. See his Note previously quoted. Corre-

Equilibrium and the Theoretical Norm

conditioned — ^and as brittle as that — ^had better be discarded altogether.
We can gain, however, in the direction of competition, some of the ground
we thus lose in the direction of monopoly: since in practice almost every
firm either actually produces, or at very short notice is able to produce,
any of a wide variety of commodities or qualities, some of which are, as
a rule, almost perfect substitutes for the products of its competitors, its
price and quantity adjustments will not in general differ fundamentally
from those that it would have to make under conditions of perfect com-
petition. That is to say, if we do insist on using the language of the
theory of monopolistic competition, the demand curves for the products
of individual firms will, in general and in the long run, display a high
elasticity, though not the infinite one of the pure logic of competition.
And this, in turn, will enforce approximate realization of the results of
perfect competition that follow from it — ^in particular, differences in the
prices of different qualities or types will tend to correspond to the differ-
ences in the costs that must be incurred in producing them. Hence the
tendency of firms to secure institutional protection for their special
markets.

Strictly, this applies only to cases which differ from perfect competi-
tion in nothing else but product differentiation. An exception must, no
doubt, be allowed in those cases which would, in the absence of product
differentiation, be of the type of pure oligopoly. A certain amount of
indeterminateness flows from this source. Where potential competition
is no more than a remote possibility, this exception may be important for
the course of events in the particular industry; but it is hardly ever
important enough to interfere substantially with the working of the
system as a whole. There are other qualifications. Product differentia-
tion cannot be strictly continuous. Plants and shops cannot be spread
continuously over an area. But all this is not overwhelmingly interesting
or important.^

spondingly, the suggestion so strongly pressed by Mr. Harrod — or originally by Mr. Sraffa
— to appeal to the theory of monopoly as a savior from theoretic troubles, is less helpful
than was at first believed.

1 The above argument seems to the writer to be substantially identical with that of
Mr. Hicks in the survey quoted before. The qualification that follows in the text is also
implicitly present in his exposition, as is explicitly the point about the cost curve made in
our previous note. In fairness to Professor Chamberlin, it must be emphasized that the
case of monopolistic competition without oligopoly verging toward perfect competition
has not been overlooked but listed by him. Difference of opinion does not arise from
any charge of theoretical error we have to bring against him, but from his evaluation of the
practical importance of the other cases which do deviate from this schema of quasi-perfect
competition. In spite of what will presently be read in our text, it seems hardly justified
to claim that the perception of the monopolistically competitive pattern alters our whole
outlook on economic reality or, as Professor Chamberlin has recently put it, creates a new
economic Weltanschauung.” This seems to be an optical delusion, one cause of which

Business Cycles

Two points remain. The one is the great increase in the amount of
friction which, as stated above, monopolistic competition will bring about
in the system. It will also produce additional sloppiness and, in some
sectors, inactivity in our sense and rigidity. Traditionalistic and coop-
erative forms of behavior will often lead to, and be reenforced by, all
that. We must expect our system — ^particularly its equilibrium tendency
— ^to function much less promptly and effectively than it otherwise would
and everywhere points to be replaced by zones. Moreover, it is not
denied that, where circumstances are favorable, as they are, for instance,
in some professions and in many branches of retail trade, the consequences
predicated by some authorities on monopolistic competition may even in
the long run prevail: if newcomers flock into the legal profession and fees
are being kept up, all lawyers will be underemployed and feel unable to
make what they consider a decent living. Acting in a well-known frame
of mind, they may well try to mend the case by raising fees. Independent
cabmen, retailers of milk, and so on are very likely to behave just like
that. Excess capacity and the paradox of prices rising with increase of
potential supply then ensue. In interpreting the details of a situation, all
this must be taken into account, of course, as it always has been. In
doing so, we must not forget, nevertheless, that this is but one of many
possible forms of behavior and that such pyramids of prices and capacities
will, as a rule, be brought down by the capitalist machine itself: into the
peaceful pastures of backward retailers the department store and the
mail-order house intrude, and disregarding this mechanism is, in matters
of application to reality, as serious a mistake as reasoning on the hypo-
thesis of perfect competition would be.

Second, in the short-run situations of an economic world incessantly
disturbed by external and internal factors of change, immediate reaction
is, indeed, very different in the case of monopolistic competition from
what it would be in the case of perfect competition. This is due to the
fact that the possession of a special market, however precarious, gives
scope for short-time strategy, for moves and countermoves which would
not otherwise exist. In particular, it is owing to that fact that reaction
by decreasing output rather than by decreasing prices may suggest itself

will be explained in the text, when it will also be seen that there is more justification for Mr.
Harrod s claim that the theory of imperfect competition substantially contributes to our
understanding of the mechanism of business cycles. We will add, that in believing that
the schema of perfect competition affords in important cases a better description of what
actually happens under monopolistic competition than does the theory of monopolistic
competition itself, we do not think, as Mr. Hicks seems to do, that we can now contentedly
return to the Marshallian apparatus. For the industrial demand-and-supply curve is not
a comfortable tool to handle if homogeneity of product is absent. At the least, it would
have to be replaced by very complicated demand and supply fields. But this need not
concern us here.

Equilibbium and the Theoketical Norm

as a short-run policy,^ and that if any given situation is expected to be
short-lived, construction of a more elaborate plant than can be used to
optimum point so often becomes advantageous. Excess capacity results
from this, rather than from any particular properties of normal equilib-
rium in monopolistic competition that are held to account for the
phenomenon irrespectively of actual or expected change.^ Again,
presence of monopolistic competition not only means a different technique
of adjustment characterized by many movements that seem, and some-
times are, erratic, but possibly also a different equilibrium, if indeed
any equilibrium be eventually reached. It is worth noticing, however,
that unemployment could in this case be due only to imperfections of
equilibrium.

On the one hand, then, change that comes from within the system, as
well as change that comes from without it, impinges on situations, induces
short-time adaptations and produces short-time equilibria, which in many
cases conform well to the picture drawn by the authors of the theory of
monopolistic competition. On the other hand, new firms producing new
commodities or old commodities by new methods will, as a rule, try to
behave according to it, for that is the obvious method of exploiting to the
full, and of keeping alive, the temporary advantages they enjoy. It will
be seen, as our argument unfolds, how important that is for the subject of

^Tlie above statement will, however, be qualified in Chap. X, last section. That
policy must not be confused with the other policy, also characteristic of monopolistic com-
petition and statistically indistinguishable from the first, of offering an improved quality
and other concessions, rather than reducing price. It often takes the place of price reduc-
tion in depression and is not always duly taken account of in general appraisals of the
effects of monopolistic competition.

2 This seems to be a much more straightforward explanation of such facts as there are to
warrant association of monopolistic competition with excess capacity than the one usually
given. It will be observed that it does not apply to those cases which really approximate
monopoly and also that it differs from our theory of excess capacity in the case (if it exist)
of pure oligopoly. Mr. Harrod after having linked excess capacity to the fundamental
properties of monopolistic competition in general (op. dt,, p. 451) as the theorists of that
group are in the habit of doing (Professor Chamberlin should, however, be commended for
his much more guarded statement) goes on to build (p. 466, et seq.) a rather heavy super-
structure on this slender base. He argues that if, in a system consisting of two industries
only, one of them is subject to decreasing costs which, according to him, is always the case
under conditions of imperfect competition, contraction of output in trade recessions wHl
on that account be particularly severe. If the industry that displays increasing cost
contracts fortuitously, the other will “have to restrict by a larger amount,’’ because, as
soon as it contracts at all, its cost per unit increases. Thereupon the former contracts
again and so they may chase each other indefinitely,” until they hit a new equilibrium at
perhaps quite abnormally low outputs. This argument has evidently been written with a
view to certain well-known phenomena which its author believed he explained by it. But
since they are essentially short-run phenomena, marginal costs would have to be falling in
order to produce that pattern, which moreover is, also for other reasons, readily seen to
describe what at best is a very special case.

Business Cycles

tkis book. Knowledge of the mechanism of cyclical situations has,
indeed, been improved by that theory. Mr. Harrod has, in this respect,
not claimed too much {of. dt.y p. 465), although he based the claim on
grounds which we cannot wholly accept.

G. Equilibrium Economics and the Study of Business Fluctuations. —
In order to sum up part of the argument of this chapter and to take one
further step, we will now return to the question: What is the use, for
our purpose, of the analytic apparatus thus imperfectly described? For
brevity’s sake we will consider the perfectly competitive case only,
although there is nothing to prevent us from extending the following
remarks to all other cases. We have seen, first of all, that the theory
of equilibrium or (as in this connection we may say equally well) of the
stationary flow, gives us, as it were, the bare bones of economic logic
which, however abstract or remote from real life it may be, yet renders
indispensable service in clearing the ground for rigorous analysis. The
best way to convince oneself of the value of this service is to try to define
such phenomena as overproduction, excess capacity, unemployment,
maladjustment. Very little reflection suffices to show that these terms, as
commonly used, do not carry any precise meaning at all, and that the
fact that they do not, explains the inconclusiveness of much argument
that goes under those headings. As soon as we try to find such precise
meaning for them and to fit them for the task of identifying definite
states of the economic organism, the necessity of falling back on equilib-
rium relations becomes apparent.

Although, in the second place, every event impinges on an economic
world that is already disturbed and in disequilibrium, our understanding
of the way in which the economic organism reacts to any given new event
is unavoidably based upon our understanding of those equilibrium rela-
tions. The time-honored exercises which consist in trying to define by
means of a generous allowance of ceteris paribus, the consequences of the
imposition of a small tax on some commodity or of a small increase in
the supply of labor and so on, are nothing but a method of exploring the
nature and properties of those equilibrium relations which determine how
any given change in data will be absorbed by the economic system and
what final results will eventually emerge. Now, what causes fluctuations
may either be individual shocks which impinge on the system from out-
side, or a distinct process of change generated by the system itself, but
in both cases the theory of equilibrium supplies us with the simplest code
of rules according to which the system will respond. This is what we
mean by saying that the theory of equilibrium is a description of an appa-
ratus of response. We know that it is no more than a first step toward
such a description, but even so it is just as important for the study of fluc-
tuations as is the theory of disturbing events or disturbing processes itself.

Equilibbium and the Theobetical Nobm

Third, the concept of a state of equilibrium, although no such state
may ever be realized, is useful and indeed indispensable for purposes of
analysis and diagnosis, as a point of reference. Actual states can con-
veniently be defined by their distance from it. As far as this goes, the
more rigorous procedure of the theorist does not differ fundamentally
from a habit of the layman’s mind. During the whole of the postwar
period, for instance, individuals and groups frequently argued their case
in terms of a comparison of absolute or relative quantities of commodities
and of absolute or relative prices or incomes with those values of the same
variables which obtained in 1913. Of course, there is no warrant for
doing this. All the data of the economic system having changed, there
is no reason why prices of agricultural commodities, for instance, should
stand now in the same proportion to other prices as they did then. But
the idea which underlies that habit also lends itself to a more favorable
interpretation. It may imply recognition of the fact that there are
equilibrium relations between economic quantities, departure from which
creates difficulties and untenable situations, and comparison with which
is the obvious method to be followed in order to estimate the nature and
extent of actual deviations. If, instead of comparing the actual situation
with that equilibrium state which would correspond to its data, people
compare it with a past situation that was not an equilibrium state and
would, even if it had been, no longer be relevant, they are simply acting
on a belief that the situation of 1913 was at any rate more normal than
any later one and that it is not too far removed from us to serve as a
norm. This may be wrong, but the underlying principle of comparing
actual with normal values is not invalidated thereby. One of the services
which the business and political worlds can most justifiably expect from
the economist consists precisely in devising more satisfactory methods in
order to give effect to that principle.

Hence, much more interest and importance than most of us are
inclined to admit attach to the endeavors of some statisticians and econo-
mists to distill from the statistical material of an economic world which is
chronically in a state of disequilibrium, the time sequence of equilibrium
values. Perhaps it is true to say that some such idea must be present in
the back of the mind of any statistician who calculates trends. He may
have no other purpose but to eliminate them in order to make fluctuations
stand out more clearly. But fluctuations must be fluctuations around
something and, if pressed, he would probably define that something in
terms more or less related to our equilibrium concept. The first econo-
mist to develop the idea consciously and to go, at least in conception
and intention, the whole way, was Henry L. Moore. Throughout his
work, summed up in his Synthetic Economics, runs the principle that
trends are loci of points, everyone of which indicates the ideal equilibrium

Business Cycles

value corresponding to the actual value taken by each time variable in
the same point of time. We shall not go as far as that, partly because we
shall find reasons to doubt the validity of the methods of trend analysis
actually used. But this is not the essential point. We entertain a more
fundamental objection.

The most important of the uses we shall make of the concept of equilib-
rium is, fourth, contingent on the existence of a tendency toward equilib-
rium. We have seen that assertion of it is subject to many qualifications
and is not so simple a matter as older generations of theorists have
believed. Since factors of change actually impinge on a world that is
disturbed already and since, even if they had the opportunity of impinging
on a world that was in perfect equilibrium previously, the processes of
response would in most cases not directly lead to equilibrium in a simple
way, our belief in the existence of an equilibrium tendency, which after
every excursion draws the system back toward a new state of equilib-
rium, will have to stand on trial to the last page of this book, although
facts of the most common observation support it much more strongly
than does general theory, which quite rightly endeavors to take account
of even the most freakish cases. The thing that matters to us, is never-
theless this tendency considered as an actual force, and not the mere
existence of ideal equilibrium points of reference. We take our stand on
the fact that the values of economic variables fluctuate in the course of
business cycles between figures which roughest practical common sense
recognizes as abnormally high and figures which it recognizes as abnor-^
mally low and that somewhere between these two lie values or ranges of
values which that same common sense would recognize as normal. We
wish to distinguish definite periods in which the system embarks upon an
excursion away from equilibrium and equally definite periods in which
it draws toward equilibrium. In order to harness our equilibrium concept
to this service, which is fundamental for our analytic technique, we wiU
not postulate the existence of states of equilibrium where none exist, but
only where the system is actually moving toward one. When, for
instance, existing states are in the act of being disturbed, say, by a war
financed by government fiat, or by a ‘‘mania’’ of railroad building, there
is very little sense in speaking of an ideal equilibrium coexisting with all
that disequilibrium. It seems much more natural to say that while such
a factor acts there is no equilibrium at all. When it has ceased to act, and
when we observe that readjustment sets in which we interpret as a move-
ment toward equilibrium, then and only then the ideal equilibrium
becomes the goal of an economic process, the nature of which can be
elucidated by reference to it. Then and only then equilibrium becomes
what we have called it before, the “theoretical norm” of the economic
variables. Hence, we will, for our purpose, recognize existence of equi-

Equilibiiium and the Theoretical Norm

libria only at those discrete points on the time scale at which the sys-
tem approaches a state which wouldy if reached, fulfill equilibrium conditions.
And since the system in practice never actually reaches such a state, we
shall consider, instead of equilibrium points, ranges within which the
system as a whole is more nearly in equilibrium than it is outside of them.
Those ranges, which are the operational form to which we shall apply
properly modified equilibrium considerations, we call neighborhoods of
equilibrium (the term must not be understood in its mathematical sense)

1 The importance of the concept of equilibrium for the analysis of business cycles is
being increasingly realized. See K. Pribram, Equilibrium Concept and Business Cycle
Statistics, Institut International de Statistique, 22nd session (London, 1934) and Gleich-
gewichtsvorstellungen in der Konjunkturtheorie, Zeitschrift fur Nationalokonomie, vol.
VIII, No. 2.

CHAPTER III

How the Economic System
Generates Evolution

A. Internal Factors of Change. — We start from the picture, sketched
in the preceding chapter, of an economic process which merely reproduces
itself at constant rates and is in equilibrium at every point of time. We
recall that there are two motives for doing so. We wish to guard effec-
tively against circular reasoning, and to use the relations which link
economic quantities in such a process as an ^‘apparatus of response."’
And we ask the question: What is it that makes that process change in
historic time?

One reason why the process changes, t.e., why at different dates differ-
ent kinds, qualities, and quantities of goods are being produced and sold
at different costs and prices, is obviously that it is acted upon by what
we have termed external factors. These we shall now exclude from con-
sideration, recalling once more, however, not only that they are always
important and sometimes dominant, and that the res'ponse of the system
to their impact must always be expected to account for a great part of the
economic changes we observe, but also that their occurrence may and
often does condition changes of the kind which we are about to consider.
These two things must be kept distinct. By response we mean only what
may be termed passive adaptation, i.^., adaptation within the fundamen-
tal data of the system. Adaptation may, however, consist in altering
some of those data, and such creative response belongs to the class of
internal change. For example, if government demand for any given type
of weapon increases, business may adapt itself according to the rules of
the game which we (virtually) observe in the stationary process : it may
turn out increasing quantities of that type of weapon at increasing costs
and prices, which impulse may in turn propagate itself throughout the
system according to the same rules. But it may also adapt itself by turn-
ing out another type of weapon or by producing the one demanded by a
new method. This would be internal change conditioned by an external
factor.

How THE Economic System Generates Evolution 73

Factors of change internal to the economic system are changes in
tastes, changes in quantity (or quality) of factors of production, changes
in methods of supplying commodities. One of the services that our
equilibrium system renders consists precisely in assuring us that this
classification of internal factors is logically exhaustive, for everything
else in the system is deducible from tastes, quantity and distribution of
productive resources, and production functions. Autonomous monetary
changes, it will be remembered, have been included in the class of external
factors. We take up those three factors in turn.

1. We will, throughout, act on the assumption that consumers’ initia-
tive in changing their tastes — in changing that set of our data which
general theory comprises in the concepts of “utility functions” or “indif-
ference varieties” — ^is negligible and that all change in consumers’ tastes
is incident to, and brought about by, producers’ action. This requires
both justification and qualification.

The fact on which we stand is, of course, common knowledge. Rail-
roads have not emerged because any consumers took the initiative in dis-
playing an effective demand for their service in preference to the services
of mail coaches. Nor did the consumers display any such initiative wish
to have electric lamps or rayon stockings, or to travel by motorcar or air-
plane, or to listen to radios, or to chew gum. There is obviously no lack
of realism in the proposition that the great majority of changes in com-
modities consumed has been forced by producers on consumers who, more
often that not, have resisted the change and have had to be educated up
by elaborate psychotechnics of advertising. For our purposes, the case
for our proposition is not impaired by the fact that consumers’ satisfaction
supplies the social meaning for all economic activity, or by the fact
that new and unfamiliar commodities have ultimately to be “taken up,”
or ratified, by consumers and may, hence, be said to have been produced
with a view to latent or potential or foreseen consumers’ wishes, or on
indications other than effective demand. As far as changes in taste go,
this is entirely irrelevant to the mechanics of the processes we are to
analyze. The fact that the work of “consumers’ research” is typically
one of criticism of commodities, brands, and qualities may be pointed to
in illustration.

But however completely the proposition that changes in consumers’
tastes are brought about by the action of producers may fall in with the
general opinion on the subject, it is yet not quite true. It is easy to
adduce instances of initiative change of consumers’ tastes and even to
group them around familiar types. Two of them may be mentioned. In
every social circle, particularly if it be not too large and if its members
enjoy a certain minimum of means and leisure (we may think, for the
earlier parts of the period covered by our material, of the society of

Business Cycles

courts as an instance), we observe leaders of fashion, specialists in creating
new forms and habits of private life. Again, there are ‘‘movements”
which may powerfully influence the collection of consumers’ goods that
is being bought by households — ^the temperance movement may serve
as an example.

We hold, however, that this class of facts is not important enough to
matter and that its neglect will not substantially invalidate our picture.
Shifts in demand which come about in that way are, besides, no more
than different choices between existing commodities, and, if unsupported
by a change in real income which they do not in themselves entail, create
a situation to which industry can and will passively adapt itself. When-
ever we meet exceptions (war demand by governments seems to be the
most important of them) nothing prevents us from dealing with such
cases on their merits, but we do not include them in our general schema.

The reader should observe that this arrangement rests on several asser-
tions of fact and, of course, stands and falls with them. If anyone should
hold that changes in taste, which in any case are among the most obvious
phenomena of economic history, do arise regularly and systematically
from consumers’ initiative in the above sense, in such a way that this
initiative constitutes one of the main motive powers of economic evolu-
tion, he would logically have to deny the validity of our analytic schema.

2. Increase in productive resources might at first sight appear to be
the obvious prime mover in the process of internal economic change.
Physical environment being taken as constant (opening up of new coun-
tries enters as we have seen into a different category), that increase
resolves itself into increase of population and the increase of the stock
of producers’ goods. Neither can, of course, be treated as an independent
variable; both are at the same time effects of economic changes and
conditions of other economic changes. Our reason for listing variations
in population among external factors was that there is no unique relation
between them and variations in the flow of commodities. Hence, it
seemed convenient for our purpose, although it would be inadequate for
others, to look upon an increase in population as an environmental change
conditioning certain phenomena. Moreover, it could be demonstrated
by familiar cases (India and China) that mere increase in population does
not brinff about any of those phenomena which presuppose either a certain
density or a certain rate of increase in population except a fall in real
income per head. Finally, it occurs so continuously as to be capable of
current absorption.^ Short-time variations in marriage rates are
obviously the reflex of business fluctuations and do not cause them.

^ In fact, increase per month of population seeking gainful employment is always small
in comparison with population gainfully employed. Even yearly increase — if that be the
figure to take — could, barring frictions and rigidities, never by itself cause any disturb-

How THE Economic System Generates Evolution 75

Similar considerations apply to the increase in the stock of durable
producers’ goods which would ordinarily follow from the presence in a
society of a positive rate of net savings. We will profit by the occasion
in order to introduce a few concepts, conventions, and propositions which
will be of use later on. f

By Saving we mean the earmarking, by a household, of an element of
its current receipts — as distinguished from capital gains” — ^for the
acquisition of titles to income or for the repayment of debt. If a firm
does the same thing with an element of its net receipts from the sale
of products and services, we shall speak of Accumulation. The distinc-
tion between Saving and Accumulation also applies, although it may be
difficult to carry out, in cases in which, as in the case of many farmers,
‘‘firm” and “household” are one. We confine both concepts to decisions
about monetary funds and we neglect, for convenience’s sake, any similar
decision that may be taken with respect to commodities. Saving and
Accumulation will thus be treated as elements of a monetary process:
the complementary processes in the world of goods constitute a distinct
problem. Where no confusion is to be feared we shall use the word Sav-
ing to cover also Accumulation. Dissaving — ^which includes consumers’
spending of “capital gains” — and Decumulation are self-explanatory.^
Therefore, Saving (Accumulation included, when required by the
context) does not mean:

ance. For Germany, for example, the highest figure on record, for prewar times, is 2.25 per
cent (1902) . See L<5sch, Bevolkerungswellen und Wechsellagen, p. 23. As has been pointed
out before, however. Dr. Losch does present an argument for believing that “waves in
population” play a causative role in economic fluctuations, into which we cannot enter but
which is not simply disposed of by the above remark.

^ Full justification of the conceptual arrangement adopted cannot be given without
going much more thoroughly into the theory of money than is possible in this book, and will,
it is hoped, be presented in the writer’s treatise on money. That provision, say, for one’s
old age, is Saving only if the intention is to live on the revenue from the sum assembled for
the purpose, and not if the intention is to spend that sum as well (so that, ideally, there is
nothing left on the dying day), sounds not less strange than that it is Saving if one “ear-
marks” in order to purchase a house for the purpose of letting it, while it is not Saving if
the intention is to live in the house. Also, it will be objected that, the defining criterion
being an intention, we cannot from observable behavior know whether there is Saving or
something else until the intention is carried into effect, and that even then we could not be
certain because what we see might still be Temporary Investment (to be defined presently
in the text). These and similar objections vanish, however, ff the purpose and the logic
of our definition are kept in mind. Saving in the sense defined is a distinct phenomenon,
playing a role and producing effects different from those produced by the other actions or
decisions which it is usual to include in Saving, and much confusion can be averted by dis-
tinguishing them clearly. To some extent, the importance of this will become evident as
we go on. We include earmarking of elements of income for the purpose of repaying
debts. But this will be dealt with separately and is not considered in this section. In
fact, it has no place within our present set of assumptions.

Business Cycles

a. The assembling of a sum earmarked for the purpose of buying a
durable consumers’ good, or of meeting an item of expenditure which
cannot be covered by current receipts: ^"saving” in order to buy a motor-
car for nonbusiness use or a house to live in, or ‘^saving up” for holidays is
not saving at all in our sense, but merely rearranging consumptive
expenditure so as to fit *Tumpy” items. Nor does any mere rearrange-
ment of the time shape of one’s real income stream necessarily involve
saving.

b. Notspending or deferment of spending.^ The decision on which
our definition turns, may, but need not, result in the money leaving the
saver’s account and eventually reaching some commodity market later
than it would have done if retained in the service of financing consumptive
expenditure. It may possibly reach it sooner. In itself the decision to
save is not a decision not to spend or to defer spending, and the latter
decision may equally well occur with respect to sums which are and
remain earmarked for consumptive use or, in the case of a firm, for expen-
diture in the ordinary run of business. Whether the decision not to
spend occurs in these spheres, or in the sphere of saving, it is in any case
neither saving nor explainable by saving as such, but a distinct phenome-
non calling for a distinct explanation. Nor is Hoarding (to be defined
later) synonymous with saving.

The carrying into effect of the decision to acquire titles to income we
shall call Investment. In the case of households we shall mainly think
of the acquisition of shares and bonds (including mortgages and the
like) and of land or buildings, if intended for business purposes. In
the case of firms we shall, however, include spending on all kinds of pro-
ducers’ goods beyond replacement — ^neglecting the difficulties incident to
the question of what constitutes replacement. Such acts of expenditure
we will designate by the term Heal Investment.

Older doctrine, being primarily concerned with fundamentals, has
undoubtedly excluded a great mass of facts from its horizon by despising
the monetary approach and by linking investment — in particular real
investment, still more real investment in plant and equipment — much too
closely to saving. Saving and investment, as here defined, are of course
distinct events. The former exerts influence of its own independently
of investment and the latter can be financed, as we shall see, from sources
other than saving. One of them, of great importance for our subject,
should be mentioned at once. Suppose that somebody who is in the

^ The objection to the term deferment is not only that expenditure can be deferred for
many reasons which characteristically differ in nature and effect, but that in no case
does it express the social meaning of thrift. The saver himself does not defer but defini-
tively renounces expenditure on consumers^ goods of the sum saved, while the latter
may be spent on consumers* goods by other people without any delay.

How THE Economic System Generates Evolution 77

habit of buying a new motorcar every five years, assembles the necessary
sum continuously on his checking account. The units of account ear-
marked for that purpose are not withdrawn from circulation. They
‘‘circulate’^ in the same sense that any others do, only they do so with a
longer period (lower ‘‘velocity,” to be defined later) than others. The
modern money market offering the facility, our man may decide to buy,
say, treasury certificates as his motorcar fund grows and to sell them when
the time has arrived to buy the car. He does not save. His behavior
toward consumption or his intention to spend on consumers’ goods has
not changed. Yet he invests. The money leads a sort of double
existence, serving all the purposes of a cash item earmarked for a certain
purpose and at the same time all the purposes of the borrower. We call
this Temporary Investment, and will carefully bear in mind its obvious
peculiarities.

Moreover, saving, even if invested, need not issue into real invest-
ment as readily as the reasoning of older authors seems to imply. Not
only can the saver invest by financing other people’s consumption, but
his money may serve to finance producers’ deficits or to pay debts. Even
if it does not, it need not be applied in such a way as to entail increase of
the national stock of durable producers’ goods, although it is obvious that,
inasmuch as increased saving means rates of interest lower than they
otherwise would be, there always will be a tendency in that direction.
In addition, the reader is welcome to insert here a whole chapter on the
innumerable incidents and accidents, errors, frictions, and lags, by which
savings may be lost or stopped on their way or misdirected or dissaved
again and which will account for imperfect coordination between saving
and investment. But it is vital to realize clearly that any want of coordi-
nation which we may observe is not simply due to the absence of an
equilibrating mechanism; for, though different acts and very often the
acts of different people, saving and investment are interdependent and
correspective so as to shape each other.

Saving, as defined, implying intention to acquire titles to income, the
decision to save is taken with reference to given or expected investment
opportunities and the prospect of income they offer. Moreover, it can
be currently revised as they change: the case of savers is not analogous
to that of farmers who have to make decisions which will take effect but
one year later and then take effect for all of them simultaneously. It
might be said, however, that in the case in which saving issues in real
investment there is a lag between decision to effect the latter and the
emergence of the corresponding equipment goods. This lag gives room
for the ordinary chapter of accidents to unfold itself but not for a special
kind of maladjustment, since the rate of interest is free to react at once.
It will be apparent from the argument which follows, finally, that even

Business Cycles

if saving, say, becomes a habit and outruns its rationale — a qualification
which must be added to any proposition about economic behavior —
maladjustment does not necessarily ensue because, whether savers save
rationally or not, their action in any case influences investment oppor-
tunity, which in turn tends as much to adapt itself to the amount and the
rate of saving as it tends to influence that amount and rate. Of course,
there is very little meaning in an application of Marshallian demand and
supply curves to this case. They do not illustrate but rather obscure the
nature of the relation between saving, investment, and the rate of
interest. Since this relation is the net result of the interaction of all the
variables of the system, it can be expressed only in terms of the Walrasian
apparatus. From the attempt to do so by means of two independent
single-value functions of the rate of interest nothing but caricature can
result.

Actually, of course, we find that that equilibrating mechanism very
often does not work. But sound diagnosis cannot be expected from
denying its existence or from setting up such entities as ‘‘optimism,’’
“pessimism,” “saving instinct,” or from simply asserting that people
elect to act in such a way that maladjustment will ensue and that saving
and investment can each go its own way indefinitely. In order to make
headway, we must locate the sources of the trouble. They will be found
in the business situations incident to the process of economic change we
are about to describe, and link up with notspending and with variations
in real investment rather than with saving. At the moment, however, it
is desirable, since the ground is so fertile in misconceptions, to make
quite sure that the saving-investment mechanism, as such, does not
produce anything that could qualify for the role of an explanation of
crises or depressions.^

^ If, given our definitions, the reader should think this obvious, so much the better.
If he should think, in particular, that our rigorous distinction between saving and notspend-
ing begs the question, this woxild precisely imply granting the point which the writer wishes
to make. There are many economists, however, who do use the simple saving-investment
mechanism for the purpose above alluded to, and it is they whom the reader should blame
for what the writer agrees are very trivial considerations. It should be observed that,
while the argument presented above runs substantially on very familiar lines — it
would be possible to quote in support, besides Walras, Mill, Boehm-Bawerk, Hayek,
Hansen (for the latter’s views see his criticism of Foster and Catchings in Business-cycle
Theory, for instance, p. 57) — agreement ceases beyond it. For, barring many individual
points which cannot be insisted on since this is no place for a full development of the theory
of saving, there is a fundamental difference which must be kept in view: aU those authors
attribute to saving a role which is denied to it here. And all of them look upon the argu-
ment to be presented, or a similar one, as a satisfactory theory of saving, to which not
more than a general proviso about frictions and disturbances from outside has to be
added in order to make it applicable to the explanation of reality. This is not so, however.
For us, the stationary assumptions we are going to make have importance only for the

How THE Economic System Generates Evolution 79

For this purpose we will envisage a society, stationary in every
respect except in that it displays a positive rate of saving. Production
functions are invariant and external disturbances are absent. There is
a positive rate of interest. We exclude — ^but this is only for the sake of
convenience and brevity — all investment opportunities except lending
to firms (this merely excludes consumers* credit) and assume that saving
is the only source of supply of such monetary means as these firms may
wish to have in addition to their current receipts (this assumption
excludes credit creation: money consists, say, of a fixed number of gold
coins which must be actually handed over to effect a transaction).
Obviously, this model will display only the effects of saving and invest-
ment as such. We start from competitive equilibrium, although exten-
sion to the imperfectly competitive case would not present any difficulties.
Now, that equilibrium is incessantly disturbed by the flow of new savings
which are being offered to the firms. If, however, the system is adapted
to the actual rate of savings — an assumption which is not only reasonable
under the circumstances of this model, but also much nearer the truth
in reality than devotees of oversaving theories are in the habit of admitting
— ^this disturbance will be currently absorbed; for, as long as saving goes
on at all, each installment will depress the rate of interest to the extent
required to create its own investment opportunity. No other price,
either of consumers* or of producers* goods will be affected at this stage.
As to consumers’ goods, the question whether saving in general reduces
their prices is irrelevant here, since in any case they have been produced in
quantities, decision about which already took account of that rate of
saving. As to producers’ goods, the analogous question — i.e., whether
investment increases their prices — ^is irrelevant for the same reason. And
the new producers’ goods are sure to find their buyers because the previous
combination of factors of production is, owing to the fall in rate of
interest, no longer optimal and the combination which is optimal now
requires an increase in the more durable elements, let us call them
machinery, such as will exactly equal the additional savings offered both
in value and in cost, which is what we mean by saving creating its own
demand. It is readily seen that, in this case, what above has been
described as a caricature, works satisfactorily, because we have by our
assumptions paralyzed everything else that could vary. The result
would, in fact, be a steady growth of the system’s industrial outfit by the
steady addition to it of new units of plant and machinery, which, however,
must be of the same types as those which are already in use or would be

purpose of preliminary clarification and are admitted from the outset to yield an inadequate
picture which, taken by itself, could only mislead. Reference should be made to Professor .
Bresciani-Turroni’s paper on the Theory of Saving, Economica for February and May 1936,
and Mr. Robertson’s on Saving and Hoarding, Economic Journal for September 1933.

Business Cycles

in use but for lumpiness, in order to exclude a new and different element
which would otherwise intrude.^

The fundamental meaning or ^‘social function’^ of saving and invest-
ment, as interpreted by classical doctrine, stands out clearly and need
not detain us. But it is important to notice that since no losses are
incurred by producers of consumers’ goods owing to the failure of the
households to spend their whole income for purposes of consumption, there
is no reason for any producer to refuse additional “capital” on the
ground that, because of such losses, he wants to contract rather than to
expand operations. Nor will there be any “glut” when the products
of the new machines reach the markets for the consumers’ goods. Prices
will now fall but this does not spell losses, because it will necessarily be
compensated for by the corresponding fall in costs per unit of finished
product. There may be difficulties, of course, such as the impossibility
of adjusting old loan contracts quickly, but they belong to the class of
frictions. Unless interest falls to zero — and then saving in our sense
stops, though, for example, “saving for the rainy day” may continue —
this process can go on indefinitely, without of itself creating any problem,
along constant production functions. The continuity of the latter is in
this case no more serious a restriction than it is in others. It is worth
while noticing, however, that such addition to the stock of durable
producers’ goods can be injurious to the interests of the working class.
Whether it is or not depends on the elasticity of substitution between
labor and those goods. ^ But this is not relevant to our argument.

If, however, the system is, at any time, not adapted to the saving
actually done, analysis becomes more complicated. We will assume that
savers suddenly and unexpectedly take to saving, say, double the sum per

^ It is not necessary that every single firm should always add only such units as it already
used before. For reasons of indivisibility, the additional machines may differ from those
used before because, with expanding output, other types may become the most profitable
ones. But they must be within the existing production functions. See what has been said
on the subject of the latter in Chap. II.

^ For that concept see Mrs. Robinson^s Economics of Imperfect Competition, Mr. Hicks’
Theory of Wages, various discussions in the Review of Economic Studies, particularly J- R.
Hicks, Distribution and Economic Progress, 1936, and the articles, by Professor Pigou in
the Economic Journal for June 1934, and by Mr. Champernowne and Mr. Kahn, ibid., June
1935. There is a tendency to discount the value of the concept, principally because it
works with reasonable efficiency only in the case of two factors of production and becomes
unmanageable as soon as there are more of them. This is true. But it is submitted that
the above instance, nevertheless, proves its utility. That question has been the subject
of controversies for over a century; yet the concept of elasticity of substitution enables us,
for the special case of invariant production functions, to answer it in one line by means of
the theorem due to Mrs. Robinson: The demand price of labor (in money) increases
(decreases) as a result of a fall in interest if the elasticity of demand for ‘‘capital” is
greater (smaller) than the elasticity of substitution between “capital” and labor.

How THE Ecoi^^omic System Generates Evolution 81

unit of time i^ey to save titherto. It should be observed at once
that the violent fluctuations usually associated with thrift are variations
in the rate of spending.^ Our problem is, therefore, little more than an
exercise in pure theory, for long time changes in the rate of saving come
about by truly infinitesimal steps, and although its fluctuations in the
business cycle are considerable, owing to the great variability of the profit
component, it must be borne in mind that these are a consequence of the
cyclical situations, while here we are primarily concerned with the ques-
tion whether saving would of itself produce depressions. Autonomously,
abrupt changes in the rate of saving hardly ever occur. At least, the
writer does not know of any instances, outside of the cases of ‘Vild’’
inflation.

But assuming that such changes do occur, disturbance of the sort
which always attends sudden changes in the channels of trade will in
most eases ensue. Its precise nature, as well as the ultimate outcome,
now depends on a great many variables, and also on other properties of
the process and of the system, such as the number and sequence of the
steps in the saving-investment process (the ''periodicities”; here degree of
vertical integration of industry becomes relevant^). We will simplify
matters by again excluding bank credit and assuming that savers offer
their additional savings to firms which, having been in competitive
equilibrium at the previous point of time, have no use for them at the
previous rate of interest and, at a suitably reduced rate, no other use than
to add new units to their existing stock of machinery.

Now it is easy to construct a case in which the sudden withdrawal of
the savers’ demand from the market of the consumers’ goods which they
used to buy before their decision to double their rate of saving, causes
catastrophe. This withdrawal on the one hand enforces emergency bor-
rowing by the firms which produced those goods that they are now unable
to sell and, on the other hand, deters all firms from committing themselves

^ This will become clear later on. Meanwhile, it is useful to insist again on the conse-
quences, for analysis and policy, the confusion between those two things, which are different
in nature and in behavior, must have. Most of what writers who are above primitive error
attribute to thrift really applies to non-spending — in particular, most of what is true in
the talk about saving financing the losses which it creates and “ saving helping to destroy
rather than to increase the stock of society’s real capital.” Hence, though it is no doubt
regrettable that it is impossible to present a definition of saving which will make it less
refractory to statistical evaluation, we have yet no choice. Statistical measurability is no
advantage if the measurable thing is devoid of meaning, or carries another meaning.

^ If we were dealing with the problem of the effects of saving in its full extent, we should
have to mention the reactions of cash holdings and of bank credit and, what is most impor-
tant of all, much more so than anything connected with the behavior of monetary aggre-
gates, the purposes which are financed by saving and the degree of success that attends
them.

Business Cycles

to new real investment. If savers go on after this, we can even, by
properly choosing sequences, arrive at the result that all values will after
a time asymptotically approach zero.

It is not less easy to construct a case in which there will be no fall at
all in prices of consumers* goods because, the additional savings having
been offered and accepted and work on the new machines having started
before those prices had time to fall, demand from the increased incomes
in the machine industries steps into the place of the demand discontinued
by savers, so that nothing can happen except possibly a shift within the
sphere of consumers* goods. This case is but a paraphrase, in monetary
terms, of the idea that saving and investing fundamentally consist in
handing one’s claims to consumers’ goods to laborers and other suppliers
of productive services in order to set them to work on, say, intermediate
products. It does not, as far as this goes, make any difference whether
these services were previously employed or not: saving is not ‘^abortive”
if they were previously employed. But then their employment in
the machine industry will temporarily reduce the supply of consumers’
goods, so that in this case there will be a period during which saving and
investment produce an increase in their prices.^

The best that can be said for both constructions is that, though they
are absurdly overdrawn pictures of possible variants of an impossible case,
they nevertheless may serve in the role of magnifying glasses with which
to look for otherwise invisible traits of reality. The second is perhaps
more apt to bring out fundamental truth that is not obvious to the lay-
man, but for our purpose we are particularly interested in the first. In
itself it is trivial, for all it teaches is that a violent change in the rate of
saving causes trouble which, if we allow suitable expectations to play
around it, may go on intensifying itself so that the new rate of saving
and the new rate of investment may diverge for a considerable time.
But the interesting point about it is that such a violent change, coming
about autonomously, yields the only case in which saving could possibly
have anything to do with the causation of business depressions in the
sense that it could create them by itself. Moreover, these changes would
have to recur periodically.

We now return to our argument. We do not, of course, exclude
Saving and Accumulation from the internal factors making for economic
change; for, unlike variations in population, they certainly are a purely
economic phenomenon. But we do exclude them from the fundamental
contour lines of our analytic model. This decision may well look
strange. To many it may seem to exclude the very essence of the mat-

^ In any case it is useful to observe that the sum total of incomes in the income-tax sense
is always increased by savings which reappear in other people’s incomes within the period
of account.

How THE Economic System Generates Evolution 83

ter.^ A little reflection will, however, quickly dispel that impression.
As soon as we realize the necessity of starting our analysis of economic
change from a stationary state in perfect equilibrium, exclusion of savings
as a major factor in bringing about that change follows logically, for
whatever the definition of saving the reader adopts, it is clear that most
of its sources, as well as most of the motives for it, would be absent in a
stationary state. If we take up any of the familiar attempts at estimat-
ing statistically the amount of saving done in any country at any time,
we see immediately that the bulk of it, whether done within the sphere of
business or the sphere of households, flows from revenues or elements of
revenues which would not exist at all in a stationary state, namely from
profits, or from other incomes created or swelled by previous economic
change.

As to motives, it is equally obvious that most of them arise out of
situations incident to economic change. It does not matter now,
whether we define the stationary state so rigorously as to exclude all
saving or not. What matters is the fact that its quantitative importance
would be exceedingly small, at any rate very much smaller than it
actually is, if the economic process in any way approximated the equilib-
rium picture: Saving would be a ‘‘trickle” and by virtue of this fact alone
could not give rise to any troubles. This is, in fact, the reason why
“primitive” countries find it so difficult to finance the beginnings of
capitalist industry themselves. It follows that, if we included savings
as a major factor initiating economic change, we would be including in
our premises part of what we are attempting to explain. Hence, it seems
advisable as a matter of analytic neatness to construct a model which
does not contain it among the fundamental constituents. By this we may
hope to get much better insight into the nature and role of saving than
if, trying prematurely to be realistic, we carried it with us from the start.

To sum up, we shall designate by the term (positive or negative)
Growth changes in population (strictly also changes in age distribution)
and in the sum total of savings plus accumulations corrected for variation
in the purchasing power (to be defined later) of the monetary unit. That
term is to emphasize not only that variation in both those variables is
continuous in the mathematical sense — that if we look upon, say,
population as a function of time, then for any point of time that function
has a certain finite value which is equal to the limit it approaches as the
time variable approaches the chosen point — ^but also that it occurs at a
rate which changes but slowly and is per se incapable of producing those
fluctuations in industry and trade which interest us here. This does not

^ The element of saving will, however, be reintroduced and the reader will then be in a
position to judge whether or not the position assigned to it does or does not do justice to its
actual importance.

Business Cycles

mean that it cannot cause any fluctuations: it obviously can. Nor do
we mean, that this factor of change is irrelevant to those fluctuations
which are our subject, or that it is quantitatively insignificant. Within
fifty or sixty, or even nine years — ^which, as we shall see, are for us
important periods — ^the cumulative change due to Growth will assert
itself in many of our figures. All it means is that the effects of Growth
are, as we have put it, capable of being currently absorbed — in the sense
that any disequilibrium created by every newcomer in the labor market
or every dollar newly saved in the money market could under ordinary
circumstances be corrected without giving rise to any visible disturbance
— Whence, cannot by themselves create the alternation of booms and
depressions we observe. Moreover, Growth, but especially saving, owes
its actual quantitative importance to another factor of change without
which its modus operandi in the capitalist world cannot be understood.
To be sure, there is interaction and interdependence and actual results
are the product both of Growth and that other factor. But the modus
operandi of the latter does account for booms and depressions and can be
understood without Growth, which, therefore, we will relegate until we
must call it up again in order to complete our survey.

S. By changes in the methods of supplying commodities we mean a
range of events much broader than the phrase covers in its literal accept-
ance. We include the introduction of new commodities which may even
serve as the standard case. Technological change in the production of
commodities already in use, the opening up of new markets or of new
sources of supply, Taylorization of work, improved handling of material,
the setting up of new business organizations such as department stores —
in short, any “doing things differently’’ in the realm of economic life — all
these are instances of what we shall refer to by the term Innovation. It
should be noticed at once that that concept is not synonymous with
invention” (see Chap. I, Sec. B). Whatever the latter term may mean,
it has but a distant relation to ours. Moreover, it carries misleading
associations.

First, it suggests a limitation which is most unfortunate because it
tends to veil the true contours of the phenomenon. It is entirely imma-
terial whether an innovation implies scientific novelty or not. Although
most innovations can be traced to some conquest in the realm of either
theoretical or practical knowledge that has occurred in the immediate
or the remote past, there are many which cannot. Innovation is pos-
sible without anything we should identify as invention and invention
does not necessarily induce innovation, but produces of itself, as has been
pointed out in the first chapter, no economically relevant effect at all.
The economic phenomena which we observe in the special case in which

How THE Economic System Generates Evolution 85

innovation and invention coincide do not differ from those we observe
in cases in which preexisting knowledge is made use of. Stressing
the element of invention or defining innovation by invention would,
therefore, not only mean stressing an element without importance
to economic analysis, but it would also narrow down the relevant phe-
nomenon to what really is but a part of it.

Second, even where innovation consists in giving effect, by business
action, to a particular invention which has either emerged autonomously
or has been made specially with a view to a given business purpose and in
response to a given business situation,^ the making of the invention and
the carrying out of the corresponding innovation are, economically and
sociologically, two entirely different things. They may, and often have
been, performed by the same person; but this is merely a chance coinci-
dence which does not affect the validity of the distinction. Personal
aptitudes — ^primarily intellectual in the case of the inventor, primarily
volitional in the case of the businessman who turns the invention into an

^ In many important cases, invention and innovation are the result of conscious efforts
to cope with a problem independently presented by an economic situation or certain fea-
tures of it, such as, for example, the shortage of timber in England in the sixteenth, seven-
teenth, and eighteenth centuries. Sometimes innovation is so conditioned, whereas the
corresponding invention occurred independently of any practical need. This is necessarily so
whenever innovation makes use of an invention or a discovery due to a happy accident, but
also in other cases. It might be thought that innovation can never be anything else but an
effort to cope with a given economic situation. In a sense this is true. For a ^iven innova-
tion to become possible, there must always be some ‘‘objective needs to be satisfied and
certain “objective conditions”; but they rarely, if ever, uniquely determine what kind of
innovation will satisfy them, and as a rule they can be satisfied in many different ways.
Most important of aU, they may remain unsatisfiled for an indefinite time, which shows
that they are not in themselves sufficient to produce an innovation. The rise of the motor-
car industry may serve as an example. The sense in which it may be true that motorcars
emerged when conditions called for them is not relevant to an economic inquiry. For any
“need” for them that may have existed was certainly subconscious and not an element in
the then existing system of economic values. The “need,” as far as economically relevant,
was created by the industry, and people could obviously have gone on without any motor-
cars. Therefore, it seems reasonable, on the one hand, when everybody calls for a certain
innovation and everybody endeavors to effect it, to recognize this fact and, on the other
hand, not to insist on seeing it when it is not there. The problem of determining how far
“necessity is the mother of invention” is a difficult one. Its solution may well read differ-
ently for different purposes of analysis. We shall have to emphasize this more than once.
Meanwhile, it should be pointed out that we may accept a theory of invention as presented,
for example, by Mr. S. C. Gilfillan in his Sociology of Invention — the present writer, as a
matter of fact, substantially does — and yet adopt another point of view for our purposes.
We take the opportunity to refer to Professor A. P. Usher's History of Mechanical Inven-
tions, 1929, from which work the present writer has derived much help, andR. K. Merton,
Fluctuations in the Rate of Industrial Inventions, Quarterly Journal of Economics for May
1935. The writer wishes to acknowledge his obligation, in the matter of invention, to a
report made for him by Mr. Gilfillan.

Business Cycles

innovation — and the methods by which the one and the other work,
belong to dijBFerent spheres. The social process which produces inven-
tions and the social process which produces innovations do not stand in
any invariant relation to each other and such relation as they display is
much more complex than appears at first sight.

As soon as it is divorced from invention, innovation is readily seen
to be a distinct internal factor of change. It is an internal factor because
the turning of existing factors of production to new uses is a purely
economic process and, in capitalist society, purely a matter of business
behavior.^ It is a distinct internal factor because it is not implied in,
nor a mere consequence of, any other. Of course, in reality, all three
factors — changes in tastes, growth, and innovation — interact and
mutually condition each other, and observed historic changes are the
result of them all. But we can satisfy ourselves of their logical inde-
pendence by visualizing societies in which internal change is merely
caused by autonomous change in consumers’ tastes or merely by growth
or merely by innovation.

If we do this, we immediately realize that innovation is the outstand-
ing fact in the economic history of capitalist society or in what is purely
economic in that history, and also that it is largely responsible for most of
what we would at first sight attribute to other factors. To illustrate this
by an example: modern economic processes are to a great extent con-
tingent upon agglomerations of population in cities and upon the
facilities put at the disposal of the business community by public action.
But these conditions of further innovations themselves are, not indeed
always, but in most cases the results of industrial processes which come
within our concept of innovation, and either directly produced or made
possible by them.^

The changes in the economic process brought about by innovation,
together with all their effects, and the response to them by the economic
system, we shall designate by the term Economic Evolution. Although
this term is objectionable on several counts, it comes nearer to expressing
our meaning than does any other, and it has the advantage of avoiding the
associations suggested by the cognate term Progress, particularly the
complacency the latter seems to imply. This terminological decision is,
of course, but the expression of an analytic intention, namely, the inten-

^ This business behavior may, of course, be molded not only by general environmental
conditions but also by the specific action of other social organs, governments for instance,
taken with the intention of calling it forth. This subject will be discussed in Chap. VI.

2 That proposition has meaning only for the purposes of economic analysis. In a wider
setting, it is other social factors by which, among other things, innovation itself is deter-
mined and which make economic as well as general history. It cannot too often be repeated
that every sentence of this book is to serve but a restricted purpose and moves within a
restricted horizon appropriate to that purpose.

How THE Economic System Generates Evolution 87

tion to make the facts of innovation the basis of our model of the process
of economic change. Nothing but success in showing that the processes
incident to innovation do account for the phenomena we want to under-
stand can justify that intention. But the reader is invited to observe
how very natural it is. The worst that could befall the analytic schema
presented in this book would be an impression to the effect that it is
ingenious or farfetched. Surely, nothing can be more plain or even
more trite^ common sense than the proposition that innovation, as
conceived by us, is at the center of practically all the phenomena, di£E-
culties, and problems of economic life in capitalist society and that they,
as well as the extreme sensitiveness of capitalism to disturbance, would
be absent if productive resources flowed — either in unvarying or con-
tinuously increasing quantities — every year through substantially the
same channels toward substantially the same goals, or were prevented
from doing so only by external influences. And however difficult it may
turn out to be to develop that simple idea so as to fit it for the task of
coping with all the complex patterns with which it will have to be con-
fronted, and however completely it may lose its simplicity on the way
before us, it should never be forgotten that at the outset all we need to
say to anyone who doubts is: Look around you!

B. The Theory of Innovation. — ^We will now define innovation more
rigorously by means of the production function previously introduced.
As we know, this function describes the way in which quantity of product
varies if quantities of factors vary. If, instead of quantities of factors,
we vary the form of the function, we have an innovation.^ But this not
only limits us, at first blush at least, to the case in which the innovation
consists in producing the same kind of product that had been produced
before by the same kind of means of production that had been used
before, but also raises more delicate questions. Therefore, we will simply
define innovation as the setting up of a new production function. This
covers the case of a new commodity, as well as those of a new form of
organization such as a merger, of the opening up of new markets, and so
on. Recalling that production in the economic sense is nothing but

^ The triteness the writer wishes to stress, becomes particularly obvious if the proposi-
tion be put into the form : Economic change is due to External Factors, Growth, Innovation.
But it should be observed that even in this form, and stripped of any implication as to the
relative importance of these three types of factors of change, the proposition is not the
tautological consequence of our definitions.

2 Headers versed in economic theory can easily translate the above into the language of
isoquants. They will also perceive that the difficulties noticed in the following sentence of
the text are not altogether insurmountable. But it would lead too far astray to go fully
into the matter. Be it repeated again, that the above definition does not make innovation
equivalent with “change in method’’ or “change in technique” of production. Such
changes may also occur in response to changes in relative prices of factors.

Business Cycles

combining productive services, we may express the same thing by saying
that innovation combines factors in a new way, or that it consists in
carrying out New Combinations, although, taken literally, the latter
phrase would also include what we do not now mean to include — namely,
those current adaptations of the coefficients of production (see Chap. II)
which are part and parcel of the most ordinary run of economic routine
within given production functions.

For cases in which innovation is of the technological kind we could
have defined it directly with reference to the so-called laws of physical
returns. Barring indivisibility or lumpiness, the physical marginal
productivity of every factor (for definition see Chap. II, Sec. B) must, in
the absence of innovation, monotonically decrease. Innovation breaks
off any such ‘‘curve” and replaces it by another which, again except for
indivisibility, displays higher increments of product throughout,^
although, of course, it also decreases monotonically. Or if we take the
Ricardian law of decreasing returns and generalize it to cover industry as
well, we can say — as, in fact, Ricardo himself said in the case of agricul-
ture — ^that innovation interrupts its action, which again means that it
replaces the law that had so far described the effects of additional doses
of resources by another one. In both cases transition is made by a jump
from the old to the new curve, which now applies throughout and not only
beyond that output which had been produced before by the old method.

We can define innovation also with reference to money cost. Total
costs to individual firms must, in the absence of innovation and with
constant prices of factors, monotonically increase in function of their
output.^ Whenever at any time a given quantity of output costs less to
produce than the same or a smaller quantity did cost or would have cost

^ This does not mean that xmless there be innovation every coefficient of production
necessarily increases in function of output, or that every coefficient of production is neces-
sarily decreased by innovation. This bars us from measuring innovation by the behavior
of these coefficients. Still less admissible is it to try to measure it by the change in one of
them, for instance man-hours per unit of product or the reciprocal. The danger of such
mistakes as that of comparing, say, the hours of work on the farm that went to produce a
bushel of wheat in 1700 and 1900 and of overlooking that at the former date much more of
the total work that ultimately issues into a bushel of wheat was done on the farm than at
the later date, is the least of all that beset this path. The presence of other factors, and
particularly of substitutable factors, makes any such measure all but meaningless. How-
ever, innovation must certainly reduce some coefficients, and if we are content with what
amounts to almost heroic roughness, we may use product per man-hour for some purposes as
an Index of Rationalization with respect to labor.

2 As intended, the above proposition is self-evident. Compare, for instance, Henry
Schultz, Statistical Laws of Demand and Supply, p. 104. A possible objection on the
score of external economies will be cleared up as we proceed. Internal economies, also to
be discussed presently, obviously cannot avail to reduce total cost of producing a quantity
below total cost of producing a smaller quantity, unless they imply innovation.

How THE Economic System Generates Evolution 89

before, we may be sure, if prices of factors have not fallen, that there has
been innovation somewhere.^ It follows that it would be incorrect to
say that in this case innovation produces falling long-run marginal cost
curves cr makes, in certain intervals, marginal cost negative. What
should be said is that the old total or marginal cost curve is destroyed and
a new one put in its place each time there is an innovation. If there are
indivisibilities and the innovation becomes possible only beyond a certain
quantity of output, while below it the old method remains superior and
would promptly be resorted to again, should output fall sufficiently, we
may indeed draw one cost curve to combine costs with the old method
in one interval and costs with the new method in another interval. But
this is possible only when the new method has become familiar and the
whole system is adapted to it, which means that it enters the production
functions — i.a., the practical range of choice open to all — and is no
longer an innovation.

If prices of factors are not constant but change independently of the
action of the firm, the effect on its cost curves — ^total, average, and
marginal — ^is exactly analogous to the effect of innovation: they break
off and new ones emerge instead. It is easy to see that we cannot con-
struct a theoretical — as distinguished from a historical — cost curve that
would in one stretch refer to, say, a given wage rate and, in another
stretch, to a different one. The analogy may, hence, serve to illustrate
still more clearly the impossibility of representing marginal costs in func-
tion of output as falling (whether continuously or not) and total costs as
falling or rising less than they otherwise would, under the influence of
successive innovations. If prices of factors change in function of the
action of the firm — ^the same applies, mutatis mutandis^ to industrial
curves — ^it is no longer so, and cost curves have to take account of such
changes. But, in general, prices of factors could then, unless there is
lumpiness^ or innovation in their production or supply, change only in the
same direction as the quantity of the product, so that we need not appre-
hend that any fall along cost curves arises from this source.

^ It need not necessarily have occurred in the industry under observation, which may
only be applying, or benefiting from, an innovation that has occurred in another. On the
other hand, that criterion may be extended to apply to new commodities, if we compare the
revenue that can be derived from a certain outlay in the new line with the revenue that can
be derived from the same outlay in the most advantageous of the old lines. It should be
observed that, unless we bar indivisibilities, the criterion is only sufi&cient, but need not
hold for every quantity of output.

2 In particular, if a small firm gets some raw material at a lower price if it takes more of
it, this can be due only to some lumpy factor in the cost combination of the supplier of it.
This may also happen in the case of a big firm and of an industry, but here other ele-
ments are likely to enter. The fact that a big firm may obtain a certain quantity cheaper
than a number of small competing firms could obtain the same quantity, may of course be

Business Cycles

This helps to clear up some much-discussed points about the theory
of cost which are of considerable importance for our subject. For the
sake of brevity, we shall consider total cost per unit (average cost) only
and define the so-called Law of Increasing Cost (not quite correctly) with
reference to it. It readily follows from the above that in the long run —
that is to say, when overhead may be treated as variable in function of
output — average cost curves can be falling only because of the presence
of lumpy factors, while all other causes that may bring about fall in
average cost do not produce fall along these curves, but a downward
shift of them. Hence, they can never be falling throughout, but only in
intervals the length of which is determined by the nature of the lumpy
factor or factors, and after which they must rise again. Now, dis-
regarding the effects of lumpiness or smoothing them out by drawing
a monotonic curve through the alternating stretches of rising and fall-
ing average costs, we should, strictly speaking, get a curve which would
for a small individual firm, be parallel to the quantity axis, i.e., con-
stant unit costs. A Law of Increasing Cost comes in, however, if we
admit that some factor is in absolutely inelastic supply even in the long
run — ^the factor management for instance. For an industry or a big firm
we may, in addition, get increasing total unit costs if factor prices rise
against it as it increases output. This not only disposes, in the realm of
fundamental principles, of the difEculties that have been raised^ about
competitive equilibrium under conditions of decreasing cost, but also
enables us to take care, by means of the concept of innovation, of
a multitude of industrial patterns which seem recalcitrant to those
principles.

In fact, since decreasing total unit costs are mere interruptions, of
necessarily limited extent, of the fundamental property of any given total
unit cost curve either to rise or to be horizontal, increasing and decreasing
costs are not coordinated alternatives. Only the former is a genuine
‘‘law”; the latter expresses but a modification of it by an accidental
technical circumstance, which while it acts will indeed prevent perfectly
competitive equilibrium from emerging but cannot do so indefinitely,
because it must ultimately surrender. There is, hence, no Law of
Decreasing Cost to parallel the Law of Increasing Cost on equal terms
and there is no warrant for the monotonically descending cost curves
that are sometimes drawn. At the same time, however, we recognize
first, that in some cases lumpy factors may be so big — a railroad track

due to a monopoloid or a monopsonoid situation, and then has nothing to do with the
argument.

1 See, for instance, the Symposium on Increasing Eeturns, Economic Journal for March
1930, an echo of the important article by Mr. P. Sraffa on Laws of Return, December

1926.

How THE Economic System Generates Evolution 91

for instance — that for a very long time ahead the whole of the useful
range of total unit cost lies within the falling interval, and second, that in
practically all cases there is an important falling interval, owing to fixity
of overhead, on short-run total unit cost curves within which firms may be
moving for years together. In cases of ‘‘building ahead of demand” and
with imperfect competition, in particular in the presence of oligopolistic
struggles (compare Chap. II, Sec. F), the latter situation will be much in
evidence — ^firms may possibly even move within the descending interval
of their marginal cost curves — and account for many instances of “ over-
production” and “overcapacity.”

But what dominates the picture of capitalistic life and is more than
anything else responsible for our impression of a prevalence of decreasing
cost, causing disequilibria, cutthroat competition and so on, is innovation,
the intrusion into the system of new production functions which inces-
santly shift existing cost curves. Thus, having been led by other reasons
to question the validity of the analysis which rests upon the concept of
monotonically descending cost curves, we also see that we do not need
it, for the concept of cost curves that shift under the impact of innovation
gives us all we want in order to handle the mass of facts for the sake of
which those descending cost curves were devised.^ Even the cases above
alluded to, in which decreasing cost actually does constitute an important
element of a business’ situation — of those “cramped” situations in which
everybody tries to contract while everybody could expand sometimes
even at falling prime costs per unit — ^find their proper setting and their
interpretation within this analysis, which, as pointed out before, gives
to Short-time Analysis and to the Theory of Imperfect Competition
what seems to the writer to be their true significance. The impression
that firms moving in intervals of decreasing costs are often in the center
of the vicissitudes of industrial life is not wrong. But this links up with
innovation, because the firms which, rushing down along such intervals,
are upsetting existing industrial structure and, as it sometimes seems,
heading toward monopoly, are in general precisely those which have set
up new production functions and which are struggling to conquer their

^ This is the reply to Mr. Robertson’s remark {Economic Journal for March 1930, p. 84)
that the present writer’s rejection of descending long-period supply curves (the relation of
these to the corresponding total unit cost curves need not detain us) is “a counsel of despair,
which Marshall considered and rejected.” The reason for Mr. Robertson’s opinion and for
the course taken by Marshall is precisely that they believed descending long-period supply
curves to be indispensable for the treatment of that vast mass of facts which seemed to call
for them. We see, however, that this is not so and that we can take care of those facts
more naturally by another method. Mr. Robertson’s solution of the difficulties surround-
ing those supply curves looks to us much more like a coimsel of despair than does our own.
Those difficulties are, in themselves, a symptom of something being wrong about descend-
ing supply curves, for inadequate analysis will generally be productive of pseudo-problems.

Business Cycles

market. If it were not for this, the space that decreasing costs fill in the
economists’ thought would rapidly dwindle to very modest proportions.

Before going on, it will be well to repeat the same argument in terms
of the two familiar concepts due to Marshall,^ Internal and External
Economies. As to the former, it may seem strange to say that economies
of scale internal to the individual firm, if they are to explain the shape of
a cost curve, necessarily reduce to effects of lumpiness. Yet it is so, not
only in the case exemplified by costly machinery, but also in the cases of
more rational division of labor or, more generally, better ""organization”
of factors which is held to occur when output expands. For if, for
instance, a small tailor decides to employ a specialist in sewing on buttons
because, and only because, his business expands, and if he would have
taken that decision from the outset had his output been from the outset
what it now is — ^if this is not so then, to repeat, this decision spells
innovation and has nothing to do with negative inclination of cost
curves: we must try to divest ourselves of the idea that innovation
necessarily means something spectacularly important — then the only
possible reason why he did not take that decision sooner is that, in his
modest circumstances, labor is a lumpy factor. If internal economies are
meant to designate the outstanding industrial fact we actually think
of when referring to large-scale industry, they are due to innovation
and cannot be expressed as a simple function of output even if they
should historically be conditioned by an increase in the latter. In
neither case does any difficulty arise about decreasing costs being
incompatible with competitive equilibrium or about explaining the
disequilibria we actually observe.

External economies are reductions in unit costs that are due to favor-
able circumstances incident to the growth of an industry, ^ notably to its
growth in a certain locality. As pointed out by Professor Pigou (Eco-
nomic Journal for June 1928), they are not always easy to distinguish
from internal economies and there are many intermediate cases. This,
however, we will disregard. Much more important is it that ""external
economies must usually take their ultimate origin in the internal econ-
omies of some subsidiary industry” (R. F. Kahn, Economic Journal for

^ Headers not familiar with them shotild refer to Marshall’s Principles, Book IV. No
actual mistake is here imputed to Marshall in his handling of those concepts, nor is it the
writer’s intention to deny either the historical merit which Vas implied in introducing them,
or the usefulness they perhaps retain for some purposes.

^ We need not consider separately the case of external economies which arise not from
the growth of any individual industry but of the industrial environment as a whole. What
we are about to say in the text can easily be applied to this case. Nor is it necessary for us
to enter into a discussion of the use made (with indifferent success) of the concept of the
Bepresenti^ve Firm which seems to the writer to be one more of the devices used to hide the
fundamental problem of economic change.

How THE Economic System Generates EvolijtI?^

March 19S5, p. 11). If an industry grows, some firm may specialize m
the production of machinery needed by that industry and no other, or
somebody may set up a broker^s business to provide it with raw material
or start a trade journal. Cases of this type arise either from lumpiness —
the journaFs overhead, including, say, an owner-manager, requires a
minimum of readers and advertisers in order to pay for itself — or else they
constitute innovations: the journal may very well be one. Neither alter-
native puts external economies on a par with external diseconomies or, at
all events, their most important instance, which consists in the rise of the
price of factors in response to increase in the demand for them. Nor
would discussion of other cases alter the result. Take the instance of the
growth of a supply of workmen specially skilled in the work of an industry.
Lack of it is indeed one of the major difficulties which innovation fre-
quently meets. It is overcome as the industry develops and reaches
maturity, which means that it becomes adapted in size to its environment.
While this process lasts, the industrial as well as the individual cost curves
are incessantly shifting and no single cost curve describing this process
can have any but a historical meaning. When it is over, this source of
external economies ceases to flow. In fact, it would be hard to find any
instance of the phenomenon in question except in connection with new
industries. Therefore, no monotonically declining cost curves can be
deduced from external economies. The term is still useful in order to
denote some of the effects on one industry of innovations in another, which
are, of course, a most important piece of the mechanism of economic
evolution in our sense. But it must not be allowed to act as a screen to
hide the innovations behind it, or be represented as a factor distinct from
them.

We return to our argument. In order to bring out strongly the
modus operandi of innovation, we will now promote to the rank of assump-
tions a few facts of common observation which present themselves in
connection with our analysis of costs.

First, we observe that major innovations and also many minor ones
entail construction of New Plant (and equipment) — or the rebuilding of
old plant — ^requiring nonnegligible time and outlay. We shall reason on
the assumption that they always do. If they did not, a great part of the
theoretical schema which we are going to use would have to be modified.
But these modifications, while of great theoretical interest, would be
practically important only if the innovations that can be carried out
instantaneously and without appreciable expense were themselves impor-
tant. Experience seems to teach, however, that as a matter of fact they
are not, that is to say, that our assumption fails to conform to fact only
in the case of innovations which are of such small importance that we can
safely neglect them although, there being no logical necessity for this, we

Business Cycles

jMust always be prepared to meet cases which cannot be thus disposed
oL Therefore, we shall impose a restriction on our concept of innovation
sand henceforth understand by an innovation a change in some production
function which is of the first and not of the second or a still higher order of
magnitude. A number of the propositions which will be read in this book
are true only of innovation in this restricted sense.

Of course the reverse would not be true : not every new plant embodies
an innovation; some are mere additions to the existing apparatus of an
industry^ bearing either no relation to innovation or no other relation
than is implied in their being built in response to an increase in demand
ultimately traceable to the effects of innovations that have occurred
elsewhere. The relative importance of these cases varies, of course, and
is extremely difficult to estimate. In fact, we meet here one of the most
serious statistical difficulties of our subject. In a system in which the
process of evolution goes on strongly, it is presumably not very far from
the truth to say that practically all new plant that is being constructed
beyond replacement, and much of what is being constructed by way of
replacement, either embodies some innovation or is a response to situ-
ations traceable to some innovation.

Second, we shall in general argue as if every innovation — as now
defined — ^were embodied in a New Firm founded for the purpose. There
is obviously no lack of realism about this assumption.^ The one signifi-
cant exception will, together with the reason for it, be noticed under the
next heading. Even* the reverse proposition would be much more nearly
true than it appears to be at first sight: Most new firms are founded with
an idea and for a definite purpose.® The life goes out of them when that
idea or purpose has been fulfilled or has become obsolete or even if, with-
out having become obsolete, it has ceased to be new. That is the funda-

^ Such cases are, of course, particularly frequent in industries that are established and
highly standardized, such as the shoe industry: one can order a shoe factory almost as easily
as one can order a pair of shoes.

2 It is most instructively exemplified by Professor McGregor’s essay on Enterprise and
the Trade Cycle, in Enterprise, Purpose and Profit, 1934. He shows very convincingly
that entrepreneurial activity as reflected by the formation of new concerns is the decisive
influence in starting prosperities, less convincingly, that failures initiate downward
movements.

® It is true that many people take up small retail businesses — ^retailing milk or running
gasoline stations — ^for no other reason than that they do not know what to do with them-
selves, or as a temporary occupation during imemployment. In other cases, particularly in
the artisan strata in some European countries, a man establishes a business of his own as a
matter of course when he has reached a certain age and acquired a certain amount of experi-
ence. No particular idea or purpose, in the sense of a perception of a definite new oppor-
tunity and of a decision to exploit it, enters here. Even outside of the sphere of small
business this happens sometimes. But this does not substantially afiect the statements in
our text.

How THE Economic System Generates Evolution 95

mental reason why firms do not exist forever.^ Many of them are, of
course, failures from the start. Like human beings, firms are constantly
being born that cannot live. Others may meet what is akin, in the case
of men, to death from accident or illness. Still others die a ‘^natural’’
death, as men die of old age. And the “natural’’ cause, in the case of
firms, is precisely their inability to keep up the pace in innovating which
they themselves had been instrumental in setting in the time of their
vigor. No firm which is merely run on established lines, however con-
scientious the management of its routine business may be, remains in
capitalist society a source of profit, and the day comes for each when it
ceases to pay interest and even depreciation. Everyone who looks around
knows the type of firm we are thinking of — ^living on the name, connec-
tions, quasi-rent, and reserves acquired in their youth, decorously drop-
ping into the background, lingering in the fatally deepening dusk of
respectable decay. ^ Analytically, our assumption is a device to bring
within the reach of theory an important feature of capitalist reality in
general and a material element in the causation of economic fluctuations.
We visualize new production functions as intruding into the system
through the action of new firms founded for the purpose, while the existing
or “old” firms for a time work on as before, and then react — with various
characteristic lags and in various characteristic ways — adaptively to
the new state of things under the pressure of competitiPn from downward

^ Quantitative information about tbe life span of individual firms and analysis explana-
tory of their careers and their age distribution are among our most urgent desiderata. They
would be important for many other purposes besides the study of business fluctuations, and
throw a flood of light on the structure and working of capitalism, now obscured by so much
empty phraseology and preconceptions of a pseudotheoretical nature. In particular, it
would do away, the writer believes, with the prejudice deeply ingrained in traditional
theory that an assemblage of durable producers’ goods is in itself a source of — on principle
— ^permanent surpluses. Some information exists, but it is too fragmentary to be conclu-
sive. Difficult questions arise in connection with those companies which, though they
reach legal existence, never get so far as to begin operations, and again with those which are
but shells of changing purposes. An investigation on these lines has been carried out by
J. Alfter, Das Lebensschicksal der Aktiengesellschaft, Bonner Staatswissenschaftliche
Untersuchungen, 1932, who had however, to deal with a very* small sample.' .The writer
gleaned a similar impression from the story of 50 American corporations which were listed
for him by Mr. G. B. Roberts of the National City Bank of New York as having at one
time been leading in their branches. The list, however, only included concerns of 10 million
capital or more which actually failed or were liquidated or reconstructed. It should be
mentioned that throughout his Principles, Marshall shows himself to have been keenly
alive to the point we are trying to make, although he did not make it central to his analysis.

2 There is also an obvious connection between innovation and the rise of new industries,
although, of course, innovation may also rejuvenate old ones. That is why, as Adam Smith
observed, new industries are as a rule more profitable than old ones. They will, of course,
give us the most telling illustrations of oxir theory of innovation. But we do not insist
on this here.

Business Cycles

shifting cost curves. This arrangement accurately describes, so it seems
to the writer, the situations and struggles that we actually observe in
surveying capitalist evolution, and in particular the nature of its dis-
equilibria and fluctuations. It also describes that process of incessant
rise and decay of firms and industries which is the central — ^though much
neglected — ^fact about the capitalist machine.

Third, we will assume that innovations are always associated with
the rise to leadership of New Men. Again, there is no lack of realism
about this assumption, which but formulates a fundamental truth of the
sociology of industrial society.^ Verifications abound and may be gleaned
from any textbook on, say, the industrial revolution, although the full
extent and importance of the fact will not be realized until we know more
than we do at present about what may be termed the personal history of
industry. The main reason for introducing this assumption into a purely
economic argument not primarily concerned with the structure of society,
is that it provides the rationale for the preceding assumption. In fact, it
explains why new production functions do not typically grow out of old
businesses — if a new man takes hold of an old firm, they may — ^and hence,
why their insertion proceeds by competing the old ones out of existence
or by enforcing the transformation of them. Since this is part of our
model and wiU be used to explain features characteristic of the process
which is the subject of this book, we must notice the case of big, particu-
larly of ‘"giant,” concerns which often are but shells within which an ever-
changing personnel may go from innovation to innovation. They are,
thus, no exceptions to our third assumption, but they may be exceptions
to the second, because with such concerns innovation may and, in fact
frequently does, come about within one and the same firm which coordi-
nates it with its existing apparatus, and therefore need not assert itself
in the industry by way of a distinct process of competition.

In order to take care of this case, which in future may steadily gain in
importance, we introduce the concept Trustified Capitalism, in distinction
from Competitive Capitalism. Economic evolution or “progress” would
differ substantially from the picture we are about to draw, if that form of
organization prevailed throughout the economic organism. Giant con-
cerns still have to react to each other’s innovations, of course, but they
do so in other and less predictable ways than firms which are drops in a
competitive sea, and many details — ^in some points, more than details —
would then have to be altered in our model. We have to recognize, in
this as in other respects, that we are dealing with a process subject to
institutional change and therefore must, for every historical period, see

^ A very inadequate remark only will, in passing, be offered in explanation of this in the
next section. For a more elaborate statement, the writer refers to his Theory of Economic
Pevdopment.

How THE Economic System Geneeates Evolution 97

whether or not our model, however faithfully copied from the history of
other periods, still fits facts. However, the sector of concerns which are
‘"big,"’ not only in the usual sense of the writers who figure out what per-
centage of the total national capital of the United States is controlled by
the £00 biggest concerns, but in the sense required by the present argu-
ment, is as yet not great enough to dominate the picture in any country.
Even in the world of giant firms, new ones rise and others fall into the
background. Innovations still emerge primarily with the “young"''
ones, and the “old"" ones display as a rule symptoms of what is euphemis-
tically called conservatism. On the whole, the exception seems, there-
fore, to reduce to modifications to be dealt with on the merits of each
practical case.

Our third assumption, then, inserts into our model of economic life a
class of facts of the behavioristic type. It helps to localize, as well as to
interpret, the sources and eflfects of those downward shifts of cost curves
which we saw were inadequately described by the device of monotonically
descending curves, and to describe the way in which the system reacts to
them. In particular, it explains why innovations are not carried into
effect simultaneously and as a matter of course, either by all firms or, if
they involve the use of lumpy factors, by all firms beyond a certain size,^
in the same manner as all firms will, other things being equal, try to
employ more labor if it becomes cheaper. If this were so, all major
innovations would still create disequilibria. But if action in order to
carry them out were equally open to all as soon as they became technically
and commercially possible, those disequilibria would not be different from,
and not more serious than, those which arise currently from changes in
data and are currently absorbed without very great diflSculties and with-
out “revolutions’^ or upheavals — ^which, in the political sphere also,
would not occur in the way in which they actually do occur, if all people
accepted new political facts with equal promptitude.^ Innovations which
may be thought of as becoming “objectively” possible in a continuous
stream, would then induce a current and continuous process of absorp-
tion, save in exceptional cases which should not display any regularity.
However, the disequilibria which we observe are of a different nature.

^ This is, in fact, often implied in traditional analysis. There would then be some
justification for treating innovations — excepting, perhaps, ‘‘revolutionary” ones — as a
function of the size of firms (possibly, as measured by output) and for arriving at a descend-
ing cost curve after all which would include such changes of the production function as
presuppose a certain size and are easier to carry into effect for big firms. But we see now
that this means stressing a secondary element and obscuring the essential one.

2 That is more than an illustrative analogy. The writer believes, although he cannot
stay to show, that the theory here expounded is but a special case, adapted to the economic
sphere, of a much larger theory which applies to change in all spheres of social life, science
and art included.

Business Cycles

Their characteristic feature is precisely that they recur with some regu-
larity and that they can be absorbed, not currently and smoothly, but
only by means of a distinct and painful process. This is because only
some firms carry out innovations and then act along new cost curves,
while the others cannot and have merely to adapt themselves, in many
cases by dying. This fact, in turn, forces upon us recognition of the
element formulated by our third assumption.

What we are doing amounts to this: we do not attack traditional
theory, Walrasian or Marshallian, on its own ground. In particular, we
do not take offense at its fundamental assumptions about business behav-
ior — at the picture of prompt recognition of the data of a situation and
of rational action in response to them. We know, of course, that these
assumptions are very far from reality; but we hold that the logical schema
of that theory is yet right “in principle’’ and that deviations from it can
be adequately taken care of by introducing friction, lags, and so on, and
that they are, in fact, being taken care of, with increasing success, by
recent work developing from the traditional bases. We also hold, how-
ever, that this model covers less ground than is commonly supposed and
that the whole economic process cannot be adequately described by it
or in terms of (secondary) deviations from it. This is satisfactory only
if the process to be analyzed is either stationary or “steadily growing”
in the sense of our definition of the term Growth: any external disturb-
ances may enter, of course, provided adaptation to them is passive.
And this is equivalent to saying that the assumption that business
behavior is ideally rational and prompt, and also that in principle it is the
same with all firms, works tolerably well only within the precincts of tried
experience and familiar motive. It breaks down as soon as we leave those
precincts and allow the business community under study to be faced by —
not simply new situations, which also occur as soon as external factors
unexpectedly intrude but by — ^new possibilities of business action which
are as yet untried and about which the most complete command of routine
teaches nothing. Those differences^ in the behavior of different people
which within those precincts account for secondary phenomena only,
become essential in the sense that they now account for the outstanding
features of reality and that a picture drawn on the Walras-Marshallian
lines ceases to be true — even in the qualified sense in which it is true of
stationary and growing processes : it misses those features, and becomes
wrong in the endeavor to account by means of its own analysis for phe-

^ Those differences belong, as a special case, to tbe class of facts usually dealt with
under the heading of Leadership. Sir Francis Galton’s South African oxen that differed so
characteristically in behavior are a good illustration of this point. Some of them went
on as serenely when at the head of a team as they did when at the tail of other oxen.
The majority simply would not move at aU when at the head.

How THE Economic System Geneeates Evolution 99

nomena which the assumptions of that analysis exclude. The reasonable
thing for us to do, therefore, seems to be to confine the traditional analysis
to the ground on which we find it useful, and to adopt other assumptions
— ^the above three — ^for the purpose of describing a class of facts which
lies beyond that ground. In the analysis of the process dominated by
these facts traditional theory, of course, still retains its place: it will
describe the responses to innovation by those firms which are not innovat-
ing themselves.

We may formulate the same point by means of the concept of Horizon.
This we define as that range of choice within which a businessman moves
freely and within which his decision for a course of action can be described
exclusively in terms of profitability and foresight.^ It differs widely
with different types and individuals. But within a stationary or a grow-
ing process, we may assume that the management of each firm commands
that horizon which enables it to transact its current business and to
handle ordinary emergencies. Outside of such processes however, hori-
zons of different people differ according to the criterion that the horizons
of some are and the horizons of others are not confined to the range of
possibilities tried out in business practice. This ability to decide in
favor of untried possibilities or to choose not only between tried but
also between tried and untried ones, may, however, be distributed in the
population according to the Gaussian — ^though more plausibly a skew —
law, and should not be thought of as confined to a few exceptional
cases.

We neither can nor, for our purpose, need go fully into this matter,
but will be content to point to the common-sense justification of our
emphasis on this difference in behavior that we hold is productive of
phenomena which without it would not be understandable. Everyone
knows, of course, that to do something new is very much more diflScult
than to do something that belongs to the realm of routine, and that the
two tasks differ qualitatively and not only in degree. This is due to

^It will be seen that foresight, or anticipation, and horizon are not made synonymous.
A trivial example may serve to elucidate one of the differences. Tire trouble is nowadays
so rare an event that any given case cannot be said to be foreseen. But, provided a motor-
ist knows perfectly well how to manage the situation if the case arises, it is still within his
horizon. Foresight is, of course, more difficult in an environment disturbed by innovation
and, as soon as we have independently explained the situations, in which it becomes more
difficult from this cause, we are within our rights if we in turn explain secondary features
by lack of foresight, without laying ourselves open to the charge of thoughtlessly appealing
to a dem ex machina. But such lack is not primarily linked to innovation and emphasizing
it with respect to innovation would be emphasizing the wrong spot. Also, differences in
foresight are undoubtedly the source of many phenomena relevant to the study of business
cycles. But differences in foresight are not coterminous with differences in the ability to
“walk alone” and to act on ground untried by experience.

100

Business Cycles

many reasons, wMch we may group in three classes. First, in the case
of something new being attempted, the environment resists while it looks
on with — at least — ^benevolent neutrality at repetition of familiar acts.
Resistance may consist in simple disapproval — of machine-made products,
for instance — ^in prevention — ^prohibition of the use of new machinery — or
aggression — smashing new machinery. Second, for the repetition of
acts of routine the environment offers the prerequisites, in the case of
new things it sometimes lacks, sometimes refuses, them: lenders readily
lend for routine purposes; labor of the right type is available for them in
the right place; customers buy freely what they understand. Third (this
must be kept distinct from points one and two), most people feel an inhibi-
tion when the possibility of treading a new path offers itself. This may,
in part, have rational foundation: it makes, in fact, a great difference
whether the items entering our calculations derive from facts of daily
experience or entirely from estimation. Even familiar data vary, of
course, and their behavior may often be difficult to foresee, but within a
familiar frame the average businessman knows how to manage them. If
a new frame is to be constructed, the task changes its character. In order
to see this, we need only visualize the situation of a man who would, at
the present time, consider the possibility of setting up a new plant for the
production of cheap aeroplanes which would pay only if all people who
now drive motorcars could be induced to fly. The major elements in
such an undertaking simply cannot be known. The situation is, propor-
tions guarded, not different in the case of a new perfume. But also,
irrational inhibitions enter. Neither error nor risk expresses adequately
what we mean.

Considerations of this type entail the consequence that whenever a
new production function has been set up successfully and the trade
beholds the new thing done and its major problems solved, it becomes
much easier for other people to do the same thing and even to improve
upon it. In fact, they are driven to copying it if they can, and some
people will do so forthwith. It should be observed that it becomes easier
not only to do the same thing, but also to do similar things in similar
lines — either subsidiary or competitive ones — ^while certain innovations,
such as the steam engine, directly affect a wide variety of industries.
This seems to offer perfectly simple and realistic interpretations of two
outstanding facts of observation: First, that innovations do not remain
isolated events, and are not evenly distributed in time, but that on the
contrary they tend to cluster, to come about in bunches, simply because
first some, and then most, firms follow in the wake of successful innova-
tion; second, that innovations are not at any time distributed over the
whole economic system at random, but tend to concentrate in certain

How THE Economic System Generates Evolution 101

sectors and their surroundings.^ Neither observation can be new to
anyone. The point we wish to make is that both follow from our premises
and find their place within our analytic schema, instead of remaining
outside of it in the class of deviations or modifying circumstances. The
first puts into its proper light our former statement, that disturbances of
equilibrium arising from innovation cannot be currently and smoothly
absorbed. In fact, it is now easy to realize that those disturbances must
necessarily be ‘^big,” in the sense that they will disrupt the existing system
and enforce a distinct 'process of adaptation which should show up as such
in any time series material. This is independent either of the size of the
innovating firm or firms or of the importance of the immediate effects
their action would in itself entail. What we see at first glance may well
be a multitude of reactions not easily traceable to any definite innovation
behind them. But in many cases comprising historically important
types, individual innovations imply, by virtue of their nature, a ^"big’^
step and a "‘big’’ change. A railroad through new country, i.e,y country
not yet served by railroads, as soon as it gets into working order upsets all
conditions of location, all cost calculations, all production functions within
its radius of influence; and hardly any “ways of doing things” which
have been optimal before remain so afterward. The case may be put
still more forcibly if we consider the railroadization and the electrification
of the whole world as single processes. There is, however, some danger
in overstressing such obvious instances, because this may easily lead to
the familiar attitude of confining the phenomenon to this class and over-
looking it in all the others — Whence, to missing its true dimensions.^

The second observation, the explanation of which follows naturally
from our general schema, is no less obvious. Industrial change is never
harmonious advance with all elements of the system actually moving, or
tending to move, in step. At any given time, some industries move on,
others stay behind; and the discrepancies arising from this are an essential

^ Both observations primarily rest on the objective situations incident to the process of
innovation. It is neither necessary nor desirable to stress the psychological aspect beyond
a few common-sense comments. We do not appeal either to the psychology of imitation
or to any other psychology. To this point, which might give rise to misunderstandings of
the drift of our argument, we shall later return.

2 As stated before, this is our fundamental reason (apart from our objections to the term
Invention) for doubting the value of the concept of Revolutionary Inventions (opposite:
Minor Inventions) if it is to suggest that they or their effects differ qualitatively, or in a way
relevant to the theory of the subject, from others. We shall not use the concept of Auto-
nomous Inventions either, although this seems to carry a connotation more relevant to our
argument. But the concept Induced Innovations we shall occasionally use in order to
denote those additional improvements which present themselves in the process of copying
the first innovators in a field and of adaptation by existing firms to their doings.

102

Business Cycles

element in the situations that develop. Progress — ^in the industrial as
well as in any other sector of social or cultural life — not only proceeds by
jerks and rushes but also by one-sided rushes productive of consequences
other than those which would ensue in the case of coordinated rushes. In
every span of historic time it is easy to locate the ignition of the process
and to associate it with certain industries and, within these industries, with
certain firms, from which the disturbances then spread over the system.

It has been stated above that the facts which our three assumptions
are the means of introducing into our analytic model explain not second-
ary phenomena only but the essential features of the process of economic
— or, as the writer believes, any other — evolution in our sense of the
term. We shall meet with many examples of this, as in the theory of
profit to be outlined in the next section. Here we will notice one only,
namely, their bearing upon our general conception of progress. Evi-
dently, we must cease to think of it as by nature smooth and harmonious
in the sense that rough passages and disharmonies present phenomena
foreign to its mechanism and require special explanations by facts not
embodied in its pure model. On the contrary, we must recognize that
evolution is lopsided, discontinuous, disharmonious by nature — ^that the
disharmony is inherent in the very modus operandi of the factors of prog-
ress. Surely, this is not out of keeping with observation: the history of
capitalism is studded with violent bursts and catastrophes which do not
accord well with the alternative hypothesis we herewith discard, and the
reader may well find that we have taken unnecessary trouble to come to
the conclusion that evolution is a disturbance of existing structures and
more like a series of explosions than a gentle, though incessant, trans-
formation.

C. The Entrepreneur and His Profit. — ^For actions which consist in
carrying out innovations we reserve the term Enterprise; the individuals
who carry them out we call Entrepreneurs. This terminological decision
is based on a historical fact and a theoretical proposition, namely, that
carrying out innovations is the only function which is fundamental in
history and essential in theory to the type usually designated by that
term. The distinction between the entrepreneur and the mere head or
manager of a firm who runs it on established lines or, as both functions
will understandably often coincide in one and the same person, between
the entrepreneurial and the managerial function, is no more difficult than
the distinction between a workman and a landowner, who may also hap-
pen to form a composite economic personality called (in America) a
farmer. And surely it is but common sense to recognize that the eco-
nomic function of deciding how much wool to buy for one’s process of
production and the function of introducing a new process of production
do not stand on the same footing, either in practice or in logic.

How THE Economic System Generates Evolution 103

Tte outlines of an economic and sociological analysis of both types and
both functions have been given elsewhere.^ We will briefly note the
points that are most important for our purpose.

1. It is not always easy to tell who the entrepreneur is in a given
case. This is not, however, due to any lack of precision in our definition
of the entrepreneurial function, but simply to the difficulty of finding
out what person actually fills it. Nobody ever is an entrepreneur all the
time, and nobody can ever be only an entrepreneur. This follows from
the nature of the function, which must always be combined with, and
lead to, others. A man who carries out a ‘^new combination” will
unavoidably have to perform current nonentrepreneurial work in the
course of doing so, and successful enterprise in our sense will normally
lead to an industrial position which thenceforth involves no other func-
tions than those of managing an old firm. Nevertheless, we have little
difficulty in identifying entrepreneurship in the times of competitive
capitalism. The entrepreneur will there be found among the heads of
firms, mostly among the owners. Generally, he will be the founder of
a firm and of an industrial family as well. In the times of giant concerns
the question is often as difficult to answer as, in the case of a modern
army, the question who is the leading man or who really won a given
battle. The leading man may, but need not, hold or acquire the posi-
tion that is officially the leading one. He may be the manager or some
other salaried employee. Sometimes, he is the owner of a controlling
parcel of shares without appearing on the list of responsible executives
at all. Although company promoters are not as a rule entrepreneurs, a
promoter may fill that function occasionally and then come near to
presenting the only instance there is of a type which is entrepreneur by
profession and nothing else.

2. But it should be easy to distinguish our function from those others
which, though often found in combination with it, are yet not essential
to it. We have already seen that the entrepreneur may, but need not, be
the ‘‘inventor” of the good or process he introduces. Also, the entre-
preneur may, but need not, be the person who furnishes the capital. This
is a very important point. In the institutional pattern of capitalism there
is machinery, the presence of which forms an essential characteristic of
it, which makes it possible for people to function as entrepreneurs without,
having previously acquired the necessary means. It is leadership rather!
than ownership that matters. The failure to see this and, as a conse-
quence, to visualize clearly entrepreneurial activity as a distinct function
sui generis, is the common fault of both the economic and the sociological

^ See the writer’s Theory of Economic Development, notably Chaps. II and IV. Com-
pare, also, the historical sketch in the writer’s article TJnternehmer in the Handworter-
buch der Staatswissenschaften.

104

Business Cycles

analysis of the classics and of Karl Marx. It is partly explained by the
fact that previous ownership of the requisite producers’ goods or of assets
that may serve as collateral, or of money, makes it easier to become an
entrepreneur, and the additional fact, alluded to above, that successful
entrepreneurship leads to a capitalist position for the entrepreneur and,
normally, his descendants, so that we do, as a matter of fact, find
successful entrepreneurs very soon in possession of a plant and the other
paraphernalia of a going concern. Two consequences follow, one of which
is of an economic, the other of a sociological, nature.

First, risk bearing is no part of the entrepreneurial function.^ It is
the capitalist who bears the risk. The entrepreneur does so only to the
extent to which, besides being an entrepreneur, he is also a capitalist, but
qua entrepreneur he loses other people’s money. Second, entrepreneurs
as such do not form a social class. Although, in case of success, they or
their descendants rise into the capitalist class, they do not from the
outset belong to it or to any other definite class. As a matter of historical
fact, entrepreneurs come from all classes which at the time of their emer-
gence happen to exist. Their genealogies display most varied origins —
the working class, the aristocracy, the professional groups, peasants and
farmers, and the artisan class, all have contributed to what is sociologi-
cally not a uniform type. We cannot stay to show that a fundamental
piece of the sociology of capitalism and of bourgeois society is contained
in those statements, nor how economic theory and sociology should
combine to account for their institutional patterns.^

The above implies what it may nevertheless not be superfluous to
state explicitly, that although entrepreneurs may be or become stock-
holders in their firms, mere holding of stock does not, any more than
would mere ownership, make an entrepreneur. The only realistic defini-
tion of stockholders is that they are creditors (capitalists) who forego part
of the legal protection usually extended to creditors, in exchange for the
right to participate in profits. To the economist, the legal construction
of an equity in this case is but a lawyer’s fiction that almost caricatures
the real situation.

S. Let us visualize an entrepreneur who, in a perfectly competitive
society, carries out an innovation which consists in producing a com-

^ Risk, nevertkeless, enters into tke pattern in whick enterpreneurs work. But it does
so indirectly and at one remove: riskiness — and every new thing is risky in a sense in which
no routine action is — ^makes it more difficult to obtain the necessary capital and thus forms
one of the obstacles entrepreneurs have to overcome and one of the instances of resistance
of the environment which explain why innovations are not carried out smoothly and as a
matter of course.

2 The principles imderlying the above are, of course, applicable to all types of society.
Compare the writer’s Die sozialen Elassen im ethnisch homogenen Milieu, Archiv fur
Sozialwissenschaft, 1927.

How THE Economic System Generates Evolution 105

modity already in common use at a total cost per unit lower than that
of any existing firm because his new method uses a smaller amount of
some or all factors per unit of product. In this case, he will buy the
producers’ goods he needs at the prevailing prices which are adjusted
to the conditions under which ‘‘old” firms work, and he will sell his
product at the prevailing price adjusted to the costs of those “old” firms.
It follows that his receipts will exceed his costs. The difference we shall
call Entrepreneurs’ Profit, or simply Profit. It is the premium put upon
successful innovation in capitalist society^ and is temporary by nature : it
will vanish in the subsequent process of competition and adaptation.
There is no tendency toward equalization of these temporary premia.
Although we have thus deduced profit only for one particular case of
innovation and only for conditions of perfect competition, the argument
can readily be extended to cover all other cases and conditions. In any
case, it is evident that, though temporary, profit is a net gain, i.e.^ that it is
not absorbed by the value of any cost factor through a process of Imputa-
tion.2 It should be observed, however, that for profits to emerge it is
essential that the “suicidal stimulus of profits” should not act instantane-
ously. In the preceding section we have seen the reasons why, as a rule, it
does not. But cases are thinkable, occasionally occur, and may in the
future be expected to occur more frequently (compare in/ra, sub 5), in
which it does. We then get innovation without profit, or almost without
it, and thus realize the possibility of what, anticipating later argument, we
may term Profitless Prosperities.^

Of course, in a stationary economy, even if disturbed by action of
external factors, both the entrepreneurial function and the entrepreneurial
profit would be absent, and so would the bulk of what is in common par-
lance described as profits. For, although there would be rents and
quasi-rents of factors owned by firms, also, in the case of a manager-
proprietor, his “earnings of management” or wages, to which we may for
the sake of argument add various interest items, and although there may
be monopoly gains and (if we admit external disturbances) also windfalls
and possibly speculative gains, it will be readily seen that all these items
would, in the conditions of a stationary or even of a growing economy,
sum up to much smaller totals than they do in reality. Innovation
is not only the most important immediate source of gains, but also indi-
rectly produces, through the process it sets going, most of those situations

^ The increment of value which in that form of society becomes profit would, of course,
also emerge in a socialist society in the moment of transition to a new process of production.

2 That problem and other theoretical matters relating to it have been fully dealt with
in the writer's book to which reference has been made.

® This possible case should not be confused with another possible case previously noticed
displaying no period of expenditure on plant or period of gestation.

106

Business Cycles

from whicli windfall gains and losses arise and in wMcii speculative opera-
tions acquire significant scope.

It follows that the bulk of private fortunes is, in capitalist society,
directly or indirectly the result of the process of which innovation is the
“prime mover.” Speculative maneuvers which are responsible for some,
are evidently incidents to the process of economic evolution in our sense,
and so are largely the unearned increments reaped by owners of natural
resources — ^urban land, for instance — which account for others. Saving,
consistently carried on through generations,^ could not have been nearly
so successful as it was if there had not been surpluses, due to innovation,
from which to save. But the position of the typical industrial or com-
mercial or financial family directly originates in some act, or some series
of acts, of innovation. When their ppriod of entrepreneurship is past,
those families live, it is true, on quasi-rents, often supported by mono-
poloid situations, or, it they entirely sever their connection with business,
on interest. But a new production function practically always emerges if
we follow up those quasi-rents or monopoloid gains or monetary capitals to
their sources. Of this we shall see many examples in our historical
survey, which the writer believes to be sufficient, in spite of its fragmen-
tary character, to establish the main points of this analysis beyond
reasonable doubt.

4. Profit, in our sense, is a functional return — ^its peculiarities and
especially its temporary character constitute a justifiable reason for
hesitating to call it an income — ^but it would not always be safe to locate
the entrepreneurial function according to the criterion of accrual.
Whether it accrues to entrepreneurs or not is a matter of institutional
pattern. It does so most completely in that form of organization which
is characterized by the prevalence of the family firm. It is there that
it has most regularly served (together with gains from speculation and
from monopoloid positions) as the economic basis of industrial dynasties,
by being reinvested or simply embodied in the ownership of a plant. In
corporate industry profits accrue to the firm as such, and their distribu-
tion ceases to be automatic and becomes a matter of policy — shareholders,
executives (whether entrepreneurs or not), and employees receiving, in
the most varied forms (bonuses, tantiemes, and so on) indeterminate
shares in it or contractual equivalents for shares in it. Attempts by
entrepreneurs to recover elements of profits to which there is no legal
claim, account in part for a number of familiar practices praeter legem or
contra legem.

Such struggles for a share in profits that have been made are, however,
less important for our subject than the struggles to conserve the stream of

^ Marx called that a tale for children {Kinderjihel ) . So it is if used as a general theory
private wealth. But we should not, on that account, overlook the very real instances of
it and the very real “abstinence” associated with them.

How THE Economic System Generates Evolution 107

profit itseK. Secrecy regarding processes, patents,^ judicious differentia-
tion of products, advertising, and the like, occasionally also aggression
directed against actual and would-be competitors, are instances of a
familiar strategy, which in the public, as well as in the professional, mind
have done much to veil the source and nature of profits in our sense,
especially because that strategy may be resorted to in other cases as well.
We realize at once that these devices are the same as those which play a
role in cases of monopolistic competition and that the fact that they
are met with in our case is precisely due to the other fact that an enterprise
in our sense almost necessarily finds itself in an ‘"imperfect” situation,
even if the system be otherwise a perfectly competitive one. This is one
of the reasons why we so persistently stress the relation between evolution
and imperfection of competition. It follows that profits might, as far as
this goes, be also included in the category of monopoloid gains. This,
however, would blur the specific character of our case: not every generali-
zation is profitable to the analyst ^ — any more than every innovation is to
the innovator. Moreover, profits change their character in the course of
such struggles.

Not only is practically every enterprise threatened and put on the
defensive as soon as it comes into existence, but it also threatens the
existing structure of its industry or sector almost as unavoidably as it

^ Patent legislation is one of the few instances of legal recognition of the social functions
of profit in capitalist society. Patents may, of course, keep profits alive longer than would
be required for those functions to be fulfilled and then become similar in nature to less
approved practices. We intend neither social criticism nor social apologetics but it may be
useful to state that these practices are responsible for a view frequently met in popular
arguments for social reform, according to which profit is necessarily the outcome of anti-
social activities and there is necessarily antagonism between receivers of profits and, say,
consumers’ or workmen’s interests. In such propositions, the meaning of which greatly
varies, profits is in general used in a sense different from ours. But the above shows that
there is a range of phenomena, within which profits in our sense are all but indistinguishable
from surpluses, to which such indictments do apply.

2 For an analogous reason we do not include profits among wages, although the former
are returns to personal exertions and although we do define the latter as returns to personal
services. In an as yet unpublished Note on Profits, Mr. P. M. Sweezy argues that, profits
being for these reasons undistinguishable from monopoloid gains, there is no point in speak-
ing of pure profits in our sense at all. It is readily admitted that amount of profit is no
measure of social service which, whatever its definition, is often much greater or much
smaller than profits would indicate. But it is nonetheless important to point out this
source, as distinguished from others, of monopoloid surpluses. Moreover, the fact that a
return has something to do with monopoly does not affect its economic nature. There is
probably a large monopoloid element in the income of a leading tenor, yet this income is
nevertheless a wage. Any strong labor union secures monopoly gains. Its members earn
eflSciency wages all the same. The Jiature of a ‘‘service” is one thing. The method of
pricing which is being applied to that service is another thing. For simOar reasons, we do
not include profit among frictional gains, although frictional resistance to instantaneous
adaptation is essential for the emergence of profit; if we did, we would still have to empha-
size the peculiarity and the peculiar role of this particular kind of friction.

108

Business Cycles

creates unemployment somewhere or other. An innovation sometimes
may do so by its mere possibility and even before it is embodied in an
enterprise. That structure, being a living organism and not merely the
congeries of rational billiard balls that theory represents it to be, resents
the threat and perceives possibilities of defense other than adaptation by
a competitive struggle which generally means death for many of its units.
Situations ensue which produce the paradox that industry sometimes tries
to sabotage that ^‘progress,’’ which it inexorably evolves by virtue of the
very law of its own life. There is no contradiction in this. It is sub-
mitted, however, that our general schema derives some support from the
fact that it resolves that paradox so easily and shows us how and why
industrial ‘‘progress’^ comes to the majority of firms existing at a given
time as an attack from outside.^ Taking industry as a whole, there is
always an innovating sphere warring with an old sphere, which some-
times tries to secure prohibition of the new ways of doing things — ^as the
artisans* congresses did in Europe as late as the eighties of the nineteenth
century — or to discredit them — ^the ‘‘machine-made product,** for
instance — or to buy them off — ^which is sometimes the real rationale of
cartelization — or to penalize them, by fiscal legislation or in other ways,
including public “planning** of the type sometimes resorted to in
depressions.

5. It has been stated above that our assumption about New Firms
carrying the new things into effect against resisting strata of old firms,
which was to embody the characteristically different behavior in the face
of new possibilities, may occasionally fail us. For the past it is obviously
very realistic. Even in the present the writer is not aware of important
instances which would prove it to be contrary to fact. But several minor
ones he has observed. It is interesting to note that such absence of fric-
tion does not always make the path of progress smoother. In the country
X, for example, all firms existing in the industry F took at exactly the
same time, about 15 years ago, to producing the article Z according to a
new and much cheaper method. A deadlock ensued, very quickly reme-
died by an agreement which deprived that innovation of any effect beyond
a surplus, unemployment, and some excess capacity There is some
reason to expect that such cases will increase in importance: on the one
hand, technological research becomes increasingly mechanized and
organized; on the other hand, resistance to new ways weakens. Any

^ Sociologically, the case is, of cotirse, not different from the case of a new scientific
principle — or, for that matter, of a new way of seeing nature in the case of painting —
which also comes as a hostile shock both to existing habits of scientific thinking — or of
painting — ^and to those who expound or practice them.

* The ‘‘statesman’' who successfully exerted himself to bring that agreement about took
great pride in this piece of planning.

How THE Economic System Generates Evolution 109

technological improvement which is becoming ‘‘objectively possible/’
tends to be carried into effect as a matter of course. This must affect
the phenomenon which is the subject of this book. It must also affect
the importance of the social function, and in consequence the economic
and social position, of that stratum of capitalist society which exists by
entrepreneurial achievement as the knights of the Middle Ages existed by
virtue of a certain technique of warfare.

Already, the volitional aptitudes that made the successful entre-
preneur of old are much less necessary and have much less scope than
they used to have. It is no chance coincidence that the epoch in which
this decrease in importance of the entrepreneurial function first asserted
itself is also the epoch in which the social and political position of the
bourgeoisie jBrst began to display obvious symptoms of weakness and to be
attacked with success. However, it would be as great a mistake to over-
rate the length to which the process has as yet gone as it would be to
ignore it. For our theme, it will be seen not to have proceeded far enough
to matter for general contours, even in the postwar period.

D. The Role of Money and Banking in the Process of Evolu-
tion. — This subject will be more fully discussed, on the one hand, in the
historical survey (Chaps. VI and VII) and, on the other hand, in the
discussion of relevant time series (Chaps. XI-XIV), where the complex
structure of credit will come into its own as far as that is possible within
the limits of this work. In this section we will merely try to unravel its
logical, as distinguished from its historical, roots and in so doing move on
the same level of abstraction as we do throughout this chapter. Results
cannot fail to look extremely unrealistic and, in this case more than in
others, utterly contrary to facts. It is in no case easy to discern the
element of innovation under the mass of induced, derivative, and adventi-
tious phenomena that overlies it. But in the sphere of money and credit
the layer is so thick and the surface so entirely at variance with the
processes below, that the first impression of the reader may well be fatal.
It is submitted, however, that the proof of the analytic pudding is in the
eating, and that the monetary part of our model is nothing but a device
to get hold of those very facts to which the reader may feel inclined to
point in refutation.^

^ The theoretical background of the analysis of credit to be presented in this section
will be developed in the writer’s treatise on money. That analysis was first published
in his Theory of Economic Development (first German ed., 1911). At that time, criticism
was mainly directed against certain points about credit creation which have become com-
monplace by now. The really controversial proposition which turns on the relation of
credit creation to innovation was then not discussed at all. Nor has it really been dis-
cussed since, for the arguments from the classical theory of banking to the effect that what
banks finance is precisely not innovation but current commodity transactions, miss the
salient point entirely.

110

Business Cycles

1, We will discard, on the understanding that they will be introduced
later, consumers’ borrowing, both public and private, on the one hand, and
saving and accumulation, on the other. Discarding the first, in a discus-
sion of fundamental principle, will presumably not meet with insuperable
objection. It is merely a measure of simplification and does not mean
that consumers’ borrowing is held to be of no importance in the cyclical
process. The contrary is obvious: consumers’ borrowing is one of the
most conspicuous danger points in the secondary phenomena of pros-
perity, and consumers’ debts are among the most conspicuous weak spots
in recession and depression. Discarding the second is more than a meas-
ure of simplification. It implies the view that financing innovation from
funds that have been saved or accumulated, presupposes previous profits,
hence previous waves of evolution, and therefore has no claim to a place
on the ground floor, as it were, of a model that is to display logical
essentials. This follows from the argument in sec. A of this chapter, and
does not imply anything about the role which financing of innovation
by (the entrepreneur’s own or other people’s) savings plays in any actual
historical situation. In later discussions we shall assign to it all the
importance we conceive it to have, and also develop its modus operandiy
although the writer thinks the importance to be smaller than, and the
modus o'perandi different from, what it is commonly believed to be.

In accordance with our conception of New Men setting up New Firms,
we also assume that would-be entrepreneurs do not already happen to
own part or the whole of the assemblage of producers’ goods which they
need in order to carry out their plans, or any assets which they could
exchange for what they need. There will always be such cases, although
they can become as frequent as we know them to be only when the
evolutionary process is in full swing and when it has brought into existence
a machinery for selling assets which we cannot assume now.^ But they
present no problem beyond those which we have dealt with in the pre-
ceding sections. Nor does a distinct problem of financing arise with the
“old” firms in the stationary process from which we start. They have
their plant and equipment, and their current expenditure — ^including
repairs and replacement — can be financed from current receipts. Assum-
ing, finally, that they are so financed, we arrive at the following three
propositions, which sound strange but are tautologically true for an
economic world embodying our assumptions : Entrepreneurs borrow all
the “funds” they need both for creating and for operating their plants —
Le,, for acquiring both their fixed and their working capital. Nobody
else borrows. Those “funds” consist in means of payment created ad

^ This instance illustrates well one of the source of objections to our model: we behold a
fully developed industrial and financial system, and are prone to introduce the features of
the building into a discussion of the scaffolding.

How THE Economic System Generates Evolution 111

]ioc. But although in themselves these propositions are nothing but
pieces of analytic scaffolding, to be removed when they have served their
purpose, the logical relation which they embody, between what is called
‘‘credit creation by banks’" and innovation, will not be lost again. This
relation, which is fundamental to the understanding of the capitalist
engine, is at the bottom of all the problems of money and credit, at least
as far as they are not simply problems of public finance.

Before going on, we will try to clarify the meaning of credit
creation” considered as the monetary complement of innovation, by a
comparison with what would correspond to it in a socialist society.
Since the central authority of the socialist state controls all existing
means of production, all it has to do in case it decides to set up new
production functions is simply to issue orders to those in charge of the
productive resources to withdraw part of them from the employments in
which they are engaged, and to apply the quantities so withdrawn to the
new purposes envisaged. We may think of a kind of Gosplan as an
illustration. In capitalist society the means of production required must
also be withdrawn from their employments — ^the case of unemployed
resources can easily be taken into account — and directed into the new
ones; but, being privately owned, they must be bought in their respective
markets. The issue to the entrepreneurs of new means of payments
created ad hoc is, since our entrepreneurs have no means of their own and
since there are — so far — ^no savings, what corresponds in capitalist society
to the order issued by the central bureau in the socialist state.

In both cases, the carrying into effect of an innovation involves, not
primarily an increase in existing factors of production, but the shifting of
existing factors from old to new uses.^ There is, however, this difference
between the two methods of shifting the factors : in the case of the socialist
community the new order to those in charge of the factors cancels the old
one. If innovation were — and as far as it is — ^financed by savings, the
capitalist method would be — or is — analogous, for the way in which
saving and lending to entrepreneurs effects a shifting of factors through
a shifting of means of payment may, indeed, be likened to the canceling of
an old and the issuing of a new ‘‘order” to the owners of factors. But if
innovation is financed by credit creation, the shifting of the factors is
effected not by the withdrawal of funds — “canceling the old order” —

^ Even with respect to those quantities of factors which currently accrue, say, in an
increasing population, and can be used for the new purposes without having previously
served any old ones, it is more correct to say that they are shifted from the uses they would
have served had the new pmposes not been decided on, than simply to say that they go to
the new uses directly. The point is of some importance, because in the traditional model it
was increase in factors, rather than the shifting of factors, that was made the chief vehicle
of economic progress. But essential phenomena of the cyclical process depend on that
shifting of factors.

Business Cycles

from tlie old firms, but by the reduction of the purchasing power of
existing funds which are left with the old firms while newly created funds
are put at the disposal of entrepreneurs:^ the new “order to the factors’’
comes, as it were, on top of the old one, which is not thereby canceled.
It will be shown later, but really is obvious, that and how this will affect
prices and values and produce a string of important consequences which
are responsible for many characteristic features of the capitalist process.
This side of credit creation may also be clarified by means of the analogy
with the issue of government fiat, although in all other respects the
differences are much more important than the similarities.

Now, suppose that our socialist community finds it convenient to rule
that the executive submit every innovation it wishes to carry out to
another body, which passes upon it and may grant or withhold assent.
In case it sanctions the plan, it countersigns and issues the orders to the
factors to form the new combination. This is the function which in
capitalist society is filled by banks which, in providing entrepreneurs
with means to buy factors of production or their services, do something
akin to issuing such orders. We now introduce this new kind of firms
into our model. They are nothing but establishments for the manu-
facture of means of payment. We distinguish member banksy which
keep the accounts of, and manufacture balances for, firms and households
(so far, for entrepreneurs only), and bankers^ banks — or, if there is but one
of them in each country, central banks — which keep the accounts of, and
manufacture balances for, member banks. For the sake of convenience
we will assume, in matters of general principle, that bankers’ banks have
no other customers but banks and that no member bank fills bankers’

^ Since the effect is still that entrepreneurs acquire command over producers" goods and
services as they would if some savers had lent them an equivalent (not equal) amount of
savings, many economists (the present writer included) have tried to elucidate the matter
by speaking of “forced savings” (Mr. Robertson used the expression “imposed lacking"").
But it is better to avoid a phrase which, while stressing one important similarity, may be
misleading in other respects. It not only tends to hide the important differences, in
mechanism and effects, of the two phenomena, but also suggests ideas that are definitely
wrong. It fails, moreover, to emphasize the important fact, that it is primarily the pur-
chasing power of other that is reduced in order to make room for the requirements of
entrepreneurs, and that the reduction of the “real"" purchasing power of some households is
a secondary phenomenon which, moreover, is compensated in part by the increase in the
real purchasing power of others.

It is not superfluous to note in passing that voluntary saving may so superimpose itself
on credit creation as to neutralize some of the effects of the latter: if, for example, a bank
creates balances for an entrepreneur which the latter spends, and if the recipients of this
increase in money income save it, and lend it to the entrepreneur who, in turn, repays his
loan, then there has been both “real investment"" (a machine, for example, having been
added to equipment) and voluntary saving, and the deposit figure is back to what it was.
This case is, of course, comprised in our propositions about the role of saving to be intro-
duced at a later stage of our argument.

How THE Economic System Generates Evolution 113

banks’ functions, although, in discussions of actual situations we must
take account of the facts that many bankers’ banks also bank for firms
and households and that many member banks also bank for other member
banks: there are cases, the outstanding one being that of the banking
system of the United States until 1914, in which central bank functions
are entirely discharged by some members of the system and, perhaps,
some government department, such as the United States Treasury. It
is important to bear in mind that what directly matters for business is the
amount of credit creation by member banks. Credit creation by
bankers’ banks stands at one remove from this and the two are not
additive. Interbank deposits, existence of which implies that member
banks are rendering central bank service to each other, should always be
dealt with separately and excluded from the sum total of effective deposits.

3. By confining the manufacture of credit to banks, we are roughly
conforming to fact. But this restriction is not necessary. In various
ways, firms may create means of payments themselves. A bill of
exchange or a note is not, in itself, such a means. On the contrary, it
generally requires financing and thus figures on the demand rather than
the supply side of the money market. If, however, it circulates in such
a way as to effect (economically, though not in the legal sense) payments,
it becomes an addition to the circulating medium. Historically, this
has occurred repeatedly. An example is afforded by the practice which
prevailed in the Lancashire cotton industry until at least the middle of
the nineteenth century. Manufacturers and traders drew bills on each
other which, after acceptance, were used for the settlement of debts due
to other manufacturers and traders, much as bank notes would be. This
should be taken into account in any estimate of the quantity of credit
creation but will here be neglected throughout, because the statistical
questions involved are entirely beyond us. The case is a special one and
must not be confused with others, such as the cases of finance bills or
notes that are offered for short-time investment and, although they may
also circulate, never directly pay for commodities.

Government fiat might also serve the purpose of financing enterprise.
There have been cases in which it did. The Brazilian government, for
instance, fin anced coffee plantations by this method in the seventies.
More frequently, however, this method was advocated without being
actually resorted to. Friedrich List for instance — ^proving thereby how
well he knew how to generalize from American experience — ^wished to see
railroad construction (sic!) financed in this way. We insisted above on
the differences between the issue of government fiat and credit creation
by banks, not because of the difference between the creating agencies
but because of the difference in the purposes usually associated with the
two, which is what accounts for the difference in effects. For it must

114

Business Ctcles

never be forgotten that the theory of credit creation as, for that matter,
the theory of saving, entirely turns on the purpose for which the created —
or saved — means of payment are used and on the success which attends
that purpose. The quantity-theory aspect or, as we might also say, the
aggregative aspect of the practice is entirely secondary. The trouble
with John Law was not that he created means of payment in vacuo, but
that he used them for purposes which failed to succeed. This will have
to be emphasized again and again. We now exclude government fiat
because of its historical association with consumptive expenditure, and
are thus left with ‘‘credit creation by banks.’’

Anticipating discussion in subsequent chapters, we may at once free
our theory of banking from part of its apparent unreality. Financing of
enterprise has been assigned logical priority in the sense that this is the
only case in which lending and the ad hoc creation of means of payment
are essential elements of an economic process the model of which would
be logically incomplete without them. But the familiar picture of bank-
ing business as it is can easily be developed from that element. The loans
to entrepreneurs need not — ^not entirely, at least — ^be repaid, but can be,
and often are, renewed in such a way as to make the corresponding
amount of means of payment permanently, or at all events indefinitely,
part of the circulating medium. In the disequilibria caused by innova-
tion other firms will have to undertake investments which cannot be
financed from current receipts, and hence become borrowers also. It is
easy to understand that, whenever the evolutionary process is in full
swing, ^ the bulk of bank credit outstanding at any time finances what has
become current business and has lost its original contact with innovation
or with the adaptive operations induced by innovations, although the
history of every loan must lead back to the one or the other.^ If, finally,
we insert consumers’ borrowing on the one hand, and saving on the
other, we have before us not only all the elements of which the practice
of a bank actually consists, but also the explanation of the fact that
current, or “regular,” business has been emphasized to the point of giving
rise to a theory of banking which recognizes nothing else but the financing
of current commodity trade and the lending of surplus funds to the stock
exchange, and to a canon of the morals of banking by which the function
to which we assign logical priority is almost excluded from the things a
banker might properly do. We shall see however, that this does not
invalidate our view and that credit creation for the purpose of innovation

^ It should be repeated that that statement does not imply anything about historical
sequences. See Chap. VI, Sec. B.

* The above proposition will be qualified later on, when accotmt will be taken of the case
of financing business losses.

How THE Economic System Generates Evolution 115>'

asserts itself and supplies the chief motive power for the variations in
credit outstanding, all the same.

The latter assertion will have to justify itself in our analysis of mone-
tary time series. But it is necessary to advert at once to its bearing on
the modern controversy — ^it is really the modern form of a very old con-
troversy — about the commercial vs. the investment theory of banking.
By commercial, or classical, theory we mean the one alluded to in the
preceding paragraph. Investment theory — ^there is no established word
for it — ^we call the theory which defines the function of the banking
system, not in terms of any specific type of transaction, but in terms of
the amount of deposits which results from all the possible transactions a
bank can embark upon. The term investment theory has been chosen
because investment, in the sense of the purchase of assets, bonds in
particular, is the transaction which banks can most nearly effect on
their own initiative and in which they are less than in any other dependent
on the initiative of their customers. Now, it is extremely difficult to
convey a correctly balanced impression of the relative merits of these
two “theories’^ and of the reasons why we have to disagree with both.
This difficulty is due not only to the fact that neither is a scientific theory
— ^both aim at giving practical advice about how bankers should behave
or be made to behave — ^but also to the fact that the propositions held by,
or implied in, both of them are not simply contradictory or right or wrong
all along the line.

The commercial theory may be, and with older writers often has been,
associated with a denial of the fact of credit creation, sometimes expressed
in the phrase : Bankers can lend only what has been entrusted to them by
depositors. Apart from this misconception of what deposit banking
means, there is no definite error in what it holds and plenty of wisdom in
what it advocates.^ In particular, it should be clearly realized that no
argument follows from our theory against banks’ specializing in the cur-
rent business of discounting commercial paper or against the proposition,
largely though not wholly true, that this business, together with lending
surplus funds on the stock exchange, will produce that amount of deposits
which will equally avoid ""inflationary” and ""deflationary” impulses
being imparted to the system. Our objection to the commercial theory

1 Recognition of this has been obscured by a secondary controversy about the value,
practical or otherwise, of eligibility requirements imposed or to be imposed on the paper or
other assets which banks may discount or buy. These requirements (whether imposed by
law or banking practice) have worked well in some countries and not at all in others. The
question is important, of course, but it has nothing to do with the question of principle,
with which we are concerned. Moreover it is only blurred by stressing the number of
signatures which should be on a bill.

116

Business Cycles

rests on its failure to reach down to the sources to the process of which it
describes part of the surface, and to diagnose correctly the nature of
credit creation for other purposes than that of financing current com-
naodity trade. This also obscures the relation which even classical”^
credit creation for short-time purposes bears to innovation — ^best exem-
plified by loans to the stock exchange, which help to carry new issues —
and leads to a narrow view about the function of finance bills and of
credits in current account. Thus the theory contributes, through the
phraseology which it has been instrumental in creating, to what may be
described as the mimicry of credit creation, especially of credit creation
for the purpose of innovation which tends to hide behind credit creation
for the purposes of current trade. In this respect the investment theory
is superior. But it assigns to the ‘‘regulation of the flow of funds by
banks’" a causal role in the economic process which does not belong to it
and, by its insistence on quantity of credit outstanding, entirely loses
sight of the essential element of purpose.^

It should be observed how important it is for the functioning of the
system of which we are trying to construct a model, that the banker
should know, and be able to judge, what his credit is used for and that he
should be an independent agent. To realize this is to understand what
banking means. To have stressed it, at least by implication, is one of the
chief merits of the commercial theory of banking, just as it is one of the
chief demerits of the investment theory — which is a typical outsider’s
idea and could never, like its rival, have grown out of practical banking
experience — ^to have overlooked it and to have made banking a mechan-
ical function which might just as well, if not better, be filled by some
government department. Even if he confines himself to the most regular
of commodity bills and looks with aversion on any paper that displays a
suspiciously round figure, the banker must not only know what the
transaction is which he is asked to finance and how it is likely to turn out,
but he must also know the customer, his business, and even his private
habits, and get, by frequently “talking things over with him,” a clear
picture of his situation. But if banks, whether technically so called or
not, finance innovation, all this becomes immeasurably more important.
It has been denied that such knowledge is possible. The reply is that
all bankers who at all answer to type, have it and act upon it. The giant

^ The element of purpose” sometimes underlies the phrase ‘‘quality of assets.” This
is a fertile source of misunderstanding. Quality is, of course, in all cases very relevant to
sound practice and a main defense against catastrophes and swindling. But that is not
what is meant when “ quality” is pitted against “ quantity.” What is meant seems to point
in the wrong direction, although the type of assets (or of collateral) often bears some relation
to purpose, so that the view which stresses “quality” in this sense may occasionally bring
in the really relevant element by a backdoor.

How THE Economic System Generates Evolution 117

banking concerns of England bave tbeir organs or subsidiaries which
enable them to carry on that old tradition: the necessity of looking
after customers and constantly feeling their pulse is, for instance, one
of the reasons for the division of labor between the big banks and the dis-
count houses in the London money market. However, at the same time
it is clear that this is not only highly skilled work, proficiency in which
cannot be acquired in any school except that of experience, but also work
which requires intellectual and moral qualities not present in all people
who take to the banking profession. Hence, deviations from the theore-
tical type must be expected to be much more frequent than in those
sectors of economic reality in which we need not require more than the
ordinary intellectual and moral aptitudes of the "‘economic man.” This
difficulty is not peculiar to our model. It is met by anyone who tries to
describe the way in which the capitalist machine is being run. Whatever
our theories, we must all recognize — although we may draw different prac-
tical conclusions from it — that the leading functions are not simple
matters which people can be expected to perform as effectively as they
can be expected to leave an employment that offers a lower for one that
offers a higher wage, or to produce beans instead of peas if it pays better;
but that they are difficult to fulfill, so much so that many of those who
attempt to fill them are hopelessly below the mark in a sense in which
even the subaverage workman, craftsman, farmer is not. This is, of
course, so with entrepreneurs. But in their case we take account of it
by recognizing from the start that a majority of would-be entrepreneurs
never get their projects under sail and that, of those who do, nine out of
ten fail to make a success of them. In the case of bankers, however,
failure to be up to what is a very high mark interferes with the working
of the system as a whole. Moreover, bankers may, at some times and in
some countries, fail to be up to the mark corporatively : that is to say,
tradition and standards may be absent to such a degree that practically
anyone, however lacking in aptitude and trainin'^, can drift into the
banking business, find customers, and deal with them according to his
own ideas. In such countries or times, wildcat banking — ^incidentally,
also wildcat theory about banking — develops. This in itself — ^whatever
the legal rules about collateral and so on may be — ^is sufficient to turn the
history of capitalist evolution into a history of catastrophes. One of the
results of our historical sketch will, in fact, be that the failure of the bank-
ing community to function in the way required by the structure of the
capitalist machine accounts for most of the events which the majority
of observers would call “catastrophes.” It is but natural that since
such failure primarily shows in dealing with novel propositions — ^where
judgment is most difficult and temptation strongest — an association
has developed between financing innovation and miscarriage or mis-

118 Business Cycles

conduct which, however understandable, does not make analysis any
easier.

Not less important for the functioning of the capitalist machine is it
that banks should be independent agents. If they are to fulfill the func-
tion which has above been illustrated by the analogy with that socialist
board which examines and passes upon the innovations envisaged by the
executive, they must first be independent of the entrepreneurs whose
plans they are to sanction or to refuse. This means, practically speak-
ing, that banks and their officers must^ not have any stake in the gains
of enterprise beyond what is implied by the loan contract. This inde-
pendence, most nearly realized in English banking, has always been
threatened by attempts of entrepreneurs to gain control over banks and
by attempts of banks or their officers to gain control over industry. We
shall see later how far these attempts have been successful and how far
they have interfered with the working of the system. But another kind
of independence must be added to the list of requirements: banks must
also be independent of politics. Subservience to government or to public
opinion would obviously paralyze the function of that socialist board. It
also paralyzes a banking system. This fact is so serious because the
banker’s function is essentially a critical, checking, admonitory one.
Alike in this respect to economists, bankers are worth their salt only if
they make themselves thoroughly unpopular with governments, poli-
ticians, and the public. This did not matter in the times of intact
capitalism. In the times of decadent capitalism this piece of machinery
is likely to be put out of gear by legislation. The motive, as well as the
justification, for speaking in such cases of a theoretical type and a
deviating reality lies in the diagnostic value of this distinction, and will
be exemplified in our historical survey.

4. There are many ways in which banks may manufacture means of
payment in fulfillment of their promises to lend.^ Only two of them
interest us here — ^the*"issue of bank notes and the creation of balances,
misleadingly and insincerely called deposits. There is no difference
between them, except one of technique (which is responsible for diffi-
culties concerning the interpretation of statistics), the note being a
balance embodied in a perfectly negotiable paper and the balance being a
note which is transferable, not bodily but by check. Since the former has

^ ‘‘Must’’ liere is no moral imperative, but simply indicates tbe fact that, unless that
requirement be fulfilled, an important element of the capitalist engine is put out of opera-
tion and that certain consequences will follow from this.

2 It will be seen that, deviating from current practice, we stress loans (which term is to
include discounts) rather than the investments of banks. The theoretical reason for this
will become obvious later on, but few students of banking will deny that as far as prewar
banking practice is concerned, emphasis would in any case have to be on loans rather than
on investments.

How THE Economic System Generates Evolution 119

undergone, from the forties of the nineteenth century on, a change in
function which has rapidly deprived it of its role as a vehicle of industrial
and commercial member-bank credit, we will in general think of the
latter only, except when discussing patterns in which the bank note
actually filled that role.

In a formal sense, all balances are of course created.’’ But we
confine this term to balances the creation of which increases the sum of
existing means of payment. These are not necessarily ‘‘borrowed,” but
may also result from sales of assets to a bank. In this case the customer
acquires an “owned” balance, as he does when he deposits legal-tender
money or newly mined or imported monetary metal — ^thus acquiring
balances which are owned but not created — ^the only cases in which the
term deposit (in the sense of depositum irregulare) is appropriate. If we
use the word deposit instead of the word balance^ we will distinguish these
cases by the term original deposits from created deposits. Although these
deposits do not increase the means of payment, the newly mined or
imported monetary metal itself does, and it is worth noticing that,
opportunely timed, such additions to the stock of legal tender may
replace credit creation that would otherwise have come about. Deposit-
ing “old” legal tender which circulated before, also increases deposits, but
not the sum of existing means of payment. During the growth of
deposit banking, which in America, England, and Germany was sub-
stantially, though not wholly, completed before the World War, legal-
tender money which had previously circulated outside of the banking
sphere kept on streaming into banks. As long as this process played any
significant role, there was a special trend in the figure of total deposits,
and a number of propositions usually made about deposits require
qualification for countries and periods in which that was the case. Mostly
we shall consider a perfectly developed system of deposit banking in
which legal tender, while moving into and out of banks, both in the ordi-
nary course of current business and under the influence of panics, never
enters into banks for the first time unless newly issued. But it should be
borne in mind that by doing so on principle we would leave out of account
a fact which may be very important. Por instance, the answer to the
question how far the fall in gold production which occurred after 1873
can have had any effect on prices, largely depends on our estimate of the
immigration of legal tender into banks which coincided with it.

If payments are made out of a “borrowed” balance, the payee acquires
what for him is an “owned” deposit, although for our purpose it is prefer-
able to say that the “borrowed” balance has been simply transferred
without losing that character. We may do so because, in any case, the
increase in the balance of the payee is compensated by the decrease in
the balance of the borrower. Where we distinguish between time and

120

Business Cycles

demand deposits, transfer from demand to time account, or vice versa,
causes uncompensated variation in both, but there is still compensation
within the sum total of all deposits. If an original deposit of ‘"old”
legal tender be made, there is compensation within the total amount of
means of payment. No new ‘‘spending power’" emerges. Nor does any
“spending power” vanish if a customer cashes a check. But there may
be compensation in still another sense. In the case which is the ideal
one from the standpoint of the commercial theory of banking, balances
are, say, by discounting commercial bills, created against commodities —
raw materials, for instance — ^which have just come into existence and are
about to start on their career through the system. Those balances are
uncompensated ones in any of the above meanings of the term. But
they may be said to be compensated in the sense that the effect on
prices of the increase in the stream of money is compensated by a simul-
taneous increase in the stream of goods, as it also may be whenever there
are underemployed resources. This proposition is not above criticism on
various counts. But it stiE expresses a rough common-sense truth and
may serve to characterize the difference between the classic case of credit
creation and the cases of credit creation for the financing of innovation on
the one hand, and credit creation for the financing of consumption
government fiat) on the other. The balances created in the latter cases
are not compensated in any sense. But their effects will be more than
compensated in the case of innovation when the new products are released.
Their effects will never be compensated — and can be eliminated only by
a distinct and painful operation — ^in the case of government inflation.

For the purpose of describing prewar patterns it will be convenient to
reason in general on what, from the standpoint of the theory of money, is
a very special case, namely, the case of perfect gold monometallism, and
to treat all other cases — gold-exchange standard, bimetallism, govern-
ment paper money, and so on — as deviations from it. But it should be
clearly understood that this is done for convenience only, and not because
any logical priority is attributed to that case: we do not, of course, mean
to hold that it is essential for legal-tender money to consist of, or to be
covered by, gold. On this understanding we will, in general, assume that
there is, in the domain under consideration, actual circulation of gold
coins and of bank notes of the central as well as of some other banks, that
those coins may be lawfully melted or exported, that gold is coined for
any private party without charge or loss of interest, that member banks
must on demand redeem their deposits (or notes) in gold or notes of the
bankers’ bank, which acts as clearing house for them and must redeem
its notes in gold.

The obligation to redeem balances or notes in legal tender or, in fact,
in anything which exists independently of the action of banks, obviously

How THE Economic System Geneeates Evoeution 121

restricts their power to create them. In the system now envisaged, in
which redemption must be effected in a money that at the same time
serves in the role of small cash for the current transactions of business
and private life, it means for each individual bank, on the one hand,
the necessity of holding a stock of till money with which to meet the
ordinary and extraordinary cash requirements of customers, and on the
other hand, the necessity of keeping adverse clearing-house balances
within the limits set by the practice of the bankers’ bank. For the bank-
ing system as a whole the limit may be defined by the necessity of keeping
the unit of account at par with the unit of legal tender, i.e,^ in our case,
a certain quantity of gold. We need not go into the various attempts
which have been made to figure out, for a given system, the numerical
value of that limit;^ but the following remarks suggest themselves.

First, redeemability is a restriction on credit creation that is not
implied in, but additional to, the other rules of ‘‘classical banking” and
will, in general, exclude transactions which, but for considerations of
redeemability, would be sanctioned by even the most conservative
principles. It is the safety brake which gold monometallism auto-
matically inserts into the engine. If, in such a monetary system, law
or usage imposes further restrictions, they cannot have any other mean-
ing except to strengthen that brake and to make sure that it functions.
Those attempts to evaluate the limit of credit creation are usually con-
cerned with the effects of such legal restrictions only and hardly ever
posit the fundamental problem.

Second, it would in fact be difficult, if not impossible, to indicate, in
the absence of further legal or customary rules, the numerical value of
that limit. This value depends, for the individual member bank, on the
kind of customers it has and on the kind of business these customers do,
on the amount of internal compensation which is effected on its books —
with the giant concerns of England and Germany, a very considerable
part of the sum total of checks is drawn by customers in payment to
other customers of the same bank — on how great a risk it is willing to
run, how far it is willing to lean on the bankers’ bank, and on the attitude
of the latter.

Third, the limit is, particularly over time, extremely elastic. A bank
does not expand its credits singlehanded. It does so when others do the
same. Hence, adverse clearing-house balances are not so likely to arise
as they would be if the other banks stayed behind. Customers can
be educated and to a certain extent educate themselves to use less and less
actual cash in their transactions. The nonbanking sphere of circulation

^ Such attempts are frequently, though not necessarily, associated with the assumption
that banks will actually expand up to that limit. In this case we get a modernized form of
the old quantity theory which bids fair to repeat all the old errors with a vengeance.

122

Business Cycles

may be conquered. Technique may lend its aid: whenever arrangements
about overdrafts take the place of crediting customers* accounts with the
whole amount of loans, only the amounts actually drawn will contribute
to the sum total of deposits. In Germany acceptance credit, which does
not directly swell demand liabilities, was very popular also for purposes
other than financing international trade. The shifting of cash between
banks can be regulated so as to make it support a heavier superstructure
of deposits. Thus there are many devices by which reserve requirements
might be almost indefinitely reduced, some of which are operative even
in the case of statutory restrictions. Finally, law and usage are them-
selves but modes of expression — ^though possibly very faulty ones — of the
factors which determine our limit, and change in response to change
in those factors o/., the successive increases of the legal maximum amount
of the notes of the Banque de France. If they do not so change, they are
evaded; witness the development of the American trust companies along-
side of the banks which were subject to stricter regulations.^

Nothing, therefore, is so likely to give a wrong impression of the
operation of credit as taking a mechanistic and static view of it and
neglecting the fact that our process, by virtue of its own working, widens
the limits which, ex visu of a given point of time, seem to be rigid fetters.
If that fact be called inflation, then inflation has been going on practically
all the time, nowhere more than in this country, while deflationary influ-
ence originating in the monetary system — shortage of gold and the like —
is a myth. This may, according to one’s standpoint, be virtue or vice.
It may also be good in principle and work out badly in practice, or vice
versa. It may be a reason for or a reason against monetary management
or, in general, planned economy. But it is a fact which we must never lose
sight of, if we are to understand capitalist evolution. How it has actually
worked out we shall see in our historical discussion. What it means for
business fluctuations will be considered in Chaps. VI, VII, and XI-XIII,
To the question how great a quantity of commodities and services
will be withdrawn (Beal Levy) from its previous uses by a given quantity
of newly created credit, there is also no general answer. We must know

^ The xiltimate or absolute limit, beyond which in a closed domain the banking system
could not go without violating the condition of parity of its unit of account with gold, is
theoretically given by the value of the latter in the arts into which all monetary gold would
in the end emigrate. But this would, of course, imply so great a fall in this value that that
limit would indeed be wide. Before it be reached, expansive tendencies could have their
way and for reasons alluded to it would not be correct to say that since every individual
bank cannot expand without endangering its solvency with its customers or at the clearing
house, therefore the system as a whole cannot expand. Each bank can exert a little pull,
even if unsupported by the action of others, and in most cases aU pull together. The falling
trends in the relation between cash and deposits and between money in circulation and
deposits, both of which we observe in all countries, is enough to illustrate the process.

How THE Economic System Generates Evolution 123

the whole business situation on which the creation impinges, in order to
frame an expectation as to how it will act, in this respect as in others; and
that business situation will not only determine the effects of any given
amount of balances created but also that amount itself. The problem
not being immediately relevant to our argument, we will dismiss it with a
reference to Professor Pigou’s treatment (Industrial Fluctuations,
Chap. XIV) . Even the amount of credit creation in terms of money is
exceedingly difficult to measure, still more the net amount, Le.y the sum
which member banks’ credit creation adds to the sum which business
would use in the absence of such creation. The difficulty arises not only
from the interference of credit creation with saving and the fact that
created balances are used for other purposes besides productive ventures,
but also from the facts that what credit business actually uses, or would
use, is different from the amount of facilities put at its disposal, and that
in the absence of credit creation not only price levels but also sectional
relations of prices would be different from what they are.

E. Interest^ (Money Market; Capital). — ^Prom what has been said
about entrepreneurs’ profits on the one hand, and the role of money and
credit on the other, we derive certain propositions on interest as an ele-
ment of the economic process which we are trying to describe, or of the
model which we are trying to construct. Whichever of the many
explanations of the phenomenon of interest we may hold, all of us will
agree to the following definition, although some of us may think it very
superficial: Interest is a premium on present over future means of pay-
ment, or, as we will say a 'potiori, balances. Interest — ^more correctly,
the capital sum plus interest — ^is, to use our turn of phrase, the price paid
by borrowers for a social permit to acquire commodities and services
without having previously fulfilled the condition which in the institu-
tional pattern of capitalism is normally set on the issue of such a social
permit, i.e., without having previously contributed other commodities
and services to the social stream.

For a positive premium to emerge, it is necessary (though not suffi-
cient; but this does not matter here) that at least some people should
estimate a present dollar more highly than a future dollar. This may

1 The theory of interest presented in this section has also, like the theory of credit, been
first published, in the writer’s Theory of Economic Development in 1911. The many
adverse criticisms it met have failed to convince him. But since he naturally wishes to
minimize avoidable differences of opinion, he has endeavored throughout to formulate the
propositions in this book in such a way as to make them, wherever possible, acceptable also
to those who differ from him in their views as to their natrire of interest. This also applies
to this section, most of the propositions of which could be couched in terms of any theory of
interest. On the relation between interest and the quantity of money, also see the writer’s
Zinsfuss und Geldverfassung, Jahrbuch der Gesellschaft der Oesterreichischen Volkswirte,
1913.

124

Business Cycles

result from many circumstances. A man may expect, for example, wliile
being a student, to bave a larger income in tbe future than he has now, a
government may similarly count on an increase in its revenue, or it may
find itself in an emergency — as may any private individual too, of course —
or all of us may systematically underestimate future wants as compared
with present wants of the same rank. If we believe that there is such a
thing as a schedule or curve of marginal utility of income, we may
express cases of the first kind by saying that we expect to stand in future
at a lower point of an invariant curve of marginal utility of income, and
cases of the second kind by saying that we have one curve of marginal
utility of income for present and another and lower one for future income.
Business will pay a positive interest if a present sum can be so used in
commerce and industry as to yield a greater sum in future, zero interest if
the most lucrative operation within the horizon of businessmen is expected
to yield, all costs counted, no more than the sum required to carry it out,
and negative interest if, as is sometimes the case, nothing they can do will
cover costs. Surely there is nothing paradoxical in that.

We may go one step further without touching controversial ground.
It is obvious that borrowing by consumers, particularly governments, is
of itself sufficient to enforce a positive rate of interest also for industry
and trade, and the writer has no wish to exclude such cases or to minimize
the quantitative importance of consumers’ credit. But it is equally
obvious that, in the sphere of business, innovation is the pillar of interest,
both because the profit it yields to the successful entrepreneur is the
typical reason for a readiness to pay interest — ^for looking upon present
dollars as a means of getting more dollars in the future — ^and because,
as we have seen, borrowing is, in the situation of an entrepreneur, the
typical means of getting those present dollars. The relation of this to
credit creation follows from our previous argument.

All the more controversial is the proposition that entrepreneurs’
profits and related gains which arise in the disequilibria caused by the
impact of innovation are, as far as the business 'process itself is concerned
and apart from consumers^ horrowingy the only source of interest payments
and the only cause” of the fact that positive rates of interest rule in the
markets of capitalist society. This means that in perfect equilibrium
interest would be zero in the sense that it would not be a necessary ele-
ment of the process of production and distribution, or that pure interest
tends to vanish as the system approaches perfect equilibrium. Proof
of this proposition is very laborious,^ because it involves showing why all
the theories which lead to a different result are logically unsatisfactory.
Happily, it is not necessary to enter upon it, because we shall not have
to use that proposition except in very few instances. All that the writer
^ See Theory of Economic Development, Chap. V.

How THE Economic System Generates Evolution 125

has to ask is that the reader assent to the modest statement of the pre-
ceding paragraph, while reserving his rights as to the nature of interest
and retaining some kind of rate of interest in his picture of the state of
perfect equilibrium. We may, then, confine ourselves to a few remarks
and pass on. First, the thesis that the capitalist class lives on a return
which, except for the financing of consumption, derives from innovation
or processes directly induced by innovation, and would, hence, disappear
if economic evolution ceased, is of some importance for what may be
termed the economic sociology of capitalism. Second, although it is
possible to deny that innovation is the only cause’’ of interest within the
realm of production and commerce, it is not possible to deny that this
‘‘cause” is sufficient to produce it in the absence of any other, or that a
premium on present balances follows from our model of the evolutionary
process in a way which is not open to any of those logical objections that
have been raised against other theories of interest. Whoever dissents
from the writer’s view, would have still to admit that cause into his
picture of reality, and to expect it to assert itself in the variations of the
rate of interest.^ Third, although government borrowing, changing
premiums for risk bearing, currency troubles, extra-economic pressure,
and varying organization of the markets for loans cannot fail to distort
the picture, facts are, as we shall see, more favorable to that theory than
theorists have been so far — so much so that there is, if we accept the
ordinary rules of scientific procedure, no reason to use any other.

There is, however, one point which presupposes a controversial
theorem and on which it is less easy to compromise in such a way as to
make it possible for the reader to accept the main argument. Interest
has been defined above in monetary terms, but now it is necessary to
insist that interest actually is, not only on the surface but essentially, a
monetary phenomenon and that we lose it if we try to pierce that surface.
It is a payment for balances with which to acquire commodities and
services, not for the commodities and services themselves that may be
bought with those balances. It is to this fact alone that interest owes
its character as a — ^potentially — permanent income, for profits in our
sense are an essentially temporary phenomenon and do not stay per-
manently with any process of production and trade or any collection of
producers’ goods (“real capital”) that may be embodied in a firm. But
the lender may still secure a permanent income by shifting his money
from opportunity to opportunity as each of them arises. Some of them
are, no doubt, very much more durable than others and there are concerns
within which innovation goes on for generations. Besides, this necessity

^ Hence, the concession usually made to the liter’s theory of interest, that entre-
preneurs’ “ demand for capital” is normally the most important single factor in the behavior
of interest, concedes much more than it is meant to concede.

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Business Cycles

of shifting does not apply to lenders who lend to consumers of indefinite
span of life, such as governments or municipalities. But no business
venture yields eternal surpluses, as any lender is bound to find out to his
cost who too confidently acts upon a belief in any of those theories of
which the abstinence theory is a typical example, or simply upon a naive
conviction that interest is a price of some productive service in the same
sense in which wages are a price of the services of labor.

The theory of interest thus hastily sketched does away with many
spurious problems which, here as everywhere else, are the consequence
of logical strains in an unsatisfactory analytic structure. It also allows
of a much more natural interpretation than can be derived from others, of
the relations interest obviously bears to other monetary magnitudes and
of its peculiar sensitiveness to monetary policy; and it seems particularly
appropriate in a study of industrial fluctuations if we look upon them as
deviations from a state of equilibrium. Interest or, if the reader prefer,
its deviation from what he believes would be its equilibrium value, then
appears, because of its central position, as a kind of coefficient of tension in
the system^ which more nearly than any other single figure expresses the
degree of disequilibrium present in the latter.

The premium on present, as against future, balances is settled by
borrowers — ^mainly governments and (industrial and commercial non-
banking) firms — and lenders — ^mainly banks and their satellites — ^who
together form what is known as the Money Market. There, every bank
has a sector of its own (whence it follows that we have before us another
case of imperfect competition), consisting of its stock of more or less
permanent customers, while transactions that cut across these sectors
make up the Open Market. Behind this and, as we have seen, at one
remove from it, is the Central Market, consisting of the transactions
between the bankers" banks and their banking customers, which but
indirectly influence the money market proper, except for any operations
that the former may undertake in the open market.

Now, interpretation of money-market events by means of that theory
of interest unavoidably runs on lines which differ substantially from those
of both older and more recent doctrine. The necessity of reconciling a
nonmonetary theory with obvious facts of the sphere of money and credit
is, in particular, responsible for the idea that there are two kinds of inter-
est rates, a natural"" or ‘^real"" one which would also exist in a barter
economy and which represents the essence of the phenomenon, a per-
manent net return from physical means of production, and a monetary
one, which fundamentally is but the former’s reflex in the monetary
sphere. The two may, nevertheless, differ of course or be made to differ
by monetary policy or by an expansion or contraction of bank credit,
but this constitutes a disturbance from which a definite string of con-

How THE Economic System Geneeates Evolution 127

sequences, among them the business cycle itself, has been deduced.
The roots of this idea reach very far into the past and are clearly dis-
cernible in the English monetary discussions of the fourth and fifth
decades of the nineteenth century. Its role in the thought of our own
time is due to the teaching of Kaut Wicksell and to the work of a brilliant
group of Swedish and Austrian economists. For us, however, there
is no such thing as a real rate of interest, except in the same sense in
which we speak of real wages translating both the interest and the
capital items of any loan transaction into real terms by means of the
expected variations in an index of prices, we may derive an expected and,
by performing the same operation ex post, an actual rate of interest in
terms of ‘‘command over commodities.’^ But nominal and real rates in
this sense are only different measurements of the same thing or, if we
prefer to speak of different things even in this case, it is the monetary rate
which represents the fundamental phenomenon, and the real rate which
represents the derived phenomenon. Hence, the money market with all
that happens in it acquires for us a much deeper significance than can be
attributed to it from the standpoint just glanced at. It becomes the
heart, although it never becomes the brain, of the capitalist organism.^

It is not difficult to see, however, that most of the problems tradition-
ally dealt with under the heading of interest will also present themselves
to our approach, and that many relations between interest and other
elements of the system will have to be formulated in a manner not so far
removed from the usual one as might be expected. Of this we can
convince ourselves at once. We have just denied the very existence of
what has been called the natural rate of interest and do not intend to put
another imaginary entity in its place. But it does not follow that all the
relations must necessarily vanish from our analysis which have been
asserted to hold between it and the monetary rate. For, as far as profits
are the basic fact about interest and both its source and its “cause,” they
will, although no permanent returns^ and although not behaving exactly

^ See Irving Fislier, Appreciation and Interest, 1896.

2 In Mr. Keynes’ General Theory of Employment, Interest and Money, 1935, the reader
finds also a monetary theory of interest which in some points agrees with the one above
submitted and in others differs from it. Comparison is invited, but it should be deferred
until the reader has perused Chap. XII. For reasons mentioned in the preface, however, no
attempt has been made by the writer himself to relate his theory to that of Mr. Keynes, and
the reader should be on his guard against both surface similarities and surface differences.
The mere idea that interest is a price of money is, of course, older than anything that can
be called scientific analysis, and figures in the list of what 20 years ago would have been
called prescientific errors; vide Montesquieu, who was duly lectured for it by Adam Smith.

^ Moreover, profits in our sense display no tendency toward equalization. This and
the essentially temporary character of profits in our sense should be sufi&cient to make it
qtiite clear that both our distinction between profit and interest and the relation between
them is not identical with an old distinction between normal business profits und contractual

128

Business Cycles

as that natural rate is supposed to behave, play a similar role in our
schema, and those relations between natural and monetary interest will
in many, although not in all, respects be replaced by relations between
profits and interest not toto coelo different from them. Nor should the
fact that interest is here defined as a monetary phenomenon and hence
must have something to do with the ‘"quantity of the circulating
medium”^ raise exaggerated hopes or fears, as the case may be, to the
effect that the writer is going to launch out into strikingly unorthodox
conclusions. For about the immediate effects of a change in the amounts
of customers’ balances, existing or potential, there cannot be much differ-
ence of opinion in any case; and anything beyond immediate effects must
unavoidably bear a relation to what the balances lent or borrowed mean
in terms of all or of certain classes of commodities, hence to the values, and
the expected and actual changes in the values, of the general and of
sectional price levels. This necessity is not less obvious in the case of zero
changes — ^which are likely to occur in the presence of underutilized
resources — as in any others. Or, to put it differently, it is never the
amount of actual and potential “funds” in the market which is relevant
to the rate of interest but the proportion — which is a variable, of course —
of these funds to the total of balances actually in circulation. As soon as
this is realized, the gulf narrows that separates our approach from others
which are more familiar.

Finally, while the theory presented in this section excludes facts which
are basic to others from the explanation of the nature of interest, it is not
intended to exclude them — as far as they are facts — ^from all arguments
about interest. Abstinence affords an instance. The fact that saving
does — or at least may — dimply a sacrifice is held to be no more sufficient
or necessary to account for the existence of interest than disutility of
labor is to account for the existence of wages. The writer also thinks that
neither abstinence nor disutility contributes very much to our under-
standing of the behavior of interest or wages. But it is not held either
that abstinence or disutility are nonexistent or that they are irrelevant to
interest or wages. Whenever any part of funds available for lending are
provided by saving, that part and its variations must in the long run bear
some — ^though not a simple — ^relation to the abstinence involved; and this
relation, whatever it is, can of course be expressed by a marginal condi-

interest. However mucli the writer welcomes anything that will link his teaching to older
doctrine, he must point out, first, that normal profits and interest are, according to this
view, still the same thing — exactly as contractual and directly earned rent of natural agents
is — which he thinks erroneous, and, second, that the analytic problem which he undertook
to solve by his theory of interest was precisely to show how it is possible that a theoretically
permanent income flows from essentially transient sources and that it should not disappear
as a net return through a process of imputation.

^ It will be pointed out in chapter XI, section A that that ‘‘quantity” is a very doubtful
one. But the above sufl&ces for the purpose in hand.

How THE Economic System Generates Evolution 129

tion. Another instance is consumers’ time preference. Whatever its
causes and whether it is a datum — as it is if we assume that people have
different utility schedules for present and future incomes — or, in part, a
cyclical variable — as it is in so far as it turns on expectations of future
increase in income — ^it will always contribute to the determination of the
rate of interest: if the latter is not to display a tendency to change, it
must in strict theory equal any marginal rate of such time preference as
may exist. ^

To this monetary theory of interest corresponds a monetary theory of
capital, which views it, on the one hand, as an accounting concept — as
measuring in terms of money the resources entrusted to a firm^ — and, on
the other hand, as a monetary quantity. It is, perhaps, best to avoid
altogether a term which has been the source of so much confusion and to
replace it by what it means in every case — equipment or intermediate
goods and so on — and this we shall do, except in cases in which no mis-
understanding is likely to arise. But it is suggested that those two mone-
tary concepts open a serviceable door by which to introduce the ele-
ment of money into general theory. Only the second is, however,
relevant here. Capital in this sense is not goods but balances, not a factor
of production but a distinct agent which stands between the entrepreneur
and the factors. It can be created by banks because balances can. Its
increase and decrease are not the same as increase and decrease of com-
modities or any particular class of commodities. Its market is simply the
money market, and there is no other capital market. No realistic mean-
ing attaches to the statement that, in the latter, “capital” (— some kind
or other of producers’ goods) is being “lent in the form of money.” But
again as in the case of interest it is necessary to add that the introduction
into our analysis of this concept of capital does not do away with the
problems of what is traditionally referred to as real capital — on the
contrary, they reappear though in a new garb — and that results arrived
at by means of a monetary theory of capital not always invalidate, but in
many cases only reformulate, the propositions of “real” theories of
capital. If our understanding of the processes of capitalist society hinges
in important respects on realizing the fact that monetary capital is a
distinct agent, it also hinges in not less important respects on realizing
how it is related to the world of commodities.

^ Nor is there any objection to Professor Irving Fisher’s concept of the Marginal Rate
of Return over Cost, the usefulness of which is, on the contrary, fully recognized by the
present writer, although his interpretation of it would differ from that of Professor Fisher.
See the latter’s Theory of Interest, pp. 155 et seq. The principle is implied in Walras’s
theory of interest.

® Capital in this sense includes all debts, whether owed to a bank or to other firms or to
bondholders. This is in accordance with the principles of accounting, according to which
capital in the usual sense figures along with all debts on the liability side of the balance sheet.

CHAPTEE IV

The Contours of Economic Evolution

A. The Working of the Model ; First Approximation. — It will be useful
to assemble the analytic tools so far described and to display the resulting
skeleton — a sort of chassis of our model. Experience teaches that there is
danger in doing this, and another appeal to the reader is in order, to
reserve judgment and to grant provisionally all simplifications, in par-
ticular, the assumptions of perfect competition (with the possible excep-
tion of isolated monopoly positions) and of a state of perfect equilibrium
from which to start. There is no saving, population is constant, and
everything else is as we assume it to be in a state that conforms to the idea
of the Theoretical Norm. We know (this, however, is no assumption)
that, in the institutional pattern of capitalist society, there will always be
possibilities of New Combinations (in the absence of all others, there
would be those due to the steady increase of knowledge), and always some
people able and willing to carry them out; and we know the reasons why
this is so. To repeat again a point which has often been misunderstood,
these people are by no means looked upon as particularly rare birds. All
we postulate is that that ability is distributed as unequally as others are
and all we hold is that this fact has an important influence on the mecha-
nism of economic change — a statement which is no bolder and, if any-
thing, more realistic than any of the set of assumptions familiar to every
theorist. Motivation is supplied by the prospect of profit in our sense
(mixed as the reader pleases with other stimuli) which does noty he it
rememheredy fresuppose either an actual or an expected rise in prices and
expenditure. What follows implies, besides institutional and technolog-
ical assumptions that are essential, others of merely expository sig-
nificance. In order to make the principle stand out clearly, we wish in
particular to assume, in the first instance, absence of certain elements
which in reality are very important — notably, errors in diagnosis or prog-
nosis and other mistakes.

Some people, then, conceive and work out with varying promptness
plans for innovations associated with varying (and ideally correct) antici-
pations of profits, and set about struggling with the obstacles incident to
doing a new and unfamiliar thing — obstacles which have been discussed

130

The Contours of Economic Evolution

131

in the preceding chapter. We look upon ability to take the lead as a
part of the entrepreneurial aptitude, and this enables us, for our present
purpose, to identify one man (as we could identify the tallest individual
in a population) who is the first, for example, to decide on the production
of a new consumers’ good. The reason why he did not do so before is in
disturbances which we assume to have preceded the equilibrium from
which we start. Conforming to previous considerations, we suppose that
he founds a new firm,, constructs a new plant, and orders new equipment
from existing firms. The requisite funds — ^his entrance ticket to the
social store of means of production — ^he borrows from a bank. On the
balance acquired by so doing he draws, either in order to hand the checks
to other people who furnish him with goods and services, or in order to
get currency with which to pay for these supplies. Under our assump-
tions he withdraws, by his bids for producers’ goods, the quantities of
them he needs from the uses which they served before.

Then other entrepreneurs follow, after them still others in increasing
number, in the path of innovation, which becomes progressively smoothed
for successors by accumulating experience and vanishing obstacles. We
know the reasons why this is likely to happen in the same field or in —
technologically, as well as economically — ^related fields: although in’ some
respects a successful innovation will make other innovations easier to
carry out in any field, it primarily facilitates them in the lines in which
it may be directly copied as a whole or in part or for which it opens up
new opportunities. Consequences begin to make themselves felt all over
the system in perfectly logical concatenation. They are almost too
obvious to describe. We will merely note, first, that our entrepreneurs
may, under the circumstances envisaged, be relied on to spend their
deposits promptly, excepting a minimum reserve. It is — again, in the
circumstances of our case — safe to say that if we multiply the amount of
created balances by the velocity figure that obtained in the previous
equilibrium, in the crudest quantity-theory style, we shall get a fair
approximation to the total by which the volume of payments will be
increased by this kind of expenditure alone, since nobody of all those who
receive payments from entrepreneurs, has any debts to repay or any
motive to increase his cash reserve beyond its previous proportion to his
transactions, and since we are considering a closed domain.^

Second, there being no unemployed resources to start with, prices of
factors of production will rise, and so will money incomes and the rate of
interest (or, as the writer thinks it would be more correct to say, a positive
rate of interest will emerge). Costs will rise against ‘^old” firms as
well as against entrepreneurs. But third, their receipts will also rise

^ Later we shall see reason for assuming that the effect will he greater than stated above,
but now we do not wish to complicate matters.

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Business Cycles

correspondingly to the expenditures of entrepreneurs on producers’ goods,
of the workmen and so on, now employed by them at higher wages, and of
the recipients of all those increased payments. How individual firms
or industries or sectors of the industrial organism will fare in this process
depends on the shifts in demand that will occur in consequence. It is
easy to see that there will be both gains and losses. In spite of the losses
in some industries which must, under such circumstances, be expected
to be a feature of the situation, all old firms taken together will, of course,
show a net surplus. Of this we can satisfy ourselves if, disregarding
everything except the first two steps — disbursements by entrepre-
neurs and again the next disbursement by income receivers — ^we assume
that labor is the only factor, wages are the only cost. Then old firms will,
obviously, have to pay but a part of the increase in the sum total of
incomes that has occurred, the increase in the income of those work-
men whom they still retain while they will, at the second turn of the
wheel and before the new products reach their markets, receive the whole
of it. However unrealistic, this case brings out the principle free from all
complications and independent of any reactions of marginal cost in
physical terms. In any case, this is the process by which the effects of the
entrepreneurial activity spread (under our present assumptions they
would spread very quickly) over the whole system, dislocating values,
disrupting the equilibrium that existed before. The term Windfall
correctly expresses the character of both these gains and losses.

Fourth, under our assumptions there could, in general, be no net
increase in total output. Owing to the difficulties inherent in the latter
concept, this proposition may justifiably be questioned. What we mean
is simply that it is impossible for all industries to increase their output
under the circumstances assumed. All those who make gains will, indeed,
try to do so; but if we remember, on the one hand, that in the preceding
perfect equilibrium of perfect competition they all produced their opti-
mum output, utilizing in particular their plants up to the point at which
total unit cost was a minimum, and, on the other hand, that quantities
of factors of production previously used by them have been withdrawn, we
shall conclude that if there were only one single consumers’ good, less of
it would be produced now than had been produced in the preceding state
of equilibrium. Instead, more producers’ goods will be produced.
These, together with part of the others which used to be produced for the
old firms, will be taken by our entrepreneurs. If there are many con-
sumers’ goods, and if the production of some of them increases, then the
production of others must decrease in such a way as to set free more
productive resources than are engaged in bringing about the expansion in
the former. If we include in total output the intermediate results of the
current work of building up the new plants, then total output would, in

The Contoues of Economic Evolution

133

the sense alluded to, be constant. If we do not include them, it would be
smaller. The output of consumers’ goods will fall in any case unless
there is no period of gestation at all. It should be observed, however,
that demand in terms of money for consumers’ goods has not decreased.
On the contrary, it has increased. The reader is urgently invited to
develop this picture, the elements of which will soon be seen to be of
fundamental importance for the argument of this book.

This is all that happens, under our present assumptions, until the first
entrepreneur’s plant gets into working order. Then the scene begins to
change and a new business situation emerges, characteristically differing
from the one we glanced at, but not less easy to understand. The new
commodities — ^let us say, new consumers’ goods — ^flow into the market.
They are, since everything turns out according to expectation, readily
taken up at exactly those prices at which the entrepreneur expected to sell
them. We will also assume that from that moment onward the new firm
will go on pouring out an unchanging stream of consumers’ goods without
any further change in its production function. A stream of receipts will
hence flow into the entrepreneur’s account, at a rate sujBScient to repay,
during the lifetime of the plant and equipment originally acquired, the
total debt incurred plus interest, and to leave a profit for the entre-
preneur. Let us imagine a strong case and assume what, of course, hap-
pens only in very exceptional instances, that at the end of a period not
longer than the time that elapsed between the entrepreneur’s first act of
borrowing and the completion of his plant, things have so worked out
that, the entrepreneur having currently made all necessary replacements
out of receipts and having discharged all his debts to the bank, thereby
annihilating all the balances newly created in his favor, is left with plant
and equipment perfectly unencumbered and in perfect working order, and
also with a surplus balance sufficient to serve him as ‘‘working capital.”
If the same applies in the case of the other entrepreneurs that followed
in the wake of the first and are just now, for argument’s sake, assumed
to have been similar prodigies of foresight, then the following situation
arises: the new firms, getting successively into working order and throwing
their products into the market of consumers’ goods, increase the total
output of consumers’ goods which had been previously reduced. In a
certain sense it may be held that under our assumptions output will
eventually be increased by “more” than it had fallen during the period
of gestation. That is to say, if we compare the elements which constitute
total output of consumers’ goods at the point of time when the new firms
have all begun to produce, with total output as it was in the preceding
neighborhood of equilibrium, and if we cancel all items which appear in
both composites, we are left with a list of plus and minus items such
that, evaluated at the prices that ruled in that neighborhood, the sum of

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Business Cycles

the former would necessarily be greater than the sum of the latter. If
there were only one consumers’ good, and if the innovation had consisted
in the introduction of a novel method of producing it, the physical quan-
tity per unit of time of the new total output would be greater than that of
the old one.

These new commodities intrude into the economic world that existed
before at a rate which will, for reasons given in the preceding chapter, be
too great for smooth absorption. They intrude, nevertheless, gradually:
the first entrepreneur’s supply will not, in general, cause visible
disturbance or be sufficient to alter the complexion of the business situa-
tion as a whole, although those firms may be immediately affected with
the products of which the new commodities or the commodities produced
by new methods are directly competitive. But, as the process gathers
momentum, these effects steadily gain in importance and disequilibrium,
enforcing a process of adaptation, begins to show. It is important that
the reader should master the mechanism before we go on to insert any
further elements into it.

The nature of the effects on the ‘^old” firms is easy to understand.
It superimposes itself on the disequilibrium caused by the setting up of
the new plant and equipment and the expenditure incident thereto. But
while the effects of this were, even in those cases in which they spelled
net losses, softened by the flow of that expenditure, the new disequilibrium
enforces much more obviously difficult adaptations. They proceed not
exclusively under the stimulus of loss. For some of the "‘old” firms new
opportunities for expansion open up: the new methods or commodities
create New Economic Space. But for others the emergence of the new
methods means economic death; for still others, contraction and drifting
into the background. Finally, there are firms and industries which are
forced to undergo a difficult and painful process of modernization, ration-
alization and reconstruction. It should be observed that these vital
parts of the mechanism of economic evolution, which are readily seen to
dominate many business situations and to produce results of fundamental
importance, can never be revealed statistically by measuring variation in
an index of production, or analyzed theoretically in terms of total output.
Such an index would display nothing except increase. But mere increase
in total output would not produce those effects. It is disharmonious or
one-sided increase and shifts within the aggregative quantity which
matter. Aggregative analysis, here, as elsewhere, not only does not tell
the whole tale but necessarily obliterates the main (and the only interest-
ing) point of the tale.

As long, however, as new entreprises continue to emerge and to pour
their stream of expenditure into the system, all those effects may be
overcompensated. The “turn” need not come, the situation

The Contours of Economic Evolution

135

described before need not give way to the situation we are trying to
characterize now, until entrepreneurial activity slackens and eventually
stops. Hence, it is essential to visualize clearly the reasons why entre-
preneurial activity in fact slackens and stops at a point which can be
theoretically determined. In actual life so many accidents and incidents
combine to produce this result that we are never lacking plausible reasons
with which to explain that stoppage in any given case. But this obscures
the question of principle with which we are now concerned — whether the
mechanism described would in the absence of such incidents and accidents
run on forever (on a ''prosperity plateau’’) or come to a stop from reasons
inherent in it and by virtue of its own effects and of the business situations
it creates.

First, since entrepreneurial activity characteristically starts off in a
definite direction and does not distribute itself equally all over the indus-
trial field — since it aims typically at production of a given commodity or
group of commodities — its possibilities are, in every instance and in any
given state of the economic body, definitely limited. The results of
innovation act directly on certain individual prices, and therefore set
definite limits on further advance in that direction or related directions.
Anxious as we are just now to work out only the pure logic of our subject,
and to avoid anything of a consequential or incidental character, how-
ever important it may be in practice, we will even retain, for the
moment, the heroic assumption that not only the full increase in the new
product, which will be brought about by more and more firms taking up
production, and the incident fall in its price have been perfectly correctly
foreseen by the first in the field, but also that those who came later also
foresaw correctly what possibilities were left to them. It is easy to see
that a point will be reached at which our new commodity will be produced
at minimum unit cost equal to the price at which it will sell. Profits will
be eliminated, the impulse of innovation will, for the time being, have
spent itself.

But second, since entrepreneurial activity upsets the equilibrium of
the system and since the release of the new products, in particular, brings
disequilibration to a head, a revision of values of all the elements of the
system becomes necessary and this, for a period of time, means fluctua-
tions and successive attempts at adaptation to changing temporary
situations. This, in turn, means the impossibility of calculating costs
and receipts in a satisfactory way, even if necessary margins are not
altogether absent while that goes on. Hence, the diflSculty of planning
new things and the risk of failure are greatly increased. In order to carry
out additional innovations, it is as necessary to wait until things settle
down as it was in the beginning to wait for an equilibrium to be established
before embarking upon the innovations the effects of which we are now

136

Business Cycles

discussing.^ Therefore, along with new products streaming into markets,
and with repayments increasing in quantitative importance, entrepre-
neurial activity tends to slacken, until finally it ceases entirely.

The reader is invited to work out the details of the picture and to
form an opinion about the behavior in this process of the factors and
indicators of business situations listed in the first chapter, before he
turns to our discussion of time series, which will again take up these
matters. Two things only call for notice. First, the outstanding con-
ductor that spreads effects all over the system (although its causal impor-
tance can easily be exaggerated and although its way of functioning is
still more open to misinterpretation) is entrepreneurs’ expenditure, and
this expenditure is now being reduced. This proposition is not quite
symmetrical to the analogous one in the case of the situation characteristic
of the period of gestation since there, the element of ‘^crowding out the
old” being absent, all effects reached the system through that one chan-
nel. But as far as it may be allowed to pass muster, it should be observed
that while mere stoppage of additional borrowing (remember that so far
nobody borrows but entrepreneurs) would be sufficient under the circum-
stances to bring discomfiture to many firms and, in particular, to depress
the price level, ^ yet this is not all that happens. Repayment of bank
loans by entrepreneurs, annihilating balances, comes in to accentuate
effects. This process we shall, in order to distinguish it from other cases
of shrinkage of deposits, designate by the term Autodeflation. It occurs
without any initiative on the part of banks and would occur even if
nobody ever went bankrupt or restricted operations, and if no bank ever
called or refused a loan. We are not concerned with the questions

1 Although we are now concentrating on the task of carpentering our logical schema,
it may be well to point to the “factual” justification of this. The English boom at the end
of the seventeenth century did not start before 1688, the spurt in economic activity in the
United States at the end of the sixties of the nineteenth century, not before the end of the
Civil War. Such examples could, of course, be readily multiplied. But if the reader
admit that this is not more than self-evident in the case of external disturbance, it follows
that it will equally hold true for disturbance of relative values through any other — Le.y
internal — cause. Professor Machlup, in an address to the writer’s class on business cycles,
seems to have expressed the matter felicitously (though from a somewhat different stand-
point) by saying that entrepreneurial risk of failure is at a minimum in equilibrium and
slowly rises as prosperity develops. Entrepreneurial activity stops at a point at which
that risk is a maximum. It will be seen that such an argument is not, as it at first sight
seems, incompatible with our proposition that risk bearing is no part of the entrepreneurial
function.

® No firm could however, under our present assumptions, be submerged merely by a
fall in price level that would otherwise have survived. This is a truism considering we now
assume absence of fixed debt-charges and of “ stickiness” in any cost elements, yet worth
remembering. It suffices to dispel some of the errors surrounding that subject. That is
why the reader should supply formal proof.

The Contours of Economic Evolution

137

whether a different and less passive reaction of the monetary mechanism
would either intensify or soften the phenomena under consideration, and
what monetary policy ‘^should’’ be followed under the circumstances.
All we are interested in at the moment is that money and credit do react
in a definite way, that their behavior is nothing but adaptation to an
underlying economic process by which that behavior, as well as the
behavior of all aggregative quantities, is explained, while the reverse is
not true.

Second, the sum total of the phenomena we are surveying forms a
connected whole which has a definite meaning and, if such teleology is
permissible, may be said to have a definite function. It constitutes the
response by the system to the results of entrepreneurial activity — adapta-
tion to the new things created, including the elimination of what is incap-
able of adaptation, resorption of the results of innovation into the system,
reorganization of economic life so as to make it conform to the data as
altered by enterprise, remodeling of the system of values, liquidation of
indebtedness. It is readily seen that, under our assumptions and with
but minor qualifications, that sequence of phenomena leads up to a new
neighborhood of equilibrium, in which enterprise will start again. This
new neighborhood of equilibrium is characterized, as compared to the
one that preceded it, by a ‘^greater’’ social product of a different pattern,
new production functions, equal sum total of money incomes, a minimum
(strictly zero) rate of interest, zero profits, zero loans, a different system
of prices and a lower level of prices, the fundamental expression of the
fact that all the lasting achievements of the particular spurt of innovation
have been handed to consumers in the shape of increased real incomes.
Thus, as soon as the entrepreneurial impulse ceases to act which propelled
it away from its previous neighborhood, the system embarks upon a
struggle toward a new one, under the influence of forces^ which should
now be perfectly clear and which are sure, barring occurrence of external
disturbances, to land it there eventually. The process takes time and
may display oscillations and relapses. But it is at the bottom of all those
apparently irregular movements during which losses seem to be strewn
at random over the whole of economic life, and under present assumptions
cannot cease until, through however many rearrangements that are dis-
avowed by the next day, it has accomplished the task.

It is a long way from this schema to the point of junction with his-
torical fact. Innumerable layers of secondary, incidental, accidental, and
‘^external’’ fact and reactions among all of them and reactions to reactions
cover that skeleton of economic life, sometimes so as to hide it entirely.

^ There is, of course, nothing allegorical about that term: the “forces” consist, to use
Spiethoff’s telling phrase, in “the candy of gain and the whip of losses,” and their eventual
success can be established by formal proof of the type alluded to in the second chapter.

138

Business Cycles

But the writer must have been sadly lacking in expository skill if the
reader does not recognize the common sense and the realistic counterpart
of this theoretical world, every element of which links up with a fact of
everyday experience. We shall refer to this construction as the Pure
Model or the First Approximation.

B. Looking at the Skeleton. — When we look at the skeleton, we
behold the picture of a distinct process in time which displays functional
relations between its constituent parts and is logically self-contained.^
This process of economic change or evolution, moreover, goes on in units
separated from each other by neighborhoods of equilibrium. Each of
those units, in turn, consists of two distinct phases, during the first of
which the system, under the impulse of entrepreneurial activity, draws
away from an equilibrium position, and during the second of which it
draws toward another equilibrium position.

Each of those two phases is characterized by a definite succession of
phenomena. The reader need only recall what they are in order to make
the discovery that they are precisely the phenomenon which he associates
with ‘‘prosperity’^ and “recession”: our model reproduces, by its mere
working, that very sequence of events which we observe in the course of
those fluctuations in economic life which have come to he called business cycles
and which, translated into the language of diagrams, present the picture
of an undulating or wavelike movement in absolute figures or rates of
change. It is worth while to pause in order to comment on this fact.

First, it is by no means farfetched or paradoxical to say that “prog-
ress ” unstabilizes the economic world, or that it is by virtue of its mecha-
nism a cyclical process. A theory of economic fluctuations running in
terms of external factors plus innovations might be considered self-
evident and only another way of stating that there would be no cycles in
an undisturbed stationary, or growing, flow. The reader should keep
this in mind in the midst of the complications which must inevitably
follow and in the face of the fact that theory as well as public opinion
have steadfastly refused to take that common-sense view of the matter
and persisted in tacitly assuming that “progress” is one thing (and
naturally smooth) while fluctuations are another thing, differing from it,
perhaps inimical to it. It is, after all, only common sense to realize
that, but for the fact that economic life is in a process of incessant internal
change, the business cycle, as we know it, would not exist. Hence, it is
just as well to try to link so obviously important an element systematically

^ It is, in logic and discarding the influence of external factors and of growth, as self-
contained as is the stationary circuit flow. Time enters, indeed, in a different sense, but it
is still theoretic time, i.e.^ a time which serves as an axis for a logical (and not merely his-
torical) sequence of events. The reader should, however, bear in mind what has been
said in the preceding chapter about the possibility of profitless and of prosperityless cycles.

The Contours oe Economic Evolution

139

to any explanation of the capitalist economy in general and of business
cycles in particular. Our proof that the few fundamental facts so far
included in our model suffice to produce a ‘^wave’’ pervading economic
life, must in any case be of diagnostic value and shed some light on such
fluctuations as we observe.

Second, the fact that innovation would suffice to produce alternating
prosperities and depressions does not establish, of course, that these
cycles are actually the ones which we historically designate as business
cycles. Even if we make the reservation, obviously necessary, as to
external factors, there may be other ‘‘causes."" Our proposition that
innovation — again, when seen in its true extent and not confined to some
part or form of what we mean by it — ^is actually the dominant element
which accounts for those historical and statistical phenomena, is so far
only a working hypothesis, which will be on trial throughout this book.
Moreover, our hypothesis is not yet in a shape to serve at all and
it remains to be seen how much matter unconnected with its present
content will have to be added to it.

But, third, starting out from an impression, drawn from economic
history, that it will in fact work well, we are encouraged not only by the
rough agreement of the symptoms which our model produces with the
symptoms which we actually observe in the course of business cycles, but
also by the ease with which certain elements, so far banished from our
picture, fit into it and can be given their due without condemning us to
any eclecticism. They seem, indeed, to acquire their true place and
significance only with reference to it. A few examples will show this.

Most students of the business cycle have been impressed by the logic
with which one cyclical situation produces the next. This was really the
discovery which ushered in the scientific studies of the cyclical mechanism
and has more recently been stressed by Professor Wesley Mitchell. But
if we stop there, our situation is obviously unsatisfactory, for the process
then lacks motive power and looks very much like a perpetuum mobile.
That difficulty vanishes and, in particular, the crucial question of what
causes the turn from prosperity into recession finds a very natural answer
if we accept our schema. We acquire the right to look upon recession as
the reaction to prosperity in the way first clearly recognized by Juglar,
without having in turn to explain prosperity by preceding recession.^

^ With Juglar’s formula that prosperity is the cause unique of depression practically all
“theories” agree. But the self-generating theories also claim that the causation of
prosperity lies in the conditions of easy money, low stocks, cheap labor and raw materials
found in depression periods, and that prosperity is merely an outgrowth of these. This
line of reasoning may perhaps serve (although there is some doubt about that) in order to
account for revival up to normal, but obviously cannot serve beyond that. So far, we have
not dealt with any “depression” that leads below normal, and prosperity is therefore seen
to be explainable without it. The subject will be taken up later on.

140

Business Cycles

Again, most people will link up recessions with, errors of judgment,
excesses (overdoing), and misconduct. This is no explanation at all;
for it is not error, etc., as such but only a cluster of errors which could
possibly account for widespread depressive effects. Any ‘"theory’’ that
rests content with this must assume that people err periodically in the
way most convenient to the economist. Our model, by showing the
emergence of situations in which it is understandable that mistakes of all
sorts should be more frequent than usual when untried things are
being put into practice and adaptation to a state of things becomes
necessary, the contours of which have not yet appeared) does away with
this and shows the place of the element of error in the various phases of
the process, without having to introduce it as an independent, still less as a
necessary, element.^

Another such dem ex machinal closely related to error, is “anticipa-
tion.” It has been pointed out in the second chapter that the introduc-
tion of this element constitutes a material improvement of our technique,
but also that expectations cannot be used as part of our ultimate data
in the same way as taste for tobacco can. Unless we know why people
expect what they expect, any argument is completely valueless which
appeals to them as causae efficientes. Such appeals enter into the class of
pseudo-explanations which already amused Moliere.^ But if we under-

^ It is believed that our arrangement assigns its proper place, not only to errors of various
types, but also to other kinds of aberration of economic action, and makes them analyti-
cally workable. The actual quantitative importance of the element of error is, however, a
dijfferent question. The writer has not been able to answer it to his own satisfaction. So
much depends here on personal observation which can only cover infinitesimal segments
of reality, and so little value attaches in this matter to newspaper wisdom, that opinions
must be arrived at on a very inadequate basis of fact and should be presented with becoming
diffidence. There is no lack, of course, in the history of the events which led to the great
crises that everyone knows, of glaring instances of all possible kinds of both error and mis-
conduct. But for the span of time to which his own observations refer, the writer con-
fesses to a feeling that the causal importance of both is likely to be exaggerated. There is a
routine procedure for dealing with new business propositions which does not make it very
easy to ** get away ’’ with either a foolish or a fraudulent scheme. Technological feasability
and conditions of commercial success, actual or potential competition included, are exam-
ined, as a rule, with considerable care and by several independent sets of experts, some of
whom have an interest in, and a habit of, giving advice that leans to caution. They may all
be wrong, of course, as they all may be corrupt, but to the writer that does not seem to be
an occurrence so frequent that mere pointing to it would, by itself, constitute adequate
explanation. A definite reason other than error and misconduct is, as a rule, necessary to
account for failure. But then the writer himself may well be wrong and too much influ-
enced by cases that were exceptional in the amount of care and study bestowed on them.
At any rate, this opinion of his, right or wrong, must be distinguished from his opinion
about the way in which the element of error should be treated, no matter how important
or unimportant it may be.

® His examiner asks the question: Quare opium facit dormiref And his candidate
answers: Quia est in eo nrtus dormihva cuius est naiura assopire. Theorists whose analytic

The Coototjbs of Economic Evolution

141

stand independently how the situations come about in which, for example,
windfall gains, rising prices, and so on produce waves of optimism, we
are free to use the fact that this optimism will feed upon itself and crystal-
lize so as to become an element of the mechanism of cyclical events and
the ‘"cause’’ of secondary phenomena. Professor Pigou does not seem
to hold an optimism-pessimism theory of cycles in any other sense. His
exposition, therefore, is not open to the objection of principle alluded
to. But there still remains the question of fact, how important, even
within their rightful domain, businessmen’s optimisms and pessimisms
actually are. There is some danger in generalizing from familiar facts
about stock exchange or land speculation — observation of which, however,
also clearly teaches that its moods are not independent causes but con-
sequential phenomena. Industry and trade are much less given to being
swayed by moods. Moreover, the writer confesses that he sometimes
wonders in what world those theorists live who do not doubt for a moment
the efficacy of “depressed states of mind” — ^to be mended, as an eminent
author seems to think, by “ballyhoo” — ^in accentuating (let alone inde-
pendently causing) depressions. His experience is to the efPect that
the average businessman always hopes against hope, always thinks he
sees recovery “around the corner,” always tries to prepare for it, and
that he is forced back each time by hard objective fact which as long as
possible he doggedly tries to ignore. The history of the recent world
crisis could almost be written in terms of ineflfectual attempts to stem
the tide, undertaken in a belief, fostered in this case by all the prophets,
that business would be “humming” in a few months. This does not
mean that businessmen are always optimistic. Far from it. What it
does mean is that waves of both optimism and pessimism are not the
obvious realities they seem to be to observers who judge from manias.

Other examples of how much-emphasized facts fit into our schema
abound. We have, for instance, nothing to offer in defense of the
so-called overproduction and underconsumption theories. But it is
readily seen how our process may produce situations which, to the
untrained mind, lend color to those primitive attempts at explanation.
As regards the facts that underlie the various theories which attribute
business cycles to overinvestment in durable producers’ goods or to invest-
ment in wrong directions (malinvestment), it is easily seen, first, that
variations in real investment are, as a matter of fact, intimately con-
nected with the causation and the mechanism of cycles; second, that in

apparatus drives tliem back upon psychology” are always in danger of drifting into this
type of argument. It is, therefore, of some importance that the reader should satisfy
himself that the analytic schema here presented is not a psychological theory in this
sense, although the behavior of the entrepreneur is amenable to description in psychological
terms.

Business Cycles

le course of our process cases of both overinvestment and malinvestment
ill understandably occur; and, third, that in other cases an appearance of
v'erinvestment will be created.

Still other examples will be met as we go along. But one more point
lould be mentioned here. The analytic schema presented in this book
rfdently does not belong to the family of monetary theories of business
yrcles. It does presuppose a certain behavior of money and credit, many
matures of which are essential for it; but if this were enough to con-
itute a monetary theory of cycles, there would be no nonmonetary
aes, since every theory does this either explicitly or implicitly. If we
ish to make that designation distinctive, we must follow Mr. Hawtrey
id define a monetary theory by the criterion that it looks upon cycles as
purely monetary phenomena’’ in the sense that peculiarities of the
)here of money and credit account for their existence and that but for
lose peculiarities they would not exist at all. It should be clear by now
id will become still more so later on, that the writer believes those
leories to be wrong and, in their practical implications, misleading. But
1 the facts, and in particular all the relations of monetary time series to
ihers, on which those theories draw, find their place and interpretation in
ir schema. It must be realized, however, that the fundamental logic of
le cyclical process of evolution is entirely independent of all those acces-
)ries which, however important they may be, make after all poor corner-
ones. We return to our argument. >

Fourth, there is a point at which the picture of the working of our
odel presents features that seem to differ from widely accepted, though
>t unanimous, opinion. It does not give to prosperity and recession,
latively to each other, the welfare connotations which public opinion
taches to them. Commonly, prosperity is associated with social well-
nng, and recession with a falling standard of life. In our picture they
‘e not, and there is even an implication to the contrary. This is partly
le to certain facts which have not been introduced as yet, and which to
me extent justify popular opinion. But we do not wish that feature of
ir present picture to be lost. It contains an important truth. Pros-
jrity in our sense is, in fact, very far from being synonymous with
elfare — ^witness, for example, the ^‘hungry forties.” And times of
*olonged ^‘depression” are very far from being synonymous with misery
■’Witness, for example, the progress in the standard of life of the working
asses, 187S-1897. Our model supplies the explanation of this, and we
tall repeatedly have to insist upon it.

The socialist form of organization has the virtue of bringing out
le economic nature of things much more clearly than capitalism.

1 a socialist community it would, for instance, be evident to everyone
lat what a nation gains from international trade consists of the imports

The Contouhs of Economic Evolution

143

and that exports are what it sacrifices in order to secure them. Similarly,
it would be obvious that times of innovation — ^witness the Gosplan — are
times of effort and sacrifice, of work for the future, while the harvest comes
after. This is so also in capitalist society; and that the harvest is gath-
ered under recessive symptoms and with more anxiety than rejoicing is
easily accounted for and does not alter the principle.^ We may note,
again, that recession, besides being a time of harvesting the results of
preceding innovation, is also a time of harvesting its indirect effects. The
new methods are being copied and improved; adaptation to them or to
the impact of the new commodities consists in part in “induced inven-
tions”; some industries expand into new investment opportunities created
by the achievements of entrepreneurs; others respond by rationalization
of their technological and commercial processes under pressure; much
dead wood disappears. There is, thus, a good deal of truth in the popular
saying that “there is more brain in business” at large during recession
than there is during prosperity, an observation which is, at the same time,
seen not to contradict any inference that may be drawn from our model.

Fifth, there is nothing in the working of our model to point to periodic-
ity in the cyclical process of economic evolution if that term is taken to
mean a constant period. And there is no rhythm or cycle if we choose to
define either of them with reference to periodicity in that sense. But
both rhythm and cycles are present in a much more relevant sense. For
there is a process which systematically produces alternating phases of
prosperity and depression through the working of a definite mechanism
set in|o motion by a definite “force” or “cause.” All we can thus far
say about the duration of the units of that process and of each of their
two phases is that it will depend on the nature of the particular innova-
tions that carry a given cycle, the actual structure of the industrial organ-
ism that responds to them, and the financial conditions and habits
prevailing in the business community in each case. But that is enough
and it seems entirely unjustified to deny the existence of a phenomenon
because it fails to conform to certain arbitrary standards of regularity.^

^ Needless to say, the above “evaluation” of the recessive phase does not carry any
laisser-faire connotations. To begin with, policy is not primarily concerned with recessions
but with depressions, which we have not yet encountered. Besides, it does not imply that
recessive symptoms could not be managed as such and as distinct from the process of
adaptation which gives rise to them. It bears, however, upon the question of policy in two
ways. First, in that it shows that recession is a process that fills a function and not simply
a misfortune; second, in that it shows that the recessive symptoms which people dislike are
part of the mechanism of that process and not accidental to it and that hence any manage-
ment of them which is not prepared to injure the process must be an extremely delicate
task.

^ Professor Irving Fisher, for example, argues in his paper in the Journal of the American
Statistical Association^ 1923, that plus and minus deviations in time series do not reveal

144

Business Cycles

We take the opportunity of recalling the self-explanatory concept of
Internal Irregularity — ^to contrast with the concept of External Irregu-
larities due to action of external factors.

Sixth, one aspect of the relation between variations of social aggregates
and variations of the quantities and values in individual industries and
concerns deserves to be noted. From the standpoint of aggregative
theory, it is in the nature of a paradox to say that partial disequilibria —
innovation and response to innovation create in the first instance nothing
else — ^produce what obviously is a general disequilibrium in the system as
a whole (see Chap. II, sec. D, particularly the quotation from Mr.
Harrod) . But we realize now in what sense that is so, how it comes about,
and how aggregative quantities are thereby changed. Perhaps it is only
common sense to recognize that, in order to produce effects on aggregates,
a factor or event need not itself be an aggregate or directly act on an
aggregate. It follows on the one hand that, relations between aggregates
being entirely inadequate to teach us anything about the nature of the
processes which shape their variations, aggregative theories of the busi-
ness cycle must be inadequate, too; and on the other hand, that it is not
a valid objection against an analysis of business cycles that it deals only
with partial situations. This applies, of course, to many "‘theories ” such
as, for example, the harvest theory: the mere fact that it locates causes in
one sector of the system only, should not be recorded against it, whatever
its other shortcomings may be.

Seventh, it should be emphasized once more that our model and its
working is, of course, strongly institutional in character. It presqpposes
the presence, not only of the general features of capitalist society, but also
of several others which we, no doubt, hold to be actually verified but
which are not logically implied in the concepts either of economic action
or of capitalism. Our argument rests on (abstractions from) historical
facts which may turn out to belong to an epoch that is rapidly passing.
In this sense the analysis presented has, in fact, itself been called his-
torical. There is no objection to this. Any application must in each
case wait upon the proof that the conditions assumed actually did exist, or
may reasonably be expected to have existed, at the time envisaged. We
assume not only private property and private initiative but a definite
type of both; not only money, banks, and banking credit but also a
certain attitude, moral code, business tradition, and “usage” of the
banking community; above all, a spirit of the industrial bourgeoisie and

characteristic phases and do not recur. This is true (and even understandable) only from
the standpoint of such arbitrary standards. In every other sense “deviations*’ do recur
and indeed characterize phases. The writer here entirely agrees with Professor Mitchell,
who unhesitatingly recognizes “recurrence” without “strict periodicity.” The question
both of principle and of fact will, however, be taken up later on.

The Contours of Economic Evolution

145

a schema of motivation which within the world of giant concerns — the
pattern which we have called Trustified Capitalism — and within modern
attitudes of the public mind is rapidly losing both its scope and its mean-
ing. This is why in our discussion of postwar events we shall put the
question whether and how far the process still persists. But the writer is
quite content to shed light, such as it is, on a piece of economic history
and to leave to the reader the decision whether or not he will consider it
relevant to practical problems or not. The deep-reaching question
whether it is the process of capitalistic evolution itself that creates the
social situations in which it dies out will only peripherically be touched
upon.

C. The Secondary Wave ; Second Approximation. — We have seen that
if innovations are being embodied in new plant and equipment, additional
consumers’ spending will result practically as quickly as additional pro-
ducers’ spending. Both together will spread from the point or points in
the system on which they first impinge, and create that complexion of
business situations which we call prosperity. Two things are then prac-
tically sure to happen. First, old firms will react to this situation and,
second, many of them will “speculate” on this situation. A new factory
in a village, for example, means better business for the local grocers, who
will accordingly place bigger orders with wholesalers, who in turn will do
the same with manufacturers, and these will expand production or try to
do so, and so on. But in doing this many people will act on the assump-
tion that the rates of change they observe will continue indefinitely, and
enter into transactions which will result in losses as soon as facts fail to
verify that assumption. Speculation in the narrower sense of the word
will take the hint and start on its familiar course or rather, anticipating
all this, stage a boom even before prosperity in business has had time to
develop. New borrowing will then no longer be confined to entrepre-
neurs, and “deposits” will be created to finance general expansion, each
loan tending to induce another loan, each rise in prices another rise. Here
those transactions enter into our picture which 'presup'pose an actual or
expected rise in prices in order to become possible.^ Our analysis adds
nothing to this well-known piece of mechanism except the ignition of it
and the means of distinguishing it from the more fundamental process
which sets it in motion. This is what we will call — ^retaining a perhaps
questionable term introduced in the writer’s book of 1911 — ^the Second-
ary Wave, which superimposes its effects on those of the Primary
Wave.

^ While, as we have seen, no such rise is, on principle, necessary to call forth innovations
and while they are, in the Pure Model, profitable without it, there may and generally will be
soTue which show profit only if rising prices are anticipated. These belong here and not to
the igniting mechanism.

146

Business Cycles

There is no need to emphasize how great a mass of fact now enters our
picture. Indeed, the phenomena of this secondary wave may be and
generally are quantitatively more important than those of the primary
wave. Covering as they do a much wider surface, they are also much
easier to observe; in fact they are what strikes the eye first, while it may
be difiScult, especially if the innovations are individually small, to find the
torch responsible for the conflagration. This is one reason why the
element of innovation has been so much neglected by the traditional
analysis of the business cycle: it hides behind, and is sometimes entirely
overlaid by, the phenomena of what appears at first glance to be simply a
general prosperity, which is conspicuous in many branches and strata and
apparently unconnected with any activity that could in any way be called
innovating, let alone ‘‘inventing.” It seems only natural to think that
for this general prosperity some equally general — e,g.y monetary —
explanation should be found and that both it and the reaction to it should
be locked upon, as they actually are by many fellow workers, as mean-
ingless and functionless disturbances of economic life and of the march
of progress.

The cyclical clusters of errors, excesses of optimism and pessimism
and the like are, as we have seen, not necessarily inherent in the primary
process — which process would produce ups and downs and, be it particu-
larly remembered, also losses without any errors — although they can be
adequately motivated by it. But now they acquire additional impor-
tance. Part of the phenomena of the secondary wave consists, in fact,
of nothing else. Among the logically nonessential, but practically most
important facts we now mean to insert, one, though mentioned above,
may deserve a further remark. We will discuss it in terms of Professor
Irving Fisher’s Debt-Deflation Theory not of cycles — ^the existence of
which he denies — ^but of Great Depressions.^ Of all the “starters” of
debt “the most common appears to be new opportunities to invest at a big
prospective profit [Professor Fisher’s italics] as compared with ordinary
profits and interest, such as through new inventions, new industries,
development of new resources, opening of new lands or new markets”

^ See the paper under that title in Econometrica for October 1933 or Booms and Depres-
sions, 1932. Since Professor Fisher recognizes that overindebtedness must have its starters
and since, among those starters, he stresses facts that come within our concept of inno-
vation (the Erie Canal, railroads, cotton developments) while others are what we call
external factors, there is obviously considerable affinity between that interpretation and the
one presented in this book. Moreover, the present writer agrees entirely with some of the
*‘49 articles” by which, in that paper. Professor Fisher formulates his “creed.” As to
debt-deflation as a basis for a theory of booms and depressions, the writer can only repeat
what he urged in a conversation he had on the subject with that eminent economist: “If
a man dies of consumption, I say he dies of consumption and not of the fever which is one
of the concomitants of the process.”

The Contoubs of Economic Evolution

147

{of. city p. S48). This is so. But we have seen that if the borrowers are
entrepreneurs and everything is as it was assumed to be in our Pure
Model, no dire consequences need, autodeflation notwithstanding, follow
from this. As far as that goes, we have only to add a qualification about
entrepreneurial miscalculations. Whenever loans are used in ways which
will decrease costs per unit of product, the same may apply to the borrow-
ing of nonentrepreneurs, even of old firms which borrow in order to carry
out adaptations that prove sufficiently successful. Professor Fisher,
therefore, rightly emphasizes o^^erindebtedness induced, primarily, by
easy money. But he does not define overindebtedness. Nor is it easy to
do so. The only way which the writer can think of is precisely by refer-
ence to ‘‘productivity.” And the processes of the secondary wave, in
fact, supply us with plenty of instances of unproductive loans. Once a
prosperity has got under sail, households will borrow for purposes of
consumption, in the expectation that actual incomes will permanently be
what they are or that they will still increase; business will borrow merely
to expand on old lines, on the expectation that this demand will persist
or still increase; farms will be bought at prices at which they could pay
only if the prices of agricultural products kept their level or increased.^
In these cases there is no increase in productivity at all, and it is this
fact and this fact alone which is responsible for a fall in prices sometimes
spelling disaster, even without speculation in the narrower sense of the
word, which however never fails to add to the structure of debt. “Evi-
dently debt and deflation go far toward explaining a great mass of phe-
nomena in a very simple logical way” (p. 342).

The reader wiU see how easy it is to jump from this to misleading
conclusions. The only conclusion that really follows is that the credit
machine is so designed as to serve the improvement of the productive
apparatus and to punish any other use. However, this turn of phrase
must not be interpreted to mean that that design cannot be altered. Of
course it can and also the existing machine can be made to work in any one
of many difiierent ways. Professor Fisher’s suggestions about “reflation ”
by open-market operations, which illustrate very instructively how many
questions besides those of the efficacy of the measure proposed and of its
ulterior consequences enter into any such recommendation, and how
completely they are ignored by so eminent a monetary planner, do not
now concern us. But although recommendations are no part of the task

^TMs may be expressed by saying that in prosperity present earnings which are
ephemeral and future earnings which are imaginary, are capitalized. Excessive borrowing
is facilitated thereby, A subsequent fall in prices then impairs these values and may
enforce liquidation even before, and independently of, any default in interest payments.
This point has been emphasized by Professor Hytten in his Presidential Address to Section
G of the Australian and New Zealand Association for the Advancement of Science, 1937 .

148

Business Cycles

of this book, it should be pointed out that distinction between debts
according to purpose, however difficult to carry out, is always relevant to
diagnosis and may be relevant to preventive policy.

The break in secondary prosperity is similarly induced by the turn of
the underlying process. The latter supplies the only adequate explana-
tion of the former, which in fact constitutes the great crux of those theories
of the cycle that attempt to deal with it by itself.^ Again, we will not
stay to describe the details of a pattern that is familiar to everyone.
Any prosperity, however ideally confined to essential or primary proc-
esses, induces a period of liquidation which, besides eliminating firms that
have become obsolete beyond the possibility of adaptation, also involves
a painful process of readjustment of prices, quantities, and values as the
contours of the new equilibrium system emerge. But when we take
account of the phenomena which constitute the secondary wave, we real-
ize at once that there is much more to liquidate and to adjust. In the
atmosphere of secondary prosperity there will also develop reckless,
fraudulent, or otherwise unsuccessful enterprise, which cannot stand the
tests administered by recession. The speculative position is likely to
contain many untenable elements which the slightest impairment of the
values of collateral will bring down. A considerable part of current and
investment operations will show loss as soon as prices fall, as they will by
virtue of the primary process. Part of the debt structure will crumble.

AU this does not necessarily amount to panic or crisis — ^neither word,
let us recall, is a technical term — ^but it easily induces panics or crises. If
they occur, still another situation is created, than would otherwise
prevail, and additional adjustments become necessary. But even
if they do not, we readily see the two effects which define the Vicious
Spiral, On the one hand, any fall in values which enforces liquidation,
induces quite mechanically another fall in values. ‘‘Prices fall because
they have fallen’^ (Marshall). Measures of defense, efforts made by
firms or households to repay loans, or by banks to call them in order to
improve liquidity, drive debtors in the well-known way toward the very
rocks which those measures were taken to avoid. Freezing of credits,
shrinkage of deposits, and all the rest follow in due course. On the
other hand, not only we, the observers, but also the dramatis personae
realize how much there is to liquidate, or even go into hysterics about
it. Then pessimistic expectation may for a time acquire a causal role.
But again it is necessary to warn against overrating its importance. The
simplest appeal to experience should be sufficient to justify this warning.

^ That is the case with most theories. Hence the embarrassment voiced by the ques-
tion: Why should there be a break at all — what is it that puts an end to prosperity? This
is but the natural consequence of the fact that what we call the johenomena of the secondary
wave is all their authors see.

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149

No great crisis has ever come about that was not fully explainable by the
objective facts of the situation. Expectation not so conditioned never
has produced more than short-lived spurts or breaks. And this is true
not only for general business situations but for any particular market.
No corner ever succeeded unless the course of events gave independent
support. No amount of optimistic expectation could have kept up the
price of copper in the twenties; no amount of pessimistic expectation
could have kept it down if sources of supply as important as those which
were added, had suddenly been exhausted.

Now that class of facts, whenever it is of suflScient quantitative signifi-
cance, has an important bearing upon our schema. As long as we took
no account of it, we had only two phases — ^Prosperity and Recession — in
every unit of the cyclical process, but now we shall understand that under
pressure of the breakdown of the secondary wave and of the bearish antici-
pation which will be induced by it, our process will generally, although
not necessarily, outrun (as a rule, also miss) the neighborhood of equilib-
rium toward which it was heading and enter upon a new phase, absent in
our first approximation, which will be characterized by what we shall refer
to as Abnormal Liquidation, that is to say, by a downward revision of
values and a shrinkage of operations that reduce them, often quite
erratically, below their equilibrium amounts. While in recession a
mechanism is at work to draw the system toward equilibrium, new dis-
equilibrium develops now: the system again draws away from a neighbor-
hood of equilibrium as it did during prosperity, but under the influence of
a different impulse. For this phase we shall reserve the term Depression.
But when depression has run its course (see, however, infray sub 2), the
system starts to feel its way back to a new neighborhood of equilibrium.
This constitutes our fourth phase. We will call it Recovery or Revival.
Expansion up to equilibrium amounts then sets in and yields temporary
surplus gains or eliminates the losses incident to operation at the trough
amounts. But even apart from imperfections, this new neighborhood^
will not be the same as that which would have been reached without
abnormal liquidation. For, first, abnormal liquidation destroys many
things which could and would have survived without it (in particular, it
often hquidates and weeds out firms which do not command adequate
financial support, however sound their business may be, and it leaves
unliquidated concerns which do command such support, although they
may never be able to pay their way), and hence produces a pattern
more or less different from that which the normal process would have

^ The state of things in that, or any, neighborhood is not correctly described by saying
that there is equilibrium of forces of displacement and forces of restoration. There are,
in the ideal point, no forces of either kind: no displacement forces have as yet emerged and
the forces of restoration have done their task and spent themselves.

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Business Cycles

evolved. Second, depression and the return of the system from the
depressive excursion take time. They may take several years. During
that time data change and what would have been a neighborhood of
equilibrium when depression started is no longer one when all is over.
We will refer to prosperity and revival as the positive phases of a cycle, to
recession and depression as the negative phases.

It is again left to the reader to work out the picture of depression and
revival.^ We confine ourselves to the following comments:

1. We have seen that while recession and — if depression occurs —
revival are necessary parts of the cyclical process of economic evolution,
depression itself is not. We are able to make it understandable or
plausible that from the business situations which necessarily obtain in
recession, depression may easily develop, but in all its essential aspects
the cyclical process would be logically complete without it. Whether it
occurs or not is a question of fact and depends on accidental circum-
stances, such as the mentality and temper of the business community
and the public, the prevalence of get-rich-quick morals, the way — con-
scientious or otherwise — in which credit is handled in prosperity, the
ability of the public to form an opinion about the merits of proposi-
tions, the degree to which it is given to belief in phrases about pros-
perity plateaus and the wonders of monetary management and so on.
Moreover, no theoretical expectation can be formed about the occurrence
and severity of depressions. We may, in any given situation, try to
appraise the extent of existing maladjustments, of the presence of
fraudulent schemes, unsound credit,’’ and so on; but beyond such indica-
tions it is impossible to go. In a very diJfficult situation, aggravated,
for instance, by serious external events, the business community may
keep its nerves, while it may become frightened on much smaller pro-
vocation. A scare or panic, in particular, may occur almost anywhere
in the course of a cycle, although, of course, it is much more likely to
occur at certain junctures than at others. Such a panic may mean very
little and yet violently send down values and even certain physical
quantities. A lesson follows from this for the analysis of time series:

^ If the reader really wishes to master the analytical schema presented, to learn how to
use it and to reap the benefit, such as it is, which his economic thought may derive from the
study of this book, he should on no account omit that exercise. He should first form expec-
tations about the behavior of the dozen or two more important time series. We shall do
this later on, when we take up the study of our statistical material, but it is very important
that the reader should do it for himself and compare his results to what he will read. He
will encounter such familiar phenomena as the decrease in velocity of deposits, which adds
itself to their shrinkage. He will wonder how important in all this is the initiative of banks
in calling in loans, or in giving support to tottering concerns. He will be able to insert
into their proper places in the picture all the phenomena which everyday experience
leads us to associate with depression and revival.

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151

We must not trust our graphs implicitly. Both peaks and troughs may
easily mislead and it is hardly an exaggeration to say that, as far as infor-
mation about fundamental processes goes, they are precisely the most
unreliable items in an array. ^

Next, what may be termed the Problem of the*Ilecovery Point now
emerges in its proper setting. The much-debated questions whether or
not the system stops of itself when once it has entered upon a negative
phase, and whether it then starts of itself on a positive one, only arise
in the case of four-phase cycles. For we know that and why the process
of liquidation or absorption which constitutes recession in a two-phase
cycle will, barring minor oscillations, die out when it has done its work.
We also know that and why, as long as the capitalist mechanism and
capitalist motivation are intact, entrepreneurial activity will then resume
without any external stimulus. So far, our analysis leads us to agree
with those authors who believe in the existence of ‘‘recuperative forces,”
and merely gives more precise meaning to this otherwise not very help-
ful phrase. But this is no longer so in the case of a four-phase cycle.
Depression, as we have seen, has not simply a definite amount of wort
to do. On the contrary, it has a way of feeding upon itseh and of
setting into motion a mechanism which, considered in isolation, could
in fact run on indefinitely under its own steam. We have indicated
above what that “vicious spiral” consists in. Various models have
been constructed in order to display it.^ But proving from the properties
of such a mechanism, the elements of which have been taken out of their
setting in the economic organism, that the process will go on intensifying
itself, does not amount to proving that its real counterpart will actually
do so; else, we could equally well argue that, once we have a cough that

^ To all this, however, there is a qualification the importance of which will become
clear later on. What has just been said is true only so long as we keep to the hypothesis,
presently to be discarded, that the cyclical process of evolution consists in a succession of
units of one single type of wave. As soon as we drop it, a result more hopeful for diagnosis,
and perhaps even for prognosis, presents itself. However, the fact still remains that only
historical investigation can indicate whether in a given case depression has actually occimred
or not.

^ We will mention one only. Professor Ragnar Frisch in his paper on Circulation
Planning, Econometrica for July 1934, has analyzed the phenomenon of Incapsulation, as he
calls it, on the assumptions that prices remain constant and that people exchange their
products at regular intervals in such a way that the dollar volume of everyone’s purchases
is a constant proportion of the dollar volume of his sales at the previous turn of the wheel.
There is under these assumptions no difficulty in arriving at the result that the system will
either “inflate” or “deflate” itself without any assignable limit. The model seems well
devised to describe certain situations. But it is also a good instance for the argument
to be presented above, because it eliminates, much more visibly than others do, all the
organs of adaptation from the system, on the presence of which an opposite inference can
be based.

152

Business Cycles

irritates our throat and thus induces further coughing, we must go
on coughing forever. The problem is to analyze a complex sequence
of short-time situations in which the facts described by such theories
of the spiral form only one of many components.

We will first distinguish between the course of events in industrial
and commercial business, on the one hand, and the course of events in the
stock exchange and other speculative markets, on the other hand. The
latter is quite likely to conform to the spiral pattern. Traditional doc-
trine relies on three factors of recovery from a slump. First, bears will
cover and thus provide a parachute. So they will from time to time, and
this would rally the market if there were no objective reason for relapse.
If there is, because distress selling goes on and prospects are black, each
bear attack will be followed by a stronger one. Moreover, older doctrine
seems in general to have exaggerated the regulative and smoothing effects
of speculation, as we shall see later on. Second, ‘‘insiders’’ will quietly
buy. This, in fact, is almost always done to some extent but in general
not quantitatively sufficient to turn the tide. Third, the average
investor’s attitude will change because of the increasing inducement to
invest which falling quotations seem to offer. This seems to the writer
to be most unrealistic. The average investor in such cases thinks that
Doom is at hand and the higher the returns the less he buys. The
argument entirely overlooks the shift that occurs in the investor’s demand
curve and assumes that its position is invariant to cyclical phases. It
is changing business prospects, that is to say, a fact external to these
markets, which pulls them out of depression. However, if the reader
should not agree, the following argument will but hold a fortiori.

As for industry and trade, the first step is to show that recovery will
necessarily set in if the depressive process stops (in practice it is suff cient
that it slackens perceptibly). This is easy. If there is a depression
phase, then the trough is, as we have seen, no longer what it was in the
two-phase cycle, namely a state of equilibrium.^ And it will, on reflec-
tion, be realized that this proposition is in itself sufficient to prove the
point without any resort to optimistic expectations which, however, will
soon emerge to help. For saying that firms will not act in the way which
will lead to recovery and eventually to a neighborhood of equilibrium,
would be synonymous with saying that they will deliberately forego gains
and incur losses which it is in their individual power to make or to avoid,
and scrap plant and equipment which could be profitably used. It is
sometimes objected that cramped lower-level equilibria may arise from
which people will not of themselves move. This may be so in individual

^ It should be sufficiently obvious, but we will repeat that peaks are never states of
equilibrium. This is important because much faulty analysis centers in the opposite view.
The reasons why that is so really contain the theory of the “prosperity plateau.”

The Contouks of Economic Evolution

153

cases, particularly in imperfectly competitive situations. But the prob-
ability that this state of things should prevail all over the system, in all
industries and with all concerns — ^for that would be necessary to justify
the inference — ^is indistinguishable from zero. Therefore, our problem
reduces to the question whether the depressive process does stop of itself
short of, theoretically, universal starvation.

To this question, however, there is no general answer. It can indeed
be proved that the pressure from the spiral produces reactions in the
system which tend to stop it. On the one hand, there will be what we
may term diffusion or dilution of effects. The spiral process sets in by a
number of unfavorable individual events,^ such as bankruptcies, breaks
in individual markets, shutdowns. These induce similar events, but it is
readily seen that each of them taken by itself loses momentum as its
effects spread. The failure of a concern may cause the failures of other
concerns, but part of its liabilities will be to firms which can stand the
loss and which therefore act as buffers. Each addition to unemploy-
ment will cause further and further unemployment but, taken individu-
ally, at a decreasing rate. Individual contractions of output breed
contraction all around, but the impact of each of them slackens and stops
after having gone a certain way. No doubt we invariably observe a
rapid deterioration of the business situation once the system has embarked
upon a cumulative downward process. But this deterioration is not
simply due to the fact that the spiral feeds upon itself but primarily
to the other fact that it is fed from outside, i.e., from breakdowns and
contractions which occur independently of it. It will thus be seen that
increase in total effects observed is perfectly compatible with the proposi-
tion that each individual effect tends to peter out, and that a case for
believing that the spiral itself will peter out may be made on these lines.

On the other hand, there is what we may term depression business.
This may be instanced by the case of the stoppage of a firm which induces
unemployment that in turn causes the failure of a grocer whose customers
the unemployed workmen were. This grocer’s market is not completely
annihilated, however, and if he disappears there will be some space for
other grocers to expand into. To put the matter generally, the spiral
process is a movement away from equilibrium, as we see from the increas-
ing dispersion in prices and from the increasing deviation from equilib-

^In order to understand the mechanism of the spiral, it is necessary to start from
events which affect firms, industries, sectors and not from the behavior of aggregates.
The problem in hand affords a good example for how the macrodynamic approach may
mislead. Price levels, totals of deposits and expenditme, net losses, and so on becoming
the variables to be handled, the whole economic system in depression acquires the features
of a losing concern whereas it is the essence of the process that the individual elements of
those aggregates are differently affected.

154

Business Cycles

rium relations between physical quantities. This spells not only actual
and potential losses but also actual and potential gains. Hence it will,
however great total net losses may be, not only induce contractions but
also expansions, although these may for the time being not show statis-
tically. It has often been held that it is the ensuing cheapness of cost
factors, labor, money, raw materials, which eventually breaks the spiral.
This formulation does not seem felicitous because it leaves out of account
the downward shift of demand curves which might preclude production
even if, say, steel and copper were to be had for nothing. But what can
be said is that since demand and cost curves do not shift uniformly,
opportunities arise for transactions which would not be possible otherwise
and which will do something to counteract the ravages of the spiral. It
is no doubt true that pessimistic expectations will prevent many trans-
actions from materializing which are profitable on paper. But it is per-
fectly gratuitous to postulate that this is the general case. As has been
said above, whatever the businessman’s state of mind, he will take current
business that offers itself. This is in fact one of the main differences in
the functioning of an industrial and of a speculative market.

But though it may thus be shown that a restorative tendency will
develop to work against the spiral, there is nothing to prove that it
will prevail against it. As long as we keep our argument perfectly
general, we must recognize the possibility of a system so conditioned
and of a spiral so violent that that tendency may fight a loosing battle
at any given moment and that, theoretically, the system may never
conquer the breathing space in which it could recover of itself. This
seems in fact to be the element of truth in the popular opinion that there
must be help from outside of the business organism, from government
action or some favorable chance event for instance, if there is to be
recovery at all or, at any rate, recovery without a preceding period of
complete disorganization and of indefinite length.

This result calls for a few additional remarks.

First, the above analysis does not make spirals identical with depres-
sions. We might make them identical with what we shall sometimes
call Deep Depressions, But the depression phases in our sense generally
outlast any spiral processes which may occur in their course and are
particularly likely to occur at their beginning. In general revival is from
a trough in which the situation is no longer dominated by a cumulative
downward process. Nevertheless the problem of the spiral is relevant
to the problem of the recovery point because, as we have seen, revival
will ensue when the depressive process stops and because the presence
of a spiral affords the only reason for doubting that it does stop of itself.

Second, it should be noticed that the inconclusiveness of our result
is due to our wish to face squarely a problem of general theory. ^A much

The Contours of Economic Evolution

155

stronger case for believing that, in the absence of exceptionally unfavora-
ble external factors, the system will recover “of itself’’ under almost
any practically conceivable circumstances, can of course be made by
relying on restrictive assumptions amply verified by common sense and
historical fact. One of these has frequently been expressed by means
of the observation that total income fluctuates less than total output,
the item wages plus salaries less than total income, expenditure on
consumers’ goods less than wages plus salaries. This is broadly correct
and partly accounted for by our theory of dilution of effects. But partly
it also rests on the presence of incomes which are insensitive to depression
and of social strata little affected by it, i,e.y on facts which are no part
of the logic of the capitalist engine. It still remains true that the ques-
tion whether or not a given recovery was “natural” must in every
historical instance be answered anew in the face of all the difficulties
which would beset such an investigation in any case, even if the parties
to the discussion were not a priori resolved, the one to arrive always at
an affirmative, the other to arrive always at a negative answer.

Third, it has been repeatedly emphasized that depression, unlike
recession, is a pathological process to which no organic functions can
be attributed. This proposition is indeed not quite true. In our
schematic exposition, each phase is credited with what we conceive to be
its most characteristic features and this never does justice to real life.
On the one hand, much that could live according to the criterion afforded
by the theory of equilibrium, may perish in an otherwise normal recession.
On the other hand, much that according to the same criterion cannot live
(and many maladjustments and rigidities) will not be eliminated by
recession. Hence much work of reorganization and adaptation is also
done in depression. But substantially our proposition holds. It follows
that proof, even if it were more satisfactory than it is, that depressions
will find a “natural” end, does not in itself constitute an argument for
letting things take their course or trusting to “the restorative forces of
nature.” The case for government action in depression, especially of
government action of certain types, remains, independently of humani-
tarian considerations, incomparably stronger than it is in recession,
whatever we may think of that proof.

Fourth, the formal analogy of the theory of the lower, with the theory
of the upper turning point should be borne in mind.

3. It follows that division of the units of the cyclical process of evolu-
tion into two or four phases is not a matter of descriptive convenience.^

^ TMs is no peculiarity of our exposition. For practically all students, the two, three,
four or five phases which are most frequently distinguished, mean different processes and
different sets of characteristics, and the distinction embodies a good part of the results of
their analysis. It is therefore not quite correct to speak of arbitrariness in the matter.

156

Business Cycles

Each, phase is a distinct composite phenomenon, not only distinguishable
by a characteristic set of features, but also explainable in terms of the
different “forces’’ which dominate it and produce those features. As we
know, these “forces” consist in such concretely observable phenomena as
innovation (entrepreneurs’ expenditure), response of the system to the
impact of the products of new plant (and autodeflation), the impetus of
abnormal liquidation (and of depressive anticipation arising out of it)
meeting with increasing resistance, response of the system to minus devia-
tions from equilibrium (return to what now are normal quantities and
values). The second and fourth phases, recession and revival, differ in
the nature of the deviations they liquidate or absorb and in the signs of
the latter. They are alike in the nature of the mechanism at work which
in both cases consists of equilibrium relations between the elements of the
economic system asserting themselves. The first and third phases,
prosperity and depression, differ in the nature of the impulse that propels
the system and of the deviations which develop. They are alike in that
in each case the system draws away from equilibrium and into disequilib-
rium. In a two-phase cyclical movement a line through normals would
form (erratic movements excepted) a boundary of all the items plotted on
a chart, no points of our material lying above or none below it (according
to the series plotted — price series would run above, unemployment series
below the boundary line). The line or curve through normals in a four-
phase cyclical movement, on the other hand, must cut through the graphs
of series.

Since every cycle is a historical individual and not merely an arbitrary
unit created by the observer, we are not at liberty to count cycles from
any phase we please. The phenomenon becomes understandable only
if we start with the neighborhood of equilibrium preceding prosperity and
end up with the neighborhood of equilibrium following revival. The
count from trough to trough or from peak to peak is, therefore, not only
open to the objection already mentioned — ^that both troughs and peaks
may prove very unreliable beacons — ^but it is never theoretically correct.
It may be convenient at times, but it is likely to induce faulty analysis in
several ways, one of which is of particular importance for us.

Revival is the last and not the first phase of a cycle. If we count
from troughs we cut off this phase from the cycle to which it belongs and
add it on to a cycle to which it does not belong. Counting in this way, we
lose the fundamental distinction between revival and prosperity.

OpirdoB, among all students who enter into statistical material at aU thoroughly, displays a
satisfactory tendency toward agreement. The schemata in particular of Spiethoff, the
Berlin Institute, and the Harvard Committee display an obvious family likeness in spite of
differences in detail. They all have four phases, for Spiethoff *s fifth is the “ crisis ” which, as
we have seen, has no title to be considered as a phase.

The CoisTTOTJES of Economic Evolution

157

Althougli most autkors recognize at least a distinction of degree and
some also one of kind, they do not recognize the difference in the propel-
ling factor. They see indices move up from the trough and eventually
on to prosperity levels (which are mostly only quantitatively defined), and
they conclude naturally enough that the same factors account for the
whole rise. Hence, they search the processes of revival for ‘^causes” of
the entire rise and find nothing more than gradual elimination of the
abnormalities then existing — ^low stocks, unused plant, unemployed labor,
idle credit facilities — ^and in particular, they find nothing that looks like
innovation. Therefore, they arrive at the result that innovation has
nothing to do with initiating 'prosperity ^ even if they glance at this possi-
bility, which most of them do not. Such analysis easily misses the pivotal
point and drifts into perpetuu'm-mobile explanations, particularly of the
monetary sort.^

4. Along with the phenomena of the secondary wave, we will introduce
a few other facts, to complete our Second Approximation.

First, we must drop the assumption, made for convenience of exposi-
tion, that our wave is the first of its kind and that it not only starts from a
neighborhood of equilibrium — ^through all qualifications we must hold on
to this — ^but that it is entirely unaffected by the results of previous evolu-
tion. That is, we must take account of the fact that each neighborhood
contains undigested elements of previous prosperities and depressions,
innovations not yet completely worked out, results of faulty or otherwise
imperfect adaptations, and so on. There is nothing in this to invalidate
our model. On the contrary, these facts are but a consequence of the
process described by it. But they greatly increase the difficulties of
analysis and complicate the patterns of the business situations we have
to deal with,

^ We kave kere an instance botk of tke necessity of using tke concept of equilibrium
and of tke consequences of a refusal to do so. What some of tke authors in question do
provide is a theory of tke recovery point and of what follows next. What they fail to see
is tke need of a distinct theory of prosperity. But here we should notice a question which
the writer has often been asked. If we admit the possibility that, under the influence of
depressive factors “crystallizing'* and gathering momentum, the system outruns a neigh-
borhood of equilibrium on its downward path, why should it be less likely that the upward
tendency in the recovery phase also crystallize and gather momentum so that the neighbor-
hood be similarly outrun on the upward path? We believe this to be less likely, owing to
the absence of a phenomenon similar to the breakdown of the secondary wave. No
corresponding impulse toward optimistic excess exists in recovery. But even if that were
not so and speculation developed merely on the strength of favorable rates of change so
as to lift the system above equilibrium, relapse to it (perhaps somewhat below it with reac-
tion to follow) would, in the absence of stimulus from innovation (or, of course, external
factors), quickly follow. In other words, return to equilibrium may indeed be attended
by fluctuations around equilibrium but they will soon subside. That type of fluctuation
we shall discuss later on.

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Business Cycles

One point calls for special notice. Producers, becoming familial
with, the recurrent shifts of demand in the course of the cyclical phases,
learn to provide — a course which may and often is quite rational from
the standpoint of maximization of profits, as well as from a wider one — foi
the peak demand of prosperity. Industries more subject than others to
such fluctuations (for example, industries producing industrial equipment
or materials for it), which we shall call Cyclical Industries, are particularly
likely to do this. They will set up productive capacity which is intended
to be fully used^ only in times of prosperity. This tendency, which, it
should be observed, practically always presupposes imperfect competi-
tion, will be strengthened by the fact that even replacement demand is
strongly cyclical, sometimes quite irrationally so. Railroads, for
instance, could be expected to know that depressions do not last forever,
yet they often order new rails or new rolling stock late in revival or even
in prosperity. A number of obviously important consequences follow.
Output will much more readily expand in prosperity than we should
expect from the Pure Model and costs and prices will rise less than they
otherwise would. Also, a peculiar kind of unemployment, akin to sea-
sonal unemployment, may ensue; for in many cases the men who are
dismissed when prosperity demand ceases will be neither able nor willing
to get other employment during what they know is but a temporary inter-
ruption, to which they are accustomed, but will simply “hang around.”
This is an important point to remember in any short-time theory of
unemployment.

Second, we must insert growth. Saving, in particular, we cannot
longer disregard, because sources and motives are supplied by our process
strong enough to make it quantitatively significant. In fact, it would
be possible, once the cyclical process is started, to construct a model the
financial wheels of which would entirely consist of saving, and which
would function differently. This we shall not do, since even a small
amount of credit creation suflGlces to produce the phenomena we have
been describing. But we must insert it in what we conceive to be its
actual role. It will be convenient to defer this until we come to the
discussion of the behavior of monetary time series. For the moment, it
is enough to invite the reader to bear this element in mind and to form his
own opinion of how the financing of innovation by saving, instead of by
credit creation, will affect the contours of our waves, particularly in price
levels.

^That case must be distinguished from building capacity “ahead of demand.” But
inasmuch as doing this rests on an expectation which, in turn, rests on familiarity with the
results of evolution (much more so than of growth), this case should also be mentioned here.
This is another reason why so many industries are, even in prosperity, to the “left of the
optimum point.”

The Contours of Economic Evolution

159

On the other hand, third, we must recall that credit creation spreads
from its logical” source, financing of innovation, throughout the system.
It intrudes by way of credit’s being created for any kind of expansion that
cannot be financed by existing funds and by way of entrepreneurs’ not
repaying what they borrow within the cycle and very often never repaying
all of it or reborrowing regularly part of their working capital On
the surface, therefore, credit creation tends to lose its relation to
innovation and, as pointed out before, becomes an instrument for
financing business in general, and its amount will display variations not
explainable by the Pure Model For example, it may increase in recov-
ery, when ordinary business resumes its proportions. It will also decrease
less than the first approximation indicates — or not at all — in recession,
because outlay for the purpose of adaptation of old firms and the expan-
sion of some of them into the new economic space created by recent
innovation will be financed by bank credit (Chap. XI).

Fourth, the effect of innovation in opening up new investment oppor-
tunities to industries which have not themselves reformed their method of
production cannot be sufficiently emphasized. It is not confined to
industries subsidiary to the innovating one. Nor is it confined simply to
the opening up of possibilities best instanced by the building of American
transcontinental railroads. New economic space is created also by the
mere fact that additional production may call forth other production
to pay for it: if there are in the closed domain only two industries produc-
ing equilibrium amounts, and if one of them introduces an innovation
enabling it, for example, to produce a greater number of units with the
same quantity of resources, the other industry may expand its production
in response. That is what happens extensively in recession and then
again in revival, depression — if sufficiently ‘‘panicky” — ^frequently,
though not necessarily, interrupting the process.^

From these cases it is necessary to distinguish another which may
produce similar results. Some industries are so sensitive to the rate of
interest as to shape their course primarily with reference to it. In prewar
Germany, for instance, apartment-house building — significantly enough,
not factory building — could have been represented with satisfactory
approximation as a function of the mortgage rate alone. And something
of the kind is suggested by the fact that residential building in the United

1 The Robertsonian concept of effort-elasticity may be useful in elucidating one aspect
of the above argument, which should, however, be read with due regard to the functioning
of the monetary mechanism. In any case, we meet again a reason to doubt the validity of
the picture of recession, as usually drawn, which seems to overemphasize the cares and
troubles of individual firms and households and the importance of the tears of speculators
at the expense of the fact that the system then becomes richer than it was, in actual means
of satisfying as well as in possibilities.

160

Business Cycles

States precedes the Harvard barometer^s curve B by a few months — ^which
makes it in the short run roughly inverse to the money curve C. This
is somewhat more significant than it looks because, apart from the influ-
ence of interest, we should, if anything, expect a lag. It would not,
however, be safe to trust this relation too much.

Fifth, recalling what was said in Chap. II, sec. F, and Chap. Ill,
sec. C, we will, for completeness’ sake, repeat not only that the entre-
preneurial impulse impinges upon an imperfectly competitive world
but also that entrepreneurs and their satellites almost always find them-
selves in imperfectly competitive short-time situations even in an other-
wise perfectly competitive world. In fact, evolution in our sense is the
most powerful influence in creating such imperfections all round. Hence
we now drop the assumption of perfect competition altogether, as well as
the assumption, made at the threshold of this chapter, that there is
perfect equilibrium at the start. We can assume, instead, that both
competition and equilibrium are, independently of the effects of our
process, imperfect from the start, or even that the system is inactive in
the sense defined in the second chapter. We know what consequences
this will entail: propositions and proofs will be less stringent, zones of
indeterminateness will emerge, sequences of events will be less prompt,
and buffers will be inserted between the parts of our mechanism so that
its gears will be slower to mesh. There will be more room for individual
strategy, moves and countermoves which may impede, although they may
also facilitate, the system’s struggle toward equilibrium. This will
certainly produce many freakish patterns and the economist’s engine for
the production of paradoxa will be worked up to, and perhaps beyond,
capacity. But this is all. An important point to bear in mind is the
possibility, or even likelihood, of situations in which industries may, even
in equilibrium, move within intervals of decreasing average costs. ^ In
fact, theoretical expectation is, in all phases save prosperity, for this
rather than for the opposite alternative, and it may well apply also to
the beginning of the prosperity phase.

Since it has, with many economists, become a fashion to make the
presence of unemployed resources — ^labor, in particular — a datum of the
problem of cycles, to base their theories on it and to object to other theories
on the ground that they neglect it and fail precisely because they neglect

^ It should be clearly understood what this means and what it does not mean. We
do not now retract our doubts about the U shape of the average cost curve, for these
doubts referred to a long-run state of things independent of cyclical situations. And while
we do mean that being “to the left of the point of optimum output” makes it easier to
expand output at short notice, we do not mean to countenance the error that because over-
head can be spread over a larger number of units of product, output will be increased in
cases in which, without this, increase would not be rational. This, of course, is not true
for overhead already in existence.

The Contours op Economic Evolhtion

161

it, we will state once more where we stand concerning this matter.
Imperfections of both competition and equilibrium, as well as external
disturbances, may account for the presence of unemployed resources
independently of the cyclical process of evolution. We have not intro-
duced this fact into our pure model in order to relieve the latter of
unessential and secondary elements; but it can now be inserted without
difficulty and be taken account of in any given case which presents them.
Besides, since our process itself produces both imperfections of competi-
tion and disequilibria which account for underemployment that may
outlast the cyclical unit which produced it, we include, by recognizing
that every cycle is heir to preceding cycles, also what this source may
contribute to the total unemployment with which any given unit starts.
This would have been circular reasoning in the Pure Model, but it meets
with no objection now. It must be borne in mind, however, that as far
as any part of total underemployment is due to imperfection of competi-
tion, full employment ceases to he a property of equilibrium states and instead
indicates — paradoxical though this may sound — disequilibrium of a certain
type. This is important because it supplies the answer to the argument
of those economists who look for equilibrium in the cyclical peaks. In
any case, it should be abundantly clear that the presence of unemploy-
ment at the beginning of prosperity (not only at the beginning of the
upgrade, which presumably is what most of those economists think of)
need not, for those who wish to stress it, be an obstacle to accepting our
analysis. Difference of opinion, however, amounting in important cases
to difference of diagnosis, arises only if it be held that unemployment of
resources is (barring rigidities) compatible with perfect equilibrium in a
perfectly competitive situation.

D. Many Simultaneous Cycles; Third Approximation. — So far we
have implied that, barring the effects of external disturbance,' there is in
our material a single sequence of cycles, each of which is of the same
type as all its predecessors and successors. Every individual cycle has
been thought of as crippled or drawn out in duration, accentuated or
reduced in amplitude by its historic setting (wars, crops, and so on), and
as internally irregular besides; nevertheless, each was on a par with the
others. But there is nothing in our theoretical schema to warrant this.
There is no reason why the cyclical process of evolution should give rise
to just one wavelike movement. On the contrary, there are many reasons
to expect that it wiU set into motion an indefinite number of wavelike
fluctuations which will roll on simultaneously and interfere with one
another in the process. Nor does the impression we derive from any
graph of economic time series lend support to a single-cycle hypothesis.
On the contrary, the reader need only inspect any of the charts in this
book in order to satisfy himself that it is much more natural to assume

162

Business Cycles

the presence of many fluctuations, of different span and intensity, which
seem to be superimposed on each other. In accepting that inference
from theory and in recognizing this fact, we fall in with the general tend-
ency in the study of business cycles.

Spectacular booms and spectacular breakdowns were what first
attracted the attention of both economists and businessmen. The
problem thus presented itself at the outset as the problem of ‘^crises/’
These were primarily looked upon as individual catastrophes, interrupting
an even flow or an expansion that did not by its own mechanism produce
them. They were pathological incidents in a physiological process.
Even with authors who saw more in them than isolated effects of excesses,
misconduct, or misfortune, and who, recognizing their recurrence and
family likeness, tried to describe them in terms general enough to apply to
some or all of them, and to distinguish them from breakdowns of another
type such as might be brought about by war, pestilence, famine, and so
on, it was always ‘Hhe crisis” as such, which constituted the phenomenon
to be accounted for. Authors differed widely in their explanations.
Most of the arguments which even today we are in the habit of listing as
^‘theories of the cycle” were developed then, i.e., in the last quarter of the
eighteenth century and in, roughly, the first half of the nineteenth cen-
tury — ^particularly, all the monetary theories and the various theories
of overproduction, underconsumption, and so on. Some were valuable
contributions to the analysis that was to develop, others as valueless as,
although not worse than, many explanations that are offered today. But
none of those authors felt any difficulty in telling when crises had actually
occurred. The lists they drew up do indeed differ (for a careful con-
sideration of these differences the reader should consult Professor Mit-
chelPs work), but considering the imperfections of the material with
which older authors had to work, such differences do not mean a great
deal and particularly do not indicate any considerable difference of opinion
as to what constitutes a crisis. Discussion of the facts of every case would
probably have evolved a list on which a large majority of students would
have agreed.^ The great advance beyond this view of the subj'ect came
about as the result of the efforts of many authors, but is primarily asso-
ciated with the name of C16ment Juglar,^ who was the first to have a clear

^ The significant fact to stress seems to be the extent rather than the smallness of the
ground which was common to all or most of the investigators. In support of this, a
popular book may be quoted which is but an extract from the descriptive literature of the
time and has no merit beyond having collected in a sensible way the most accessible facts
about the crises of the nineteenth century: H. M. Hyndman, Commercial Crises in the
Nineteenth Century, 1st ed., 1892. It lists 1815, 1825, 1836-1839, 1847, 1857, 1866, 1873,
1882, 1890 (for “Europe,” but actually for the United States and Western and Central
Europe). Few authors, in 1892, would have found much fault with this.

^The title of his book, nevertheless, reads: Des crises commerciales et leur retour

The Contours of Economic Evolution 163

perception of how theory, statistics, and history ought to cooperate in our
field. His great merit is that he pushed the crisis into the background
and that he discovered below it another, much more fundamental, phe-
nomenon, the mechanism of alternating prosperities and liquidations, the
latter of which, as pointed out in another place, he interpreted to be a
reaction of the economic system to the events of the former. Henceforth,
although it took decades for this new view to prevail, the wave ousted the
crisis from the role of protagonist of the play. But it was the exploration
and interpretation of the wave to which students bent their energy then.
For Juglar and his followers took it for granted that what they had dis-
covered was a single wavelike movement and were not conscious of the
fact that by assuming this they were really introducing a new, bold, and
very unrealistic hypothesis.

But this hypothesis worked fairly well at first. Juglar’s findings from
his banking figures, interest rates, and prices, supported as they were by
marriage rates and other evidence, fitted in satisfactorily enough with the
dates of the big crises which had been recognized before him. Difficulties
arose, indeed, with increasing accuracy of observation, and the workers
in the field, deprived of the guidance of the spectacular symptoms of
crises, and faced with a much gentler sweep, began to waver about dura-
tion and phases. But they still kept to the hypothesis of a single wave,
although one would think that recognition of the presence of several
waves would have been the natural remedy for part of the irregularities
which now crowded upon them. This attitude of mind, asserting itself
in a reluctance to drop a familiar instrument of analysis and in a disposi-
tion to deny the reality or existence of other wavelike movements which
began to be offered for consideration, is highly interesting and could be
paralleled by many instances from other sciences. It is by no means
extinct even now. Presumably, it would be more correct to say
that the majority of students has not yet succeeded in leaving those
moorings. For others, however, the problem has again changed its
complexion. It is no longer the problem of the wave. It is the problem
of identifying and, if possible, isolating the many waves and of studying
their interference one with each another. The present writer who, when
starting work on the business cycle nearly 30 years ago, also accepted

p^riodique en France, en Angleterre, et aux fitats-Unis. 1st ed., 1860, 2d ed., 1889. His
first findings, about cyclical variations in the marriage-, death- and birthrates in France,
appeared in the Journal des iconomistes, October-December, 1851, and January- June,
1852; his first study of the series of discounts of the Bank of France, in the Annuaire de
V&conomie 'politique, 1856, a fuller account in the Journal des Sconomtstes, April- May, 1857,
and a study of English figxires in the same year and periodical. The reader should compare
with what he reads above the appraisals by Mitchell, p. 452 et passim, and Spiethofi,
op. cit,, p. 61,

164

Business Cycles

the single-cycle hypothesis as a matter of course, considers that develop-
ment to be a very important progress, but it is one of those progresses
which at first create as many difliculties as they solve. And he would
not be surprised if in the future economists would imitate astronomers in
thinking it a matter of self-respect to have private periodicities of their
own.

We will notice only those contributions to this line of advance which
are directly relevant to our own work. They refer to a wavelike move-
ment very much longer and to another wavelike movement very much
shorter than the one described by Juglar.^ Summing up earlier work of
his, Professor A. Spiethoff showed in his monograph on cycles (Krisen in
Handworterbuch der Staatswissenschaften, 4th ed., 1923) that there are
epochs in which prosperities, and other epochs in which depressions, are
relatively more marked, and these epochs he considered as bigger units
without, however, combining them into cycles containing an upgrade and
a downgrade and also without going beyond a statement to the effect
that they were probably due to other causes than what he was prepared to
call cycles* Applying his criterion of iron consumption he found that for
England the period from 1822 to 1842 constitutes such a span of (preva-
lence of) depression (Stockungsspanne) and that for Germany the years
1843 to 1873 and 1895 to 1913 make up spans of (prevalence of) prosperity
(Aufschwungsspanne), while from 1874 to 1894 we have a span of depres-
sion. It was N. D. Kondratieff, however, who brought the phenomenon
fully before the scientific community and who systematically analyzed
all the material available to him on the assumption of the presence of a
Long Wave, characteristic of the capitalist process.^ He dates the first
long wave covered by his material from the end of the eighties or the
beginning of the nineties of the eighteenth century to 1844-1851; the
second, from 1844-1851 to 1890-1896; and the third, from 1890-1896
onward.® Other students also presented evidence of the presence of
movements of average period longer than that usually attributed to the

^ For tether references see Professor Mitchell’s work, particularly pp. 227, 385.

2 See his article presenting the results of earlier work Die langen Wellen der Konjunktur,
Archiv fur Sozialwissenschaft for December 1926, translated into English by Mr. W.
Stolper in an abridged form under the title: The Long Waves of Economic Life, Review of
Economic Statistics for November 1935.

® Professor Mitchell {op. cii., pp. 226 and 468) recognizes the “existence” (on the mean-
ing of this, some remarks will presently be made) of such long movements, but calls them
“merely empirical.” If the present writer understands correctly, this qualification should
be removed by what follows in our text, since reasons will be presented for believing that
those movements are associated (to say the least) with definite historical processes in
industry which are of the same nature and produce the same symptoms as those which are
responsible for and produce the symptoms of cycles which are universally recognized as
such.

The Contours of Economic Evolution

165

Juglar cycle. We will mention Professor S, S. Kuznets (Secular Move-
ments in Production and Prices, 1930) and Dr. C. A. K. Wardwell (An
Investigation of Economic Data for Major Cycles, 19£7), wlio found
average periods of roughly 25 and 15 years, respectively.

In 1923 Professor W. L. Crum published the result of a periodogram
analysis of monthly commercial paper rates in New York from 1866 to
1922, clearly showing the presence of a period of roughly 40 months in the
series analyzed. This is the most successful application so far made of
the periodogram analysis to economic data; but the importance of the
contribution consists in the fact that it established, at least for one series
and without any further comment, the existence of a cycle which can be
observed in practically all time series and is really the most visible and
most regular of all. Simultaneously, Mr. Joseph Kitchin, by a less rigor-
ous but more pliable method, showed that cycle also in bank clearings
and wholesale prices, as well as in interest rates, for both Great Britain
and the United States, during the period 1890 to 1922, moreover contrasted
it with the Juglar cycle and a longer swing which can be roughly identi-
fied with Spiethoff’s spans and which he linked up with gold production.^
*‘The 40-month-cycle,’’ although at first none too favorably received, has
since acquired citizenship which, as we shall see, cannot reasonably be
questioned. Professor Mitchell’s authority may, it seems, be appealed
to for qualified support {of. cit, pp. 339 and 385), based upon analysis of
five American systematic series (among them, two of clearings and one of
deposits) for 1878-1923, which gives a mean duration (of cycles in gen-
eral) of 42,05 months with a standard deviation of 12.37 months, while the
median is 40 months. The high value of the standard deviation must not
astonish us. Nothing more regular can be expected in material such as
ours is. None of the variants of the periodogram method^ will give
unqualified satisfaction.

^ Both studies were published in the Review of Economic Statistics for January 1923,
preliminary vol. V, pp. 17 et seq, and p. 10 et seq. In fairness to Professor Crum it must be
stated at once that he does not share the present writer’s optimistic view about the impor-
tance of his findings. ‘‘The actual fit of the theoretical periodic curves to our data is not
good, and we cannot be sure whether the lack of fit is due merely to chance irregular
deviations or to a real modification of the period itself. In the absence of conclusive proof
to the contrary, we believe that the economic period should not be assumed constant • • ■
the periodogram can assist in finding the average length, first if it is fairly typical • • • and,
second, if the form of the cycle does not undergo great change” (p. 24) . But less than that
would, as the reader will see, be enough for us. A very interesting recent study should also
be mentioned: C. E. Armstrong, The Short-term Business Cycle, Review of Economic
Statistics for May 1936. Material: Axe-Houghton business index; method: “periodo-
graph,” a chained-average-difference process, in some respects more useful than the periodo-
gram method; result: a sinusoid of 41 months’ period.

2 Both because the periodogram analysis — and results of it — will occasionally be men-
tioned in our argument and because it is gaining ground in economics, this opportimity may

166

Business Cycles

Assertion or denial of the coexistence of several cyclical movements
may, of course, mean many different things, and discussion stands to gain
from a clear distinction among them in each case. An author who sub-
mits findings about what he holds to be a distinct cyclical movement, may
simply claim to have established a statistical fact. He may, however,
claim expressly or by implication either less or more. On the one hand, he
may merely hold that assuming the existence of several cycles will prove
to be a useful descriptive device. On the other hand, he may hold that
his cycles correspond, each of them, to different economic processes and
link up with different causes. There is such a variety of possible stand-
points between and around these two, that there is hardly any sense in
straight assertion or straight denial of anybody’s cycles. We return to
our argument, in order to make our own standpoint as clear as possible.

First, if innovations are at the root of cyclical fluctuations, these
cannot be expected to form a single wavelike movement, because the
periods of gestation and of absorption of effects by the economic system

be used for references and comments. H. L. Moore may be cited as a pioneer — in a sense
as tke patron saint — and Sir W. Beveridge (Wheat Prices and Rainfall in Western Europe,
Journal of ihe Royal Statistical Society, 1922) as the sponsor of what was the first type of
application. Professor Crum gives a little bibliography in the paper quoted and an intro-
duction to the fundamental form of periodograms in his contribution to Bietz’s Handbook.
Introductory information and discussion of principles can also be found in a paper by Mr. B.
Greenstein, to be quoted in a later footnote in this chapter, but especially in a periodogram
analysis of Colonel Ayres^ monthly index of American Business Activity from 1790 to the
present time, expressly imdertaken in order to throw light on the methodological issues
involved, by which Professor E. B. Wilson has placed economists under heavy obligation
(The Periodogram of American Business Activity, Quarterly Journal of Economics for May
1934). The result of the experiment was, according to formal tests (such as the Chi square
test), negative and presents many discouraging features — ^for instance, considerable differ-
ences between the shapes of the periodograms for various subperiods and between each of
them and the periodogram for the entire period. But Sir Arthur Schuster developed this
method of finding hidden periodicities and of determining whether the results could be due
to chance, for meteorological purposes, i.e,, for phenomena which more than ours conform
to the urn schema, especially as to independence of observations. Irregularities and inter-
ferences between components need not be very great to upset everything and to raise
questions of interpretation which throw the findings themselves entirely into the back-
I ground. It might, therefore, be asked why the writer, thinking thus and, moreover,
entirely unwilling to abide by the results the analysis gives, nevertheless attaches impor-
tance to periodograms. The answer is simply that they render service in exploring the
material, even if results are negative or untrustworthy: some of our problems might be
stated in terms of the periodograms we get. This importance is, however, primarily
accorded to natural series or to series which, though the product of a statistical process,
mean a definite thing — ^the commercial paper rate up to the war is an instance of the first,
and the price level is an instance of the latter. A composite of the kind of Colonel Ayres’
index contains too many elements, the movements of which will interfere with each other,
to be quite convincing. The danger of spurious components is also enhanced thereby. A
few other remarks will follow in the next chapter.

The Contours of Economic Evolution

167

will not, in general, be equal for all the innovations that are undertaken
at any time. There will be innovations of relatively long span, and along
with them others will be undertaken which run their course, on the back
of the wave created by the former, in shorter periods. This at once sug-
gests both multiplicity of fluctuations and the kind of interference between
them which we are to expect. When a wave of long span is in its pros-
perity phase, it will be easier for smaller waves — ^which, as a rule, will
correspond to less important innovations — ^to rise, and as long as the
“underlying” prosperity lasts there will be a cushion ready for them
while, say, in the depression phase of the underlying wave it may be
impossible for them to rise visibly at all, although they might still assert
themselves by softening that depression through their prosperities and
intensifying it through their depressions. The impression some of us
have that seasonal fluctuations are particularly strong in times of pro-
longed depression may be due to that. Variations in expenditure within
each class of cycle will accentuate or compensate the effects of variations
in expenditure occurring in the course of all other contemporaneous cycles,
and no variation will be what it would be in the absence of the others.
These cycles will displace each other’s peaks and troughs and between
them produce contour lines that are completely ununderstandable with-
out due recognition of the phases of the others into which the phase of
any given cycle happens to fall. Behavior of time series that seems to
disavow expectation can often be explained in this way.

Second, a statistical and historical picture of a movement displaying
more than one cycle may result from the fact that successive cyclical units
are not so independent of each other as we assumed, conveniently but
unnecessarily, in constructing our model. When some innovation has
been successfully carried into effect, the next wave is much more likely
to start in the same or a neighboring field than anywhere else. Major
innovations hardly ever emerge in their final form or cover in one throw
the whole field that will ultimately be their own. The railroadization, the
electrification, the motorization of the world are instances. One railroad
or a few lines may be all, and more than all, that can be successfully built
in a given environment at a given time. Reaction and absorption may
have to follow before a new wave of railroad construction becomes possi-
ble. The motorcar would never have acquired its present importance and
become so potent a reformer of life if it had remained what it was thirty
years ago and if it had failed to shape the environmental conditions —
roads, among them — ^for its own further development. In such cases,
innovation is carried out in steps each of which constitutes a cycle. But
these cycles may display a family likeness and a relation to one another
which is easy to understand and which tends to weld them into a higher
unit that will stand out as a historical individual. The case is entirely

168

Business Cycles

different from the previous one. There we had a multiplicity of cycles
each of which was an independent entity. Here we have a sequence of
cycles of one type only, and the cycle of higher order is but a product or
composite of these and has no existence of its own.

Third, a sequence of cycles, whether independent of one another or
not, may be the result of processes which have also effects other than those
which show in the cycles themselves. Railroadization may again serve
as example. Expenditure on, and the opening of, a new line has some
immediate effects on business in general, on competing means of trans-
port, and on the relative position of centers of production. It requires
more time to bring into use the opportunities of production newly created
by the railroad and to annihilate others. And it takes still longer for
population to shift, new cities to develop, other cities to decay, and, gen-
erally, the new face of the country to take shape that is adapted to the
environment as altered by the railroadization. Another example is
the process known as the Industrial Revolution. It consisted of a cluster
of cycles of various span that were superimposed on each other. But
these together wrought a fundamental change in the economic and social
structure of society which in itself also had some obviously cyclical charac-
teristics. It came about in phases in which prices, interest rates, employ-
ment, incomes, credit, and output behaved much as they did in the
fluctuations universally recognized as cycles. And we should be losing
an obvious opportunity of pushing our analysis deeper into the material
of economic history if we refused to take account of this. Again, this
kind of cycle, if cycle we call it, or rather this aspect of what it has become
usual to call the Long Wave, is completely different from either the first
or the second case. It differs from the latter in that it is a real phenom-
enon and not merely the statistical effect of a sequence of real phenomena
having more in common with one another than with similar phenomena
outside the sequence. It differs from the former in that it cannot be
linked to a particular type of innovations as against other types carried
out during the same epoch, but is the result of all industrial and com-
mercial processes of that epoch.

We accept all those facts and we conclude, as stated in the first para-
graph of this section, that there is a theoretically indefinite number of
fluctuations present in our material at any time, the word f resent meaning
that there are real factors at work to produce them and not merely that
the material may he decomposed into them hy formal methods ^ a distinction
which will become clearer in the next chapter. Their duration (period)
varies greatly — ^f or we know that some of them are associated with effects
of processes which run their course in a year or two, others with effects
which are secular by nature — ^but might in a limiting case vary continu-
ously. As a matter of fact, we shall not expect this, but rather that periods

The Contoxjrs of Economic Evolution

169

will display finite differences clustering around certain averages. Some
of these periods will be so close together as to be undistinguishable, or
undiscoverable by formal methods such as the periodogram analysis,
which then may show other than the true periods, e.g,, an intermediate
one. Others will be so wide apart as to satisfy one of the requirements
of the periodogram analysis almost ideally.

Nothing in this implies a hypothesis. All it has to do with hypotheses
is that it implies the refusal to accept one, viz,, the single-cycle hypothesis.
Nor are we going to make another hypothesis to take the place of the
latter. But we are going to make a decision. Por our purpose, as for
many others, it would be highly inconvenient to leave matters at the
above result and to attempt to work with an indefinite number of cycles or
classes of cycles. Nor is there any necessity of doing so. It stands to
reason that as we draw away from the single-cycle hypothesis we shall
reap the bulk of the harvest to be hoped for at the first steps and that
then these returns will be rapidly decreasing. Hence, we decide now to
content ourselves, for the rough purposes of this volume, with three classes
of cycles, to which we shall refer simply as Kondratieffs, Juglars and
Eitchins, because the average spans by which we choose to identify the
individuals belonging to each of our three classes approximately cor-
respond to the spans of the cycles ^‘discovered” by those three investiga-
tors,^ respectively. Since this arrangement plays a considerable role in
the exposition that is to follow and since any misunderstandings about it
might easily impair the contribution to the study of business cycles, such
as it is, which this book may be hoped to make, it is desirable to stay in
order to comment upon it.

1. By saying that in adopting a three-cycle schema we are not making
any hypothesis which is to replace the single-cycle hypothesis, but only a
decision, we have waived any claims for that schema beyond those we are
about to state. There are no particular virtues in the choice made of
just three classes of cycles. Five would perhaps be better, although, after
some experimenting, the writer came to the conclusion that the improve-
ment in the picture would not warrant the increase in cumbersomeness.
In particular, it cannot be emphasized too strongly that the three-cycle
schema does not follow from our model — ^although multiplicity of cycles
does — and that approval of it or objection to it does not add to or detract

^ Since the present writer’s decision to make the *‘40-month cycle” (which, of course, is
not exactly or even modally just 40 months) an element of his schema, rests on considera-
tions which Professor Crum’s paper was primarily instrumental in crystallizing, he felt
inclined to label the short cycles Crums instead of Kitchins. But Professor Crum’s
scholarly conscience is so averse to countenancing anything that may look like rash generali-
zation (although our arrangement, as we mean it, does not really imply this) that the writer
deemed it more correct to refrain, the more so because Mr. Kitchin actually intended to
present evidence for an all-pervading movement, a true general cycle of that type.

170

Business Cycles

from the value or otherwise of our fundamental idea, which would work
equally well or ill with many other schemata of this kind. If we discuss
the behavior of time series in terms of Kondratieffs, Juglars, and Kitchins,
this will be done simply because the writer has found it useful in his own
work and in marshaling his facts. So far, then, the three-cycle schema
may be looked upon as a convenient descriptive device, and readers who
so wish need never look upon it in any other light. As far as this goes, it
follows that we are estopped from calling the single-cycle schema wrong:
the only reproach we can cast upon it is that it is inconvenient.

£. But one motive of the decision made was to have as many classes
or orders of cycles as are necessary in order to assure us that all of the
three reasons for the multiplicity of cycles have the opportunity of coming
into play, and not more.^ Another was to have the families of long,
medium, and short cycles represented. And, finally, it was thought
reasonable to require that each of the cycles to be chosen should have
definite historical and statistical meaning. This requirement accounts
for the fact that our cycles are precisely those ‘‘ discovered ” by the authors
by the name of whom we designate them, for whatever exception may be
taken to their material and methods and however much room there
may be for difference of opinion about the details of their findings, certain
broad facts, often observed without any intention to discover any cycles,
stand out to bear witness to the historical and statistical meaning of those
three orders of cycles.

Historically, the first Kondratieff covered by our material means the
industrial revolution, including the protracted process of its absorption.
We date it from the eighties of the eighteenth century to 1842. The
second stretches over what has been called the age of steam and steel.
It runs its course between 1842 and 1897. And the third, the Kondratieff
of electricity, chemistry, and motors, we date from 1898 on. These dat-
ings do not lack historical justification. Yet they are not only tentative,
but also by nature merely approximate. A considerable zone of doubt
surrounds most of them, as will be seen more clearly later on. Each Jug-
lar not only has its ‘^big’’ crisis — ^we do not attach much importance to
this — ^but also can be associated with definite innovatory processes in
industry and trade. Average duration is between nine and ten years.
Historical association of that kind is most doubtful in the case of the
Kitchins, partly because the writer has not been able to accomplish the

^ Three turned out to be the minimum number satisfying that requirement; but this
does not mean that we specifically associate each of our cycles with one of those reasons.
Inasmuch as the second and third reasons refer to effects which must take a comparatively
long time to assert themselves, the Kondratieff will bear a particular relation to them.
Otherwise, it is merely a chance coincidence that, having seen three reasons for the multi-
plicity of cycles, we also chose to confine that multiplicity to three orders or classes.

The Contoxjks of Economic Evolution

171

heavy task of investigating each of them but had to be content with a
survey of a few intervals. Results were not conclusive, and it is even
necessary to leave open the possibility that Kitchins are merely fluctua-
tions of the adaptive type (sec. E).i Whether or not the statistical
evidence supports the historical to the extent necessary to make our
schema a useful tool of analysis, will be for the reader to judge. All
classes or orders of cycles show differently in different series and countries :
in some series, such as pig-iron consumption and unemployment, Juglars
show best; in others — ^the maj*ority of the series is among them — the
Kitchins. The latter stand out better, on the whole, in America than in
England, Juglars better in Germany than in England.^ All this also
defines the sense in which we claim “real existence” for our three orders
of cycles.

3. From the reasons given for expecting the simultaneous presence of
cycles of different order, it follows that for us the problem that arises
as soon as we recognize the presence of more than one cyclical movement,

iThey might he cycles of the kind discussed by Professor Frisch, Propagation and
Impulse Problems, Volume in Honor of Cassel, p. 190. He obtains 8j^-year “primary”*
cycles, 3j^-year “secondary,” and (possibly) “tertiary” cycles of a period of a little more
than 2 years, and envisages the possibility that the last two are of different nature, the
secondary cycle having to do with investment and the tertiary being what in the next sec-
tion will be called an oscillation. This would make the Kitchin a real cycle of the same
nature as the Juglar; but it may also turn out to be of the nature of Professor Frisch’s
tertiary cycle.

2 Very little will be said, as opportunities arise, about those diiEferences. This makes it
all the more important to emphasize here that they may in future prove to be very helpful
clues to a wide variety of problems- Differences in the behavior of the same (or closely
related) series in different countries may tell us a great deal about the economic structure of
these countries, the peculiarities of their economic engines, and their economic relations to
each other. Differences in the degree to which different cycles show in different series are
full of potential information about the details of the cyclical mechanism and the character
of the different cycles. It should be added that, while the fact that a given class of cycle is
absent or very weakly marked in any single series is, for that reason, always very interest-
ing, it must never be recorded against the “reality” of that class of cycle. For instance,
Mr. B. Greenstein, in his periodogram study, which ranks very high on the list of con-
tributions of this type (Periodogram Analysis with Special Application to Business Failures
in the United States 1867-1932 — data, relative number of failures from Dun’s Review
— Econometrica for April 1935) finds a cycle of a typical dmration of 9.4 years, which the
present writer (but the reader knows by now how easily satisfied he is) considers extremely
satisfactory and, in fact, wishes to list as one of the major statistical testimonials for the
Juglar cycle. There are also minor peaks but nothing whatever to indicate anything like
the Kitchin cycle. This, however, is precisely what we should expect. Fluctuations the
depression phases of which are as short and gentle as those of the Kitchins are not likely to
drive any abnormal number of firms into bankruptcy or, more generally, failure, while the
stronger swings, due to more deep-reaching industrial change, of the Juglars naturally will.
In this respect the case is similar to those of unemployment percentage or pig-iron con-
sumption mentioned above: variations of these cannot be great in the course of Kitchins.

172

Business Ctcles

is a problem of interference only and not — ^with the proviso just
made as regards the Kitchin cycle — a problem of different causation.
They are all to be explained in terms of the process of economic evolution
as described by our model. Innovations, their immediate and ulterior
effects and the response to them by the system, are the common ‘‘cause”
of them all, although different types of innovations and different kinds of
effects may play different roles in each. With this qualification and also
another which will suggest itself in the next section (presence of fluctua-
tions of different types), it is the same phenomenon and the same mecha-
nism we observe in all of them. In particular, we have in all cases the
same reasons for expecting two or four phases. Difference in duration
alone suffices to alter many details in the pictures presented by cycles of
different orders and in many cases expectations will have to be formulated
separately for cycles of different span. But, in principle, our general
propositions apply to all of them.

For the analysis of given patterns of reality this conception of the
process of evolution producing a multiplicity of simultaneous waves is of
considerable importance, although it does not, of course, touch upon
any of those phenomena which are produced by external factors, because
it allows us to see the economic process in the light of a single simple
principle. Therefore, it seems to be worth while to use it as a schema of
interpretation and to fit it for this service by investing it with some
additional properties suggested by what we know about the mechanism of
cycles and by analytical convenience. Representation of what, in reality,
is indefinite multiplicity by three orders of cycles was the fundamental
step. We now go on to postulate that each Kondratieff should contain
an integral number of Juglars and each Juglar an integral number of
Kitchins. The warrant for this is in the nature of the circumstances
which give rise to multiplicity. If waves of innovations of shorter span
play around a wave of a similar character but of longer span, the sequence
of the phases of the latter will so determine the conditions under which
the former rise and break as to make a higher unit out of them, even if the
innovations which create them are entirely independent of the innovations
which carry the longer wave. There will be a relation between the phases
of each of the two movements which will tend to keep the shorter ones
within the longer span. The analogous proposition for the second and
third causes of multiplicity is obvious. The fact that the units of a
cyclical movement of a certain order cannot be considered as independent
— ^any more than the individual items in any time sequence — ^accounts for
many difficulties encountered in analysis by means of formal statistical
methods.

The units which fall within a unit of the next higher order will display
certain relations to one another which separate them from others, and

The Contouks of Economic Evolution

173

the units of cyclical movement of a certain order which happen to
fall in the corresponding phases of successive units of a cyclical move-
ment of next higher order will also have some characteristics in common
which, in some respects, make a distinct universe of them. Moreover it
follows that the sweep of each longer wave supplies neighborhoods of
equilibrium for the wave of the next lower order. Since, of course, shorter
waves must in most cases rise from a situation which is not a neighborhood
of equilibrium but disturbed by the effects of the longer waves in progress
at this time, we must now modify our previous proposition that the
process of innovation starts from such neighborhoods only, as well as
our concept of neighborhood of equilibrium itself. From the standpoint
of the transactions which carry a fluctuation of short span, the sweep of
the longer waves constitutes the long-time conditions of doing business,
although full equilibrium could, even theoretically, exist only in the points
in which all cycles pass their normals. This accords well with the
attitude toward economic fluctuations of the business community. What
the businessman sees, feels about, and takes account of are the relatively
short waves. In our three-cycle schema they would be the Kitchins.
Waves much longer than these he does not recognize as such, but only as
good or bad times, new eras, and so on. He, therefore, acts as a rule on
the conditions of a phase of longer cycles as if these conditions were per-
manent. This is obviously so in the case of the Kondratieff. The
Juglar is in this, as in other respects, an intermediate case. We will
express this by saying that for every time series the sweep of any cycle
is the trend of the cycles of next lower order. No hypothesis about the
precise form of the relation between cycles of different order is implied in
this. In particular, we shall have to recognize repeatedly that their
effects are not simply additive, although it may suffice for our rough
purposes to assume that they are logarithmically additive. Even so, it
is clear that the coincidence at any time of corresponding phases of all
three cycles will always produce phenomena of unusual intensity, espe-
cially if the phases that coincide are those of prosperity or depression.
The three deepest and longest ‘‘depressions’’ within the epoch covered by
our material — 1825-1830, 1873-1878, and 1929-1934 — all display that
characteristic.

As the reader sees, there is some rational justification for the two
additional properties of the cyclical movement which we have now intro-
duced. But there is no rational justification that tiie writer can see for
assuming that the integral number of Kitchins in a Juglar or of Juglars
in a Kondratieff should always be the same. Yet from the study of our
time series we derive a rough impression that this is so. Barring very
few cases in which difficulties arise, it is possible to count off, historically
as well as statistically, six Juglars to a Kondratieff and three Kitchins to

174

Business Cycles

a Juglar — ^not as an average but in every individual case. We shall
make use of this fact in our exposition, but the writer is very anxious to
make it quite clear, not only that no major result depends on this, but also
that no part of his theoretical schema is tied up with it. There is nothing
in it to warrant expectation of any such regularity. On the contrary, the
logical expectation from the fundamental idea would be irregularity;
for why innovations which differ so much in period of gestation and in
the time it takes to absorb them into the system should always produce
cycles of respectively somewhat less than 60 years, somewhat less than
10 years, and somewhat less than 40 months, is indeed difficult to see. We
state the fact of what seems to us considerable regularity,^ deviations from
which are in every case easily accounted for by external disturbances,
because we believe it to be a fact but not on account of any theoretical
preconception in its favor. Ji the reader accept that fact, he ought to
record it, not for, but against the analytical schema presented. If he
refuse to accept it, such disagreement will not entail any consequences
beyond complicating description. It should be added, however, that our
observation is in rough accord with many well-known estimates of the
duration of cycles and looks as strange as it does only because we combine
estimates not usually presented together.

E. Other Fluctuations. — Obviously, the waves of which we have been
trying to describe the mechanism and the causes are not the only economic
fluctuations. The reader need only think of seasonal fluctuations in

^ Of course, it is largely a matter of opinion — or of tests, tlie validity of whicli is a mat-
ter of opinion — how far we should recognize that fact at all. Having made it abundantly
clear that cycles are an irregular phenomenon playing in an environment disturbed by
additional irregularities, the writer would feel safe against any misunderstanding of the
meaning of his schema if such misunderstandings had not frequently arisen. From stand-
ards which are clearly inapplicable to material such as ours, it is, of course, easy to argue
that no regularity has been proved either by the present or any other writer and that, in
particular, our three cycles are not adequately established by the evidence to be presented
later. Therefore, it may not be superfluous to insist once more on the sense in which we
are going to speak of, say, the Kitchin. We mean that there are fluctuations, shorter than
those of the Juglar group, but which we nevertheless believe to be of similar nature and
which we think to be tolerably represented by a typical duration somewhat exceeding
three years. We do not mean that they are exactly 40 months — ^mostly, they are shorter.
Nor do we believe that that “somewhat exceeding three years” represents a mean or mode
that meets any formal dispersion test. The writer thinks that any such test would not
have had much sense. That is why he left the duration so little determinate. He remem-
bers that the most valued assistant he ever had once threw up his hands in holy horror
when he expressed himself satisfied, in a certain case, with a “periodicity” of 48 months as
showing the presence of the “40-month cycle.” He frankly admits that this sounds
absurd, but what he meant was not so at all. Traces of fluctuations substantially longer
than 1 and substantially shorter than 9 years was all he felt justified in looking for. And
these he always found, though often only in rates of change.

The Contouks of Economic Evolution

175

order to satisfy himself of this. Statistical and theoretical analysis
reveals the presence in our material of very many other wavelike move-
ments. Except for the purposes of the theory of static equilibrium, the
economic process ought really to be thought of as an infinitely complex
composite of many synchronous waves of different nature, quite apart
from the class which interests us here. One of the most important tasks
of the theory of the future lies in this direction.

The business cycles with which we are concerned are really not at all
what one thinks of when using the terms Wave and Pluctuation. They
are the result of a process which, indeed, produces upward and downward
movements in our graphs, but these movements are not analogous to the
oscillation of an elastic string or membrane — which, once set into motion,
would, but for friction, go on indefinitely — because they are due to the
intermittent action of the “force” of innovation, by which the action of
the equilibrium “force” is each time brought into play. But there are
other economic fluctuations which answer more nearly to the physical
analogy.

1. Before discussing a few of these, however, it is necessary to point
out again that our cycles are not even alone in their own class. Very
many external factors will act so as to produce a sequence of phenomena
which will look in many respects similar to a unit of the cyclical process.
If they occur often enough, the graphs of the time series of a world in which
they are the only ones to act on an otherwise stationary process may
easily present the picture of a wavelike movement, even if there were no
oscillations around it. War finance affords an instance. While war
demand is being financed by inflationary methods, we shall observe many
of the phenomena which we associate with the prosperity phases of our
cycles. When the war demand ceases and budgets are balanced again,
we shall have before us most of the surface phenomena of recession and
depression — ^with secondary waves superimposed — after which a period
will follow which should display many of the characteristics of a cyclical
recovery. The shifts occurring during the process in the industrial organ-
ism, first from peace to war production and then again from war
to peace production, will present further analogies. Causes and
effects are all different, of course, but there will be “waves” nevertheless.
In fact, many authors reason on the cyclical process in a way which would
be much more appropriate in the case of such war waves than it is in the
case of the former. And no inconsiderable part of what to us seems
faulty analysis may be due to the analogy with the modus operandi of
external disturbance. There would, hence, be some point in working out
systematically both similarities and differences, particularly with refer-
ence to the behavior of the monetary mechanism, but we cannot stay to
do this.

176

Business Cycles

Another external factor which may be responsible for wavelike behav-
ior of some or all of our series, is variation in gold production, strictly
speaking variation in gold production as far as due to chance or ‘‘autono-
mous’^ discovery only. Since the theories which use it as a basis for the
explanation of shorter cycles (such as our Juglar and Kitchin cycles)
seem no longer to have adherents, the only question is whether the long
wave can be explained by them. Such contributions to an answer as the
present writer has to offer will be found in various places, especially in
the historical chapters and those on prices and on central banks. ^ Here,
risking repetition, we will merely state first, that whatever we may think
about the value of those correlations which apparently lend support to
such a theory of the long wave, and about the problem how far there has
been, taking account of simultaneous changes in currency legislation and
habits of payment and of keeping reserves, any net effect, we are not faced
with an alternative explanation, acceptance of which would imply aban-
donment of the explanation presented in this book and vice versa. This
is obvious as regards variations in gold production that may be thought
of as induced by our process, but also true of autonomous discoveries.
They simply alter some of the conditions of entrepreneurial activity : as
we shall not tire of pointing out, it would be nothing short of absurd to
say that Californian and Australian gold discoveries called forth railroad
construction, or South African gold discoveries the “electrification” of
the economic world, both of which had begun before, or that these events
would have been impossible without them. Second, gold discoveries act
on the system through interest rates and prices, and on interest rates
wholly, on prices mainly, through the banking mechanism. Effects
can, hence, never be read off directly from gold production — or variations
in gold in monetary use, which is also a function of other variables than
gold production — ^but embody the reaction of banks and their customers.
But, third, it is perfectly obvious that prices and .values will, in the long
run, be different from what they would be if gold production were sub-
stantially different from what it is, provided gold plays any major role in
monetary systems, although not in general to the extent one would expect
on quantity-theory grounds. Many details of the picture of events will
be traceable to its behavior. And since “levels” and “trends” of prices
and values will also be influenced, we may in fact speak of a wave sui
generis, due to the influence of gold, on which the waves of our process
are (though not additively) superimposed.

Still more instructive is the “harvest cycle,” because it is commonly
spoken of as a cycle and because, as the reader knows, it has by some
authors been made the basis of a theory of the (medium-length) general
business cycle (W. St. Jevons and H. L, Moore). Here we have also an

^ The writer hopes to deal more fully with that problem in his book on money.

The Contours of Economic Evolution 177

intermittent force acting on the economic system.^ We may waive the
question whether it acts strictly periodically or quasi-periodically, since
this would affect only the regularity of such cycles, which from our stand-
point is of minor importance in any case. But the other question, just
how harvests affect the general business situation, is less simple than we
might think. In itself, the mere fact of autonomous variation of crops,
that is to say, of deviation from the quantities to which the system is adapted
at the moment, under the influence of weather, plagues, and so on only —
and under the influence neither of innovation in agriculture nor of adap-
tive increase or decrease in acreage or intensity of cultivation, all of which
comes within our schema — ^is more relevant to welfare than to prosperity
or depression. What matters for the latter is only the influence on values
and incomes which such an event will exert. There will be no great
effect at all if the abnormal harvest sells for the same amount of money as
a normal one would, though there will be some disturbance unless every
individual household and firm spends the same amount on agrarian prod-
ucts which it spent before. If it sells for more or less, there will be a shift
in incomes and expenditures, but in an isolated country prosperity or
depression does not necessarily follow. For the prosperity or depression
of the agrarian sector which does follow is compensated by conditions of
opposite complexion in other sectors.

This conclusion cannot be evaded by an appeal to any effects of cheap
or dear bread on wages — ^for this effect, asserted by classical doctrine, is,
for England, Germany, and the United States at least, negligible since
about the seventies of the nineteenth century and can, barring exceptional
cases, never have been very important with reference to chance variations
of crops, which are essentially short-run events — or by an appeal to
effort elasticity, i.e., a wish in the nonagrarian sector of the community to
expand its output in order to buy a supernormal crop — ^for there is no
obvious machinery to give effect to any such wish. If that conclusion
seems to run counter to all experience and if, in particular, everybody in
this country used to expect better business from a good harvest — ^this
rule no longer holds — ^this is primarily due to the fact that, in most cases
and especially if it coincided with poor harvests- in Europe, it meant
increase in value of exports, which directly acted on the system as a whole.

^ For wliat follows compare Professor Pigou’s treatment in his Industrial Fluctuations.
We confine ourselves, here and elsewhere, to perfunctory remarks on a subject which,
except for the interpretation of particular situations, is best treated by itself. We there-
fore shall not go into the technical problems involved, which begin at the very threshold
by the question of what a bad harvest is. In Germany, for instance, precipitation and
temperature which are bad for wheat are good for potatoes and even for countries of such
comparatively modest extension as Germany or Yugoslavia, compensation within the
territory of results for a single crop is not negligible while regional catastrophe might be
quite sufficient to affect the general situation.

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Business Cycles

Ttere are other possibilities, however. Expecting bigger receipts, farmers
will borrow and spend promptly, beyond the requirements of harvesting
and moving the crops (which if the harvest be supernormal will also,
though not proportionately, be supernormal). We observe, in fact,
increased banking activity in this country’s agricultural districts in such
cases. This, then, may enliven business all round. Moreover, many
industries will on their own initiative prepare for meeting farmers’
demand, and also borrow and expand, before any compensating fall in
demand from other sectors has had time to show, which therefore may
not show at all. But while we thus see that chance variations in crops
will exert an influence on general business situations, even apart from their
effects on values of exports, we also see that this influence mainly rests on
the reaction of the credit structure — ^meaning thereby reaction of both
borrowers and lenders — and is neither so dependable nor so strong as is
commonly believed. It may mitigate or accentuate depressions or pros-
perities and thus often help to turn the tide. In other instances, it
may even seem to turn it by itself, especially if we admit variable lags.
But any claim that it explains the cyclical character of the economic
process is, of course, disposed of by the proof that this process would
display cycles of its own, even if no external factor ever acted upon it.
The natural thing to do, therefore, is to recognize the recurrent fluctua-
tions caused by fortuitous variations of crops as a special type of cycles
(Special Cycles^) which will superimpose themselves — again, not addi-
tively — on the cycles which are the object of this study There is no

1 Special cycles must not be confused with deviations of, say, tbe price or quantity of a
commodity from some average of prices or quantities. It is not particular form of reaction
but particular causation that constitutes a special cycle. Also, the concept has nothing to
do with Professor Mitchell’s concept of Specific Cycles.

® The above formulation coincides, it is believed, with Professor Mitchell’s view. Also,
it is not so far removed from the theory of V. P. Timoshenko (The Role of Agricultural
Fluctuations in the Business Cycle, Michigan Business Studies, 1930) as from that of H. L.
Moore, which issues into the statement that (Economic Cycles, 1914, p. 127) ‘‘the funda-
mental, persistent cause of the cycles in the activity of industry and of the cycles in general
prices is the cyclical movement in the yield per acre of the crops,” as represented by an
index of yield of nine crops. This statement about causation would not follow, even if the
correlation between the deviations from its linear trend of the crop index and the deviations
from its linear trend of pig-iron production (lagged by two years) were more convincing
than it is (on this and the instability of the lag see Timoshenko, p. 50). Dr. Timoshenko’s
statement is not only very much more guarded but also stresses primarily the cyclical
importance of agrarian development in general. With this, of course, we have no quarrel:
here we are, to repeat, dealing only with the influence of chance variations in crops and
have no intention of minimizing the importance of the agrarian sector within our process.
Nor is there any objection to S. A. Pervushin’s analysis of Russian business fluctuations,
which corrects Tugan-Baranowsky’s underemphasis on fluctuations in agriculture (see
Sonderheft 12 of the Vierteljahrshefte zur Konjunkturforschung). Some points bearing
on the complex relation between agriculture and the business cycle will be discussed in the

The Contotjbs op Economic Evolution

179

theoretical presumption as to the relative importance of these special
cycles. It varies obviously historically and geographically. At some
times and in some countries they may dominate observed fluctuations.
Russia to about 1900 affords an instance, though not a simple one.

It is, of course, a question of fact whether this is the only instance of a
Special Cycle. If we answer in the affirmative, that only means that we
do not know of any others. We have seen in the instance of building that
what strongly looks like a very special movement can yet be brought
within the schema of cyclical events and understood as a consequence of
conditions which, in turn, can be traced to our process. The writer has
not met with any case other than crops as influenced by weather in which
that was impossible unless, indeed, we choose to include wars and autono-
mous gold discoveries.

We now pass on to consider fluctuations which more nearly fit the
model of elastic (acoustic) waves, A general remark suggests itself at
the outset. We have just had another instance — ^the mechanism of
innovation being the outstanding one — of the fact that an all-pervading
cycle may arise in the system from a particular or sectional cause, such
as the chance variation of output in the agrarian sector. We have now
to take notice of the further fact that, in order to produce wavelike move-
ments, an impulse or ‘‘force’’ or factor — ^the responsible something, in
short — ^need not itself act intermittently or in a wavelike fashion. Its
graph need not display any fluctuations. One case of this sort we can
visualize by means of the analogy with a vessel into which water flows
at a perfectly steady rate, but which is so constructed that it releases
the water by a valve each time a certain weight has been accumulated.
Saving might afford an economic instance, although we do not believe it
would act in this way independently of our process which opens and shuts
the valve. For an illustration of another case we will fall back on the
analogy with the elastic string which, in response to a single pull, con-
tinues ever after to oscillate — in the absence of friction. This case
primarily interests us here. Both cases, however, arise obviously from
the properties of the system on which our “something” acts and are
largely independent of the nature of the latter. Economic waves of this
kind constitute a distinct class. Professor Tinbergen even goes so far
as to regard them as the only type of “endogenous ” waves and as the main
object of exact business-cycle analysis. The reasons why we do not
follow him in this, and also the reasons why that type of wave plays but a
subordinate role in this book, are clear from the design of our model. But
in studying our material we must always look out for them and we must

Kistorical and the postwar chapters. On ‘‘weather and harvest cycles^’ compare Sir Wil-
liam Beveridge’s article in Economic Journal for December 1921.

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Business Cycles

now define tteir relation to our cycles. We shall refer to them as Waves
of Adaptation or Oscillations,

Setting aside the nice question — which, as we know from the rudi-
ments of a discussion in Chap. II, should be answered in the negative —
whether an economic system can, without any particular “force”
impinging upon it, work in a wavelike fashion merely by virtue of its
structure, we will next notice the cognate possibility suggested by Pro-
fessor E. Slutsky, that a great number of small random shocks so acts
upon a process as to give it an undulatory character (Slutsky effect).^
The model devised in order to display the phenomenon was this: Series
consisting of purely random items, such as the last digits of the numbers
drawn in Russian lotteries, were turned into series consisting of correlated
items by the operation of moving summation of the nth order, so that in
the latter “each of two adjacent items has one particular cause of its own
and n ““ 1 causes in common with the other. ” And a strongly cyclical
movement revealed itself at once, which, in the case of an unweighted
10-year moving summation, imitated the graph of Dr. Dorothy S.
Thomas's quarterly index of British Business (trend eliminated) exceed-
ingly well.

We cannot here enter into the economic, statistical, and epistemo-
logical questions raised by this most interesting result of the extension
of the classical hypothesis about the distribution of random events to the
distribution of their moving sums. Common sense tells us that cumula-
tion of the effects of small disturbances will often be met with in economic
life, although, owing to the presence of shock absorbers in the system, this
fact should not be relied on, or linked with the Slutsky theorem, without
previous exploration of the economics of each case. The possibility of
undulatory movements solely due to this fact may be granted at once.
But the manner in which Professor Slutsky posits the problem of applica-
tion to the economic process suggests, first, that he thinks of it as a possi-
ble explanation of the business cycles of reality and, second, that he
attaches some weight to the covariation of his series with that index of
cycles. It is, hence, not superfluous to remark, concerning the first
point, that a model of the economic process for which such explanation
could be defended would have to be entirely unrealistic, and, concerning
the latter point, that the elimination of trend by least squares or a method
using similar assumptions will, of course, go far toward making deviations
conform to the Slutsky model. Even if there is no trend to eliminate, any

^Compare E. Slutsky, Accumulation of Random Causes as tke Source of Cyclical
Fluctuations, 1927. Of this work, wMch is in Russian, the writer knows only the English
abstract. But recently Professor Slutsky has published his theory in an English version
enriched by important results that were, at any rate, not contained in that abstract. See
Econometrica for April 1937.

The Contours of Economic Evolution

181

series undulating witli^ sufficient regularity will be amenable to approxi-
mate reproduction from any random series, provided the period be suit-
ably chosen. Let us assume, for argument's sake, that all our series
moved in regular sines. Then the proof that these sines may be produced
by cumulation of random causes, however interesting in itself, is not only
no proof, but even no reason to suspect, that they are so produced. Else
all sinelike processes would have to be. But that proof did two things for
us: first, it removed the argument that, since our series display obvious
regularities, therefore their behavior cannot result from the impact of
random causes; second, it opened an avenue to an important part of the
economic mechanism, which has since been explored by B. Frisch in a
powerful piece of work.^

That cumulation performed on a sequence of random figures can create
cyclical’’ fluctuations which may easily be made to depict the move-
ments of economic time series, has also been discussed by Professors
Bullock, Crum, and Persons in connection with Mr. K. G. Karsten’s
interpretation, in the light of his theory of quadrature, of the Harvard
curves. No comment is necessary about either the economics or the
statistics involved in that interpretation.^ But it is necessary to insist on
the fact that cumulation of effects is as obvious a reality in many eco-
nomic processes as are acceleration, self-reinforcement, multiplication.
All these phenomena, which everybody knows and which it is hence
hardly necessary to define, belong to the oldest stock in trade of the usual
type of historical reporting on booms and crises — ^in some cases they are
the whole of it. The reason why their role in the mechanism of cycles
has not throughout our exposition been emphasized more strongly is
simply that it seemed to be sufficiently taken care of in various ways,
particularly by such concepts as the Secondary Wave and the Vicious
Spiral, which must be understood to include them and, embedded as they
themselves are in the current of a definite process, to give them their
proper setting and motivation.

We have now to add that these phenomena can, of course, be also
produced by the impact of external factors, chance occurrences among
them, and will, hence, reproduce part of the cyclical mechanism whenever
such factors impinge on the system. There seems, however, some danger

R. Frisch, Propagation and Impulse Problems, Economic Essays in Honour of G. Cassel,
Sec. 5: Erratic shocks as a sotirce of energy in maintaining oscillations. Although he
quotes both WickselFs and Slutsky’s work as a starting point, his argument is really quite
a different one. Witness his concept of Changing Harmonics. On this also see his article
in Skandinavish Aktuarietidskrift, 1928.

® The interested reader is referred to that article. Review of Economic Statistics, 1927,
and to Professor Bresciani-Turroni’s Considerazioni sui Barometri Economici, Oiornale
degli Economisti for January, May, and Jidy, 1928. Mr. Karsten’s interpretation is in the
Journal of the American Statistical Association for December 1926.

182

Busuntbss Cycles

of accepting tkem as such, for an adequate explanation of the historical
cycles. It has been remarked in the first chapter that an external-factor
theory of business fluctuations would by no means be obviously absurd.
These external factors would then work through cumulations, accelera-
tions, and so on, and there would be no need for them to be important
in order to create important ups and downs. It is, in particular, possible
to argue that if some such event has once set into motion a self-reinf orcing
process of prosperity, this will go on of itself — each increase in demand
for, say, consumers’ goods increasing the demand for equipment goods,
production of which increases again consumer’s purchasing power, and
so on — and thereby create increasingly precarious situations, so that the
longer it lasts the smaller the influence will be which is required to bring
about a crash when an equally self-reinf orcing depressive process will set in.
The inadequacy of such explanations does not rest with the fact that in
the popular and semipopular literature on individual crises, in which they
primarily occur, cumulation, acceleration, and so on are little more than
words loosely connected with surface observations lacking in precision.
It is, no doubt, possible to put up a better showing. Against this we
urge, first, that in order to establish such a theory as a fundamental
explanation satisfactory in logic, it would be necessary to show that, by
means of the elements comprised under the heading self-reinforcement, a
small disturbance could create a cycle from a strictly stationary process
in which all the steadying forces and mechanisms of the system are per-
fectly intact and the burning cigarette falls upon moist grass. Failure
successfully to meet this test, throws the theory back upon big disturb-
ances, such as wars or serious social unrest or sudden changes in monetary
or commercial policy, about which there cannot be any difference of
opinion. Refusal to meet this test, on the ground that actual states
are never stationary, amounts to evading the point at issue. ^ Second,
we urge again, as we did when discussing the Vicious Spiral, that his-
torically there never was a case in which any wave would have had to be
explained like this. The proposition itself that small disturbances may
induce larger ones, noticed by Johan Akerman (Bet ekonomisk livets
rytmik, 1928) is not entirely invalidated by these considerations.

^ In one case, such a refusal would have to be accepted, although this would but open
the door on a long discussion of principle. The refusal can be based on the denial of the
existence of any equilibrium tendency or equilibrating mechanism or conservative forces in
the system, the equations of which would then have no stationary solution at all. This
woidd imply a picture of economic reality altogether different from the one we have been
trying to draw throughout. Since both, however, are nothing but analytic schemata,
choice between them, as far as not due to extrascientific preference, would have to turn on
results. In a system that always reacts, and reacts to reaction, exclusively by acceleration
until it meets catastrophe or, at the low point, an upward pull, explanation of fluctuations
would indeed be easy. It would, in fact, be superfluous.

The Contours of Economic Evolution

183

Waves that are simply the result of small disturbances magnified
by self-reinforcement would not, however, be of the ‘‘ elastic type. But
it is worth mentioning that we may also derive elastic’’ waves from, say,
acceleration. Let us take, as an instance, price level, which we will, for
argument’s sake, assume to be influenced by deposits Q. Consider its
time shape, P (t, Q) and its rate of change in time P, which itself changes
at the rate of P. Now let the facts of the case suggest the hypothesis
(which is not believed to be true and which would have very little meaning
in any case) that this acceleration in the price level series is proportional
to the second partial derivative — also a sort of acceleration — of the price
level with respect to Q, P = c^P", being a constant factor of propor-
tionality. We turn to the regulation method of solving this partial
differential equation — ^well known under the auspicious name of wave
equation, though it does not necessarily represent a wave — ^by means of
expressing P as the product of two functions, each of one of the two
variables only, P = f{Q) • In order to satisfy our differential equa-

tion it is necessary that

fl^JL

f c^<p

which can be the case only if both sides equal a constant, say since
they depend on different variables. This enables us to solve for each side
separately and a general solution in terms of sines and cosines is readily
derived,^ on which we then would impose boundary conditions appro-
priate to our facts. No claim is made for this setup except that it illus-
strates a possibility which at first blush one might feel inclined to
doubt.

3. The simplest case of Waves of Adaptation or Oscillations may
be illustrated, as noticed in the second chapter, by any individual price
which happens to be out of equilibrium. Even if no further disturbance
occurs, we do not observe that it at once assumes its equilibrium value
or that it makes straight for that value and stops there. As a rule, it
will miss it or outrun it and turn back again. Equilibrium has to be
found, as Walras put it, par tdtonnemenL Most of our series will behave
like this. Sometimes there are technical reasons for it. On the stock
exchange, for instance, bulls and bears will from time to time consolidate
their positions and cover before they go on. But this is not necessary.
The graphs of our weekly, or even monthly, series reveal oscillations of
this nature by the saw-tooth-like contour of their larger movements. We
might call them Hesitations. If the change to which a series responds in

1 E, Si Tf U being constants, those general solutions are:

/(Q) = E cos KQ + S sin KQ
4p(t) == T cos cKt + TJ sin cKt

184

Business Cycles

this way has not originated in it, but in another series — ^think, for exam-
ple, of oscillations of this type possibly arising in interest rate by way of
response to a given change in price level (see Mr. Zinn’s article in Review
of Economic Statistics for October 19£7) — we speak of Vibrations.

Hesitations and vibrations are part and parcel of the cyclical mecha-
nism, although in this book, which cannot adequately deal with anything
except principles and the broadest of contours of facts, they will not
show up as they should. But again, they are not confined to specifically
cyclical disturbances. Any disturbance, whatever its nature, will pro-
duce them. The surface similarity between our cycles and other fluctua-
tions will be intensified thereby and all the oscillations they start will
interfere with each other. The same is true of those waves of adaptation
which may (though they need not) result from the introduction of lags,
or lags and time derivatives, or of the influence of past and (expected)
future values of our variables.^ Cases in which, say, the quantity of a
commodity — as, for instance, in the cases which give rise to the spider-
web problem — adapts itself with a lag or in which lags or velocities of
adaptation differ in different parts of the system, thus creating inter-
mediate situations which may be reacted to in such a manner that wave-
like movements will ensue, have been met in Chap. II and will be met
again in Chap. X. Their occurrence is perfectly easy to understand on
obvious common-sense considerations. Their exact theory, a most
important and hopeful contribution to the general theory of prices, is,
with the exception of a few instances, beyond the scope of this book.^
It is sufficient to repeat that, however much light it sheds on details of
the mechanism both of the cyclical process and of other disturbances, it
has to be coupled with other propositions in order to make of it a theory
of the cyclical process. Unless this be done, that apparatus is com-
patible with any explanation and renders the same kind of service to each.
The very catholic view taken of the cyclical problem by Dr. Eoos in the
paper quoted below is, from the standpoint of the task he set himself, both
understandable and correct.

^ Considerable progress has been made as to technique. Grateful acknowledgment
from all students of economic fluctuations is due to Professor Evans and Mr. Roos in this,
as in other respects. In particular, they (and Professor Tinbergen) were the first to realize
what Vito Volterra’s functional calculus can do for us. On the importance for economic
analysis of functionals, see, for example, Tinbergen’s article in Econometrica for January
1933. Professor Prisch has developed one of the most immediately useful techniques
{Econometrica for April 1935).

® We will quote, however, Mr. J. B. S. Haldane’s paper in the Review of Economic
Studies for June 1934, and Mr. F. C. Roos’s in the Journal of Political Economy for October
1930. The reader finds an excellent introduction to the subject in Professor Tinbergen’s
Survey, Econometrica for July 1935, See, in particular, Secs. 15 and 16 (on lag schemata
and wave conditions).

The Contours of Economic Evolution

185

By the same or similar methods, aggregative theory can be ‘dyna-
mized” (“macrodynamics”). For instance, the oldest and most familiar
proposition of aggregative theory, the equation of exchange (MV = PT)
is, as it stands, simply an equilibrium condition. But it can easily be
made dynamic by the introduction of lags and rates of change. Or we
may simply assume that industrial output at a point of time is a function
of the rate of change of price level at some earlier point of time, industry
reacting to the stimulus with a lag. This model must be used with care,
since such a two-variable relation always does violence to a process in
which many more (even aggregative) quantities interact, but it is readily
seen how wavelike time shapes of those variables might result from it. A
lag between price level and output would not by itself produce them,
unless we assume that industry behaves as hog-producing farmers are
supposed to behave. If, however, industry reacts at any time to the rate
at which the price level changed at an earlier moment, for instance to a
positive rate by an increase in total output, then this increase will tend to
produce a fall, i.e., a negative rate of change in price level, whereupon
output will shrink in due course, and so on — ^if we so please and choose to
neglect everything except the relation this model isolates, this may even
go on eternally and in an explosive fashion. Following a suggestion of
Professor Irving Fisher which will be noticed elsewhere. Professor Luigi
Amoroso worked out and extended this model so as to include all aggrega-
tive processes. Professor Felice Vinci’s work constitutes a further step
on similar lines. ^

As another example, Mr. Kalecki’s theory^ may be mentioned. It
follows well-established tradition in making investment pivotal in the
description of cyclical sequences, but it does so in an original way. In
order to derive cycles in investment which generate, instead of being

1 See L. Amoroso, Contributo alia Teoria Matematica della Dinamica Economica, in
Nuova Collana di Economisti, voL V, 1932, and La Dinamica dei Prezzi, Gnip'po Universi-
tario Fascista, Rome, 1933 (mimeograplied). Professor Vinci's theory has been published
in Econometrica for April 1934, and is certainly a most interesting contribution. But the
system of equations into which he puts it (p. 137), though it gives eight equations for eight
unknowns, does not seem to the present writer very easy to handle (considering the form
of equations III and IV). Professor Tinbergen, to whose criticism of this model in the
Survey quoted before the reader is referred, seems to feel more confidence in the uniqueness
of the solution and less confidence in the reasonableness of the economic assumptions
embodied in it than does the present writer.

^ The theory has been published repeatedly. The first exposition is in Polish, hence
not known to the present writer. An English version has been published in Econometrica
for July 1935 (comments thereon, showing among other things, how prices and wages
implicitly enter the model, in Econometrica for October 1936), another in the Review of
Economic Studies for February 1937. In the latter, the theory is compared to that of Mr.
Keynes. Into the ramifications of the subject we cannot enter here. The fundamental
idea and a remark on the principle involved are aU that can be presented in this book.

186

Business Cycles

generated by, the cyclical impulse, Mr. Kalecki introduces the period
that must elapse between the order for an equipment good and its
delivery, which for simplicity's sake he assumes to be constant (or nearly
so) and the same for all investment goods. Now, we could try to make
this lag produce a cycle, by generalizing the argument developed by
Professor Tinbergen for the special case of shipbuilding which we will
discuss in Chap. X, that is to say, we might make deliveries of new invest-
ment goods (minus those intended for replacement) directly depend on
the amount of investment that existed at an earlier point of time. This
Mr. Kalecki does not do. Instead, he introduces profits plus interest
(= consumption of ‘‘capitalists” plus saving) explicitly,^ and makes
orders for equipment goods beyond replacement — ^replacement demand
being assumed to be constant throughout the cycle — ^linearly depend on
them and on the total volume of industrial equipment existing at the
same time. Then he — ^this is the original turn — expresses both these
items in terms of orders for new equipment. In order to make this clear,
we will restate the argument. Let I{t) be amount of orders given at time
B be the lag and A that part of the revenue of “capitalists” which
they save (nobody else saves). By way of a simplification warranted by
Mr. Kalecki’s assumptions, we will neglect the amount these “capitalists”
spend on consumers’ goods so that A becomes — since Mr. Kalecki himself
puts capitalists’ revenue equal to consumption plus accumulation spent
on equipment goods — ^the whole of capitalists’ net revenue equal to the
money equivalent (corrected for price level) of the production of equip-
ment goods beyond replacement in the (small) unit of time. AB is the
amount of orders given, paid for, and taken in hand during the period of
the lag. If K(t) is the “volume” (= corrected value) of equipment
existing at time i, then the “volume” of orders placed could be expressed
as a linear function of the rate of profit and of the rate of interest. Fol-
lowing Mr. Kalecki, we choose, however, to consider as dependent variable,
not the volume of orders /, but the relative volume //K. Moreover, we
throw out interest, on the ground that it is a single-valued increasing
function of the rate of profit A/K. Thus we have

and since it has been decided that this function be linear,

/ A

^ In Professor Tinbergen^s model of the shipbuilding cycle, they are also present, of
course, but only implicitly.

The Contours of Economic Evolution

187

m and n being constants, or

I = mA nKy

or, differentiating with respect to time,

7 = mA — • nK

But A^ is equal to the integral of the orders placed in each unit of time
during the period 0, hence A equal to this integral divided by The
increment of JK in point of time t is equal to the orders placed 0 units of
time before, I(t — 0), This is the way in which the lag comes in, if now
we express everything in terms of orders

f m - I(t - e)

I = ^

— nl{t -- $)

1$ = ml(t) — (m + nd)l{t — 6)

This is the mixed difference and differential equation we want in order
to apply the technique which has been made familiar to economists by
Professor Tinbergen and will be displayed in his shipbuilding case. Sub-
stitution of an exponential with a complex exponent easily reveals the
possibility of a periodic process. Using American and German material,
Mr. Kalecki has little diflSculty in arriving at a major component that
shows a 10-year period. This accounts for the business cycle which,
according to this model, certainly requires a starting impulse — some
trouble, for instance, having occurred in the apple-growing industry at
the time Adam and Eve dwelt in Paradise — ^but then might go on for-
ever. And this is so because ^‘investment considered as capitalists’
spending is the source of prosperity. . . . But at the same time invest-
ment is an addition to the capital equipment and, right from birth, it
competes with the older generations of this equipment ” {Review of Eco-
nomic Studies y voL IV, p. 96). In case the reader should think this a
“paradox,” Mr. Kalecki has the reply to offer, which has before him
brought comfort to so many economists faced with impossible results of
their own making, namely, that “it is not the theory which is paradoxical
but its subject — the capitalist economy.”

That this is inadequate and that investment in Mr. Kalecki’s sense
would, by itself and in the absence of other factors, not produce any
waves or crises has been shown in the preceding chapter, sec. A, But
since Mr. Kalecki’s type of argument is so frequently met with and so
inexhaustible a source of paradoxes, it will not be superfluous to indicate
explicitly the cause and nature of what at first sight appears to be an
irreconcilable difference of principle. To begin with, such difference as

188

Business Cycles

there is does not, as one might think, derive from a difference in the
definition of saving or from a different view about its relation to what we
termed real investment. On the contrary, in our discussion on saving in
the third chapter, we assumed — ^what we do not otherwise hold to be the
case anywhere in this book — ^that savings were turned into equipment
precisely as promptly as Mr. Kalecki lets them produce orders for new
equipment. It is true that he does not distinguish the two steps but fuses
them into one and this, as will be seen presently, has something to do with
the result he arrives at. But fundamentally there is no difference in
this point. There is difference in that we have been discussing the case
of a process stationary in every other respect. If we repeat that we did
this in order to find out whether saving and investment, as such, will
produce fluctuations, it might be replied that, since initial disturbance
is in any case essential in order to set Mr. Kalecki’s model into motion, our
negative result, even if correct, is not relevant to a criticism of his. This
is, however, not so. If our result be correct, it follows that, unless new
disturbances occur, any waves of investment that might have been created
by the initial one would have to die down, owing to the presence of an
equilibrating mechanism which works without lag. This, in fact, affords
the opportunity to recognize the contribution of Mr. Kalecki^s construc-
tion: it adds one more item to the list of possible waves of adaptation or
of the reasons to expect wavelikeness of contours within the cycle.

The essential point now comes into view. Mr. Kalecki eliminates
that equilibrating mechanism — exactly as all such models, in one way or
another, eliminate vital parts of some mechanism — ^by postulating that
the money rate of interest varies in the same direction sls A/ Now, it
should be noticed that objection to this postulate is not raised on the
ground that it fails to be borne out by observation. On the contrary, it
is fully admitted that, in a first approximation, that postulate does fit the
facts. But this is a problem to be solved, not a datum to be accepted.
For, as we have seen, saving itself reduces the rate of interest and thereby
creates complementary investment opportunity, which is precisely the
reason why we cannot expect the saving-investment process to produce, of
itself, waves or any crises or difficulties. Hence, other factors, extraneous
to the saving-investment process as such, are necessary to account for the
shift of the demand schedule for loans, which overbears that tendency and
causes the rate of interest to behave as it does. Such factors can no doubt
be found. But then it is no longer investment per se, reacting upon itself,
which can be appealed to for explanation.

For other schemata of a similar formal nature the reader is referred to
Professor Tinbergen’s writings. ^ The more their authors are aware of

A study miglit convemently begin by the pure lag schema presented in the Survey,
p, 274.

The Contours of Economic Evolution

189

their limitations, especially of the fact that they are nothing more than
exact statements of possible aspects of repercussions within the adaptive
apparatus of economic life (‘‘propagations”), the less objectionable and
the more useful they are likely to be. This applies particularly to the
only additional instance we are going to notice, the elegant model devised
by Professor Frisch in his Cassel essay previously quoted. It connects
three elements by three simple relations. One of them z(t) is formally
analogous to Mr. Kalecki’s J. (;f) but simply expresses equipment in process
of production, without tying it to saving in the way to which we found
reason to object. The second element, y{i), differs from Mr. Kalecki’s
1(f) by taking account also of replacement demand — assumed to be
proportional to the third element, consumers’ goods sold, x{t ) — and not
only of demand for new investment, which is assumed to be proportional
to The latter, the rate of change of consumers’ buying, is made linearly
dependent upon cash holdings treated as a fraction of the money volume
of transactions in the spheres of production and consumption. If this
model had been associated by its author with a claim to representing the
cyclical process, objections mutatis mutandis similar to those formulated
above would again have to be urged. But since it is not intended to be
another perpetuum-mobile theory of business cycles but the presentation
of a piece of mechanism, we can not only enjoy its simplicity, but also
use it to demonstrate the possibility of a distinct type of oscillation.

4. A few other matters may conveniently be disposed of here.
Replacement of industrial equipment has been linked sporadically with
business cycles ever since Marx’s time, some authors coming near to
making it the central element of causation. Into our analysis replace-
ment enters in two ways. First, it is obvious that cyclical situations
are not a matter of indifference for the decision to replace. Less obvious
is the precise nature of their influence. Replacement becomes necessary,
either because of wear and tear — for our purpose we can include in this
the physical effect of mere lapse of time, irrespective of use — or because
of obsolescence. Obsolete or obsolescent machinery is not typically
replaced in prosperities. We find, rather, that the intense competition
of the recession and depression periods will, with a qualification for the
prostration and paralysis of deep depression, in general force firms to
install the newest available types. The reverse, however, holds true, if
we may trust the incomplete information we have, for the replacement of
machinery that is wearing out. There is no doubt, for instance, that the
American and the English cotton-textile industries renew their equipment
when business is brisk, although there is some doubt as to the interpreta-
tion of this fact. The life of a building or a machine is, of course, not a
purely technological, but an economic, variable. Barring obsolescence, it
is rationally determined by the point of time from which on the unit of

190

Business Cycles

product can be produced more cheaply by installing a new machine than
by keeping the old one, and therefore a function of many quantities,
actual and expected, rate of interest included- These quantities fluctuate
cyclically and, particularly if the technological superiority of a new
machine varies with the degree of utilization and if the price of the
machine is inflexible, replacement may often figure out more advanta-
geously in prosperity than in recession- But such considerations are
hardly relevant, since in any case the lifetime of the average machine is
very much longer than any but the longest cycles- Most of the common
textile machinery remains fully efficient for from 30 to 40 years — mules
that have been well treated, even longer than that.^ Such statistics as
we have do not, in fact, encourage a belief that either those or other
rational considerations play a dominant role in the decision to replace, and
in old-established industries with a (substantially) stationary technique, a
considerable percentage of the machinery in use at any time is of greater
age than experts^ standards seem to justify. We need not however go
into this. But that fact is beyond doubt, perhaps as the simple
consequence of the other fact that, when prices fall, people are quite
naively and a-rationally discouraged and so have to make up for deferred
replacement when things look better again. It is clear that this is not
an unimportant item in the list of secondary phenomena, but, of course,
it presupposes the existence of a cyclical movement. Not even the
theory of the ‘Tower turning point” (recovery point) can safely be based
upon it,* for the situation is in practice never such that it would at a given
time become necessary, under penalty of breakdown, to replace. It is, as
we have seen before, only when recovery has set in for other reasons that
this demand for equipment goods revives.

Second, there will be genuine replacement waves if the age distribution
of an industry’s equipment clusters around certain values. This will
have to be explained in each individual case and cannot be appealed
to in abstracto as an independent cause of fluctuations. But as a rule
such reasons are not difficult to find. External factors will often supply
them. If, for instance, the equipment of a district has been destroyed
by an earthquake, and replaced in, say, the subsequent two or three years,
we can, at the expense of assuming that the lifetimes of all elements of
that equipment are rigidly fixed and equal and that all elements are
actually replaced thereafter, derive what will look like an ideally regular
wave rolling on forever. But it is clear how tmreasonable such assump-
tions would be. Bulges of decreasing amplitude will, however, in most
cases persist, and influence the behavior of our time series, for a while.

^ The writer is at a loss to understand how Marx — who when speaking of capitalist
industry, primarily meant textile manufactures — could have spoken of a “ten year life
cycle ” of the fixed “capital” of that industry.

The Coisttoues of Economic Evolution

191

Now our model supplies us with an ‘‘endogenous’’ instance: when innova-
tors have ridden to success in some branch of industry and the new
combination is spreading, we shall readily understand that new machin-
ery will be installed in this and in complementary branches, often also in
others, owing to the impulse imparted to business in general, at a velocity
which will in fact produce the required (skew-bell-shaped) age distribu-
tion. This is part of our mechanism and contingent upon its working.
But it is no new or independent cause of fluctuations, least of all
of permanent ones: the effect will, as regards specialized machinery, tend
to vanish from diffusion (different firms replacing at different times, some
not replacing at all) though successive innovations in different fields will
tend to keep it alive in the higher stages of nonspecialized semifinished
metal products.

Wavelike bulges in the output of equipment and construction indus-
tries, for use in the explanation of ups and downs, have been derived in
many other ways, one of which should be noticed. In its crudest form
the argument may be put like this : let us assume, to bring out the essential
point, that an industry uses one million units of a certain — strictly homo-
geneous — ^type of machinery which we will baptize hohhy horse and which
lives exactly 10 years, not more nor less. These hobby horses have been
evenly installed — at a constant rate of 100,000 hobby horses a year — ^the
industry using, and also the industry furnishing, the hobby horses has
reached perfect equilibrium — 100,000 hobby horses being produced and
sold for replacement each year. This schema would not be substantially
affected if we assumed further expansion at a constant rate known to all
firms. But instead we assume now that “something” permanently but
suddenly raises the demand for the product by 10 per cent. If hobby
horses have been previously utilized to optimum point, 10 per cent more of
them will be demanded now. Producers will, therefore, sell 200,000
hobby horses, say, next year; but after that demand will again drop to the
100,000 necessary for replacement until the new ones will themselves
have to be replaced, when another bulge will show. Those producers are
supposed to have doubled their capacity, and the firms in the higher
stages above the hobby-horse producers, to have expanded correspond-
ingly — ^this is the intensification or multiplication of effects — and the
consequences are obvious.

Nobody, of course, has ever pre'sented this argument in so grotesque
a form, but reasoning not far removed from it keeps on turning up. It
is, therefore, worth while to stay in order to realize the absurdity of it.
“Something” is not an admissible cause. If it be made more concrete, it
will be seen that such sudden jerks are not likely to occur except in conse-
quence of innovation, and if the increase be not sudden many of the
consequences will fail to follow for this reason alone. But even if demand

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Business Cycles

for the product increase suddenly, it does not follow that the producing
firms will promptly demand proportionally more hobby horses. In
practice, there will be the buffer of excess capacity. Even if perfect
equilibrium of perfect competition should have prevailed, they wiU not
all act equally promptly and in the same way — some, for instance, over-
working their hobby horses or using them beyond their usual lifetime
(for the rigid lifetime is, of course, a most unrealistic assumption).
Granting, however, that they all order 10 per cent more hobby horses, this
will not necessarily induce the manufacturers of the latter to increase
plant capacity all at once to the full amount. They may equally well
raise their prices or add to their unfilled orders. Owing to the presence
of buffers at every step of the process and also to normal foresight, the
impact, instead of gathering force at every step, will tend to spend itself.
If it does not, this is no verification of the argument but merely a proof
that there is another process at work. The neglect of all equilibrating
influences amounts in this, as it does in all similar cases, to theoretical
fault.

But what should be stressed more than this is the lack of realism
displayed by the argument under discussion. No attempt at technical
improvement — ^for instance, insertion of a considerable lag between the
effect of the new expenditure for investment goods on the prices of con-
sumers’ goods and the effect of the consequent increase in the supply of
investment goods — can do away with the fact that a picture of business
behavior is being drawn, not from reality, but from the needs of the theo-
rist. Moreover, there is no reason to believe that any such bulges would
be suflSciently synchronized to matter. But again it must be observed
that this criticism applies only if that argument is to stand by itself as a
major contribution to the explanation of cycles. It is not denied that
hobby-horse manufacturers, or some of them, may thus foolishly behave
and that they are most likely to do so in the atmosphere of prosperity
which, however, would then have to be independently explained.

CHAPTER V

Time Series and Their Normal

A. Introduction. — ^In this chapter we will assemble into one connected
argument what for our purpose it seems necessary to say on questions
of principle concerning statistical method. This is indeed but little.
No exposition of technique can be attempted here and the reader unfamil-
iar with usual procedure should turn to some treatise on the subject.^
The problem of the elimination of seasonal variations remains excluded.
Our discussion thus reduces to analysis of time series which reflect economic
growth and the cyclical process of evolution as distorted by the influence

^ If the reader be a complete stranger to the theory of statistics it is indeed difficult to
ask him to take the trouble involved. But nobody can, under present conditions of eco-
nomic research, be a competent economist who has not mastered as much of it as is admir-
ably presented in the textbook by Crum and Patton or in the book of F. C. Mills. A
popular introduction into probability which, at the same time, has all the freshness of
originality is: R. von Mises, Wahrscheinlichkeit, Statistik und Wahrheit, 2 ed., 1936.
The reader who has a sufficient command of mathematics will find a polished presentation
of principles in the treatise by G. Darmois (Statisiique Math^matique) . Most of the
necessary tools are sufficiently explained in the Handbook edited by Rietz, but the theo-
retical fxmdaments necessary for a full understanding of the implications of techniques
and the assumptions involved are not. The neglect of these is, however, the only explana-
tion of the uses to which that technique is sometimes put and of the confidence with which
large claims are made for its results. The wish to enable the reader to form an opinion
about what a given method and a given result means and especially does not mean
is the main motive of the advice submitted in this note. It is believed, however,
that the comments of the text, superficial and unsystematic though they are, will do some-
thing toward this end. In this hope they have been framed as simply as the writer was
able to frame them, and they can be perused, and their main import understood, even by
those who do not understand every sentence. That is why the writer, on the one hand,
cannot recommend skipping the chapter and why, on the other, he has thought it excusable
to use, here and there, without explaining them, terms which will carry meaning only to the
specialist. Reference should be made also to what was said on matters of statistical
method and material in the first, and also in the fourth, chapter and to some books to be
quoted later, particularly to that by O. Anderson. Finally, it is impossible not to mention
the works of Tschuprow and R. A. Fisher. The writer feels much obliged to Dr. G. Tintner
for criticism invariably helpful and stimulating, even where discussion did not lead to
agreement. Some of his comments suggest the advisability of warning the reader that
perusal of this chapter is not possible without a previous study of the preceding ones.

193

194

Business Ctcles

of external factors. At first (sec. C) we shall proceed, for the sake of
convenience, on a single-cycle hypothesis, then (sec. D) we shall discuss
the problems arising out of the presence of more than one cycle.

In order to put into relief the nature of time series and of the statistical
problem they present, we will distinguish three types of variables,
which we shall call theoretical^ random or stochastic, and historical variables.
If we have before us a system, i.e., a set of quantities between which
certain relations are known to exist, we may investigate these relations
by allowing those quantities to vary ‘ Virtually. As a result we get
theoretical ‘‘laws’’ with which to operate. Time, if it enters at all,
has no reference to any particular date and serves only as one of the
coordinates. The theoretical law, once established, is raised above the
sphere of the actual findings from which it was gleaned, by the decision
to rely on it until further notice. Of course, every law in this sense is
relative to the general properties of the system. A variable thus related
by a “law” to one or more or all variables within the general conditions
of a system, we call a theoretical variable. Any quantity occurring in a
proposition of classical mechanics will illustrate this. An economic
instance of such a variable is the quantity of a commodity that is effec-
tively demanded within a Walrasian world.

The logical counterpart of a theoretical is a stochastic variable.^
It is not defined by a functional relation, known or supposed to be
known, to another variable. On the contrary, the absence of any such
relation is its outstanding characteristic. We do not “understand” its
variations in the sense in which we “understand” the variations of a
theoretical variable; they are mere experimental or observational facts.
Instead, we note the relative frequency of the occurrence of different
values of a quantity in the course of experiments or observations carried
out under conditions under which a theoretical variable would display
a constant value. We may think of those experiments as consisting
of sets of drawings from an urn known to contain black and white baUs
in unchanging proportions, and base upon them certain measurements and
(whatever the logic of this may be) mathematical expectations, every-
thing in fact that centers around the unfortunate term Probability or the
less objectionable one. Limiting Value of Relative Frequency. We
need not follow Borel (Elements de la Theorie des Probabilites) in
tying statistical method to the urn schema, but we must bear in mind
that it is the prerequisite of all reasoning about random variables that
their values, actual and possible, should constitute a universe in the

^ Tschuprow’s definition — stochastic variable is a variable that can assume different
values each associated with a different probability^’ — is too wide, because it would also
include hybrid cases. Moreover, the property it uses as definiens follows from the nature
of stochastic variables and does not give a good idea of what that nature is.

Time Series and Their Normal 195

technical sense, and that we are on safe ground only when moving
within the walls of this severely restrictive condition.

As soon as we step out of the world of theoretical schemata and try
to link to actual fact any of the theoretical relations that hold within
them, we get hybrid variables which are neither theoretical nor random
but borrow characteristics from both categories. If, in particular, we
wish to derive a form of some theoretical function more concrete than
that which theory supplies — say, of a Marshallian demand function — ^we
face aU the dilBSiculties of distinguishing between both classes of char-
acteristics and, among other things, the danger, pointed out by Frisch,
of being entirely misled by our inability to do so. Disregarding this,
however, we may illustrate the difference between theoretic and stochas-
tic variables and their simultaneous presence in the actual material
as follows: suppose we know that a given set of price-quantity data repre-
sents a Marshallian demand curve which is ideally invariant in the
interval of time covered by those data. Then, to every quantity within
the interval corresponds one single “true” price which is a theoretical
variable. Now, let the observations of the prices be subject to small
random errors. We shall get either several price quotations for each
quantity or else single quotations which deviate to an unknown extent
from their “true” value. Each quotation, taken by itself, is therefore
a stochastic variable and may be looked upon as an observation in the
technical sense. If there are several prices to one quantity, they are all
observations of the same thing, form (a sample of) a universe, and may
be said to represent fragments of a frequency distribution. But obvi-
ously the whole set of prices cannot be so interpreted. In the graph of all
of them the theoretical variation asserts itself. However, since in our
case we know that the theoretical law is invariant we may be able to find
it from the material by purely statistical methods;^ but it is that knowl-
edge and not the statistical logic per se that enables us to do so.

A historic variable is, in one sense, precisely that kind of hybrid.
But it differs from the case just discussed by the fact that its theoretical
law is in a process of change. We assume for simplicity’s sake that the
frequency distribution about each “true” point remains invariant.
Let us start with an economy in perfect Walrasian equilibrium and fasten
upon the price of any commodity the quality of which is to remain
strictly the same. This price is, as everything else, at Theoretical
Normal (now in the sense defined in the second chapter) and any varia-

1 Success will in this case, as in the one discussed in sec. B, 2, depend on the ‘‘law of the
movement’* being sufficiently obvious for us to be able to hit it by the formula we choose.
Both cases reduce to the schema of shots being fired at a target moving according to an
unknown law. If the demand curve shifts, then the analogy would be with shots fired
at a target moving according to an unknown law that changes in an unknown way.

196

Business Cycles

tions we observe in quotations would (unless we allow small variations
in quantity, whicb we do not just now) be due only to errors of observation
or small chance events which can be treated as if they were errors of
observation. Hence, it would reveal nothing except a frequency distri-
bution. Let the system embark upon a prosperity excursion under
entrepreneurial impulse. Both price and quantity of our commodity
will change now, but the new values they assume cannot be directly
used^ for the derivation of its (Marshallian) demand curve, because they
do not lie either on the original or any other single demand curve, but
successively on different ones — ^which it is usual, though not quite cor-
rect, to express by saying that the demand curve shifts. The old
Theoretical Normal has been destroyed without being replaced by
another. We may, indeed, imagine that every price-quantity pair lies
on a temporary demand curve, and interpret its values as the result of
two components: a movement of, and a movement along, a demand
curve. But, in general, we cannot distinguish between the two without
further information or hypotheses.

This situation lasts throughout the cycle and until a new equilibrium
is reached. Then we shall have again a Theoretical Normal as before,
but a different one: price and quantity of our commodity will then be
adapted to the conditions of a new Walrasian world in which new equilib-
rium values result from, and may — ^in strict logic, only virtually — vary
along new demand, supply, cost functions, and so on. This property of
belonging at different times to different systems, or of representing
different Theoretical Normals, is the outstanding fact about historic
variables which determines their nature. Among other things, it is
that fact and that fact alone which brings in the axis of historic time
and makes the actual dates of those variables or their actual location
on that axis essential to their very meaning. Without it, dates would
be irrelevant, and arraying items according to their dates would be
nothing but a very inconvenient and unenlightening mode of presenta-
tion, Hence we may, for our purpose, define a historic variable as a
variable, the Stochastic Normal of which changes owing to a change of
its Theoretical Norm.^ A sequence of values of such a variable we call

^ TMs does not mean, of course, that we cannot do anything with them. We are here
concerned with a principle only, which it is important to grasp, but which is not an absolute
bar to progress in this direction. A theory of the mechanism of the cycle is one of the most
powerful tools with which to make headway.

® The writer, having been told that the above is liable to be misunderstood, wishes to
add an explanation, though he does not himself see the necessity of it. We assume that
nothing disturbs the economic process except cyclical evolution in our sense. We observe
a variable in two successive states of ideal Walrasian equilibrium, A and B, Its value is
constant at equilibrium amount in A and in B, though differing as between A and B.
In both cases we are supposed to be able to make many observations which are subject to

Time Seeies and Their Normal

197

a time sequence or, slightly incorrectly, series. We may now also adopt
the usual definition, which would not, taken by itself, convey our mean-
ing: a sequence of values of a variable arrayed according to consecutive
dates of occurrence.

Now, the only thing that is universally true about time series is
that they do not fulfill probability requirements. We have to add that,
since the evolutionary process reflected in every time series goes on in
distinct cyclical units, the individual items within each unit are not
independent of each other. Neither, strictly speaking, are the cycles
themselves independent; but we may overlook this in a first approxima-
tion and make them our observational units. This, however, reduces
the number of our observations to a dangerous degree. The fact is
that only for what we have called the Kitchins our material covers a
number of units at all sufficient for statistical treatment and the value
even of this is much impaired by the possibility of systematic change
during all that time. For most series, available Juglars are few. For
no series are they ‘‘many’^ in the technical sense: from to 14 are all
we have, in the most favorable cases, for prewar times. And of Kond-
ratieffs we have, up to 1914, a little more than 23^:^. If, finally, we recall
the external and internal irregularities to which our process is subject,
we have before us the natuxe of the statistical task involved in Time-
series Analysis.

That heading commonly denotes two problems. First, the problem of
splitting up any individual time series into the components present in it.
As a matter of common sense, we look upon it as a composite which we
naturally would like to decompose by formal methods, i.e,, methods
which involve as little theory as possible, because one of our main objects
in doing so is precisely to confront results with theoretical propositions.
Second, the problem of ‘‘correlation’’ of different time series with each
other. Again as a matter of common sense, we look upon each series as
one element of what we feel to be a process, which it is no less natural
to try to explore by putting our time series in such a shape that they
will display the relations between variations of economic quantities
peculiar to that process. It is again very understandable that we should
wish these relations to be derived by formal methods so as to make them

errors of measurement and form in both the same frequency distribution, say a symmetrical
one. This distribution, of course, could change, but is for simplicity’s sake assumed not
to do so. By the Statistical Normal which does change we, of course, do not mean the
function descriptive of the distribution but the values of the variable which in A and in B
would turn out to be the *‘true” ones in the sense of the theory of errors of observation.
Under our assumptions, these coincide with the values that are theoretically normal ones,
and the reason why they are different as between A and B is that the theoretical or equilib-
rium value of the variable in A has been changed into the equilibrium value of the same
variable in B by the process of evolution.

198

Business Cycles

as independent as possible of theories. But as we have seen before from
other standpoints, so we see now from the standpoint of statistical
theory that neither problem is amenable to solution by formal methods
or, indeed, has any sense if stated in terms of formal methods.

It is important for the reader to grasp clearly what that means and
what it does not mean. Of course it is a well-known proposition that
any material can be split into components — say of the sine-cosine type
— ^in an infinite number of ways (see, for example. Lamb, article on
Harmonic Analysis in the Encyclopaedia Britannica) and that even if the
constants of the function that is to represent it are subject to restrictions
suflScient to make the problem determinate, such as are implied in the
Fourier analysis, no amount of closeness of fit proves in itseK that the
individual components have any meaning in the sense that distinct
phenomena correspond to them. Therefore, there is, in a formal sense
and in the absence of further information, no logical meaning to the
question what components are ‘^present” in any given material, and even
periodicity that seems to stand out visually, as well as obvious absence
of periodicity, may prove very misleading. Not only is it, for example,
possible to approximate, to any desired degree, a straight line by a
Fourier series, but a straight line may really be the resultant of two sine
movements of equal period and amplitude and opposite phase- But our
analysis leads us much beyond these and similarly familiar arguments.
By formal methods we understand here methods deriving from, and
making use of, probability schemata: and our point is that these schemata
become, in strict logic, inapplicable under the conditions which give rise
to time series as defined, and that application of methods based upon
them may hence give spurious results. We must introduce further
information or postulates in order to make them work at all. But even
then they may work faultily. Hence, they cannot be relied on to dis-
cover and isolate any components and for this reason alone, even if there
were no others, would also fail to solve the second problem of time-series
analysis.

We do not however go so far as to say that they must work faultily
and can never turn out results that are at least justifiable in the first
approximation. To clear the ground in order to make room for judicious
use of them, at least in some classes of cases, is on the contrary one of
the objects of the above analysis, as it was one of the objects of many
of the arrangements decided on in the fourth chapter.^ We have, for

^ What would happen to the probability foundations in case various tools of statistical
theory should turn out to be applicable to our material, and how they would have to be
transformed, is a problem into which we cannot enter in this book. Nor shall we system-
atically Hat and discuss the methods in use or suggested for dealing with time series. But
it is easy to see what justification of the type of what, in Erench criminal procedure, are

Time Sekies and Their Normal

199

instance, so chosen our three cycles as to make* them significantly differ
in period. This will open the door to several methods that would other-
wise be excluded. Moreover, we have stressed that virtue of the three-
cycle schema which consists in making it less absurd than it otherwise
would be to assume approximate equality of periods for each class of
cycles. This does not amount to justification, to be sure, and even if it
did, would not suffice to render application of either Fourier or Schuster
analysis plain sailing, but it certainly makes matters easier for both.^
We have also pointed out, that each of our “higher’^ cycles may be
plausibly assumed to span an integral number of the next lower ones. As
the Fourier analysis consists of a fundamental term and its harmonics,
this removes one of the difficulties its application encounters. In a
sense, the mere fact that our analysis of the business cycle shows essential
sameness of the process all along, both in nature and symptoms, goes
some way toward discouraging that extreme scepticism which, at first
sight, might seem to follow from the above considerations : to us, therefore,
it does not seem correct to say that statisticians have, in their time-series
analyses, been completely stepping on clouds.

The fundamental indictment, however, remains. We may express it
in a nutshell by saying that statistical methods are not general in the
sense in which our logic is and that, outside of the range of probability
schemata, they must grow out of the theory of the patterns to which they
are to apply. From knowledge about the phenomena to be handled,
which is of course basically empirical but at the same time a priori with
reference to each individual task in hand, we must try to form an idea
about the properties of statistical contours and to devise statistical pro-
cedure appropriate to expressing those properties. This requirement we

called the circonstances attenuantes may from our argument be derived for, say, the method
of moving averages, the area method and its affiliates (moving integration and the like),
and others.

^ Be it repeated again: there is no connection between our theory of the cyclical process
of evolution and that assumption. However, if it were too wide from the facts, the
Fourier method would become impossible, and so would the periodogram method. Hence,
it is not superfluous to emphasize that the argument, **it is one of the very characteristics
of business cycles that their length varies greatly even over short periods’’ (comment by
Dr. Tintner on above passage), is not as convincing as it seems, as soon as we give up the
single-cycle hypothesis. In this connection arises the question whether suitable reforms
in both the practice and the theory of those methods mi^ht not improve their value; One
example may suffice. We sometimes observe (compare E. B. Wilson’s chart on page 399,
(op. cit^ particularly the top curve) that while the ordinates of the periodogram nowhere
reach heights significant within the meaning of the usual tests, there is a tendency for
relatively high ones to cluster together. The writer speaks with diffidence on a matter
which belongs to the realm of the specialist in statistical method. But it seems to him,
that these clusters are not without significance and should be taken notice of, independently
of mere height.

200

Business Cycles

call the Principle of Economic Meaning.^ The whole of the argument
of this book may be looked upon as an attempt to provide material with
which to satisfy it.

B. Various Meanings of the Term Trend. — The strong impression
which all but compels us to distinguish trends and cycles may be embodied
in quite noncommittal definitions. We may say that a series displays a
trend if it is possible to divide the whole time interval covered by it into
subintervals such that the mean values of the time integrals over these
subintervals are monotonically increasing or decreasing in function of
time, or that they display recurrence of the same figures once only. By
the term cycle we designate the fact, that a given series corrected for
seasonal displays recurrence of values either in its items or in its first or
higher time derivatives more than once. Inasmuch as these fluctuations
do not occur independently in individual series but display either instan-
taneous or lagged association with fluctuations in others, we may define
the concept of cycle so as to cover this additional fact. Series which
do not display such cycles we call Clean Trend Series; series which do
not display a trend in the sense defined, Clean Cyclical Series. As these
purely formal definitions do not involve any restriction as to the length
of the interval to be studied, there are, of course, instances of both. For
those intervals, however, which we consider in this book there are no
instances of clean trend series, and only two major ones of clean cyclical
series : unemployment percentage and interest rate.

Before we go on to develop our own view about the precise nature of
trends in economic quantities and the methods of isolating them, we will
in this section discuss some of the more important meanings of that
overworked term in the hope that this will contribute toward a clarifi-
cation of the issues involved.^ In doing this we shall try to give to
each meaning its operational complement, that is to say, to indicate
which method of trend determination logically corresponds to it or is
implied in it. We disregard two groups of meanings, both of which make
the term serve as a substitute for the word tendency, which seems to
have gone out of fashion. The first may be instanced by the proposition
that prices have, on a certain day, displayed a downward ‘‘trend’’: this
has, of course, nothing to do with what we are here concerned with. The

^ Tlie Cumulation Metliod and some of its applications afford good illustrations of
that principle as well as of the consequences its neglect may entail. See Editorial on the
Harvard Index of Business Conditions, Review of Economic Statistics, 1927, p. 80.

^ The writer wishes to call attention to Professor E. Erickey’s paper on the Problem
of Secular Trend in the Review of Economic Statistics for October 1934, which presents a
view in many respects similar to the argument of this section. See, also, Ellen Quittner-
Bertolasi, Das Verhaltnis von Trend und Konjunkturzyklen als mathematisch-bkono-
misches Problem, 1933.

Time Series and Their Normal

201

second could be instanced by quotations from any one of that host of
popular writers or speakers who seem to derive satisfaction from writing
or talking about “trends and forces in a nontechnical and nonquantita-
tive way.

1. Our understandable wish to survey the behavior of any economic
quantity during any length of time without being bothered by all the
ripples or dents in the graph, or to have before us the “general slope’" or
the “underlying movement” of that quantity during that time will, as a
rule, require some economic analysis, however crude; for it is obviously
not a matter of indifference what it is which that smooth slope excludes.
We may, however, also gratify that wish in a purely formal way by the
application of some method of smoothing or graduation.^ It is most
completely gratified by fitting to the material a simple curve, such as a
straight line, a parabola, a Gomperz, a logistic, or one of many others.
If, for instance, we are interested in the average rate of change a quantity
displayed during a certain period of historic time, the exponential y = cr\
where c is a constant and r expresses that average rate, will serve well,
even if the fit be not good according to some formal test. For an example
of its application the reader is referred to Professor Mills, Behavior of
Prices, p. 66. Curves or functions that aim at representation of time
series in some such simplified form and at nothing else we shall call
Descriptive Trends.

No objection is being raised against them, provided it be clearly
realized that they are nothing but a piece of economic history in the form
of a curve or the most radical of all smoothing devices. Considerations
of adequacy of representation or goodness of fit, on the one hand, and of
calculatory convenience or expense, on the other, may legitimately enter.
The highly subjective character of these is, to be sure, in striking contrast
with the apparent exactness and objectivity of the results, indeed almost
amusingly so. But this is the natural consequence of the indefiniteness
of the purpose. The problem is essentially one of reasonable compro-
mise. A simple curve with few constants is easy to calculate but may
be a poor representation. A high-degree parabola is expensive to
calculate and may pick up too much of the fluctuations we wish to
discard. Use of orthogonal functions carries among other advantages also
the practical one that, each constant being independent of the degree of
the function, it is possible to proceed to higher approximations simply by
adding new items, without having to do all calculations over again.^

^ For a very good discussion of principles and metliods compare, for example, F, R.
Macaulay, The Smoothing of Time Series, 1931.

2 As far as the writer knows, the case for orthogonal functions has been first presented
and the theory of their application first worked out by P. Lorenz in his monograph on Trend,
Special Number 9 of the Vierteljahrshefte fttr Konjunkturforschung. Dr. Tintner has

202

Business Cycles

Such considerations cannot be made determinate, but this is no reason
to condemn them. Even such practices as leaving out clearly abnormal
points ’’ and recognizing ‘‘breaks in trend” — ^which means fitting different
simple functions, say, straight lines, to subintervals — ^have their place,
although they imply an exercise of judgment which must be justified in
each case.

The difficulties adverted to in the preceding section arise, however,
as soon as we try to put descriptive trends to any other use than that
of expressing quantitatively the rough contours of our material. To
begin with, there is no warrant whatsoever for extrapolation. Moreover,
it must not be taken for granted that such trends describe a real — still
less a smooth — ^process, distinct from the process which gives rise to the
fluctuations, and that by eliminating such a trend from our material we
are eliminating certain factors and isolating the effects of others, thus
performing a piece of economic analysis. To make this quite clear, let
us visualize the particular case of fitting by the method of least squares
(or moments). There is, as we have seen, because of the obvious absence
from the material of the properties that justify application of the proba-
bility schema — these properties are zero correlation, uniform variance,
normal frequency distribution of deviations — ^no basis for that method
in strict logic. ^ But as long as we confine ourselves to the meaning we
have attributed to descriptive trends, this does not greatly matter, since
there is no particularly convincing justification for any trend line of that
nature. It does matter, however, as soon as we give analytic meaning
to the operation and expect it to effect separation of distinct processes.
The trend we decide on will determine what the fluctuations will be. But
irregularities and cylical fluctuations will, in turn, determine the trend.
It follows that no progress toward analysis is possible on *these lines
and, also, that correlation of remainders, ue,, of series thus “corrected
for trend,” is almost, though of course not quite, as objectionable as
correlation of uncorrected values would be.^

pointed out to the writer that they were used in physics before. R. A. Fisher's Analysis
of Variance and the test it provides (“Z" test) undoubtedly rationalizes our behavior with
respect to number of constants. But it does not seem to the writer to affect the above
argument.

^ That proposition is not dependent on the way in which Gauss originally deduced the
method of least squares. The assumptions which create the difficulty are all still present
in more modern expositions.

* Bobrofif's moving correlation, while still open to some of the objections alluded to,
certainly improves the situation. Further progress has been made by Zinn, A General
Theory of the Correlation of Time Series, Remew of Economic Statistics for October 1927.
Compare, also, O. Anderson, Eorrelationsrechnung in der Konjunkturforschung, 1929, and,
for procedures which avoid probability considerations entirely, Professor Frickey’s and
Professor Mitchell's methods, noticed in the first chapter.

Time Series and Their Normal

203

Once more, as in the preceding section, we have to add not only that
this criticism does not touch the use of descriptive trends for the purpose
of provisionally exploring our material, but also that trend analysis by
means both of smoothing and of fitting may, from additional theoretical
and historical information, derive a right to existence not naturally or
generally its own. In illustration of this we may point to a result of
Professor Frickey ’s study on the Problem of Secular Trend quoted before.
He shows (see tables on pp. 204 and 206, Review of Economic Statistics for
October 1934), or rather intends to show, that almost any cycles can be
derived by means of fitting different functions to different intervals of our
series or by means of calculating moving averages for periods of different
length. But, while applauding the main drift of his argument, the
present writer yet wishes to point out that the wholly pessimistic inference
drawn from this by Professor Frickey does not quite follow. For we
get not only meaningless cycles but also cycles which can be justified by
historical analysis. The reason for this, and the method by which we
may hope to distinguish the latter from the former, had better be dis-
cussed in the setting of a somewhat different argument.

2. The situation would be completely changed if it were possible to
assume that our material reflects, as a matter of economic facty first a
smooth and steady movement, and second fluctuations around it which
are due to random shocks or disturbances that behave as if they were
random shocks. This would supply the missing warrant for the appli-
cation of probability schemata and our task would reduce to finding the
precise form of the ‘^empirical law^’ of that movement, for which purpose
use of the method of least squares coidd, barring the ‘‘big” disturbances,
be defended on principle. The Harvard method proceeds, in fact, from
such an assumption, as we may conclude from the comments of its
inventors and from the use of the phrase Secular Trend which seems to
point in that direction.

However, this implies a definite theory of economic evolution. It is
not difficult to say which it is: the Marshall-Moore theory of organic
growth. Since we believe that theory to be unsatisfactory and the
picture of a steady march of progress to be misleading, we are estopped
from following the road which it seems to open. But, besides shedding
some light on the relation between statistical method and economic
theory and on the working of the postulate of “freedom from theoretical
preconceptions,” this case may again serve to show that results of
methods unacceptable on principle need not, therefore, be valueless. If
the cyclical process of evolution, as we conceive it, is at all clearly marked,
there is some likelihood that the results arrived at from the assumption
under discussion will have the value of first approximations to the trend
we shall define in the next section, for properly chosen intervals. It is a

204

Business Cycles

significant fact, to which we shall have to advert again, that the Harvard
method gave satisfaction in the sense that it brought out obviously
plausible fluctuations about an equally plausible trend line when tried
out on material covering 1896--1914 and that difficulties arose when the
same treatment was applied to the whole stretch from 1875 to 1914. In
terms which will later on acquire their full significance, we may formulate
this by saying that in the first instance the least square trend^ did, and
in the second it did not, approximately hit upon the line between the
normals of the shorter cycles, because in the first instance it did, and in
the latter it did not, roughly follow the sweep of a Kondratieff phase.
Whenever it does. Professor Frickey ’s indictment requires a qualification,
which, however, does not impair its validity in strict logic.

We shall use the term Keal Trend to denote a trend which embodies
the contour of a real process, distinct from whatever causes cycles, such
as a least-square-trend line would describe if the above conditions were
fulfilled, i,e,y if the Marshallian picture were sufficiently lifelike. The
effects of Growth in our sense afford an instance. Their presence
undoubtedly accounts for a real trend which, however, is so much
overlaid by the effects of other and more important external and internal
factors that it cannot be found by any process of curve fitting. There
is no reason why a curve descriptive of our Growth should go midway
through the graph of observed values or display any definite, let alone
invariant, relation to them. Real trends will never do this unless the
factor which they express so dominates the given material that the effects
of all the others may safely be treated as ‘‘minor” deviations.

3. Economists who share our doubts about the validity of fitted
trends, and also some who do not, sometimes analyze a given time series
by referring it to another of wider or more fundamental significance.
Thus, a series representing variations in the price of an individual
commodity may be referred to, or corrected by, an index of general

^ Dr. Tintner having objected to the above passage on the grounds that the term Least
Square Trend is ambiguous as long as the function to be fitted is not defined, and that it is
not the method of fitting but the form of that function which follows from the economic
assumptions, the writer wishes to restate his meaning: What follows from the economic
assumption that there is a factor or set of factors making for even growth and distinct from
random factors which produce the cycles is precisely that the particular method of fitting
by least squares (or moments) now becomes defensible on probability considerations. Its
application is not on that account plain sailing — ^this follows from our analogy with the
moving target — ^but there is not in this case any logical objection to it. The choice of the
function to be fitted will, of course, also have to be justified on the lines of the Principle of
Economic Meaning. But this is another matter, with which we are not now concerned.
It may have to be a ‘‘law of organic growth’^ in the sense of a simple exponential or a logis-
tic, but whatever it is has nothing to do with the point we are trying to make. That is
why, leaving the form of the function indeterminate, we have used the term Least Square
Trend, in order to designate any function fitted by that method.

Time Series and Their Normal

205

prices. Professor Bresciani-Turroni, who has as far as the writer knows,
been the first to suggest this procedure as a substitute for formal methods
of trend analysis, took total output as a reference quantity in a study of
exports. Professor Warren Persons gave another lead in this direction
by comparing short money rates with bond yields. Such trends might
be called Reference Trends Their meaning and the correctness of the
idea that underlies them are not in question. They certainly express
fundamental movements of a particular series in a much richer sense than
descriptive trends do. But they do not directly help us to isolate cycles.
In fact, they unavoidably contain all the elements which it is the aim of
trend analysis to separate.

4. Some factor unconnected with the cyclical process of evolution
may exert steady influence on some particular element or elements of
the economic system which it may be desirable to study in isolation or to
eliminate. If it directly acts on the system as a whole, its effects on our
figures would constitute a real trend. If it acts on parts of it only — and
but indirectly on the whole system — ^we will speak of a Special Trend.
Autonomous changes in taste, such as occurred with respect to alcoholic
drinks or heavy foods, afford examples. Such trends may or may not
conform to our general idea of what a trend should be, but can in no
case be found by formal methods. It should also be observed that
phenomena which according to our analysis are essentially elements of
the cyclical process of evolution will, in very many cases, look like special
trends. Output of a new commodity may easily trace out a Verhulst
curve which many students will have no hesitation in interpreting as a
trend special to that commodity and distinct from any cycles that may
run their course during the same period. From our standpoint, of course,
this is never strictly correct, although it may, for the purposes of partial
analysis, be convenient to express oneself so, particularly in dealing with
the problems of the shortest cycles.

5 . We will, finally, recall again that, the Kondratieffs not being
recognized as cycles by the majority of students, many of those long and
slow movements upward and downward which are cyclical for us will be
treated by others as properly belonging in the class of trends, which
results in differences of theoretical analysis on a number of important
points. But this view, which implies that those movements are non-
cyclical in nature, should not be confused with the proposition of sec. D
of this chapter, that every cycle of higher order may be considered as
the trend of the cycle of the next lower order.

C. A Single Cyclical Movement. — ^We return to the principle of eco-
nomic meaning and our definition of time series. In order to facilitate
exposition, we will in this section assume not only that seasonal variation
and growth (in our sense) are absent or have been successfully eliminated.

206

Business Cycles

but also that the process of economic evolution embodied in our model
works in such a way as to produce one cyclical movement only. Of
course, these assumptions already constitute additional knowledge.”
We know, further, the nature of the process that any time series fulfilling
those requirements would reflect. Each item of such a series indicates,
in a way appropriate to the nature of the element represented by the
series, a stage in that process which, as we know, sometimes propels the
system away from, and at other times draws the system toward, a
neighborhood of equilibrium. It follows, even without formal proof,
that there must exist on the graph discrete points or, slightly more real-
istically, discrete intervals in which the series passes through neighbor-
hoods of equilibrium or comes, at all events, as near to such neighborhoods
as it will go and as its inactivity, rigidity, or sloppiness allows. This is a
fact of fundamental importance for us. It supplies the link between
what we have called the Theoretical Normal and its statistical shadow,
the Statistical Normal. This term, as we shall henceforth use it, has
nothing to do with frequency distributions. Its meaning is analogous to
what the business services mean when they say that business is above or
below normal. In fact, what we are trying to do is merely to offer a
more precise definition and a somewhat different interpretation of this
very idea, so familiar to business practice.

To locate the points on our graphs which correspond to points of
equilibrium, or the intervals on our graphs which correspond to neighbor-
hoods of equilibrium, therefore, is from our standpoint the first and
foremost task of time-series analysis. For the state of the economic
system in those neighborhoods sums up and presents, however roughly,
the net result of the preceding spurts of evolution as shaped and absorbed
by the response of the system. They mark the path of economic evo-
lution as steppingstones mark the path across a brook. They are the
most relevant items of a series, most pregnant with information and most
important as reference points for the rest. A line or curve through those
points, or a band or narrow zone through those neighborhoods, supplies
a trend that really has economic significance. We shall use the term
primarily in this sense. We know from the analysis in the second and
fourth chapters that this trend does not describe a phenomenon distinct
from the cycle. On the contrary, since evolution is essentially a process
which moves in cycles, the trend is nothing but the result of the cyclical
process or a property of it. In order to express this, we will call our
trend the trend of results or Result Trend. Moreover, we also know
that it carries realistic meaning only in discrete points or intervals. If
we connect them by straight lines or fit a smooth curve to them, it must
be borne in mind that the stretches between the neighborhoods are

Time Series and Their Normal

207

notHng but a visual help and devoid of realistic meaning. No facts
correspond to them. Real is only the cycle itself.^

Just as statement of the problem was possible only from the eco-
nomics of the case, so methods for its solution cannot be derived from
anything else: they are but a translation into statistical tools of such
information as we may be able to command. But we will emphasize
once more that historical information about each individual case is the
only means by which to reduce to bearable proportions the influence of
external factors and that study and discussion of each situation which
seems to have some claim to being called a neighborhood of equilibrium,
and unavoidably rough estimates will be the surest way to reliable results,
at least for some time to come. It is this method on which the writer
has chiefly relied and it is in order to illustrate principles rather than for
the sake of the use we make in our work on time series (some experiments,
of course, have been made) that we now attack the question of the purely
statistical procedure.

In the case of two-phase cycles solution would be easy. First, we
should have to establish the fact that a given cycle displays two phases
only, and to make sure that the points between cycles are really normal
and not freakish — ^for there could obviously be cases in which some or all
symptoms outrun equilibrium, but rebound so quickly that there is
practically no depression and consequently no recovery. Second, having
satisfied ourselves on those points, all we have to do is to mark the
highest or the lowest points, as the case may be, according to the nature
of each series. A smooth curve connecting those points will then give
the trends which, as already stated, in this case do not go through the
material but trace lines bordering on it in certain places and deviating
from it in others. Of course, external factors must be expected to pro-
duce at least dents — ^but, as a rule, fluctuations also — ^which will upset
the cyclical schema unless historically diagnosed. That they may, and
certainly often will, deflect the whole series for good must be recognized.
What we get is, hence, never a trend resulting from or produced by the
cyclical process alone, but by the cyclical process as distorted by external
factors.

In the case of a four-phase cycle the problem and the principle of its
solution are the same, but practical difficulties arise. The price level,

^ The above paragraph merely restates conclusions arrived at in the three preceding
chapters and should be read in the light of what was said there. It will then be clear, first,
why the concept of a moving equilibrium of the type indicated by Moore, while useful for
other purposes, would not suit ours and, second, in what sense we are entitled to say that
the cycle is a “reaF’ phenomenon, while the trend is not: the latter is not a product of a
distinct set of causes (except insofar as it reflects growth).

208

Business Cycles

for instance, would in strict theory rise both in prosperity and recovery
and fall both in recession and depression. But even if in fact it always
behaved like this, the neighborhood of equilibrium might still lie any-
where between the peaks and troughs and there is obviously no prima-
facie warrant for assuming that it should lie, for example, midway.
Hence, our only hope of identifying neighborhoods from time series
themselves reduces to the possibility that their graphs display some
characteristic behavior in or around those neighborhoods. This might,
of course, consist simply in their assuming a particular numerical value,
which, however, is obviously out of the question. But equilibrium
positions might also be betrayed by more general properties of the graph.
Consideration of this opening imposes on us, it is true, a big toll at the
outset. For unless we rest content with a visual impression (which may
be the wisest and most straightforward thing to do, the more so since
any result, however arrived at, will have to be tested in the light of
historical information), we will first have to perform a smoothing oper-
ation in order to get rid of oscillations, vibrations, hesitations, and also
of some of the effects of some of the external factors.^ As soon, however,
as this toll is paid, we reap all the advantages incident to being able to
deal with differential properties of the smooth curve only, i.e., with rates
of change (and higher derivatives; although, owing to cumulation of
errors, it is dangerous to go very far) at every point.

This idea is due to Eagnar Frisch.^ In order to illustrate his Method
of Normal Points, we will follow him in first considering the case of an

^ Smootliing, if it be done in the course of an analysis that is to reveal fundamental
forms of the phenomena under study, is a much more serious operation than some of our
fellow workers seem to realize. In particular, it may, besides displacing points the precise
location of which is of importance, suggest properties of the material which do not really
exist in it. But smoothing (or, for that matter, curve fitting) also may yield a much truer
picture of the essential featmres of the phenomenon than the graph of the raw figures
themselves. Which it does is a quaestio facti and cannot be settled by formal criteria.
In material like oxirs the best fit may tell the biggest lie. Any fitting or smoothing involves
a number of assumptions about the behavior of the material, the reasonableness of which
should be tested in each case.

2 First published in a mimeographed essay entitled The Analysis of Statistical Time
Series, 1927, which should always be referred to in preference to later publications, because
it contains the only full presentation of the mathematical background of the method (sec.
3 and 4) and the only full discussion of the nature and degree of approximation to be
reached by it. A condensed statement embodying the results of later work was published
in the Skandinavisk Aktuarie Tidskrift, 1928, a short note (A Method of Decomposing an
Empirical Series into Its Cyclical and Progressive Components) in the Journal of the
American Statistical Association^ supplement, March 1931. To the present writer, the
method has always seemed to be a stroke of genius and an excellent illustration of how,
according to the Principle of Economic Meaning, statistical method should grow out of our
knowledge of the particular phenomenon to which it is to be applied — ^that knowledge
being embodied in two postulates, to be noticed in the text, which are, however in some

Time Series and Their Normal

209

economic time series, the smoothed graph of which can be represented
by a sine curve on an axis that displays, say, a positive gradient. Of
course, in this case there would be no objection to ordinary Fourier
analysis and a number of other methods. But it also serves to show that
the curve would, in fact, display characteristic behavior, namely, points
of inflection, whenever it passes a neighborhood — in this case, a point —
of equilibrium: the second derivatives would vanish in those points, since
sine TIT = 0 (n = 0, 1, 2 • • • ), In order to get at the economic meaning
of this, let us choose, say, a series of employment figures cleared of
seasonal, and free from accidental, fluctuations, that moves in a four-
phase cycle. Obviously, it is not unreasonable to expect that employ-
ment will increase at a slackening rate during prosperity, that it will
decrease at an accelerating rate during recession, that the rate of decrease
will be at a maximum when the system embarks upon depression and
that employment will then go on decreasing at a rate which gradually
decreases until recovery point is reached, after which it will increase,
haltingly at first and then more and more decidedly as the processes of
recovery get the upper hand, until equilibrium is reached. All this is
highly schematized, of course, and very far from being the picture of any
actual process, but it is not absurd. At any rate, it shows how economic
factors which we know to be at work could produce a behavior of our
graphs that would not only characteristically differ as between the phases
but also indicate neighborhoods themselves. There is nothing in the
logic of the process to bar advance on these lines, although there are
plenty of other obstacles in the way.

Economic meaning not being wanting, we might even go so far (we
shall not be so bold) as to use that particular shape as a schema with
which to express essential features (in German the writer would use the
word Wesensform) of the phenomena and to compare actual behavior.
If, to keep to our example, employment, at the beginning of what can
historically be proved to be a true prosperity, should not increase at all
and afterward for a time increase at an increasing rate, there surely
would be some justification for suspecting that this behavior was due to
an external factor and for starting to hunt for it. If presence of such a
factor could be satisfactorily established, we might have the same right
to bridge the cavity by a stretch of sine form that the archaeologist has
to reconstruct the ""true"’ form of an ancient temple from the ruins plus
his knowledge about what a temple is. This sounds absurd only as long
as we disregard historical evidence, which, of course, has to supply the
warrant in each case.

respects more, in others less, general than is our theory. The other method developed by
Professor Prisch (method of moving differences) will not be discussed here.

210

Business Cycles

Professor Frisch, had no difficulty in doing away with what are most
obviously unacceptable properties of that schema, namely, the constant
period,^ equality of excursions to both sides of normal, and equal length
of phases. If in the differential equation, = 0, of which the

solution is the sine curve, we replace the constant c by a function of
time F{t)^ assumed to be regular and always positive, we get the general
form of a differential equation of the second order y" + F{t)y = 0.
And this makes it possible to take care of very many patterns which are
much nearer to reality. In particular, we need no longer assume that
intensity of the action of equilibrium ligamina is proportional to the
distance. Deviations above’’ and ‘‘below” may stand in any relation
to each other as to duration and amount. However, no less than in the
case of the sine curve, the trend is assumed to be the gravitational axis
of the smoothed curve, i,e,^ the latter will always have to turn its concave
side toward that trend. Again, there is a perfectly sound economic
meaning to this. From the standpoint of our model we shall, indeed,
think it highly plausible^ that the action of equilibrium ligamina should
be the stronger (gains and losses incident to disequilibrium the greater),
the farther away from equilibrium the system is : as far as that goes there
would be little objection even to straight proportionality. Only, this
formulates but one tendency. However well established and expressed,
it will not prevail in reality or in the graph, unless all the other tendencies
which also are reflected in it — ^in particular, the entrepreneurial impulse
and factors responsible for external and internal irregularities — act in a
certain way. The method, hence, implies certain additional assumptions
about that. Consider, for instance, a function as little freakish as y {t) =

^ C. A, K, Wardwell in An Investigation of Economic Data for Major Cycles, privately
printed 1927, used, however, a moving average of periods which varies with the length of
each cycle. An analogous idea is implied in the National Bureau method.

2 In strict theory, that postulate is more than merely plausible. It might even be held —
although the writer confesses to some doubts about this — that it is no postulate at all but
a consequence of the fundamental properties of the system. This would not, however,
exclude that it fit facts but ill. To illustrate this by an analogy: an elastic string will
break if exposed to tension greater than a characteristic constant. Moreover, it may cease
to act without breaking or act with lesser force beyond a certain point, if exposed to tension
either recurrently or for a sufficient period at a time. There are some suggestions for
further analysis in this. But this apart, there are, of course, other hypotheses besides the
one discussed in the text which may help us to get on to the facts of our case. One that
seems very promising has been suggested by M. Le Corbeiller (compare his article on Les
Syst^mes Autoentretenus et les Oscillations de Relaxation, Econometrica for July 1933).
It is embodied in the Van der Pol equation y" — €(1 — y^)y^ -j- y = 0 (compare B, Van
der Pol, Oscillations sinusoidales et de relaxation, FOnde Electrique for June-July 1930)
which, if € be great, describes a process of accumulation of energy followed by a quick
release. In this book we shall not, however, follow up this clue. The use of skewed
sines*’ has been suggested by Professor Crum in a paper quoted below.

Time Series aot> Their Normal.

211

— a^). The graph (the reader should draw it) presents the picture
of a clean cycle, astride on ^ = 0. But not only are inflection points
absent where they should be present (for t ^ a and t ^ —a), but there
are three of them within the cycle, of which two (the one at 35 = 0 is all
right) may be very misleading in more complex cases.

The example is merely intended to show how very easily the funda-
mental postulate may fail to be fulfilled. In many cases, alluded to
above, the curve will be convex to the axis for considerable stretches
of prosperity and recession — owing, for instance, to speculation’s feeding
upon itself in the first and covering in the second case. In other cases,
inflection points may not occur in their “ true ” places or may be difficult to
locate. This is independent of the additional difficulty that smoothing
may produce spurious and hide real inflections. That is why our
exposition will not issue in a general recommendation to adopt this
method, for the present at least, in practical work. Although it is
successful and of practical value in many cases, ^ we see its main impor-

1 The reader who wishes to have an infallible method that will mechanically turn out
results, will unavoidably be disappointed and feel it difficult to understand the admiration
the writer feels, nevertheless, for that method most objections against which seem to him
to rest on misunderstandings. The writer is unable to sympathize with that mentality.
Although he greatly dislikes the word impossible, he believes it safe to say that, for the
present, our material being what it is, no formal method can replace common sense and
experience with both theory and material. To call for such a method is as reasonable
as it would be to call for a machine which will automatically perform surgical operations in
an ideally foolproof way. And to smile in contempt on freehand methods is as reasonable
as it would be to scorn the subjective judgment of the surgeon or the inexact working of
his hand. It is, therefore, not derogatory to the Frisch method to say that it will issue,
in very many cases, into freehand procedure, which alone can bring to bear on our work
all we know historically and otherwise and which alone can, to some extent, cope with the
fact that our material is distorted by external factors besides being internally irregular.
This is clearly brought out by the paper by L. A. Maverick on time-series analysis by suc-
cessive smoothings {Econometrica for July 1933), with which, however, the writer does not
entirely agree (see, in particular, the considerable role accorded to the midway line).
But in many respects Professor Frisch’s method compares favorably with others, even from
the standpoint of practical application. Its great virtue — the working by local instead
of total properties of the curves — ^prevents for example erratic items from directly (t.e., by
their presence, not, of course, by their effect on other items) influencing the trend, unless
the irregularity happens to occur in the neighborhood of equilibrium. It also excludes
influence of peaks and troughs, which is as it should be, apart even from the likelihood of
their being erratic. Hence, it is not correct to say that the Frisch method does not help at
all toward elimination of random fluctuations, which is the reason why some students prefer
Professor Anderson’s method advocated in the work quoted before. In no case do other
methods gain by comparison. There is no sense in holding that we ought to think any
better of them because they are more sure-footed in application than Frisch’s method is.
For, inasmuch as they are wrong in principle, this is only another reason for discarding
them. There is little compliment in saying that they tmn out error in a perfectly objective
and exact way.

212 Business Cycles

tance in the rationale and criterion it provides for all efforts in the field
of time-series analysis.

D. Many Simultaneous Waves. — ^The above analysis only served to
illustrate a principle and to lead up to the really relevant case of a
complex cyclical movement. We will, for the sake of simplicity, let it
consist of our Kondratieffs, Juglars, and Kitchins only, and disregard
all the other types of fluctuations noticed in sec. E of the preceding
chapter. Since we have nothing to add to what was previously said
about effects of external disturbances and the possibility of eliminating
them, it will also be convenient to assume their absence as well as
absence of, or successful correction for, Seasonals and Growth. Although,
of course, we do not, as a matter of principle, postulate either internal
regularity or sine form, there is some use in presenting (Chart I) the
graph of the sum of three sine curves the amplitudes of which are pro-
portional to their duration and (Chart II) the graph of the first differ-
ences of the composite curve. There is, however, no trend : the cyclical
movements represented are, in our terminology, ‘‘clean.^* Barring this,
we may look upon the charts as an illustration of all the boldest assump-
tions which it is possible, and to some extent permissible, to make in
order to simplify description and to construct an ideal schema with
which to compare observations. In particular, all cycles have four
phases of equal length, amplitudes of plus and minus excursions are equal
and constant, periods are also constant, and each of the two higher
cycles consists of an integral and constant number of units of the next
lower movement. Por the stranger to statistical technique the fact alone
that extreme regularity of but three components may result in so very
irregular-looking a composite should be instructive. But these pictures
may also help us to form an idea about how near to, or far from, reality
those assumptions are which some statistical methods impose.^

We recall that many methods which would be available for the analysis
of such a composite and are not, in strict logic, applicable to the eco-
nomic time series we meet with in practice, may yet produce results which
historical analysis permits us to accept as approximations. This fact
again suggests that our material satisfies certain conditions of regularity,
in particular those required by the Fourier and the Schuster analysis,
more nearly than we should expect on theoretical grounds.^ It also gives

^ Professor Irving Fisher has, in his contribution to Economische Opstellen, aangeboden
aan Professor Dr. C. A. Verrijn Stuart (1931), used the harmonic components of an organ-
pipe tone to convey a similar idea. We wish to draw the reader’s attention to that con-
tribution, which formulates the views of its author in a way much less distant from ours
than other publications of his.

® Professor W. L. Crum points out (The Resemblance between the Ordinate of the
Periodogram and the Correlation Coefficient, Quarterly PuhlicaUon of the American Btatia-

Time Sekies and Their Normal

215

additional importance, for our field, to an elegant method due to Dr. N-
S. Georgescu, which has been used in the analysis of one of our series
(Chart XXIV), although it consists in fitting sine curves according to a
probability test — the most probable values of the unknown periods of a
known number of sinelike fluctuations^ being found under the assumption
that ''errors are distributed according to the Gaussian law.^ And the
same fact also lends some support to quite primitive methods of pro-
ceeding by inspection — simply counting off what we see — or by means of
average periods that hardly ever get very seriously out of step with
observations except in cases which we may reasonably explain on the
score of external disturbance. The success which Mr. Kitchin (Cycles
and Trends in Economic Factors, quoted above) undoubtedly achieved
simply by counting off his short cycles, observing that two or three of
them seem to form higher units and that there is a sort of ground swell
below both, illustrates the point very well.^

But we shall here confine ourselves to Professor Frisches method of
Normal Points.^ The present problem is fundamentally the same as in
the case of the single cycle: we have again to locate statistical normals
which are to be interpreted as neighborhoods of equilibrium and to be
indicated by inflection points. This means that we continue to postulate
that each cycle is a solution of an equation of the form yn' + Fn{t)yn = 0.
The first thing to understand is that the method does not now become
open to the same charge as the Fourier analysis, namely, that it may

tical Association for September 1923) that the periodogram method will work satisfactorily
only if fluctuations do not depart too much from the sine form (p. 892). His own success
with the periodogram analysis of the short rate of interest, therefore, proves that the
fluctuations, in this series at all events and in the period studied (p. 898), actually did con-
form to it fairly closely. That paper is rich in suggestions on a number of other important
points; compare, for instance, p. 896.

^ It should be observed, however, that the method cannot handle more than three of
them.

2 See Academic des Sciences, seance du 7 juillet, 1930, Sur un probl^me de calcul des
probabilit^s avec application ^ la recherche des periodes inconnues d’un ph^nomene
cyclique. Note de M. N.S. Georgescu, presentee par M. Emile Borel, which gives the
fundamental idea.

® The “method^’ of moving averages, which is severely judged by some of the best of
statisticians, also derives some support from considerations on those lines. We shall often
treat series in this manner.

^ A method which also works with points of inflection has been independently developed
by Professor Walter A. Baude of the University of Cincinnati, who used a third-degree
parabola for trend and analyzed the B.L.S. index of wholesale prices and two synthetic
composites, among them one consisting of schematic Kondratieffs, Juglars, and Kitchins.
Results were distinctly encouraging, although a high-degree trend, entailing more than
two differentiations, creates difficulties on the score of cumulation of errors. The method
was communicated to the Econometric Society at its New York meeting, 1936. See
Econometrica for April 1936, p. 183.

Business Cycles

ai6

yield spurious components. This danger is practically avoided by the
differential character of the method, which rests upon independent study
of the behavior of the material in the vicinities of each point on the
(smoothed) curve. It is obvious that any cyclical movement which,
nevertheless, shows up at all persistently, is extremely unlikely to be
meaningless.^ But beyond this, the application of the principle now
meets with several difficulties.

We have previously noticed that there is no warrant for assuming
that our three cycles, or any cycles of different order, are additively
superimposed to each other. While by the use of logarithms multiplica-
tive relations can also be taken care of, the general case cannot be satis-
factorily handled so far. This, however, does not greatly matter in the
present state of our knowledge of the phenomenon. It seems at first
sight to be more serious that the method, giving only discrete points on
every cycle, does not inform us about the shape of the higher cycles
between neighborhoods. But from the standpoint of our theory it may
be replied that the distinction between simultaneous cycles mainly turns
on the neighborhoods and that in the intervals between them there is
not the same kind of realism’^ about it, while our trends have no
realistic meaning in those intervals. From the standpoint of the par-
ticular method under discussion, it may be urged that even if we discard
as unreliable the neighborhood of each cycle that occurs on downgrades,
we have three Kitchin neighborhoods to every Juglar and six Juglar
neighborhoods to every Kondratieff, and that if we fit through these —
taking into account, on the one hand, the possibility of two-phase cycles
and, on the other hand, our postulates about smoothness and curvature
— ^we are not likely to deviate very much from reality, although we may
sometimes feel doubtful about the precise values of relative amplitudes.

To the writer this difficulty does not seem so grave as the question
of the reliability of the points of inflection, which has been noticed in
the case of a single cycle and now reappears with a vengeance. But a
still more fundamental point emerges behind it. Except in the cases in
which the normals of the cycles of all orders coincide, the points of
inflection of the cycles of lower order obviously cannot lie exactly on a
curve which is to represent the sweep of the cycles of higher order.
Hence, a curve derived by interpolation between those points would not
trace the underlying cycle, even under ideal conditions, and the line
through the inflections of the composite does not go through the normals
of the cycle of lowest order. Our decision made in the previous chapter
— ^to look upon each ‘^underlying” cycle as the “trend” of the next one

^ It may still happen, of course, that a fluctuation of a given order is generated” by^a
fluctuation of a different order. About this no method of decomposing can tell us any-
thing. But the generated fluctuation would still be a real and significant movement and
not a product of the method.

Time Series and Their Normal

217

of lower order in the sense of locus of the normal points of the latter —
seems to involve contradiction. It will be seen, however, that this does
not amount to more than that the method now becomes essentially one
of approximation, and this is as valid a defense of the statistical as it is
of the theoretical point in question. Whether the approximation be
satisfactory must, indeed, be judged on the merits of each case and
cannot be decided once for all. If the surface movement of the composite
is dominated by the shortest cycle, and then again, the contour that
would emerge after elimination of the latter, is dominated by the cycle
of next higher order, and so on, lines through the inflections of the
composite and then through the inflections of successive remainders will
each of them indicate, although not give, the location of states which
are, relatively to each cyclical movement, neighborhoods of imperfect
equilibria. This hypothesis will undoubtedly fail in many cases, but
these cases can be seen in the graph and interpreted from industrial
history. Delicate questions of interference arise here, into which, how-
ever, we need not enter for the purposes of this book.

If besides our cycles there are also other fluctuations in the material,
the Frisch method will show them all, including seasonal ones, hesitations,
and so on. As stated above, it will do so more reliably than the peri-
odogram analysis, both in the sense that it is because of its flexibility
less likely to suppress real (though irregular) fluctuations and in the
sense that it will not produce meaningless ones. If durations of com-
ponent fluctuations are sulBSciently different, a very simple graphical pro-
cedure will give good provisional results. Chart III presents an example^
displaying seasonal and Kitchin fluctuations. The only other example
of the application of the Frisch method contained in this book will be
met with in our discussion of the cyclical behavior of the level of prices.

While the method thus helps us in exploring our material and, in
doing so, shows up to advantage, it cannot, of course, pick out from all
the movements it reveals those which are cycles in our sense, the Kitchins,
Juglars, and Kondratieffs.^ This can be done only by further economic
analysis, both of the theoretical and the historical type. In this respect,
the method has indeed the virtue of harnessing the concept of equilibrium
and a few properties of the cyclical process to statistical use, but still
remains formal beyond that. Nor does it reveal any component as it
actually acts, but only as it shows as distorted by other factors. WTien-
ever we are in a position to construct the ‘Hrue” form of a component

^The series of Average Weekly Cars of Revenue Freight Loaded was analyzed by
Mr, S. N. Whitney in the seminar conducted by Professor Frisch at Yale University in
1930-1931. The writer is much indebted to Professor Frisch for his permission to use it,
as well as for the trouble he generously took, by advice and criticism, in the work on the
price-level series referred to in the text.

® We have seen, however, that it does something toward eliminating the direct effects
of individual disturbances.

Time Seeies and Theie Noemal

219

from additional knowledge of the case — ^fluctuations due to the structure
of the adaptive apparatus, such as hogcycles, are at present nearest to
that goal — it must be discarded in favor of other methods. But even
in such cases it may serve as a starting point of advance on this line,
which may eventually lead far beyond our present horizons.

The principle of Economic Meaning becomes still more important
when we approach the problem of comparing Time Series. What the
Frisch method does for us is to enable us, first, to piece together mosaics
of neighborhoods of equilibrium by indicating the values of each time
variable which lie within them and, second, to study their behavior,
relatively to each other, during the phases or movements toward and
away from equilibrium which it similarly indicates. Again, it is the
linking of the concepts of the economic and the statistical normal which
makes this possible, but further factual and theoretical material is
required in order to make headway beyond this.^ Illustration from
individual, as distinguished from aggregative or systematic, series is
particularly telling, because the former will, as a rule, present more
complex relations than the latter. If, then, by means of the Frisch
method we analyze, for instance, the behavior, relatively to each other,
of price and quantity sold of an individual commodity, we get gross
relations, within each cyclical component, which result from ‘‘movements
along demand curves'’ and cyclical and other “shifts of demand curves.”
Various parameters which we know, from additional information, to be
relevant, say, to cyclical shifts will then have to be introduced into the
familiar relations proffered by traditional theory. At this point our
problem merges into a much more general one which seems to loom in
the future.^

^ This is not to say that formal methods are valueless. Mr. Zinn’s paper in the Review
of Economic Statistics for October 1927, previously referred to, affords an instance of an
important partial success achieved by purely formal considerations. If we have a time-
variable, which we consider as dependent on the values of another time-variable at the
same and preceding times, f{xu xt-^ * * * )> and if we develop the relation into a
power series, neglecting second and higher powers, we arrive at a linear expression
yt A -{■ Y oXt -]r YxXt^i * * * » where the constants Fo * • • Tn, represented by Fi, may
be built into a function of i, characteristic of the relation between x and y and very sugges-
tively called by Mr. Zinn the system factor. If the function Ft is the same for different
divisions of the two series, we conclude that Ft is independent of xu hence dependent upon
the “ system, the properties of which we thus explore. Application to the relation between
interest rate and wholesale price index, as carried out by Mr. Zinn, is a very interesting
contribution to the theory of vibrations or of propagation waves.

* Much work has been done and is being done on such problems, which could be use-
fully related both to our theory and to the method discussed above. Multiple curvilinear
correlation is a particularly important case in point, in spite of the difficulties that surround
the idea of correlation in the case of time series. This whole range of problems, however,
touches the argument of this book peripherally only and will come up for but a brief
discussion in Chap. X.

CHAPTER VI

Historical Outlines

1. Introduction; 1786-1842

A. The Fundamental Importance of the Historical Approach to the
Problems of the Cyclical Process of Evolution. — ^The importance of such
an approach has been emphasized from the outset. Since what we are
trying to understand is economic change in historic time, there is little
exaggeration in saying that the ultimate goal is simply a reasoned
( — conceptually clarified) history, not of crises only, nor of cycles or
waves, but of the economic process in all its aspects and bearings to
which theory merely supplies some tools and schemata, and statistics
merely part of the material. It is obvious that only detailed historic
knowledge can definitively answer most of the questions of individual
causation and mechanism and that without it the study of time series
must remain inconclusive, and theoretical analysis empty. It should
be equally clear that contemporaneous facts or even historic facts
covering the last quarter or half of a century are perfectly inadequate.
For no phenomenon of an essentially historic nature can be expected to
reveal itself unless it is studied over a long interval. An intensive study
of the process in the last quarter of the seventeenth and in the eighteenth
century is hence a most urgent task, for a quantitative and carefully
dated account of a period of 250 years may be called the minimum of
existence of the student of business cycles.

Of course, this is being increasingly realized. Histories of ‘‘crises”^
and detailed descriptions of individual crises have been written from
the beginning of the nineteenth century. That literature is richer
than appears at first sight because it includes all the descriptions of
particular aspects, as well as those written from particular standpoints —
notably, most of the attempts to analyze the working of the monetary
mechanism and of speculation, with both of which the phenomenon of

^ The histories by Wirth, Tugan-Baranowsky and Bouniatian and the condensed but
excellent sketch in Spiethoff *s article Krisen in the Handwdrterbuch der Staatswissenschaften
may be mentioned as the peak achievements in that line. Of the large literature on indi-
vidual crises the writer wishes only to mention what seems to him one of the best per-
formances: Dunbar’s essay on the crisis of 1857, which will be cited later on.

Historical Outlines

221

crises has been linked up from the first. But that is not what we mean.
Since the development generated by the economic system is “ cyclical’ ’
by nature, the task to be accomplished grows far beyond mere description
of spectacular breakdowns, on the one hand, and of the behavior of
aggregative quantities, on the other, into the formidable one of describing
in detail the industrial processes behind them. Historians of crises
primarily talk about stock exchange events, banking, price level, failures,
unemployment, total production, and so on — all of which are readily
recognized as surface phenomena or as compounds which sum up under-
lying processes in such a way as to hide their real features. Hence,
the value of that kind of historical work is not only impaired by the
fact that much of it is not up to minimum requirements of scholarship,
often vitiated, moreover, by prescientific theories, but also by the still
more important fact that, except incidentally, it did not touch upon
the essential things at all. The same objection applies to more recent
attempts, very meritorious in themselves, to follow up changing business
situations year by year so as to supply us with business annals. With
due respect and gratitude for what has been done in that line^ and what
undoubtedly was all that could be done with available means and sources,
it must still be pointed out that the mere labeling of each year according
to the general temperature of the business community as revealed by
the press, with short additions about the, state of the money market,
employment, harvests, foreign trade, and so on and about external factors,
such as political events, does not carry us much beyond the evidence of
the time series themselves. The annals, flowing from a source partly
independent of the sources of time-series material, provide a useful
check. But they may easily mislead by overstressing those aspects
which are primarily reflected in commercial and financial journals, and
because, as far as they really are independent of what goes into time
series, they mostly lack precise criteria for the diagnoses they give.
Moreover, the information they convey is, except on rare occasions,
entirely of the aggregative type.

What we really need we are more likely to find in general economic
histories: they bring us much nearer to the process which produces the
waves we observe in our time series. But much more important are the
innumerable monographs on individual industries. Although not aiming
at our range of problems^ and withholding, almost tantalizingly some-

^ Mainly in tlie annual surveys and supplements of the economic weeklies of all coimtries,
also of the daily press. The writer wishes, however, to acknowledge the help derived from
the Business Annals by Mr. W. L. Thorp (National Bureau of Economic Research, 1926)
as well as from Professor MitchelFs introductory essay to that volume.

2 The one exception is the series of monographs, BeitrUge zur Erforschung der Wech-
sellagen, edited by Professor Spiethoff which gives, for several German industries, exactly
the kind of information we need.

Business Cycles

%%%

times, the information and the exact dating required for our purpose,
they mostly indicate, all the same, how an industry arises, how it is
absorbed into the economic organism, how it affects that organism and
how it is reacted upon, and what its cyclical behavior is. In fact, they
largely agree in what they consider relevant or interesting, and a general
schema could readily be sketched which would fit the large majority of
them and could easily be improved upon. Coordination and systematiza-
tion of this kind of work would be extremely useful and is perhaps not
too much to hope for. Furthermore, we have an increasing number of
monographs on individual concerns and entrepreneurs, jubilee volumes,
biographies, and so on which, whatever their shortcomings, are a store-
house of relevant material.^ The growing interest in the genealogy of
nonaristocratic families opens up further possibilities. Additional
raw material for the annals of the future is, of course, in the archives
of banks and concerns, trade associations, public departments that
have to do with industrial questions, and also in the information to be
derived from the daily and weekly press and from trade journals. The
history of technology, of trade routes, of individual towns and industrial
districts gives in some instances even now what we want.

Compared with this vast program, the following comments or sketches,
though the result of more labor than a first impression would indicate,
are of course pitifully inadequate. What can be presented within the
limits of this chapter and the next are mere illustrations and indications
which it is hoped, however, will go some way toward filling the bloodless
theoretical schemata and statistical contour lines with live fact and
toward making our meaning clearer and more vivid. But even the urgent
task of locating cycles historically has been not more than broached.
Moreover, no satisfactory history of capitalism can, of course, be written
without taldng account of Dutch and Italian “origins” and of the later
developments in France. Yet it has not only proved impossible to
present Dutch, Italian, and French material, but the writer has also
been unable to work it up for himself beyond the most common general
treatises and the most outstanding monographs. Finally, American,
English, and German economic history has been more intensively
analyzed only from about 1780 on, and even in this restricted field there
are many lacunae, not only in the following exposition, but also in the
knowledge of its author. Details, although the core of the matter is
precisely in the details, can come in only by way of example and in order
to teach application of our theoretical schema. To save space, quota-

^ The writer has to thank Dr. Frit 25 Redlich for a reference which shows that that litera-
ture has grown to the stage of bibliography. See Hermann Corsten; Hundert Jahre
Dentscher Wirtschaft, eine Bibliographic zur Firmen-und Wirtschaftsgeschichte, Verlag
Kurt Schroeder, Kdln, first installment, January 1936.

Historical Outlines

223

tions have been restricted to works to which the writer feels particularly
indebted and to cases in which responsibility for a given statement
must be definitely located.^

B. Questions of Principle. — A few questions of principle must be
disposed of first.

1. Excluding as we do noncapitalist change, we have to define
that word which good economists always try to avoid: capitalism is
that form of private property economy in which innovations are carried
out by means of borrowed money, which in general, though not by
logical necessity, implies credit creation. A society, the economic life
of which is characterized by private property and controlled by private
initiative, is according to this definition not necessarily capitalist, even
if there are, for instance, privately owned factories, salaried workers,
and free exchange of goods and services, either in kind or through the
medium of money. The entrepreneurial function itself is not confined to
capitalist society, since such economic leadership as it implies would be
present, though in other forms, even in a primitive tribe or in a socialist
community.

If by this definition we merely meant to exercise our logical right
of terminological freedom, no more would have to be said about it.
With some authors, prominent among whom is Boehm-Bawerk, defining
capital, capitalist production, and capitalism does, in fact, not mean
more than this. With others — Marx or Sombart may be quoted as
instances — ^the definitions which they give or which can be gleaned from
their texts, imply a statement of fact, namely, that the defining char-
acteristic gives the essence of a definite historical phenomenon. But
also definitions of the latter type may legitimately differ according to
point of view and purpose, and such differences need not, although they
often do, imply difference of opinion as to the nature of the phenomenon.
Our definition belongs to this class. It undoubtedly appears strange
at a first reading, but a little reflection will satisfy the reader that most
of the features which are commonly associated with the concept of
capitalism would be absent from the economic and from the cultural

^ Practically none but published material — ^books, articles, government reports, news-
papers, and so on — has been used. Most of the facts as well as the sources are familiar to
all students and can be easily checked. The interpretations are, with the exceptions indi-
cated, the writer’s own. He, therefore, thinks it his duty to point out that he is no more a
historian than he is a mathematician. Although in his youth he had some training in
history and its auxiliary sciences, and some experience with archive work, and although
he may, therefore, hope that he knows what a historical record is, he has never acquired,
still less kept up, that wide knowledge of historical fact that would really be necessary to
substantiate some of the views submitted, which, although all reasonable care has been
taken about individual facts, may therefore well be wrong. It has been thought desirable
to say this in to warn the reader — ^not, of course, in order to reduce responsibility.

Business Cycles

process of a society without credit creation. Our characteristic is not,
however, intended to imply causal connotation. It should also be
observed that, like most other definitions of capitalism, ours is institu-
tional. But of course the institutions which, with very rare exceptions,
we treat as data throughout, are themselves the results of and elements
in the process we wish to study. The only thing that could be con-
troversial about this is our proposition that the economic process of
capitalist society is identical with the sequence of events that gives
rise to the business cycle.

Therefore, we shall date capitalism as far back as the element of
credit creation. And this, in turn, at least as far back as negotiable
credit instruments, the presence of which gives the practical, if not the
logical, certainty of the presence of credit creation — ^in the same sense
as the discovery of arms in some prehistoric deposit gives the practical
certainty of the presence of the practice of fighting. But we must go
further than this to the non-negotiable instrument which precedes the
imperfectly negotiable one, and to the possibility of transferring, by
however clumsy a method, deposits lodged with banks. This, of course,
has not in itself anything to do with credit creation; but such informa-
tion as we have strongly suggests that the practice of credit creation
is as old as deposit banking. For Southern Europe this would
carry us to the close of the twelfth and the beginning of the thirteenth
century.

2. This should help in answering the question how far back we have
a right to label fluctuations which are otherwise eligible as cycles, i.e.,
as the kind of phenomena which we now designate by that term. The
reader is presumably familiar with the controversy or difference of
opinion on this point. Many students of the cycle, notably Professors
Mitchell and Spiethoff, display a strong aversion to admitting that we
may speak of cycles in that sense before the end of the eighteenth cen-
tury, while others, historians among them, do not hesitate to go far
beyond that.^ Now, it must be granted, of course, that proper scholarly
reserve prohibits stating as a fact what, owing to lack of data, we cannot
fully prove. But the question is whether there is any warrant to use
the schema of the cyclical process as a heuristic hypothesis farther
back — ^for we shall never find what we do not look out for — and to
interpret provisionally our incomplete material, price series for instance,
in that sense. It must als6 be granted that the smaller the capitalist sector
embedded in an otherwise precapitalist world, the less the fluctuations
characteristic of the capitalist process wiU assert themselves and the

1 The writer may, perhaps, be permitted to quote Professor Gay as an authority who
seems to agree with him in the view to be presented,' without, however, using the criterion
indicated in 1.

Histobical Outlines

225

more other causes of fluctuations, in our terminology external factors
will dominate. In this sense it is not only true but obvious that before
and even during the eighteenth century crops, wars, plagues, and so on
were absolutely and relatively very much more important. The impact
of innovation will evidently be felt differently in a small capitalist
milieu which is surrounded by a noncapitalist world of much greater
quantitative importance,^ little affected by what happens in the former
and acting as a cushion. We may expect some of our phenomena but
not others, and even those which we do observe may be difficult to per-
ceive and to link up with our process. Suffering and discontent among
the crafts, for example, and, as a consequence, social struggles within
them, neither actors nor observers would have readily traced to that
source, although what we call economic progress most undoubtedly
was a major cause of the decline of which those struggles were the symp-
tom. But beyond this the attitude of the students referred to is difficult
to understand, especially with reference to such events as the bursting
of the South Sea Bubble, which bears so striking a resemblance (possibly
quite superficial, to be sure) to 1873 or 19£9. While proof must wait
upon future research, there is certainly no reason to expect that those
‘‘crises ” will eventually turn out to have been anything else but incidents
of a cyclical movement, distorted no doubt by the action of external
factors, exactly as they are today. AU evidence from such material
as we have points in our direction, certainly as far back as the sixteenth
century, down to details of financial practice.^

But in the countries around the Mediterranean we find deposit
banking at a much earlier time. Possibly it was but a continuation or
a revival of the practices of the Roman bancarii, tabularii, and argentarii,

^ Some care should be taken about this, however, for it was not only the capitalist
sector that was smaller. The 100,000 men who were said to be employed in mining in the
German Empire at the time of Charles V’s famous decree (mandatum, 1525) woidd not be
negligible even now and were far from being negligible at that time. And so was a value
of mining output of two million Goldgulden. Nothing is known to the writer about the
reliability of Charles V’s statistics. It may be mentioned, however, by way of comparison,
that the whole (ordinary) income of the House of Hapsburg from its German and “Bur-
gundian” possessions was at that time 580,000 Goldgulden a year.

2 All that the writer knows about the Dutch crisis of 1565 is from Ehrenberg^s familiar
book on the epoch of the Fuggers. The evidence there presented is, to be sure, inconclusive.
More important is the information about methods of trade and finance, which will be briefly
mentioned in the nfext section. It Undoubtedly makes us visualize the very sort of thing
which would prbduee capitalist fluctuations of the type described by our model. For an
earlier period there is interesting material about the Florentine textile (wool) trade (see, for
example, Davidson’s monumental work), also about the contemporaneous evolution of
textile machinery. The most striking instance of material giving a very “modern”
impression is afforded by Professor Earl Hamilton’s time series (see Money, Prices and
Wages in Valencia, Aragbn and Navarre 1351-1500, 1930).

226

Busestess Cycles

or the Greek trapezitai,^ ‘'The non-negotiable bill of exchange which
came into extensive use in the second half of the fourteenth century,
was an important factor in the credit business of banks, ”2 and during the
fifteenth we gather from prohibitions of the practice that negotiability
was, in various forms, steadily paving its way into recognition, though
the latter may not have been formally granted (as we learn from Freundt,
Wechselrecht der Postglossatoren, 1899 and 1909, and Wertpapiere,
1910), before the seventeenth. The use of the check was prohibited in
Venice as late as 1526 (see Usher, op. cit.) in a futile attempt to curb
credit expansion. This development of the “current account subject
to check’’ is as interesting and as relevant to our purpose as the gradual
elimination of the prohibition of interest. We will, however, not go
into the subject and also, in what follows, refrain from dealing,
except incidentally, with banking developments as such. The main con-
tour lines must be assumed to be known to the reader.

3. Finally, a point properly pertaining to the realm of general meth-
odology must be touched upon in order to eliminate an apparent con-
tradiction between our way of looking at economic or, generally, social
change and the principle of historic continuity which tends to assert
itself in historical analysis 'pari passu with increasing material and
improving methods of research. Our theory of the mechanism of change
stresses discontinuity. It takes the view that, as we may put it, evolu-
tion proceeds by successive revolutions, or that there are in the process
jerks or jumps which account for many of its features. As soon, how-
ever, as we survey the history of society or of any particular sector of

^ The question whether the general features of capitalist life, and in particular fluctua-
tions similar to those we today observe in it, were present in the antique world, we will pass
by with one reference: Heichelheim, Wirtschaftliche Schwankungen der Zeit von Alexander
bis Augustus, 1930. There cannot be any doubt but that the view which prevailed for
some time, that the Greek Oikos was in principle a self-sufficient organism essentially
anterior to capitalist forms of organization is entirely wrong. We know little about the
Greek and Roman worlds of banking and finance. But what we know looks strikingly
modern. So does the attitude of the politician, as is known to everyone who has perused
Cicero’s letters and observed the role played by the sodetates publicanorum. The rise of
the depositum irregular e and \hefoenus nauticum (see Chap. XII, A) are other indications;
for capitalist enterprise, of course, mainly (though by no means wholly) consisted of sea-
borne commerce.

2 Compare A. P. Usher, The Origins of Banking, Economic History Review, 1933, to
which paper as well as to Professor Usher’s oral teaching the writer is much indebted in
this and in other points. The paper also mentions part of the literature and may thus serve
as an introduction to further reading on the subject. The writer would like to add a refer-
ence to the contributions of Sayous. Discussion of evidence and a sociological and eco-
nomic interpretation will be presented in the writer’s treatise on Money. Compare also
B. D. Richards, The Pioneers of Banking in England, Economic History (Supplement to
Economic Journal for January 1929) for the statement that the assigning of mercantile
debts by means of the bill of exchange was practiced in England in the fourteenth century.

Historical Outlines

social life, we become aware of a fact whicli seems, at first sight, to be
incompatible with that view: every change seems to consist in the
accumulation of many small influences and events and comes about
precisely by steps so small as to make any exact dating and any sharp
distinction of epochs almost meaningless. Evolution of productive
technique may serve as an example. What we designate as a big inven-
tion hardly ever springs out of the current of events as Athene did from
the head of Zeus, and practically every exception we might think of
vanishes on closer investigation. Cooperation of many minds and
many small experiences acting on a given objective situation and coor-
dinated by it slowly evolve what appears as really new only if we leave
out intermediate steps and compare types distant in time or space.
The decisive step in bringing about a new thing or ultimate practical
success is, in most cases, only the last straw and often relatively insig-
nificant in itself. Needless to say, this holds true also of the process
of change in social institutions and so on. What is technically called a
revolution never can be understood from itself, i.e., without reference
to the developments that led up to it; it sums up rather than initiates.
Now, it is important to note that there is no contradiction whatever
between our theory and a theory of history which bases itself on these
facts. What difference there is, is a difference of purpose and method
only. This becomes evident if we reflect that any given industrial
development, for instance the electrification of the household, may
involve many discontinuities incident to the setting up of new production
functions when looked at from the standpoint of individual firms and
yet appear, when looked at from other standpoints, as a continuous
process proceeding steadily from roots centuries back. By one of the
many roughnesses or even superficialities forced upon us by the nature
of the task which this volume is to fulfill, we may characterize this as a
difference between microscopic and macroscopic points of view: there
is as little contradiction between them as there is between calling the
contour of a forest discontinuous for some and smooth for other purposes.

Not only have we no fault to find with the historic theory that
stresses continuity, but on the contrary we consider it one of the most
promising features of modern historic analysis.^ We will immediately

^ Professor A. P, Usiier^s History of Mechanical Inventions, as "well as his earlier volume
on the Industrial History of England seem to the writer to mark important stages on that
way. The first two chapters of the former book are a sketch of the sociology of technologi-
cal change which would serve as an admirable starting point, could we enter into the matter.

Compare also S. C. Gilfillan, The Sociology of Invention, to which the writer wishes
to refer as an excellent introduction to that range of problems. The first of what the author
calls **the social principles of inventions^* (p, 5) reads as follows: “What is called an impor-
tant invention is a perpetual accretion of little details probably having neither beginning,

228

Business Cycles

avail ourselves of it in order to notice, though by way of example only,
certain spurious problems the existence of which is due to neglect of
the principle of continuity and which disappear as soon as that principle
is properly made use of. The first is the problem which goes by the
caption of Rise of Capitalism. Observing, for instance. Western Euro-
pean economic life in the sixteenth century and comparing it with the
economic conditions that obtained in the same area in the tenth, we
are easily led to the conclusion that everything had altered fundamentally,
and hence to the problem how the capitalist process had come into
existence. But closer analysis reveals the presence even in the tenth
century of rudimentary forms of capitalist existence (in Venice they
were more than rudimentary) and our information, inadequate as it is,
makes it perfectly possible to see step by step how they gathered force
and increased in importance, so that we nowhere meet a distinct and
logically autonomous problem of the birth of capitalism or of any out-
burst of economic activity of a new type.

Hence, second, there is no need to speak, as Sombart and others
did, of a new ^‘spirit” (Geist) having come about somewhere in the
stretch between 1400 and 1600 to make people think and behave differ-
ently, or of the rise of a new economic system fundamentally different
from the preceding one. In particular there is no need to trace what
that group of authors entirely unrealistically considers as a new ration-
alism on the one hand and as a new attitude toward profits on the other
hand, to religious changes (M. Weber)^ — ^which is a way of arguing hardly
superior to the economic interpretation of history which it was intended
to improve or to replace. The historical sequence of the forms of
enterprise, in particular, appears in a different and much more promising
light as soon as we drop the attempt to look at each of them as a world
of its own, incompatible with all other such worlds. The type of medieval
artisans, their organization and behavior, are fully accounted for by the
conditions of their environment and particularly of their market. The
way in which they succumbed to what then was a commercially superior
method, the putting-out system, whilst, as will be seen, illustrating well
what we mean by the process of new things ‘‘competing old ones out of
existence,” does not stand in need of any extraneous principle of explana-
tion, Certainly,^ establishing a wholesale or, at all events, a large-scale

completion nor definable limits.** The present writer does not agree with all the residts of
that work, bnt aU that matters just now is to make sure that the reader realizes the absence
of incompatibility between the two views referred to in the text, and reconsiders the impres-
sion derived from our exposition in an earlier chapter in the light of what has just been said.

1 The range of problems alluded to above is relevant to our subject in more points than
one. The writer begs to refer to his article “Unternehmer’* in the Handwoerterbuch der
Staatswissenschaften. Those problems owe much to Schmoller, who must also be credited

Historical Outlines

229

trade on the basis of a small-scale production which also had to be
provided with raw materials is a typical illustration of our concept of
innovation. It was, therefore, not an adaptive but a creative response
to a changing environment. It was not uniquely determined by it
and might have failed to come about. All this is within the general
mechanism of economic life as described by our model. But no new
social, cultural, spiritual world had to emerge in order to make it possible.
Similarly the fact that, on the whole, commercial enterprise precedes
the factory and, up to the sixteenth century, predominates over industrial
enterprise, as well as the consequent facts that in very many instances
the latter was induced and financed by the profits of the former, are all
accounted for satisfactorily by the circumstances that in the environment
of that time diJ 05 .culties of transportation — ^and generally of trade at a
distance — constituted the main problem to be solved, while, within the
limits of what could be successfully transported, improvement of produc-
tive method was a secondary consideration. Therefore, the entrepreneur
of the commercial type imperceptibly shades off into the entrepreneur of
the industrial type and the transition of the one to the other does not
constitute a problem sui generis.

Third, it is evident that what is called the problem of Original
Accumulation, also, solves itself as soon as we deal with it by means of
the principle of continuity. That problem presented itself first to those
authors, chiefly to Marx and the Marxists, who held an exploitation
theory of interest and had, therefore, to face the question how exploiters
secured control of an initial stock of ‘‘capital’’ (however defined) with
which to exploit — a question which that theory per se is incapable of
answering and which may obviously be answered in a manner highly
uncongenial to the idea of exploitation. But also other authors, chiefly
belonging to the German historical school, met it on their way for the
same reason which created for them the problem of the emergence of
a Spirit of Capitalism.^ Without going into the various explanations

with having been one of the first students of economic history to realize fundamental
identities under widely different cultural forms. This, of course, would not be any high
tribute if he had been one of those philosophers of history who ride rough-shod over his-
torical facts and seem but to live in generalizations, but such was not Schmoller’s case.
On the contrary, he was a careful student of historical detail and such achievements as for
instance his identification of German merchants guilds of the thirteenth century with
modern cartels, arose out of his “factual” work and derive their significance from this
circumstance. See next note.

^ Again, M. Weber and W. Sombart are the authors to be mentioned. There is much
less of that kind of thing in SchmoUer, whose sober realism prevented him from kicking up
the dust of spurious problems. Although G. v. Below, the leading representative of
professionally historical criticism of the work of the historical School of German Econ-
omists, was much more severe in his criticisms of SchmoUer than of Sombart, it is certain

230

Business Cycles

that have been offered, we will note a few facts which point to the con-
clusion that there is no such problem at all, and which will go some way
toward preparing later discussions of the financing of enterprise at
various times.

It should be understood how this question is related to our theory of
the function of credit creation. Since logical and historical "'origins’’
of institutional patterns are two entirely different things, that theory
does neither bind us to, nor even suggest, any particular explanation of
what we might call Primitive Financing. For it is an error to believe
that the logical essentials of a phenomenon must necessarily reveal
themselves at its historical beginnings. We do hold that credit creation
goes back very far, quite as far as capitalism does according to any
definition, but we neither need nor do hold, that it played a decisive
role from the outset. To begin with, the amount of means of production
required for many primitive enterprises was quite small. This even
applies, in some cases, to such things as a mine or a ship, but it applies
much more to the cases of many industrial ventures. The shed and
""equipment” required, many an entrepreneur could put up by the work
of his hands, or with the help of such factors as he happened to possess —
the latter particularly if he was a feudal lord. There is, thus, some
historical justification for the view of some classical writers who traced
the origins of "capital” to ""industry” rather than to ‘"parsimony.”
But it does not follow that the opposite view is wrong. Saving took —
in fact, very frequently — ^the form of accumulation of cash, which it was
in any case necessary to hold in relatively high amounts. Hence, there
was to a much greater degree than later the possibility of financing one’s
venture with ready cash, either one’s own or, by means of a partnership,
somebody else’s. Moreover, with absolutely and relatively small
requirements and, in many cases, short periods of gestation, the initial
stages of an enterprise could be negotiated by many temporary shifts
which seem, indeed, to be very different in nature from the huge modern
machine for the manufacture of credit, but which served the same pur-
pose. If success attended the beginnings, profits became available to
finance further steps in the same or other directions. Finally, if a
prince financed expenditure by the debasement of coinage, he did some-
thing very similar to what modern governments do when borrowing
from banks on deficiency bills. This entailed windfall profits which
enabled the business community to meet the requirements of enterprise
as well as it could have done by borrowing. In this way, the monetary
disorders of one kind or another which prevailed during all those centuries

that in all essentials Schmoller’s work comes much nearer to displaying the true spirit of
historical research and presents a much better grasp of its scope and use in economics.

Historical Outlines

231

did what, in their absence, would presumably have been done by a quicker
development of the various methods of credit creation.

C. Conditions and Processes in the 300 Years Preceding the Epoch
Usually Studied for the Purpose of Business-cycle Analysis. — In this
section we will, by way of sketching a background and illustrating a few
points that are important for our model,^ present a handful of facts
about these conditions and processes. First of all, it is necessary to
reduce to reasonable proportions the exaggerated idea many of us have
formed as to the causal importance, for the economic development in
that epoch, of the influx of precious metals from America, which, after an
insignificant beginning early in the sixteenth century (which, however,
coincided with an increase of the production of European mines, on the
one hand, and various forms of government and commercial infiiation
in some places, on the other) set in with the opening of the Potosi mines
and continued in undiminished force until about 1630. The process
which, of course, first impinged upon Spain has been recently elucidated
much beyond what we knew before by the researches of Professor Earl J.
Hamilton.

Increase in the supply of monetary metals does not, any more than
autonomous increase in the quantity of any other kind of money, produce
any economically determined effects. It is obvious that these will be
entirely contingent upon the use to which the new quantities are applied,
and the way they take through the economic organisms. Even as far
as they enter the channels of trade merely through commercial agencies
and as far, a still more special case, as they increase credit facilities, it is
not determined by that fact alone whether they finance primarily con-
sumption or production, whether they serve purposes which will increase
the social product or purposes which will not and, if they serve the former,

1 We confine these comments mainly to England and do not touch upon the economic
history of the United States in the colonial period. The reader finds all that it is necessary
for our purpose to know about the latter in the first volume of V. S. Clark’s History of
Manufacture in the United States. English and German economic history are comparable
only up to 1618 and then ceases to be so until the second half of the nineteenth century.
What lies between is the Thirty Years’ War and its consequences. It cannot be stressed
too strongly what a complete break that event caused in the evolution of German life in
all its aspects. This was, of course, due to the amount of physical destruction which made
literally a desert of large tracts of country and in places reduced population to a few per cent
of what it had been before. The whole of German history and many features even of
modern German civilization cannot be made understandable without that fact. Economic
as well as political and cultural history took a different course because of, and must be
interpreted with reference to, that terrible experience. It is all the more regrettable that
considerations of space compelled the writer to confine this section to the English case,
because, at least to the end of the fifteenth century, German material is much more interest-
ing and instructive, reflecting as it does an almost fully fledged capitalism and all the
problems of High Finance and Big Business.

232

Business Cycles

in what direction enterprise will move. In the case of an inflow of
precious metals it is perfectly conceivable that they disappear in hoards,
or are worked into objects of use and adornment by the order and for the
benefit of an aristocracy or a feudal court. This consideration alone
would, even if there were no other, negative all money-quantity theories of
the rise of capitalism. Moreover, economic as well as — if, recalling our
theory of innovation, the reader will forgive such an expression — cultural
enterprise of the sixteenth century only continued what was achieved
or in the making in the fifteenth. The first thing to be observed is
that, as far as Spain herself is concerned, the new wealth in great part
directly — but practically all of it indirectly — served to finance the
Hapsburg policy. Presumably it was that influx which made it possible
for Charles V and Philip II to remain, in the midst of all their financial
vicissitudes (which during the latter’s reign occasionally produced
tragicomic situations in the royal household), the sound-money men
they actually were. The influx provided, therefore, an alternative to the
debasement of currency to which it otherwise would have been necessary
to resort much earlier, and thus became the instrument of war inflation
and the vehicle of the familiar process of impoverishment and social
disorganization incident thereto. The spectacular rise in prices which
ensued was a no less familiar link in that chain of events. It disturbed
settlements in terms of money, particularly in the agrarian world, prob-
ably spurred religious dissension, and induced those phenomena of
coarsening and decay which we observe in spite of the promises of the
preceding century.

In all these respects, the evolution of capitalism was indeed influenced,
but in the end retarded rather than quickened, by that expansion of the
circulating medium. Profiteering of a certain type was certainly facili-
tated and big business found many things easier than they otherwise
would have been for it. But below the glitter of the surface serious
enterprise was thwarted by the dislocation of values and by social unrest.
To satisfy himself of this, all the reader has to do is to recall the experi-
ences, economic and other, of the World War. The cases of Prance and
England were different but only because effects were more diluted. The
booty of privateers, which took the form of effective treasure, was, of
course, welcome to Queen Elizabeth and may have relieved many an
embarrassment, while the injuries to the social organism were less
pronounced. Fundamentally, however, it was the same story. All
the durable achievements of English industry and commerce can be
accounted for without reference to the plethora of precious metals, to
which, however, we need not deny the modest role alluded to at the end
of the preceding section. Since this interpretation differs so widely
from a view that is once more — as it was centuries ago — commonly

Histoeical Otjtunes 233

accepted, restatement of, and comment on, our thesis will be given
in the note below.^

A similar operation would, if space permitted, have to be performed
on another idea that has been stereotyped. Yielding to our habit of
speaking in terms of pure types and of philosophies with which we cloak

1 We hold three things: first, that the effects of the plenty or scarcity of monetary metals
has been and is being exaggerated. The error underlying such exaggerations is as old as
it is common. There were authors who attributed the fall of the Roman Empire to a
growing scarcity of gold, a theory which seems to have originated already in ancient Rome,
for Pliny bemoans gold exports to extraimperial Asia in terms that would befit a protec-
tionist American senator. Common sense should be sufficient to condemn this view and to
teach us that the effects of additional gold depend on what is done with it and that the
occurrence, simultaneously with increase in the supply of precious metals, of spectacular
events does not prove causal relation, even if that increase helps in financing them. To
reduce the social processes of the third and the sixteenth centuries to monetary processes,
bears the stamp of monetary monomania and should readily be recognized as ridiculous.
We hold, second, that the influence exerted was not in the direction of initiating new —
economic, political, artistic, and so on — creations. This can be strictly proved, and any
opinion to the contrary can only be due to the curse of aggregative thinking which never
goes step by step, as it is necessary to do, into actual causation. The question how the
new things were conditioned and precisely how they came about yields not only a conclu-
sive answer but also a canon by which to separate what, for example in the religious
movements of the time, may, and what cannot, be attributed to the atmosphere of inflation.
Third, we hold that the inflationary influence — which the writer thinks, as a matter of
both history and theory, has been exaggerated, but which he does not deny — was almost
wholly destructive. How and in what sense inflation injures the mechanism of evolution
should be abundantly clear and will become still clearer through the examples, great and
small, to be presented. Of course, any such poor formula as “cumulation of maladjust-
ments” does not express satisfactorily even part of the truth. But it is little short of a
misfortune that eminent historians uncritically yield to the current slogans of economists.
Mr. G. N. Clark, for instance, in an otherwise very suggestive paper on early capitalism
[Economic History Review for April 1936) which has the merit of realizing the importance
of the element of technological change, not only fails to see that aspect of inflation, but
actually speaks of the “rising tide of American silver” which made it possible to introduce
new and expensive processes. As regards the course of events in other sectors of social life,
our thesis seems to imply (negative) valuation of the achievements of baroque religion, art,
and so on. This is not so. The catholic revival undoubtedly developed during the period
of inflation and so did other things. It is not held that inflation annihilated cultural
achievement. But the writer finds it easier to connect with it peasants^ wars and the
spread of syphilis than the Council of Trent and the Covarrubias, Agrarian unrest in
Germany should not be entirely attributed to it: this would be one more monetary super-
ficiality. But it is dear that inflation had much to do with the discontent among German
peasants. Their feudal obligations to the lords had been to a great extent commuted into
money in the thirteenth and fourteenth centuries. The rise in prices that set in (as stated
above, already before the influx of American silver) expropriated the lords, who thereupon
(though also for other reasons) attempted to increase those payments. And this was,
though not the only one, yet a major cause of the troubles which induced the peasants
to take up arms in order to fight for the Old Law [Altes Recht or, in the Slavic regions, stara
pravda). How good these and similar things must have been for economic and cultural
progress, the reader is invited to judge for himself.

234

Business Cycles

them, rather than, of the practical necessities of the changing social
situations, we have constructed a historic entity called Mercantilism
and endowed it with a set of consistent principles, condemned by one
subsequent epoch and eulogized by another. But the policies of the
so-called mercantilist age are not peculiar to it, and the impression that
a ‘‘system’^ evolved, say in Cromwellian or Colbertian times, or earlier,
in the times of Henry VIII or those of Sully, is completely wrong. Nor
does mercantilist policy embody any set of definite economic aims or
principles. Like all policy, it was swayed by the forces of the hour and
it tried to manage as best it could the series of vicissitudes which it had
to cope with and which it largely produced itself. Mercantilist govern-
ments sometimes removed and sometimes imposed regulations, restric-
tions, and incentives. In England, for instance, the policy of price
regulation came into disuse under the otherwise mercantilist Protectorate.
In some respects they worked toward freer trade — Henry VIII, for
example, took several measures in that direction, Colbert loosened many
fetters — ^in others, toward protection and national autarky. They
at some times created monopolies, at others fought them. They tried
to foster innovation and often prohibited it. All this is perfectly under-
standable if we interpret it in the light of individual historic situations.
But it does not make a consistent philosophy either of economic life or
of the role of the state in it.

Moreover, the importance of individual measures is often greatly
exaggerated. It is, for example, difficult to share a historian’s enthusiasm
for the Navigation Act of 1489, when it is realized that this act was
not in general enforced, that on the few occasions on which it was, it
immediately led to complications and retaliations, that the way in which
it was handled strongly suggests the suspicion that from the first it was
intended to become a source of revenue from licenses of exemption,
and that parliament, in repealing it in 1559, declared it to have been a
failure.^ But our objection to the historical construction in question
does not rest on this class of argument. Nor is it intended to minimize
the significance of the economic activity that emanated from the rising
National States in their formative period and after, or from the prin-
cipalities in Germany and Italy. In Germany, in particular, the prince
and his bureaucracy became for centuries the dominant factor in economic
life. The work of reconstruction after the Thirty Years’ War was, in
some territories, almost exclusively accomplished, and all the foundations
of later development laid, by them.

^Nor should we, for that matter, take at face value the testimony of Sir Thomas
Gresham as to the excellence of his own methods of managing foreign exchange. He is
quite in the same boat in that respect with some of his more recent successors. On the
other hand, he is fairly entitled to the statement that his theory is not any worse than theirs.

Historical Outlines

235

The question arises how this activity stands to our schema. Was
it not — again, in Germany — ^the state rather than the entrepreneur
which initiated modern industry? The answer is — ^though with a
qualification to the effect that it was the Thirty Years’ War that created
the situation in which activity of the state was almost everything — in
the affirmative; and, with the dosing appropriate to each case, similar
answers would have to be returned for other countries. The German
principality in many cases, of which a few instances will be glanced at
later on, directly filled the entrepreneurial function, particularly in
mining. Beyond that it conditioned enterprise by reshaping the insti-
tutional framework (legal reforms and so on) and improving the environ-
ment (canal and road building and the like), and by fostering it in various
ways, some of which in fact come within what we usually understand by
mercantilist policy. This gives us the opportunity of protecting our
general schema from a very natural misunderstanding. We are dealing
with a particular range of problems and our schema has been devised to
serve it. What in it appears as cause” and ‘‘effect” need not be cause
and effect on other planes of analysis and within other ranges of problems.
It is not held that the entrepreneur is the primum mobile of things
social. The very question how far he is lies outside our task. For other
purposes, it may be much more correct to stress other factors,
statecraft among them. At the same time, statecraft — ^mercantilist
or other — does not enter, on our plane, as a distinct and coordinated
factor: it is, for us, either a particular kind of entrepreneurship or else
a power that shapes data. This may be difficult to accept, but it must
be imderstood.

In one respect, however, the same conclusion applies as in the case
of precious metals, namely, in respect to the expenditure of kings, popes,
and princes as a factor in the evolution of early capitalism. With the
one major exception of England — ^there are minor ones, the most impor-
tant of which is Hungary — ^the prince had subjected to his sway the
masses (peasants), the aristocracy and gentry, and the bourgeoisie (not
necessarily in this order). With all of them he made his peace, fitting
them into the organon of his state. The masses found some measure of
protection, though one that varied greatly between different times and
countries, and a regime of regulated exploitation was administered to
them. The aristocracy and gentry had to submit, but were fed and
employed. The bourgeoisie was scientifically exploited and protected —
like game in a well-ordered park — in such a way as to be properly subdued
and content. This wonderful organon was made to serve the splendor
of the prince, the court, and the army, by means of a maximum of
surplus being sucked up to finance one great center of expenditure.
{This is what Colbertism means).

236

Business Cycles

Now the theory which for our purposes it is necessary to notice is that
that expenditure was a positive force in capitalist ‘‘progress,’" jSrst
because of the demand for consumers’ goods it provided; second, because
of the financial positions and methods it created. As to the first argu-
ment, it is — ^whatever excuse there may be for primitive error about the
benefits from excesses in consumers’ expenditure at a time when every-
body has before his eyes a huge apparatus of production that has just
emerged from a crisis — unpardonable to think that in the absence of the
extravagance of courts there would not have been equivalent demand for
consumption and equipment goods from the peasants and the bourgeois
from whom the corresponding means were taken. As to the second
argument, it is, of course, true that demand for loans — and for that
form of society big revenues meant still bigger debts — ^will tend to develop
the credit-manufacturing engine, and that Jacques Coeur, Agostino
Chigi, Jacob Fugger, and other princes of finance owed much of their
success — by no means, however, all of it — ^to that demand.^ But
there seems some lack of sense of proportion involved in pitting this
detail against all the destruction wrought and all the paralysis of economic
activity spread, both by the methods of raising that revenue and by
the uses it financed. As far as this goes, that expenditure acted much
as the influx of precious metals, though extra-economically the case
may be different. It has been noticed by historians — among them, the
late G. Unwin — ^that the success of capitalist activity in the sixteenth
century was not followed up in the seventeenth, and that what seems to
the observer a natural continuation was deferred by about two centuries.
Monetary theorists of history will attribute this to the exhaustion of the
supply of silver. Obviously, it is more reasonable to speak of the exhaus-
tion of the economic, by that social, system.

Turning to a few of the well-known^ features of the evolution of
English capitalism which, for one reason or another, it is necessary to

^Lending to a court was, in spite of the exorbitant interest usually promised, very
rarely a good business in itself. But precisely because such loans could, as a rule, not be
repaid, they led to the acquisition of privileges and concessions in the field of commerce
and industry wMcb were the great business of the time: a loan to the Pope, for instance,
even if secured on the papal tiara, was not an attractive proposition, but when the Pope
had got the money and his creditor thereupon asked for a concession to exploit the papal
alum works, the Pope was hardly in a position to refuse. Besides, the granting of the
concession was probably the only way for the Pope to draw any revenue. The rise of the
Fuggers to a position never again equaled by any financial house has, similarly, much to do
with Charles V’s embarrassments.

2 We have no choice but to assume them to be well known. Be it repeated that real
understanding of the nature of the cyclical process of evolution, even in its most modern
aspects, is without some knowledge of even medieval economic history, no more possible
than it is without some knowledge of statistical method or of theory. It should be added
that the fragments to be presented have been chosen with respect to a theoretical purpose

Historical Outlines

237

mention for our purpose, we must, of course, bear in mind both the small-
ness and the agrarian character of the economic organism. Even in
England where industrial development had, by the end of the Stuart
period, probably outstripped industrial development anywhere else, at
least three-quarters of a population numbering about 53^ millions,
lived by agricultural pursuits, if we may trust Gregory King’s data about
the numbers of yeomen, tenant farmers, and ""servants in husbandry,”
With the exception of London, towns were small — ^which fact is not, of
course, intended to convey an idea about the relative importance of
industry which to a considerable extent dwelt in the country — even
Bristol and Norwich having hardly 30,000 inhabitants.

1. Agriculture, then, was the leading branch of production and,
taking the period from about 1500 to about 1780 as a whole, the most
important field of extracommercial entrepreneurial activity. The
latter statement sounds strange, no doubt, and the reader will be still
more reluctant to follow if he be invited to look upon what happened in
post-medieval agriculture as analogous to such a process as, for instance,
the rise of the electrical industry in the course of our third Kondratieff.
Yet it is necessary for us to become familiar with this view and to learn
how to pierce all the differences in garb — institutional and other — in
order to get at the essential sameness of the basic economic process.
Results may, by way of example, be characterized by the fact that wheat
yield per acre seems to have about doubled between, roughly, 1500
and 1785.^ This can be due only to innovation, unless we assume a
favorable change of climate. But the effects of innovation must have’
been considerably greater (apart from the possibility of choosing an
estimate higher than the one we have adopted), because it is impossible
to assume that there was no decreasing-return influence (defined with
respect to given production functions and invariant fertility of soil) to
overcome. Even greater success attended the improvements in sheep

and not with, respect to their general importance. A picture of that social process, taken
from them alone, would be utterly misleading.

1 We accept Mr. M. K. Bennett’s “Generalized curve of British wheat yield,” see the
Economic History Supplement of the Economic Journal, February 1935, p. 12, et seq., rather
than Mr. M. Whitney’s, see Science, October 1926, and also most of his argument. As
regards the question of soil exhaustion in medieval England, which is but distantly relevant
to the above argument, the writer, without claiming any competence in the matter, follows
R. Lennard, The Alleged Exhaustion of the Soil in Medieval England, Economic J ournal,
March 1922, p. 22. For other aspects see Usher, Soil Fertility, Soil Exhaustion atid their
Historical Significance, Quarterly Journal of Economics, May 1923. The writer has no
first-hand knowledge about English methods of estimating yield per acre in those times,
but for those continental countries, for which he has such knowledge, any numerical state-
ment of this kind would be of very doubtful meaning, at least up to about 1700. Slow
(long-time) increase of yield ever since 1200 seems, however, to be, as Mr. Bennett has
shown, the most reasonable guess.

2S8

Business Cycles

breeding and in the breeding and fattening of cattle. About all this
there was very little ‘‘invention” and the case well illustrates the reason
for the writer^s aversion to the use of that concept which so limits our
outlook. It was simply a matter of recognizing existing possibilities
of profitable improvement and getting the thing done.

In those, as distinguished from later times (the middle cf the eight-
eenth century approximately, when governments and associations began
to interest themselves systematically in agricultural improvement), the
modus procedendi was quite according to our theoretical schema. Indi-
viduals, proceeding of their own accord or accepting the teaching of
some advocate of improvement, went ahead and set up new production
functions, the success of which induced others to follow — ^first few, then
many. This was first the case in the matter of enclosures, which in
themselves implied no other innovation than one in organization — as
did the simple exchange of inconveniently dispersed strips of land —
but quickly led on to others. The movement began under the Tudors,
about 3 per cent of manorial land being enclosed, according to Professor
Gay {Quarterly Journal of Economics^ vol. XVII, p. 576, et seq.), between
1455 and 1607 — a small-scale operation that caused a quite dispropor-
tionate outcry and understandably met with government and general
resistance: the entrepreneurial act in this case mainly consisted in over-
coming this resistance of the environment. The great wave of enclosures,
meeting with no resistance from government or parliament, although
with plenty of disapproval — see “The Deserted Village” — came in the
eighteenth century, especially after 1760, when it linked up with, and
partly conditioned, the processes of the so-called industrial revolution,
exactly as it was itself conditioned by similar processes of an earlier time.

The way in which innovations in different fields (and countries:
both wool and wheat were for the greater part of this period important
articles of export) condition each other, is well exemplified by our case,
which also serves to elucidate the distinction, so fundamental for our
method of analysis, between conditions of entrepreneurial activity and
this activity itself. Possibility or profitability of enclosures — ^which
is but another name for what we call conditions — can be easily analyzed
in terms of such facts as institutional changes in land tenure making for
increasing freedom in the use of land, increase and agglomeration of the
population, increasing (real) purchasing power, improving means of
transportation. There is no necessity to fall back upon soil exhaustion
due to medieval methods of agriculture, nor any proof that it played a
role,^ but if it did, it would have to be listed among those conditions.

^ See preceding note. The behavior of the price of wheat does not in itseK lend any
support to such a hypothesis. Prohibitions of export of grain (as early as 1361) do show,
however, a certain stringency as compared with a growing demand.

Historical Outlines

239

Now, from the standpoint of the individual who decided on an operation
of enclosure or the group of individuals who did so at any time, all those
conditions were objectively and independently given. But they were
not on that account independent of entrepreneurial activity in general,
as we are led to believe if we use such general phrases as the Widening
of the Market, or External Economies, which suggest the idea of some
environmental change that goes on outside and independently of the
mechanism we are studying. Again, conditions, whatever their nature,
do not by themselves produce the results we observe. For the purposes
of general history it may be sulfficient to list those factors and to take it
for granted that they account for an enclosure movement. That is
not so, however. What the conditions could be said to bring about
automatically is an attempt to produce more within the old frame and a
tendency to take land into cultivation which it had not before paid to
cultivate. Neither of these was absent, but the enclosure movement
means more than either or both. It could have failed to come about at
all, or the reorganization of agriculture could have come about in any
one of many different ways.

The economist who directly connects enclosures with the conditioning
factors either implies that these by themselves uniquely determine
the observed result — in which case he is wrong — or leaves out a link
which accounts for this and no other result having come about in this
and no other way, and is fundamental from the standpoint of an analysis
primarily interested in economic mechanisms and results. Finally,
it should be added once more that, if we leave the precincts of a narrowly
economic analysis — within which we move in this book — ^it becomes still
less possible to reason in terms of conditions taken as independent
variables. Within the whole of that social process that simultaneously
produced free ownership of land, increase of population, agrarian and
industrial revolutions, and, as an element of all this, enclosures, there
is nothing but interaction. No argument that uses the words ‘depends
upon’" can have any meaning except for the most restricted purposes.

The agrarian world of Elizabethan England affords a series of instances
of other entrepreneurial activities, which in fact almost exhaust the
list of theoretically possible types of innovations. There was doing
old things in a new way — ^for instance, better crop rotation — ^produc-
ing commodities that were new or not produced in England before — clo-
ver, turnips, flax, potatoes — ^taking up production of others on a scale
unknown before — ^hops, fruit, vegetables. Investment opportunity
was thereby greatly increased, of course, and adaptive reaction was
clearly present although, owing to the peculiarities either of agricultural
production in general or of agricultural production under the circum-
stances of the times, other features of our schema were not. Still others,

240

Business Cycles

notably the elimination of inadaptable ‘‘firms and tbe incident sub-
mersion of their owners or managers, were no doubt present but so
complicated by the individual peculiarities of the case that it becomes
difficult to recognize them. Whether or not the process displayed cycles
and what they were, we have no means of telling. Its pace certainly
quickened in the eighteenth century, as it did in the matters of enclosures
and of sheep and cattle rearing, and there was an agricultural crisis
around 1770. But most of the things we read of in the literature of a
later time, in which agricultural as every other improvement had become
fashionable, do not seem particularly novel. Popularizers and advocates
of improvement undoubtedly developed, sometimes rediscovered,
preexisting practice. Systematic experiment definitely established
and spread such things as continuous rotation, deep ploughing, drilling
seed. Industry furnished better tools. But the big new things that
were to come later, agricultural machinery and chemistry, did not amount
to anything before the nineteenth century. This does not mean, how-
ever, that there was no innovation J it only illustrates our meaning of
that term. Particularly in the sphere of the agrarian community,
innovation may mean doing, or doing over again, something that has
been known and even locally practiced for centuries, our criterion being,
as will be remembered, whether or not a method is at the time and place
a part of ordinary routine or, what comes to the same thing, within the
existing production functions of the mass of producers.

2. Woolen textiles, being the chief English industry and the mainstay
of export in the sixteenth century, may serve as an instance of a first
type of entrepreneurial action in nonagrarian fields. Industry carried
on according to the logic of small-scale production in a numerically small
milieu was incapable of coping successfully with the problems incident
to sale at a distance and to producing for a market of an indefinite
number of individually unknown customers. Entrepreneurial activity,
in this as in all other cases, consisting in attacking tasks which, while
“ objectively possible,’’ are insoluble for the milieu existing at the moment
and beyond the reach of the vast majority of its members, then turned
to the task of overcoming distance in space and time without at first
interfering with methods of production at all. The entrepreneur had
to act outside of the organizations of small masters — ^to leave them if
he was one of them — often also to move out of the towns controlled by
them into country districts, where he found cheap labor, in order to
finance and to carry out the commercial tasks involved. He had to
overcome resistance and to “fix things” with local authorities — ^the
implications of the latter expression suggesting well one side of the
innovating activity of entrepreneurs at all times. We neither can nor
need stay to describe these familiar things. What matters is that the

Historical Outlines

241

reader should learn to see them in the light of our model and, in turn, to
interpret that model in terms of such live facts. In particular, we see
clearly that the ‘^new things” do not develop harmoniously from the
old milieu but place themselves alongside of it and compete it out of
existence. How this was done in this case could be shown in all economic,
social, and cultural details, but we must go on,

3. At the same time we observe a development of a different type
that was to crush both the small master and the putting-out system
and to revolutionize production, if revolution is the word for a process
which extends from the thirteenth to the twentieth century. Although we
are comparatively well informed by a number of well-known monographs
about the more important branches, the history of English industrializa-
tion, the rise of production in the factory to quantitative importance,
which came about in the second half of the sixteenth and the first half
of the seventeenth century, is still a series of fragments. Its nature and
mechanism, however, stand out well enough. What invention there
was came largely from abroad and English innovation consisted primarily
in transplanting things that were common practice in foreign countries
into an as yet uncongenial environment, in breaking down resistance,
and in achieving commercial success the conditions for which had to be
created. It was a process of a new native industry’s conquering and
developing the home market previously supplied by foreigners. It
was not a case of the markets widening first and carrying the development
of industry with it in a semiautomatic way.^ This is as true of the
introduction of different methods into old industries as it is of the intro-
duction of new industries. In both cases we see the figure of the entre-
preneur in our sense, stepping in from outside the existing industrial
organism to upset the equilibrium, to induce imitation, and to enforce
adaptation, thereby creating new demand and new economic space
for further ventures and underselling the inadaptable elements of the
environment.

^ The old-established woolen and worsted industries, which continued until the middle
of the eighteenth century to provide the chief article of export, and the chief object of
political attention (though Macaulay perhaps exaggerates a little if he says that worthy
politicians thought the prohibition of the export of wool second in importance only to the
hanging of Sir Robert Walpole), showed less improvement during the sixteenth century
than others did. — Because of this conquest of the home market (practically achieved during
the first Kondratieff we are going to discuss) Tonnage of the Merchant Meet and Shipping
Cleared are inadequate indicators of the increase in total output. For the same reason, it
is perhaps not quite correct to say that ships constituted the bulk of the durable capital of
the time, though they may well have been the most important item. The few figures for
the last quarter of the sixteenth century show, however, considerable activity, though the
great upswing is between 1660 and 1760. See A. P. Usher, Growth of English Shipping,
Quarterly Journal of Economics, May 1928.

Business Cycles

242

We will note a few examples. In the textiles (apart from the entre-
preneurial activity of drapers, clothiers, ‘‘master combers,’^ and mer-
chants, mentioned above) fulling mills (themselves much older) began
to mechanize their process and to use water power (“tucking mills,”
“gig mills”). The knitting frame and other machines worked by
treadle appeared. In mining, medieval adits for draining mines were
improved by German methods and by new pumping and hauling machin-
ery. Shafts and pits, ventilation and so on came in very slowly, and
the average mine of sixteenth-century England was, technologically,
as yet little more than a quarry. German and Dutch technique trans-
formed the iron and steel industry, larger furnaces coming in and various
other improvements — still mainly within the direct process — ^being
achieved by the end of the sixteenth century. Coal does not seem
to have been used to any great extent for industrial purposes until the
eighteenth century, though in the glass industry it began to replace
wood in the beginning of the seventeenth. “Sea coal” from Tyne pits
transported by barge were an important innovation in domestic fueling
under James I, but the charcoal furnaces of Sussex, the forest of Dean,
and the Kentish Weald still provided the raw material for the growing
hardware trade of Warwickshire and Staffordshire. The latter develop-
ment had by that time created a scarcity of timber that entailed high
and rising prices and elicited various measures for the protection of
forests. This is the only major case known to the writer in which a raw
material had time to approach exhaustion^ before being replaced by
something else. Production on a large scale of standardized inter-
mediate goods, such as ingots, sheets, rods, and wire for a finishing
industry which still remained in the hands of small masters, is a particu-
larly instructive example of one of the ways in which our mechanism
works. Copper mining and brass making were new industries in the
Elizabethan era. Cannon foundries, alum houses, potteries, sugar
refineries (from Brazilian raw material), glass, soap, and gunpowder
factories, and salt-boiling establishments supply instances of other types.
An Elizabethan paper mill driven by water wheels, technologically not
particularly novel, is an example of an innovation which primarily aimed
at the economies of large-scale production. The use of water power
spread rapidly and meant — ^relatively — as much as steam did later. It
remained expensive, however, owing to the necessity of using the overshot
wheel.

^ Even that is, however, true only for the time under discussion, for which the timber
situation provides a good example of a bottleneck. In the United States of today there is
a timber problem of the opposite kind. In the seventeenth century scarcity of timber
may be listed as a factor of retardation and as a condition of entrepreneurial success in
devising alternatives. But this was only one of many conditions since both the use of coal
and the use of iron instead of wood would have been profitable without it.

Historical Outlines 243

Now it is tMs industrialization (with its agrarian complement) more
than anything else that transformed the England of the Tudors and
Stuarts through the change it wrought in production functions. The
argument from comparatively small quantitative importance of innova-
tion fails because it visualizes ‘"inventions’’ only, and neglects a wide
class of activities which, if included as they ought to be, were not unim-
portant relatively to the environment. And it is readily seen that the
process perfectly fits into our schema. Nothing is absent, not the char-
acteristic feature of disharmonious advance in particular directions
entailing the consequence that the new products became relatively
cheaper and thus created their market and changed the patterns of
consumption, nor the element of the resistance of the environment.

4. We will briefly mention the more important forms of that resist-
ance. The ways of entrepreneurs would have been diificult without it.
New products or methods of production were then, still more than now,
likely to be unsatisfactory. In many cases the machine-made product
was an inferior product. This difficulty is for various reasons of so much
smaller importance in our day (although not absent) that economists
almost overlook it in their analyses of the entrepreneurial role. It
created, however, a distrust in machine-made products that persists
to this day. Competitors need not have decried the brittleness of cast
brass buckles — ^they actually were brittle. But apart from that, there
was traditionalistic resistance of consumers. It was not enough to
produce satisfactory soap, it was also necessary to induce people to wash —
a social function of advertisement that is often inadequately appreciated.
Then there was the resistance induced by what is designated in our
schema as the world of old firms which was represented in this case
mainly, though not exclusively, by craft guilds. Reaction against
innovation (sometimes joining forces with the hostility to monopolies
and “projectors”) was occasionally so drastic as to bring out what we
mean much more clearly than later examples can. Entrepreneurs were
not necessarily strangled^ but they were not infrequently in danger of
their lives. Equally hostile was the attitude of the workmen. Acts
of violence which for example made it impossible in 1663 to operate the
new sawing mills then erected, arose at first from unemployment or the
fear of unemployment in the strata working the old methods, but machine-
wrecking practices of the factory workmen themselves became common
in the eighteenth century.

^ The above refers to the story of the inventor of a loom for weaving ribbon having been
strangled by order of the Danzig municipal authority in 1579. The source is not a docu-
ment but a literary report by an Italian written in the seventeenth century. The present
writer does not know whether there is any serious foundation for this report; but — s& non
^ vero h hen trovato.

244

Business Cycles

The craft guilds also tried to use their medieval powers to restrain
both members and outsiders from using methods with which the old-
fashioned producer could not compete (thereby occasionally driving new
industries away from their towns) and sometimes petitioned the govern-
ment or parliament either for general regulation of a nature calculated to
make the factory impossible (which in Central Europe artisans tried to
do as late as the eighties of the nineteenth century) or for specific prohibi-
tion of a mechanical device. The outstanding example of attempts to
secure regulations with which large-scale industry could not comply
is the Weaver’s Act of 1555, an instance of specific prohibitions is the
Royal proclamation which in 16£4 directed that a new machine for
the manufacture of needles be destroyed. The political world wavered
in its attitude and motivation but substantially followed the course of
events and finally, about at the end of the seventeenth century (refusal
to grant a petition for the prohibition of the skey then coming into use
in the production of serges, may serve as an illustration^), dropped all
systematic hostility to innovation. So did public opinion and the
scribes. All the difficulties which define the role, and all the features
which characterize a certain type, of the industrial entrepreneur are
dramatized with unsurpassable vividness in the career of Dudley,^
But modern parallels both in attitude and argument are not so hard to
find as one would be inclined to think.

5. The monopoly problem of that time did not arise primarily in con-
nection with industrial enterprise. Of course, ‘‘projectors” tried to
secure patents not only for the same purposes that patents are applied
for now (the patent in the modern sense, for the protection of new proc-
esses, was what evolved during the seventeenth century, along with
the patents granted to Chartered Companies, from the struggle about
monopoly), but also in order to acquire for their undertakings the definite
legal status they lacked — as far as this goes, monopoly was only a form,
appropriate to the spirit of semifeudal government, of legal recognition.
But the practice soon ceased to be a matter of course and presented
itself in another light, which is much more obvious in the monopolies
granted in the fiscal interest or as favors on the one hand, and to com-
binations of traders on the other. It would be with reference to these
that we should have to discuss the problem, could we enter into it. We
must, however, confine ourselves to pointing out that acquisition of a

^This illustration is taken from Hoskins, Industry, Trade, People in Exeter, 1934.
A mine of information about motives, phraseologies, attitudes is the collection of Tudor
and Stuart proclamations (edited by Steele and Crawford). Of course, what we behold
are rationalizations, mostly running in terms of welfare and of social security.

* For that often-told tale see, for example, the summary in Usher’s Industrial History
of England, p. 320.

Historical Outlines

monopoly position was under the circumstances part of the entrepre-
neurial achievement and in some cases constituted the whole of it,
particularly if the entrepreneur '' was of the type of the Earl of Leicester,
of Elizabethan fame.^

6. Commercial and colonial enterprise is the third type to the develop-
ment of which we must devote a few remarks. Since individual venture
was, under the circumstances of the time (not before Cromwell did the
king’s ships protect trade even in the Channel), hardly possible in mari-
time trade, and since even activity of interlopers presupposed, and
fed on, the existing organizations and facilities provided by them, medieval
forms of organization which largely offered what was needed not only
survived but, changing in function and meaning under a decorously
conservative surface as so many things changed and change in England,
experienced a new impulse and became themselves the vehicles of new
developments. The Companies, whether ‘‘regulated” or not, were, of
course, not at first enterprises in our sense but corporations in the sense
of the modern 8tato Corporativo^ viz.y organizations that supplied the
legal frame within which enterprise went on. They aimed at the creation
of communities, of a spirit of community (with moral and religious
implications, regular prayers included), of legal and physical protection,
while entrepreneurial or current business was left to the members or
such associations as these might freely form among themselves. ^ Funds
with which to finance this enterprise were raised by partnerships and
frequently by temporary associations. The company itself had no
capital at all and needed funds — raised by assessment of members — only

^ As is obvious from the above, the “monopoly” of that time did not constitute just
one homogeneous problem. Each of the four categories mentioned in the text included
cases that widely differed in nature, and both contemporaneous clamor and later historical
and economic discussion confused things by throwing them together. Besides, the craft
guilds and other organizations which dated from the Middle Ages formed a fifth group.
They were not monopolies in the ordinary sense of the word but, nevertheless, were given
to monopolistic practices of the cartel type. It was but rarely, however, that their regula-
tions of price, quality, and quantity were strictly enforced. An extremely interesting study
of the combination that for a time controlled the supply of coal from the Tyne, the public’s
attitude toward it, and the economic forces that eventually broke it, should be mentioned:
P. M. Sweezy, The Limitation of the Vend, 1938.

^ The “regulated” companies, at least, were certainly fuhlici juris. But the act of
state which created a regulated company only recognized a preexisting body and insofar
only ratified conditions that themselves were independent of any such act. Not only the
sociological theory but also the juridical construction would, therefore, have to run on the
same lines in the cases of the regulated and of the unregulated companies. The writer,
however, does not feel sine of his ground here. The reader is referred to the fundamental
work of R. W. Scott (The Constitution and Finance of English, Scottish and Irish Joint
Stock Companies to 1720, 3 vols., 1912) and to Heckscher’s interpretations (Der Merkantil-
ismus, vol, I, German trans., 1932).

246

BtrsiNESs Cycles

for its foreign establishments and fortifications, for policing, and for
meeting the exactions of government, which sometimes (for example,
1560) chose the rather drastic method of confiscating a fleet and its cargo
in order to extort a loan and take hold of foreign exchange.

All this can easily be verified from the new edition (from 1903 on)
of Hakluyt's Principal Navigations, Voyages, Traffiques and Discoveries
of the English Nation, and from Carr’s Selected Charters. We will
quote but the most famous instance. One of the outstanding develop-
ments of the sixteenth century which is indicative of a burst of entre-
preneurial activity and sums up some of its general effects on the way
of doing business is the specialization of traders, obviously productive
of ‘‘external economies,” which separated retail from wholesale and
domestic from foreign trade. The tendency toward this goal reaches
far back, but it was then pushed by the government and interested
parties and institutionally ratified to the point that even past activity
in retailing sometimes disqualified for membership in the companies
of wholesale traders to whom the term mercatores was then restricted.
Those who devoted themselves to sea-borne trade were called mercatores
venturarii and a group of them, acting as a body and appearing in parlia-
mentary records in the nineties of the fifteenth century became, in the
second half of the sixteenth, a regulated company styled “Governor,
Assistants and Fellowship of the Merchant Adventurers of England.”
Together with the Eastland Company (which became a recognized
corporation in 1579) they were the most powerful body to organize and
protect maritime trade in the sixteenth century enjoying various exclusive
rights (for example, up to 1688, the right to export cloth to the Low
Countries). But they were not what we would call a trading company,
and their lawyers were not slow in pointing out that they were not
technically monopolists^ — ^which formally was quite true.

But corporative enterprise soon evolved out of this. It implied
raising “capital,” which was first done (even in the case of the East
India Company) for each individual venture — a practice of the “chief
adventurers” associating themselves with “partners” readily established
itself — ^then for a series of ventures, or for a definite period of time,
until finally the independent and impersonal capital of the company, as
such, emerged. Shares in that capital were freely bought and sold, in
curious contrast to the spirit and meaning of the old forms — ^which

1 So argued, for example, Jolin Wheeler in 1601, when the Merchant Adventurers had
been expelled from Germany|on a charge of monopolistic exploitation. Recent writers
may be glad to have this instance of the ** masquerade of monopoly.” Analogies with
cases nearer to us are indeed obvious — plus ga change plus ga reste la wMme chose, which
remark is not meant to imply that the writer has any fault to find with the case for which
Mr. Wheeler pleaded.

Historical Outlines

247

nevertheless, as forms, survived throughout the seventeenth century,^
when the Joint Stock Company started on its career. In order to make
that development possible, both legal and financial devices had to be
invented in quite the same sense as the steam engine had to be invented.^
The method of providing the capital which we associate with the idea
of a joint stock company was the fittest survivor of many that were
tried, lotteries included. But we cannot go into this. The reality of
history is in its details and, even in writing this sketch, the writer is
painfully aware that, each time he attempts to generalize, he is distorting
the facts he meant to convey.

Industry required permanent financing of corporate enterprise much
more than trade. In fact, we find two mining companies and one water-
way company (Mines Royal, Mineral and Battery works, 1568, New
River Company, 1618) among the first to display it. Some of the trading
and colonial corporations (the South Virginian and the Plymouth, for
instance) also included an industrial program. The simple partnership,
nevertheless, dominated the industrial field until about the middle of
the nineteenth century. However, as soon as the joint stock company
had established itself, though for a long time in an obsolete legal garb,
as the normal form of certain types of enterprise, and as soon as the
foundation of a company really began to mean what the old company
did not mean, namely, the foundation of a ‘‘new firm,’’ we may use
privileges and charters directly as data, although very lopsided ones,
by which to feel the pulse of entrepreneurial activity and to identify
cyclical phases.^ To a certain extent, this can be done for England on
the basis of Scott’s work on Companies. From the Glorious Revolution
we can trace a boom in company promotion which we may consider as

^ If it be really true that sales of shares (or “actions”) in the permanent capital of
“joint stock companies” did not regularly occur till the beginning of the seventeenth
century (when the East India Company had their shares sold at its commodity auctions)
similar development in Germany preceded by about a century and a half. It is true that
to the middle of the sixteenth century Germany led (with the exception of the Low Coun-
tries) in capitalist evolution and powerfully influenced the course of things in England,
even directly by financing and managing English industrial enterprise. But that “lag”
seems unbelievably great, all the same.

* That formulation the writer owes to the late romanist and sociologist, Eugene Ehrlich.
This is certain, although he has not been able to locate it in the latter’s writings.

® The joint stock company material, of course, reveals a much smaller part of the process
than it does from the middle of the nineteenth century onward, but even so, gives valuable
indications, if industrial enterprise is but scantily and unsystematically reported (how-
ever paper, silk, glass, and many other things, a periwig factory included, are there) because
it did not in general use that legal form, everything else we should expect is all the more
conspicuous. Considerations of space forbid entering into an analysis. The construction
of canals, which from 1761 onward was an important feature, will come in for a brief notice
later on.

248

Business Cycles

the backbone of a prosperity phase, with all the more confidence as none
of the other characteristics of what we now thus designate is absent,
as far as we are in a position to judge. ^ With fluctuations which are
of a kind we should expect and which are in part accounted for by external
factors, such as the recoinage trouble and the wars with France, the
activity lasted until the year of the Bubble Act (1719).^ According to
Scott, there were, in 1695, 140 companies with a capital of million
pounds, of which less than one-fifth had been founded before 1688, and
total capitalization rose to nearly 21 millions by 1717.

7. This development undoubtedly presents a number of features
which are peculiar to it and do not reappear in the booms and crises
of the nineteenth century. We will mention but one, namely, the role
played by the financing of government expenditure. Montague’s
brilliant and Godolphin’s careful finance are presumably entitled to the
credit of having averted financial breakdown which repeatedly threatened

1 Macaulay in a famous passage called tliat time the “nadir of national prosperity.”
As we know, there is no contradiction between the presence of prosperity in our technical
sense and the absence of general well-being; in fact, there is some reason to expect that pros-
perity and welfare will not go together. Still, Macaulay seems to us to exaggerate. Total
tonnage cleared in foreign trade, for instance, rose from an average of 14£,900 for 1663-1669
to an average of 337,328 for 1699-1701, then understandably fell, but rose again to a maxi-
mum of 478,793 in 1714 (see Usher, Growth of English Shipping, Table 2). And this, in
spite of the considerable losses incident to the war of the Spanish succession, during which
even coastal trade was so much interfered with that coal rose to famine prices in London.

2 Other attempts to restrain the excesses of speculation had preceded it. For instance,
as early as 1696-1697 the number of stockbrokers was restricted to a hundred. The Bubble
Act itself, primarily aimed at putting incorporation of new companies under control by
making it illegal for a group of persons to act as a corporation without parliamentary privi-
lege, and in particular to offer for public subscription shares transferable by simple sale.
That act, which was not repealed until 1825, when it was the object of a chorus of vitupera-
tion, has been adversely criticized by a long series of historians and economists, among them
no less an authority than Alfred Marshall. This would be difficult to understand were it
not for the fact that we always look at things through the spectacles of our time. To be
sure, the passing of the act was, as has often been pointed out, partly due to the influence
of some powerful interests, the South Sea Company in particular, which wished to strike
at competitors for the money of the public, but a perfectly good case can be made for it,
considering the circumstances of the time and the semicriminal practices that were involved.
And it is a gross exaggeration to hold, as some people have done, that it materially handi-
capped economic evolution for a century. Serious business opinion was entirely in favor
of it and the arguments used were by no means without force. The majority of economists
also seem to have agreed, and Adam Smith’s distrust of the joint stock company and his
advice to restrict it to a few branches of economic activity was entirely reasonable. For
our purpose, it is important to realize that the Bubble Act (which contained all the excep-
tions required to prevent it from being really injurious) was but an incident in the develop-
ment of joint stock capitalism and more spectacular than really important. It hardly
prevented more than it was intended to prevent, namely speculative excesses, and repeal
came precisely at the time from which onward it would have done more than this.

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249

during both. King William’s and Marlborough’s wars, but even so
the weak financial organization of those times was subjected to all the
pressure it could endure. To a great extent, this was done at the
expense of the joint stock companies. The great device already used
by the Tudors but then developed into a comprehensive system consisted
in ‘‘soaking” them. Owing to their dependence on government, for
privileges and in other ways, they could not resist, and owing to the
determination of the City to support the new government, they did not
really try to resist. The financial construction of the Bank of England
is the first outstanding example of this technique and also the best
example to show how it linked up with credit creation. The South Sea
Company was practically nothing else but an instrument of government
finance,^ and part or even the whole of the capital of the majority of
companies listed by Scott was invested in “governments” which most
of the time were at a considerable discount and fluctuated violently in
response to the political situation. Thus, company promotion provided
a channel through which funds flowed away from, rather than toward,
productive purposes, which is an important fact to remember in the
interpretation of the economic history of that epoch. Walpole and
Pelham improved the situation, and if the wars of the second half of the
eighteenth century kept the government in the money market, which
was until the close of the Napoleonic wars entirely dominated by its
demands,^ the companies were gradually released from its grip.

Moreover, it is also clear that the spectacular crises of the seventeenth
and eighteenth centuries link up more plausibly with wars and other
noncyclical catastrophes than those of a later time. Everyone, for
instance, wiR connect the crisis of 1640 with the war with Scotland and
the way in which it was financed, or the crisis of 1672 with the Dutch
war. The crisis of 1667 cannot with equal plausibility be interpreted
in this way, and that of 1696 is an intermediate case. 1745 was the year
in which the Pretender invaded EngUsh territory, the events of 1763
and 1783 may be looked upon as reactions of a very familiar type, to
postwar booms. We must, however, be careful as to the inference.
On the one hand, crises will in fact occur under such circumstances;
but as we know, they are not the essential thing about cycles. Nor does
coincidence of a crisis with “external” events that might account for it

^ See R. D. Richards, The Bank of England and the South Sea Company, Economic
History for January 1932.

^ Cf. E. B. Schumpeter, English Prices and Public Finance 1660—1822, Review of
Economic Statistics for February 1938. This paper is a by-product of a larger work on the
business cycles of the eighteenth century, part of the material of which has been generously
made available to the present writer who derived from it much help also in his analysis of
the Restriction Period.

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Business Cycles

and certainly precipitate and intensify it, prove that there is no cyclical
component at work. On the other hand, it cannot be denied, and is
not denied, that the course of political events during the seventeenth
and eighteenth centuries was such as to exert dominating influence on
economic life and on the behavior of such time series as we have. But
this would not prove that prosperities and depressions in our sense
were absent, even if we knew no more than that.

We can, however, prove the presence of our process. Even our inade-
quate sketch suflS.ces to establish it. We have, therefore, a right to
conclude that there must have been also prosperities and depressions of
the cyclical type. If now we find that this conclusion is fully borne out
by all the facts that the material at our disposal allows us to observe, our
case seems to be made out as far as it can be made out under the circum-
stances. To take one instance only. Nobody denies that the events
1717-1720 (when in June the flotation of new companies reached its
peak) and the bursting of the ‘‘bubbles"’ looks very much, in major fea-
tures as in details, like the big crises of 1772 — ^this, however, is the weakest
parallel case; nor is it really relevant, because it is the parallelism with
crises of the nineteenth century which is in question — 1825, 1873, 1929.
Situation, preceding events, actions and reactions, liquidation and
subsequent prostration were, as stated before, undoubtedly and strik-
ingly similar. What has been doubted is whether the economic process
under this financial surface was also similar, or whether an excess and a
breakdown of speculation was all that happened. But the answer is
clear. The mania of 1719-1720 was certainly not more than that; but
it was, exactly as were later manias of this kind, induced by a preceding
period of innovation which transformed the economic structure and upset
the preexisting state of things. The industrial and commercial process,
perfectly comparable to that of the industrial revolution, is clearly
recognizable. So are the complementary developments in the financial
sphere (deposit business of the goldsmiths, various bank projects,
eventually pushed aside by the success of the founders of the Bank of
England) and the concomitant developments of commerce and shipping.
Even the building boom which is a regular feature of cyclical situations
of this type was there, though less marked than in France. To all
these, the speculative excess and the stock exchange crisis stood in the
same relation as the excesses and crises of the nineteenth century.
The international character of the crisis and of the operations that pre-
ceded it points in the same direction.

8. This is our only opportunity to attempt an interpretation of the
activity of John Law (1716-1720) the true meaning of which is not diffi-
cult to unravel at this distance of time. He was an entrepreneur within
our meaning of the term, but one of those entrepreneurs who — ^like the

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251

brothers Pereire, of whom he may be considered as a forerunner — ^want
themselves to create the means of payments which are necessary for
the financing of their plans, i.e., to add the function of the banker to
that of the entrepreneur. Since the control of a machine for the produc-
tion of ^‘funds’’ at once brings within reach a wide variety of entre-
preneurial possibilities and seems to protect them against the criticism
and the restraints which would in general have to be expected from an
independent bank, such an idea suggests itself very naturally to the mind
of an entrepreneur who harbors very ambitious plans. That any such
attempt necessarily violates the structural idea of capitalism exactly
as the elimination of parliament violates the structural idea of con-
stitutional government, is clear, and so are the consequences which this
may be expected to have. It is also understandable that, for such a
banker-entrepreneur, acquisition of the power to create credit will
seem much more urgent than any individual one of the innovations which
he intends to carry out, so that both for him and for the observer the
mean becomes more important than the end. J ohn Law was no exception
to this rule. He first (1716) founded a bank which issued notes and
discounted bills. In 1717 he launched his entrepreneurial scheme, which
was colonial enterprise in the Mississippi Valley — ^by no means hopeless
in itself — ^in the shape of the Compagnie d’Occident, with which the other
colonial companies were merged in 1719, and the nominal independence
of which ended in 17^0 through amalgamation with the bank, against
whose notes the shares of the company were made exchangeable at a
price of 9,000 livres.

Meantime, the bank itself had been made a government institution
(Banque Royale) and had received what, in intention and in temporary
effect, amounted to a monopoly of joint stock banking for the whole
country. Manipulation of quotations, management of new issues of
shares in an atmosphere of frenzied speculation, quickly crowded out
everything else — ^for the public, the companies, and probably Law
himself — ^while the American venture was allowed to go wrong. The
details of the mania, the measures taken to prevent collapse, and the
liquidation are of no great interest to us. But one element which to
some students overshadows all others in importance, and has been
made central in many descriptions of that piece of financial history,
seems to contradict our interpretation — Law’s great operation that
turned the national debt into shares of the Mississippi Company, which
thereby became much the same kind of thing as the South Sea Company.
There is no doubt, of course, that this was not only the greatest, but the
only large-scale operation of Law’s company that was really carried out.
It was also the one which, though this is not quite easy to understand,
kindled the mania by virtue of all sorts of mysterious hopes for unheard-of

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Business Cycles

profits and general prosperity which, it raised. But the question is
whether it is correct to consider it as the crowning achievement toward
which Law had been working all along, so that his banking and colonial
schemes — ^for us the essential thing — ^would have been nothing but
preparatory steps.

Although Law’s early theories and projects seem to lend some color
to this view, the writer does not believe in it. The founding of New
Orleans was hardly a step on the shortest route to that goal. And
whatever Law’s actual intentions may have been at any moment of his
career, it seems more plausible to assume that this entrepreneur-banker,
dependent as he was, under the circumstances of the time and the country,
on the good will of the government and the favor of the Regent, was from
the first driven to put his plans into a garb acceptable to them and to
represent himself as the wizard under whose wand the Regent would
never know what it was to be financially embarrassed. It is not held, of
course, that Law experienced any reluctance against what was considered
to be very profitable business. It is also probable that, with failure of
his colonial ventures looming in the near future, he was glad to have
something to substitute for them. But it may, nevertheless, be true that
his operations in the field of government finance mean a lapse from the
logic of his plan rather than its realization. If this be so, then his rise
and failure acquire additional importance as early illustrations of the
possibilities and weaknesses of the capitalist machine and of all the rules
that apply to its handling which are as persistently taught by history as
they are forgotten each time.^

D. The Long Wave from 1787 to 1842. — ^Those years, as the reader
knows, cover what according to our tentative schema — ^it is very tenta-
tive — we call a Long Cycle or Kondratieff. We have seen reasons to
believe that this long wave was not the first of its kind. It is, however,
the first to admit of reasonably clear statistical description.^ Owing both

^ We owe to Professor E. J, Hamilton a most interesting descsription of the behavior of
prices and wages in Southern France, 1711-175^5 {Economic History Supplement of Economic
Journal, February 1937). It enters well into the general cyclical schema.

2 That period is also the earliest which the writer has endeavored to study as intensively
as he was able. This does not mean, however, that his study was adequate. On the con-
trary, it must be stated that not even the general and monographic literature of the subject
has been completely covered. Particular help was derived from Porter^s Progress of the
Nation (new ed. by F. W. Hirst, 19155) and W. B. Smith and A. H. Cole’s Fluctuations in
American Business, 1790-1860, 1935 (and Professor Cole’s previous publications in the
Review of Economic Statistics) and K. F. W. Dieterici, (1) Statistische Uebersicht der Wich-
tigsten Gegenst^nde des Verkehrs und Verbrauchs im Preussischen Staate und im Deut-
schen Zollverbande, published in six instalments, 1838-1857, (2) Der Volkswohlstand im
Preussischen Staate, 1846, as well as from the well-known works of Professor Clapham (An
Economic History of Modern England; I The Early Railway Age) and M. V. Clark (His-
tory of Manufactures in the United States I, 1607-1860).

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253

to inadequate information and to tke presence of serious political distur-
bance (mainly the troubles associated with the American Revolution and
its aftermath)/ dating is very uncertain at the beginning. Nor is the end
beyond doubt. Our choice rests on a combination of statistical and
industrial fact, mainly about the cotton textile and iron trades, which
further study may easily disavow. But few students will deny the
reality of the process, usually referred to as the industrial revolution,
which we identify with that Kondratieff.^

1. It is necessary, however, to guard against possible misunderstand-
ing by making quite clear in what sense we accept the term industrial
revolution and its implications. The writer agrees with modern eco-
nomic historians who frown upon it. It is not only outmoded, but also
misleading, or even false on principle, if it is intended to convey either
the idea that what it designates was a unique event or series of events
that created a new economic and social order, or the idea that, uncon-
nected with previous developments, it suddenly burst upon the world in
the last two or three decades of the eighteenth century. Enough has
been said already to clear this exposition of any suspicion that it counte-
nances the first: We put that particular industrial revolution on a par
with at least two similar events which preceded it and at least two more
which followed it. Nor do we adopt the second idea, for it is perfectly
clear that the industrial and commercial changes which occurred in the
course of our Kondratieiff joined on to and grew out of developments
clearly discernible before. Still less can we think of dating it by inven-

^ As soon as we admit the validity, for certain limited purposes, of an analysis wHcli
looks upon economic evolution as a distinct process having a logic of its own but going on
in a disturbed environment, it obviously must be expected that cyclical phases which are
due according to that logic or mechanism will often fail to show, owing to the opposing
influence of such external disturbances. No argument against cyclical schemata follows
from this and, in the particular case of this country, there would be no point in objecting
that we are allowing our Kondratieff to “'rise,” in flagrant violation of our schema, at a
time which is known to have been one of depression (1783-1790). To begin with, the
fact is not beyond question. Moreover, the objection rests upon what we know to be
incorrect, an identification of depression and suffering. Suffering there certainly was,
witness the rebellion of 1786, but this is not conclusive evidence about what the cyclical
phase was. Finally, there was the obvious and independent factor of physical impoverish-
ment owing to the war of independence and to the equally important effects of the inflation
incident to it. The bankruptcy of 1780, the issue of the “bills of a new tenor,” and the
final liqmdation of the “continental paper currency” were the landmarks on a route that
went through all the vicissitudes of unbridled inflation. This, by virtue of a vicious circle
which ought to be, but is not, common knowledge among economists, called for ever new
inflation in cure of situations created by antecedent inflation.

* The reader should consult the well-known book by Mantoux, without doubt the best
general treatise on the industrial revolution, in order to satisfy himself how well the facts
there described fit into our schema. Professor Mantoux’s emphasis on enterprise in our
sense is particularly enlightening.

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Business Cycles

tions, for many of the most important ones — such as Darby’s, New-
comen’s or Kay’s — ^were made in the first half of the eighteenth century,
while their genealogy, of course, goes back much further still, in some
cases to antiquity. Therefore, we have no quarrel with Professor Usher
for pushing the beginning of the industrial revolution back to 1700 —
except that there seems no cogent reason to stop there — ^if the term is to
designate the whole process of the emergence of modern industry.
Something remains, nevertheless, after stripping it of all erroneous conno-
tations. It is submitted that this something explains how it was
possible for those exaggerated ideas to arise. They contain an element
of truth. There actually was a bulge in all observable symptoms of
business activity obviously associated with industrial change of the
innovation type, and after that a process of absorption or insertion of
the results into a new system. Both ran their course and produced their
effects in a manner which can be described by means of our model, and
formed a unit within the evolutionary process in an altogether realistic
sense. ^

Tugan-Baranowsky’s dictum, endorsed by Spiethoff and borne out
by Clapham, that ^"if one wishes to refer the industrial revolution to a
definite historical epoch it can be located more justifiably in the second
quarter of the nineteenth than in the end of the eighteenth century”
accords with our view. As we know, it is in recession, depression, and
revival that the achievements initiated in the prosperity phase mature
and fully unfold themselves, thus bringing about a general reorganization
of industry and commerce, the full exploitation of the opportunities
newly created, and the elimination of obsolete and inadaptable elements,
which is exactly what happened and what accounts for what everyone
admits to have been a prolonged, though often interrupted, ‘‘depression”
— ^from the Napoleonic Wars into the forties. The fact that, as far as
we can judge, expansion of output in important industries preceded the
industrial revolution as delimited by us, falls into line for the same reason.

It should be added that, exactly as tbe innovations which “ carried ”
the industrial upswing of the eighties and nineties of the eighteenth
century in many cases emerged much earlier — ^in a preparatory state
that in some cases amounted to real, though quantitatively unimportant,
success — ^so the twenties and thirties of the nineteenth century already
display the first successes of the innovations which were to “carry” the
next Kondratieff. The next big thing in particular, railroadization of
the world, then asserted itself even to the point of playing a significant

^ Cunningliam, in dating the industrial revolution from 1770 to 1840 seems, more than
any other historian, to have visualized the process which the present writer is trying to
describe.

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255

role in the last Juglar of the Kondratieff now under discussion. We
observe the same phenomenon on the downgrade and in the revival of
the second Kondratieff when, notably in the eighties, electrification, the
most important innovation of the third, developed beyond the experi-
mental state. Why this should be is so readily understandable that we
might be tempted to consider it, by way of generalizing from our few
observations, as a normal feature of the evolutionary process, and to
insert it into our model. This has not been done because the intention
was to keep the latter as simple as possible, in order to qualify it for the
task of conveying essentials; but there would have been no difficulty in
making the insertion. Wherever we find the phenomenon, it constitutes,
of course, an additional link between successive cycles — ^there is no reason
to confine it to Kondratieffs. What matters here is that the reader
should realize that it does not invalidate our schema.

In addition to blurring — ^to the extent, in some cases, of inverting
— contours at the beginning of this period, external factors exerted
paramount influence until, roughly, 1820. The rest of the period was
much less disturbed: the influence of events — such as the invasion of
Spain by France (we mean the invasion under Louis XVIII, not that by
Napoleon) and of the Neapolitan Kingdom by Austria, the revolutions
of the Spanish colonies in South America, the Greek revolution, the
French ‘‘July revolution,” the Belgian revolution, the Portuguese and
Polish revolutions, the troubles in Turkey, the social unrest in England
— was, as far as the writer has been able to make out, either quantita-
tively small, in some cases like the Belgian revolution (the bombard-
ment of Antwerp by General Chasse, notwithstanding) astonishingly
small, or only local or of but minor moment to our three countries.
The effects of the friction between the United States and England
(1826-1830), of the Texan war with Mexico, of the American monetary
and tariff policy, though important, were never dominant in the sense of
seriously interfering with the interpretation of cyclical situations. But
the world wars of 1793 to 1815 obviously were. Nothing illustrates
better than does the figure of Napoleon what we mean by an external
factor, and both the necessity for our purposes of this concept and the
essential superficiality of the type of analysis of which it is a necessary
element. However, that factor was so important as to raise the question
of principle whether we are within our rights if we continue to speak of a
distinct process of economic evolution sui generis going on that was
merely disturbed and distorted by political events. It will undoubtedly
seem tempting to many of us to interpret both the behavior of time series
and the industrial and commercial processes behind them exclusively in
function of those events, to look upon even purely economic changes as

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Business Cycles

induced by them and to deny that there were any purely economic
cycles contributing their share to the results we actually observe.^

In order to form an opinion about this it is necessary to note first
that the process of industrial innovation obviously began before February
1793, when England declared war upon France. Moreover, we can
follow it up and conclude from our knowledge of its mechanism that it
would have produced a peak of prosperity, and afterward recession,
without those political events, however unscientific this turn of phrase
may look to anyone who envisages purposes wider than ours. These
propositions wiU presently be substantiated. That what we claim to be
cyclical fluctuations were in a number of instances associated with
political events is as true as that there were several other fluctuations
which are directly traceable to the latter. But we must guard against
an optical delusion which often arises from interpretation of the behavior
of time series in terms of spectacular events. Where these coincide with,
or immediately precede, a business situation that seems to accord with
them, this is uncritically accepted as proof of a causal relation. But
where a political event fails to produce a corresponding effect on business,
the fact is likely to be overlooked: England’s international situation in
1806, for instance, was anjrthing but comfortable, yet the year was one
of prosperity. As pointed out on a previous occasion, we must bear in
mind that a political event is never the sole factor at work, that it may,
both at the time and by the historian, be appealed to as a cause beyond
its deserts and that historical investigation into every detail is necessary
to establish a case.^

Second, we will classify effects roughly into wastage, dislocation, and
inflation. Physical destruction and real cost of armaments — ^in the case
of Germany, also of plunder and exactions both in money and in kind
— ^were of course considerable, but only locally and temporarily went to
the point of destroying or paralyzing business processes. Unless it does
this, wastage is more relevant to welfare and misery than to prosperity

^ Neither view has, of course, any general validity for a more fundamental analysis of
the social process as a whole. On the plane on which we move in this book, however,
everything is ‘‘mere disturbance” that does not come within the logic of our mechanism,
exactly as the effects of our mechanism would be “mere disturbances,” if our purpose were
to study political mechanisms. But disturbances may be so powerful as to blot out the
cyclical process of economic evolution entirely. For great parts of Germany the Thirty
Years’ War affords an instance. This is the only question we have to deal with now.

* An analogy will clarify our meaning. When the sky is clear, we see the full moon;
when it is cloudy, we do not; and so a popular belief has arisen to the effect that there is an
association between full moon and fine weather. This is independent of the fact that many
economists will look for any plausible association between external events and business
situations, because they would otherwise have to consider the latter as unexplainable.
So, even very farfetched and unconvincing associations are allowed to pass muster.

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257

and depression. Dislocation of industrial and commercial structures,
both in the short and in the long run, occurred, of course, on a large scale
and relative positions of national organisms, conditions of international
trade also, were powerfully influenced. This destroyed some, and con-
ditioned other, entrepreneurial possibilities. In the peaceful span of the
eighties England had inaugurated that policy of freer trade which is
associated with the names of Shelburne and the younger Pitt and which
made it possible for Disraeli later to claim the origins of Free Trade for
the list of achievements of the Conservative party. It no doubt intensi-
fied the spectacular increase of exports that was then already in progress.
These conditions lasted till the turn of the century. But then came the
Napoleonic policy eventually embodied in the three decrees that estab-
lished the so-called Continental System. Here we meet a characteristic
difficulty in interpretation. The effect of this policy, however imperfectly
enforced, is beyond doubt. It would on the whole account for a fall both
in quantities and prices of products of domestic industry — ^wool being
the only important raw material that came from the countries under
Napoleon’s sway — ^for depressive phenomena and, notably, for a par-
ticular type of speculative outburst and breakdown due to partly unavoid-
able and partly speculative accumulation of stocks of commodities and
their sudden release (commodity-trade crises, Warenhandels-Krisen) ,
Yet we know from experience that similar bursts and reactions happen
without any Napftleons and it could be plausibly argued that recession
and falling prices would have been due about 1800 (when prices of home-
produced manufactures actually did begin to fall) in perfectly peaceful
circumstances, even if we had not the theoretical reason we have to
support such an argument. It may be impossible to appraise quantita-
tively, or to isolate, the direct and indirect effects of these disturbances,
which at times may well have dominated situations. But none of them
was potent enough to prevent our mechanism from visibly working
according to its logic — ^however much results may have been affected by
the abrupt changes in its data — at least in England.

In Germany it may have been different. No generalization is possible
because the various parts of the country met with different fates. A lot
of institutional deadwood, however, was eliminated practically every-
where, in the territories that came directly or indirectly under French
rule as well as in others (in Prussia particularly through the reforms
known as the Stein-Hardenberg legislation). But although by removing
many fetters and creating political data favorable to free enterprise this
eventually quickened the pace of capitalist evolution, the circumstances
noticed before amply explain why we do not observe more striking
immediate effects. In the case of the United States the influence of the
European events was complicated and in some respects counteracted by

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Business Cycles

the war, and by conditions verging on war, with England. Even so,
American shipping, shipbuilding, and its subsidiaries reaped considerable
windfall gains from abnormally high freight rates and a profitable transit
trade. This, of course, helped financing and conditioned enterprise in
other directions. It is not less clear that subsequent embargoes, non-
intercourse acts, and the war put an end to much of this and account for
depressive phenomena which would not have been present to the same
degree without that temporary stimulus and its removal. But few will
deny that America, as far as it was not a farming nation, would then
have been primarily a seafaring and trading nation in any case and that
her farming interest would have felt the impulse of England ’s industrial
development — ^which made her a wheat-importing country in the eighties
— even without the obstacles that impeded exports from the continent of
Europe.

Conversely, first the war of independence and then the war of 181£
to 1814 together with its antecedents, affected industry much as pro-
hibitive tariffs would have done and encouraged investment that was
bound to become unremunerative as soon as those conditions were
removed. The year 1815 brought a regular postwar spurt and 1816 a
no less regular postwar slump, such as we always observe in such cases.
Time series and industrial history, of course, reflect both. They would
do so whatever the underlying cyclical phase might have been. But
again, this is no reason to deny the reality of the cycftal component on
principle or to assume a priori, as soon as we realize the presence of
noncyclical components, that they were the only ones to act. In our
particular case depth as well as duration (to 1821) of the ensuing depres-
sive conditions could hardly be understood without reference to the
location of those years in the Kondratieff. To this we shall add a few
details at the end of this chapter.

3. The problem of the effects of protection on the development of
American (or any) capitalism cannot be fully discussed anywhere in this
book. But we will avail ourselves of this opportunity to make a few
more general remarks. Although the result of much more complex
social, economic, and fiscal motivations, the American tariffs of 1789
and 1816 may, from our standpoint, be looked upon as attempts to
prolong the conditions that prevailed during the preceding wars and to
preserve the industrial war structures. Whatever their effects in other
respects and on other interests, this purpose was actually served by them
as was, then and later, the cognate purpose of keeping alive structures
that owed their existence to inflation and, barring further inflation, could
not have survived without protection. As it was, tariffs certainly soft-
ened downgrades and accentuated upgrades. Removal, even if gradual,
might even have produced depressive situations, sudden removal panics,

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259

that could not otherwise be explained. Fear — ^perhaps, exaggerated fear
— of immediate consequences paralyzed the badly organized and badly
led interests which were injured by that policy; and the vicious circle of
protection making itself necessary and creating situations that call for
more protection, is at the bottom of American protectionism to this day.

But this does not mean that changes in tariff policy dominate the
cyclical movement, although they powerfully determine what the
industrial structure will be. It does not mean this, as a matter of fact,
in the American case (even beyond our period). And it does not mean
this, as a matter of analytical principle. In the former respect, we will
note that the tariff of 1789 did not more than protect a number of weak
industrial striplings. Of the acts from 1816, when protection got really
under sail, to the ‘‘tariff of abominations” (18£8) — ^from which protec-
tionists receded in 1833 by what was a strategical retreat highly creditable
to the cleverness of their high command — ^none turned any tide. Since
to the knowledge of the writer nobody ever held that they did, we need
not insist. In the latter respect we will now formulate more generally:
imposition and removal of tariffs changes the conditions both for enter-
prise and for current business. As regards enterprise, protection will
stimulate it in some directions and bridle it in others, so that a distorted
industrial organism will be the consequence. Net effects there may be,
although there need not, but positive ones will always be more visible
than the (largely conjectural) negative ones. In no case is it correct to
list this influence among alternatives to the influence of the entrepreneurial
factor, through which alone it acts as does any other change in data.
This in part explains the ineffectiveness of protection in creating booms :
all it can possibly do is to add one favoring circumstance, while it is
perfectly consonant with this that the removal of protection may produce
a slump by upsetting calculations.

In its role as a condition of entrepreneurial activity, imposition of
tariffs will thus act similarly to cheap money policy: it creates margins
which would not otherwise exist and therefore calls forth enterprise and
secondary expansion that may become a source of troubles. However,
protection acts not only on enterprise, but also on current business or
what we call the world of old firms. As far as it does this, it may directly
change the complexion of the economic situation as a whole. Here it
has what may be termed a mechanical or automatic effect, although this
effect is never one way only. The by no means easy task of working out
the implications, some of them paradoxical, of this schema must be left to
the reader.^ We will add, nevertheless, that removal of import duties

^ This caimot be done, however, without going into the theory of international trade
and finance, whidbi is prcjcisely the reason why it is impossible to follow up the subject here.
But another remark may be in order. The above suggests that the writer beheves the

260

Business Cycles

in prosperity and imposition of them in recession might conceivably be
used as an apparatus of control. This is no recommendation, of course;
but such a measure would be free from some of the undesired effects of
others of the same kind, notably of measures of credit policy. It would,
however, display similar limitations.

4. The question remains to what extent the external factors Inflation
and Deflation shaped events and whether they provide an alternative
explanation of the economic history of the time that could stand by
itself, thereby proving the futility of looking for any cycles of autonomous
causation, particularly for the Kondratieff . The answer is comparatively
simple if by inflation we mean merely the financing of public expenditure
by legal tender or credit instruments created ad hoCy and if by its effects
we mean merely the impact of the amount thus created times a suitable
coeflScient of velocity (whether or not corrected for the influence such a
policy has on the disposition of people to hold cash). But such situations
are invariably complicated by an expansion of business credit which
superimposes itself on the direct effects and is very diificult to distinguish
from expansions of business credit that during the same time would have
occurred in the ordinary course of prosperity phases. For America we
have also at various junctures to take account of inflationary impulses,
given quite independently of any fiscal vicissitudes and often without
any change in the quantity and character of legal tender, by soft and
cheap money policies and ‘^reckless banking,^^^ which in America was
fostered by the inflationist temper of the public mind. This Gordian
knot interpretation has got to face, however convenient it may be to slur
over these diflBculties by aggregative propositions. We shall class with

eflFects of protectionist policy on the speed of the economic development of this country to
have been exaggerated by its friends as well as by its foes. He does not doubt, however,
that there was some positive net eiffect. What he wishes to stress now is that such an
effect would not in itself suffice to form an opinion about American Protectionism, even
if it had not produced any maladjustments but merely increased the pace of economic
development in a perfectly balanced way. For effects on the social structure of the country
and cultural aspects would also have to be taken into account. And from many stand-
points that cannot be lightly neglected, the case for speeding up economic “progress” is
by no means obvious. At the end of this chapter, a similar remark will be made about
the analogous aspect of credit creation.

^ A working definition of reckless banking, sufficiently accurate for om: purpose, is
issue of notes or the creation of deposits without regard to redeemability. More accurate
is it to stress the criterion of granting loans without regard to the borrowers’ ability to
repay. Theoretically, the one can exist without the other. But nobody should really
require a definition who has ever looked into Sumner’s work, obligation to which the author
wishes to acknowledge, or into that of Gouge and others equally well known. See, espe-
cially, Professor Bullock’s Essays on the Monetary History of the United States, pp.
7fi“99 and Bray Hammond, Long-and Short-term Credit, Quarterly Journal of Economics
for November 1934.

Historical Outlines

261

external factors, not only inflationary financing of government expendi-
ture, but also inflationary impulses of the last-mentioned type, provided
they proceed from the political world — ^which mainly, though not
exclusively, means legislation — ^while ‘'reckless banking” will be classed
with speculative manias, swindle, and the like, by which we wish to
express, on the one hand, that it does not belong to those features without
which our model would not be logically complete and, on the other hand,
that it does belong to those features which understandably present
themselves under certain environmental circumstances and in certain
stages in the career of capitalism.

It is only with regard to “reckless banking,” to be touched upon
later, that the question of inflation arises at all for the United States.
Broadly speaking, sound money policy prevailed during the whole of this
period, and the Constitution — which at the time was understood to have
deprived both state legislatures and Congress of the power of issuing not
only “bills of credit” but legal-tender fiat, an opinion held by the Supreme
Court as late as 1870 — ^reflects acknowledgment of the lesson taught by
the war inflation. It ratified the temporary defeat of inflationism and
substantially settled monetary matters until the Civil War. We need
not go into the policy concerning silver and gold, beyond stating that no
inflationary influence can have come from it, while banking develop-
ments negative — with one possible qualification to be mentioned later —
the possibility of deflationary eflfects.

In Germany there were monetary disorders differing in nature and
degree in different territories; but since we exclude Austria, we may say
that they did not amount to much. In England, however, there was
inflation in every sense this term can bear. Without staying to describe
its well-known features, we will first observe that inflation in the sense
defined at the beginning of the preceding paragraph culminated at the
turn of the century, for public revenue and genuine borrowing increasingly
caught up with expenditure in the course of the first decade of the nine-
teenth century^ — and there was only a minor relapse later — although the
peak of the absolute amount of the floating debt comes in 1814—1815.
But a “commercial” expansion of means of payments that was in part,
though not wholly, induced by that direct government inflation, took its
place for several years — a fact which illustrates the difliculties of interpre-
tation glanced at above. There cannot be any doubt, of course, that
this inflation and the other disturbances incident to the world wars of
the time affected the course of industrial, and particularly of commercial,
events and distorted the statistical picture to the point of making

^ According to Dr. E, B. Schumpeter, 70 per cent of total expenditure was covered by
revenue for the whole period from 1793 to 1816, but for 1793-1802, only 60 per cent— even
this, no doubt, an admirable performance.

262

Business Cycles

amplitudes unreliable and of throwing doubt on the ‘Hrue” location of
peaks and troughs. But the influence of inflation alone should not be
overrated. The inflation was anything but wild and never went beyond
that first stage in which effects — ^notably, on prices — are less than pro-
portional to the amount of units of purchasing power created. Confi-
dence — ^which took the form of confidence in eventual resumption of
specie payments; but what matters is not exactly that, but confidence in
preservation or restoration of the purchasing power of the pound, which
need not imply the other — ^was never seriously shaken. Effects cannot
be measured either by total advances of the Bank of England or by notes
outstanding, which would have increased in any case, or by other deposits
which were also swelled by the growing habit of bankers to keep reserves
at the bank. Movements of the price level understate them. Bicardo
certainly took the problem too easily when he measured depreciation due
to overissue by foreign exchanges. The inflation did not prevent that
fall in the prices of home-produced commodities, notably of the inno-
vating ones, which, as mentioned above, set in when it should have
according to our schema. Nor was it strong enough to blot out any of
the short cycles in which prices and country banks’ issues move well
together. It contributed to the failure of the rate of interest to fall, but
it left usual sequences of cyclical symptoms intact. Among the dis-
locating influences exerted on the productive organism, the stimulus
given to agriculture was, so the writer believes, the most important one.
In industry there was business as usual” for most of the time; but for
many a firm the day of reckoning was put off.^

More diflScult to answer is the question of the role played by deflation.
We must, of course, distinguish deflation in the sense of actual reduction
of the means of circulation originally created for government financing,
or in the sense of any other monetary measures taken in order to restore
the pound to the prewar gold parity, from mere cessation of inflation.
The latter suflSces to produce a temporary slump. In our case it must
be listed among the factors that contributed to the crises of 1810“1811
and 1815, Neither of these can, indeed, be adequately described in
terms of external factors, still less in terms of deflation, for both occurred
within the cyclical rhythm. But both were aggravated, or even turned
into catastrophes, by the direct and indirect effects of political events
— ^the indirect effects mainly consisting in business action induced either

1 The work which is compressed in the above statements started from, and was greatly
facilitated by, Mr. Norman Silberling’s study in the Review of Economic Statistics^ 1923,
as was investigation of the aggregative aspects for the rest of the period. In acknowledging
this obligation and expressing agreement with some of Mr. Silberling’s interpretations, the
writer does not wish to convey the impression that he accepts them aU. As to the facts,
he would have but minor criticisms to offer.

Histobical Outlines

263

by war conditions or by the speculative anticipation of peaceful con-
ditions — ^and by the interruption or definitive cessation of government
inflation. The crisis of 1815, in particular, which bears an obvious
family likeness to that of 1921, undoubtedly ushered in postwar adjust-
ments. The industrial activity of 1813 and 1814, which there is no
reason to ascribe to war opportunities only, since these opportunities had
also coexisted with depressed business, should have led to the recession
which, in fact, set in during the latter year. But then there super-
imposed itself upon those recessive symptoms a boom which is clearly
enough associated with optimistic anticipation, particularly with respect
to foreign trade, of the effects of the treaties of Paris and Ghent. It
lasted into 1815, was interrupted by the Hundred Days, resumed after
Waterloo, and collapsed in the fall, the most obvious cause being the
failure of those anticipations as to foreign trade — some of them absolutely
ridiculous — ^to come true. The same cause also mainly accounts for the
epidemic among banks. How innocuous the recession would otherwise
have been can be seen from the behavior of cotton imports, which more
truly than foreign trade and speculation reflect the state of the industrial
organism. They were 92 million pounds in 1815, went down to 86
millions in 1816, but rose to 116 millions in 1817. Unemployment was
to a great extent technological, but also would not have been so serious
as we are led to believe it was, without the external factors which
account for what primarily was, in England as elsewhere, a postwar
slump.

Although the crisis of 1815 can hardly be said to have had anything
to do with deflation — ^no measures having been taken as yet — ^the years
to the resumption of specie payments in May 1821 (after that year there
cannot be any question of it, as banking developments in the twenties
and thirties amply prove; moreover, the act of 1822 directly stimulated
credit expansion by provincial banks) will be by many of us suspected of
having been under deflationary influences.^ This opinion was held at
the time by one party to the discussion that naturally arose about the
monetary policy to be followed. In this discussion, which — a fact that
is not much to the credit of monetary science — already brought out, on
both sides of the question, very nearly all the arguments and recommen-
dations to which we have again become accustomed since the World War
of our own time and some of which we look upon as novelties, right and
wrong is not easy to disentangle. Both parties produced good reasoning,
even where they arrived (from their subconscious value judgments) at
different recommendations, and mistakes can be proved against both, in

^ It stould be borne in mind tbat tbe meaning of such a statement depends on tbe
definition of deflation. If deflation is, for instance, made synonymoxis witb falling prices,
then there is no problem. Only tbat is not very helpful.

264

Business Cycles

points of fact as well as in points of theory.^ Both of them — or, at any
rate, the majorities of both parties — erred, however, in one fundamental
point: even the advocates of return to gold at prewar parity, while in
many instances giving other than monetary reasons for some of the
depressive symptoms of the time, always admitted or implied that the
fall in the price level was simply due to that policy and, without it,
would not have occurred at all. We know that this is not so from the
location of the period in the KondratiefP : the normal process of the long
cycle would, as a consequence of industrial developments, have entailed
not a fall only, but the fall characteristic of the first stage of a Kondratieff
depression.^

This does not mean, of course, that monetary policy had no influence
on prices, but only that the mere fact of their fall does not in itself prove
that it had, and that such depressive influence on business as was exerted
by the fall cannot, ij)So factOy be attributed to monetary policy alone.
The extent to which deflationary measures — again, as distinct from mere
cessation of war expenditure — actually were effective, therefore, cannot
be simply read off a price-level series 1815-1821 (when the acute fall
ceased), but becomes a question of fact which it is extremely difBcult to
answer because, on the one hand, even absolute reduction of means of
payment might have very little effect — in situations in which part of
them would be idle anyhow — ^and because, on the other hand, it also
might have a much greater effect — ^if it dislocates positions and induces a
cumulative process — ^than crude quantity-theory considerations would
lead us to believe. The question acquires additional interest from the
almost perfect analogy of the financial and economic, not the social and
political, situation with that which faced England after 1918.

1 Most of the facts relevant to that controversy the reader finds in Mr. Silberling’s study
previously quoted. There are some more in the evidence collected by the Secret Com-
mittee on the Bank of England Charter (especially in the appendices to their report).
A masterly survey of the discussion is presented in Professor Viner’s Studies in the Theory
of International Trade, 1937 I. It should be observed that, whatever truth there may be
in the rumor that Kicardo later on repented of the advice he gave, his authority cannot be
claimed to 100 per cent for the advocates of return to gold at the old parity, because that
advice was offered as a part of a program, adoption of which would have made some
difference as to consequences.

^ The fall in prices set in before any measures had been taken that could be called
deflationary. Against the obvious implication of this. Professor Viner, op. dt., adduces
anticipation of such measures. But even if businessmen harbored such anticipations —
which is by no means certain; they expected a return to prewar parity, but for their major-
ity the connection between this and falling prices was, at that time especially, probably less
obvious than it is to Professor Viner — the presence of another factor would not thereby
be disproved. We do not, however, insist on this, because, as stated above, mere cessation
of inflation would in any case have given a shock to prices and it might be held, that this
shodk would not have led to continued fall but for the actual measures taken.

Historical Outlines

265

Compared to total income, the funded debt with which England
emerged from the Napoleonic wars was quite as formidable as the debt
bequeathed to her by the World War of our time. Nothing was done
about it, economic development swiftly reducing to a light burden
what had seemed a crushing one.^ Balancing the budget did not —
accomplished as it was mainly by prompt liquidation of war expenditure
— entail any drastic measures and was accompanied by the repeal of the
income tax, which it is relevant to notice because it bears upon the
question of ‘‘nonmechanical eflPects’^ of such deflation as there was — that
is to say, of those effects which, as stated above, might either enhance or
reduce the mere quantitative effect, for example, by starting a spiral.
Those measures were, in the atmosphere of the time, certainly of a nature
to spread confidence and even optimism and to stimulate activity, and
we may conclude that deflation had in this case less than quantity-theory
effects. But what did it consist in? An act was passed in 1816 to put
an end to the issue of small bank notes (under 5 pounds), which, in fact,
were reduced to less than a million by 1822.

This does not mean, however, that the circulating medium was
reduced either in the same proportion or even by the same amount.
The only other measures that could be thought of are reflected in the
increase in the bank’s gold reserve and the decrease of its total advances.
This was not accomplished by tightening the money market — ^money
was easy, as we should expect from our model, throughout the period,
except in 1816 and at the beginning of 1819 — but it came about as a conse-
quence of government ’s repaying its debt at the bank, thus normalizing
its position. The variations of the gold holdings of the bank and of its
total advances show perfect absence of any rigid grip on the reins, which
were loosened exactly as the business situations seemed to require. In
1814, gold stood at 2.2 million pounds and total advances at 42.9. By
1817 gold was up to 10.7 and advances were down to 27. But in 1819,
gold was only 3.8, advances having slightly increased; that situation was
handled by letting out gold freely. It quickly returned, without much
pains having to be taken and in the midst of the boom, 1824, we have
those items at respectively 4.7 and 17.6 millions. With the airy confi-
dence of the intellectual, most writers of both parties seem to have agreed
in thinking that the directors of the bank were absolute fools. But from
their standpoint, and within their system of values, those directors,

^ That turn of phrase implies that an internal debt can be a “burden.” Of course it
can. It would be unnecessary to insist on this, were it not for the talk that has become
familiar about “putting money from one pocket into another” and “mere transference
payments.” The keeping of capitalists, whose capital has been disabled by consumptive
use, is as much of a burden as is the keeping of workmen who have been disabled on the
battlefields. See below. Chap. XIV.

266

Business Cycles

though perhaps deficient in the art of stating — or even seeing — their case,
did an excellent job. Improvement came in 1817 — ^when “deflation”
was in full swing — 1818 was a prosperous year, 1819 a depressed year, in
1820 and 1821 things brightened up, prosperity followed — all of which
was in the ordinary rhythm of the cyclical movement.

Active means of payment were not, of course, reduced by anything
like the amounts by which total advances fell; and it is absurd to think
that what reduction there was, was torn from acts of expenditure which
would otherwise have been effected. Business simply liquidated war
expenditure 'pari passu with the government. This certainly intensified
the fall in the level of prices to 1821, as it intensified other disturbances
and dislocations. And if it be simply held that monetary policy did not
prevent this, but on the contrary helped to bring prices quickly down
toward that lower level on which they would have moved at that time
had there been no war, there is little difference of opinion, although there
seems little point in calling that deflation. Nor is there any objection if
it be held that continued inflationary, or “reflationary,” government
expenditure — ^without return to gold or with return at a lower parity —
would have prevented it and that this would have made things easier,
particularly for the agrarian interests, which had so pleasantly become
accustomed to rising prices. As it was, policy consisted in providing a
secure frame for entrepreneurial activity, in reducing burdens and
fetters (corn laws excepted) to a minimum and in defending this system
with energy — ^ruthless energy, even — against the outbreaks of discontent
and misery. Judgment on this policy, which must largely turn on the
length of the period for which effects are taken into account, is not
within our task. Only, it was not nonsense, nor unconnected with the
economic achievements that followed.

As we have seen before, England, unlike Germany and the United
States, was no longer an agricultural country even at the threshold of
our period. But agriculture was still by far the most important single
industry and the center of many important innovations. Enclosure
went on and substantially completed its task within the Kondratieff —
« 1780 to 1810, 1,699 enclosure acts were passed — ^intensive cultivation in
the neighborhood of cities, of the type first developed in Flanders, and
better methods of raising beef cattle continued to gain ground, and
improvements of agricultural methods in general — such as the Norfolk
system, drainage by means of steam pumps, more scientific use of
fertilizers (guano) — ^while not really new for the most part, were actually
carried out on a much greater scale. The obvious consequences of this
asserted themselves in due course. They were mitigated by favorably
shifting demand conditions throughout the period and, at first, also by
the wars, which, however, intensified them later on because of the

Historical Outlines

267

untenable increase in acreage induced by war prices: tbe peaks in the
official annual averages of the price of wheat occurred in 1800-1801 —
when it was 119s. 6d. per quarter^ — 1810, and 181£-1813; about 5
million acres were added to the food-producing area during the Napoleonic
wars. We observe an invincible tendency (interrupted by bad harvests
1815-1818, 18£6, 1828, 1829) of prices to fall in spite of protection and
a picture of gloom,’’ characteristically spotted by prosperity, for
instance, in Norfolk, SuflPolk, Cambridgeshire, the Lothians — ^much the
same sort of thing as in the United States of the twenties of this century.
This entirely accords with our cyclical schema and constitutes part of
the situation characteristic of that Kondratieff downgrade. It would be
difficult to find a better illustration of how innovation operates in agri-
culture. ^ But the great agricultural depression of the period after the
Napoleonic wars and the clamor for protection to agriculture is only in
part explained thereby. Foreign competition was a very real cause,
particularly in the case of wheat and of wool. Improvident acquisition
of land on the strength of war prices played, under English conditions, a
very small role in aggravating the situation but other types of improvi-
dent action were of considerable importance. Adjustment eventually
took the form of curtailment and of emigration into industry and into
foreign countries and necessarily involved depressive processes. It was
then that the yeoman class (or classes), which had been in decline since
the seventeenth century and had experienced a last spell of prosperity
after 1785, definitively disappeared.

The German case was entirely different. In 1804, 80 per cent of the
Prussian population lived by agriculture, and this is fairly representative
of the occupational structure of all the 39 sovereign states which emerged
after the breakdown of the old empire from some hundred principalities
that existed before. The great agrarian operations which were inaugu-
rated in that period and eventually created the free — and more or less
compact — ^peasant holding, did not come about in response to any
entrepreneurial impulses among peasants, but were imposed upon them

^ As a matter of fact, in 1801 wheat reached 126s.; the official annual average of 1812 »

is 126s. 6d. After 1820 the official annual average never rose beyond 74s. 9d., which figure
occurred in the Crimean War.

* It is, therefore, a matter of regret to the author that he cannot go into the subject more
f uUy, aU the more so because wrong diagnoses of that depression have been and are so widely
circulated. No full explanation is possible, in fact, without reference to the cyclical mech-
anism. But there are other objections to the theories usually offered. Sir E. West, for
example, stressed failing purchasing power of consumers, which, in the case of England, is
entirely untenable, in spite of widespread misery among the unemployed. — The Farmers*
Magazine contains much interesting material on the process. So do Smart’s Annals,
See, also. Lord Ernie’s English Farming Fast and Present, and Mr. Fay’s article in the
Economic Journal for March 1921.

268

Business Cycles

by government authority which, however conservative in other respects,
in this instance quite uncritically accepted the ideas of economic liberal-
ism. Into this matter, the source of so many serious problems of the
future, we need not go beyond stating that neither the mentality nor
the methods of the peasants were much changed, within our period, by
those rearrangements — exactly as previous personal emancipation had
failed to change them — and that the majority, continuing in their old
ways, were largely exempt from the effects of business fluctuations and,
in any case, played an entirely passive role in them. What change there
was, spread of the previously introduced cultivation of potatoes for
instance, was similarly carried by oflS^cial initiative. The landed gentry
that had taken to agriculture as a profession was in a different position,
particularly where, as in Prussia, it “enjoyed’’ the blessings of readily
available credit.^ Especially in the east, the medium-sized and larger
estates had early — ^much before our period — developed into grain- and
wool-producing factories which worked for export according to ordinary
commercial principles. Among these there was progress, of the inno-
vation type, comparable to what went on in England. In fact it largely
consisted in adopting English methods, English crop rotation, deep
ploughing, drilling, the drainpipe, and better fertilizers. Much of this
was taught by academic authority (Thaer) while agricultural chemistry
(Liebig) began to lend its aid later. Production of oil seeds and of
potatoes was on a greater scale than in England and some developments
were of domestic origin, especially industrial ventures — distilleries,
breweries and, from the thirties, beet-sugar factories. This class of
landowners was, indeed, able to make use of the new freedom (in most
respects, however, they had had all the freedom they wanted ever since
the sixteenth century) and not only to rationalize the management of
their estates but also to extend them by purchasing peasant property or
property of their less active equals.

But most of these things asserted themselves in and after the Kon-
dratieff depression. The prosperity of these landowners was, indeed,
what prosperity is not in general, namely, a function of prices, which
cannot be in turn explained in terms of the innovations that took effect
up to the Napoleonic wars. Prices went up till 1805, then fell to 1811,
rose again until 1818, when a sharp fall set in, accentuated by the good

1 After the Seven Years* War, Frederick the Great had organized landbanks (Land-
schaften) especially designed to serve the credit requirements of the larger estates (Bitter-
giiter). They issued mortgage bonds (Pfandbriefe) to the borrowers, which these had to
sell but which sometimes also circulated as means of payment, a quite original form of
credit creation. This system fimctioned but too well. By making it so easy for land-
owners to get into debt, it helped to create untenable situations, as such policies always
will: one of the home truths that everyone knows and nobody admits.

Historical Outlines

269

harvests from 1820 to 1824. In the latter year, some of the cereals had
fallen by about 70 per cent of the 1818 figure, though meat and dairy
products fell far less. Recovery (with fluctuations) still left them in
1842 at their pre-Napoleonic level. While the latter fact presumably
reflects improvement in agricultural methods and hence comes within our
schema, the fall which produced what is usually referred to as the agri-
cultural depression of the twenties of the nineteenth century does not any
more than the preceding rise bear the corresponding interpretation. The
fall in 1805 to 1811 was obviously due to impediments to exports; the fall
from 1818 to 1824 links up with English prices plus English protection.^
Besides, impoverishment of the masses owing to the preceding wars was
a very real factor in Germany. While fall in prices due to improvement
need not spell depression, fall due to such causes as these naturally does.
Moreover, its effect was greatly intensified by the prevailing indebted-
ness, which came in part from investment in land — ^in many instances, of
a speculative character — ^in part from the exactions incident to the wars
and from living above means. It follows that we must look upon this
depression in German agriculture largely as a phenomenon sui generis.

In the United States the production of agricultural raw materials in
general followed rather than preceded the development of the industries
that use them. This is especially true of wool, which, in spite of many
efforts by manufacturers, of protection, of the impulses given by the
English war and by the growing demand for mutton, and of the intro-
duction of the Merino breed (1801), developed slowly until, just beyond
our period, it temporarily became an article of export. Cotton continued
to be imported and also to be an article of transit trade — ^net exports
began in 1794 — ^until a growing industry almost impelled its production
on a larger scale. The great investment in cotton planting in the South
began in the recession of that Kondratieff: a typical example of an
induced development or of what we have called expansion into new eco-
nomic space created by previous innovation. Lumbering was, of course,
basic to the general growth of the country from the start, but not very
interesting cyclically, since so much of it was done for local purposes.
The great development was in wheat growing. Stimulated by abundance
of cheap credit due to what has above been referred to as reckless
banking,’’ and by foreign demand, it experienced a boom, 1799-1795,
which together with the development of milling incident to it — export of
flour continued to increase after the export of wheat had fallen — ^was one

^ Wool prices, while moving sharply in the shorter cycles, did not display any long-time
depression. They fell from the peak of 1818, but recovered in 1821. In 1825 they reached
their all-time high (before the World War of the twentieth century), to fall by almost
50 per cent in 1826: German wool was dominant in the English market until, after the for-
ties, Australian and La Plata wool came in.;

270

Business Cycles

of the most important elements of that Kondratieff prosperity. Since
that boom was primarily — ^though by no means wholly — a matter of
ability to export, the setback and America’s share in the ensuing agrarian
depression must, still more than in the case of Germany, be interpreted
in terms of foreign conditions, falling prices, and protection in England
in particular, the effects of which were, for the country taken as a whole,
alleviated by the favorably developing cotton situation.

But another phenomenon calls for attention which plays a role in
all agrarian depressions in this country. That is a type of innovation
which from the start has been peculiar to it and has remained so
into the twenties of this century: innovation which creates the conditions
for bringing new regions into cultivation. Grain production shifted its
center from the New England States to Virginia and Maryland aheady
in colonial times, and in our period began to shift it again to the Ohio
and the Great Lakes. Each process of this kind spells increase of pro-
duction and, at the same time, prosperity in the new and depression in
the old regions — ^the latter well illustrating that important piece of the
cyclical mechanism, the competition between the new and the old pro-
duction functions. It should be noted in passing that this also illustrates
the difficulty of talking about the ‘Tong-period depressions in the world’s
agriculture” as homogeneous phenomena, while recognition of the large
number of factors that, in very different combinations, constitute the
phenomenon in each country should be sufficient to expose the shallowness
of monetary explanations as well as of the overproduction slogan.

6. English colonial and commercial enterprise, exploiting opportuni-
ties created or conditioned by political action, remained important, of
course, throughout our period (Sir Robert Peel’s second ministry, which
took office about at the end of it, conveniently marks an important
change of political attitude in this respect) and even beyond it, but in
relative importance it distinctly declined. Commerce of the type which
is associated with peaceful trade and with all that this politically implies,
increased fairly steadily during the eighteenth century and continued to
increase (in physical quantities) throughout our period, at a growing rate.^
Foreign investment became important enough to be much in evidence in
the crises of the last two decades of the period. But the outstanding
feature was the completion of the conquest, begun in Elizabethan times,
of England’s domestic market by her own industry, the evolution of
which is the dominant factor which shaped her business situations and
induced such additional expansion (that part of the expansion which
went beyond growth) of her foreign trade as occurred. English industrial
history can, in the epoch under discussion, be almost resolved into the

^ Barring tlie various setbacks, of course. And values were stagnant or falling in the
first four decades of the nineteenth century.

Historical Outlines

271

history of a single industry, the evolution of which, together with all the
effects on and reactions from the rest of the economic system, affords as
clear an illustration of our cyclical process as we can ever hope to find —
cotton textiles.

In order to guard against misinterpretation, let us repeat: the cotton
textile industry was the new leader, according to our terminology, but it
was not new in the sense of common parlance. Production of and trade
in cotton goods, of course, existed before — ^in Germany and Switzerland
it dates from the Middle Ages, when it got its raw material from Asia
Minor — and several stages, all marked by innovations, can be clearly
distinguished. The first of these consisted in the introduction of Indian
cotton fabrics, mainly (or wholly?) by the East India Company (estab-
lishment of a new consumers’ good). By 17£1 success was important
enough to have roused hostility of threatened ‘‘old firms” — ^that is, the
woolen and silk industries — ^which in that year secured, with due reference
to the interest of the English workman, a prohibition of the sale as well
as the wearing of printed, painted, or dyed calicoes. At that time,
however, an English industry using cotton as weft in a linen warp had
already come into existence — ^the second innovation. This industry
was granted an exemption for the production of such mixed fabrics in
1736, and went on developing on these lines, thus creating a demand for
yarn and conditioning, by putting a premium on its production, innova-
tion in the latter. Complete repeal came in 1774, soon after it had
become possible to produce pure cotton fabrics. Many steps led up to
this achievement, which constitutes a third innovation clearly anterior
to our Kondratieff prosperity. But realization that counted quanti-
tatively (for the whole of the economic system) did not come before the
eighties. Experimentation, resistance, failure, and local success (Ark-
wright’s, about 1760, was the outstanding one) is what we observe before.
Spread, induced improvement, dislocation and absorption, copying,
following, and competing are what we observe afterward, in the down-
grade and revival, when the real avalanche of products came. Prices
and exports tell this tale clearly.^

Again, not only, as mentioned before, had many of the most impor-
tant textile inventions — ^the flying shuttle, the jenny. Barker’s loom,

1 See, for example. Professor Usker, Industrial History, quoted before. Price of No. 40
yarn was still 16s. at the threshold of our period (1779). It fell till 1784 to 10s. lid.; was
7s. 6d. in 1799, 2s. 6d. in 1812 (recession effect). Is. 2Kd. in 1830. Exports rose from 300,-
000 pounds in 1781 to 30 million pounds in 1825. It is, as the above abundantly
shows, no part of our intention to belittle previous developments. Our schema itself leads
us to emphasize them. But, inasmuch as appraisal of these developments is made to rest
on the fact that relative increase was just as strong 1750—1764, it is necessary to point
out that logarithmic scales also may present misleading pictures. In 1802 woolen fabrics
were ousted from their place as leading article of export.

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Business Cycles

and so on — ^like inventions in other fields that played a role in the indus-
trial revolution in our sense, been made earlier, even if we date by
eighteenth-century patents what really leads to much more ancient
roots; not only can but few of these — ^like the waterframe and the mule —
be looked upon as directly relevant to the causation of that prosperity;
but it is also a fact that many of those made during that time did not
take effect until after the turn of Kondratieff prosperity, because of their
technological shortcomings. Cartwright’s looms, for instance, were paid,
it seems, too high a compliment by the weavers who in 179£ destroyed
his factory. A really successful power loom evolved from the work of
Austin, Horrocks, and Roberts in the two first decades of the nineteenth
century. Once more we see that invention and innovation are entirely
different things, not uniquely related to each other, and that only con-
fusion can result from trying to analyze economic processes in terms of
the former. But they interact, of course, and sometimes invention is an
incident in an entrepreneurial achievement. Arkwright’s figure exem-
plifies this (as far as he really invented anything himself). He is typical
of what we call an entrepreneur: sociologically^ in his background which
illustrates so well the truth that entrepreneurs — ^Arkwrights and Dukes
of Bridgewater^ — ^form no social class; personally , in the sort of man he
was; economically, in the nature of his achievement and its effects on
the environment. Brindley the millwright, Telford the mason, Cart-
wright the parson, Hargreaves the weaver, Fielden and Strutt the farmers.
Huntsman the clockmaker, and many others in the textile and other
fields would serve equally well. Subtypes can easily be distinguished.
In the alliance Watt-Boulton- Wilkinson, we see three of them at one
glance.

But if invention is not the core of the matter, neither is objective
opportunity. Study of our period shows us again that ‘‘doing the
thing” — the actual setting up of new production functions — ^is a distinct
phenomenon. We readily see how every step conditions other steps —
yarn and cloth, for instance, alternating in offering new demand to each
other and in running up against bottlenecks, the removal of which then
makes the next achievement. We see how demand for cotton conditions
Whitney’s ginning machine and so on. But we also see that these
conditions (though not always, of course — as pointed out before, wars
condition enterprise in ordnance production) lead up to other innovations,

^ They are, however, a class in the sense of scientific classification. But in this “class”
they meet as people do in a railway station and outside of it they remain what they are
socially. No barber becomes an aristocrat by virtue of the “Sir,” and the writer guesses,
although he has not bothered to verify it, that the other entrepreneur mentioned above
remained, when not canal-building, what he socially was and that he then behaved much
as other people do who are endowed with strawberry leaves.

Histokical Outlines

273

and tkat if we stopped at tMs type of demand as an ultimate datum we
should commit the same error as we should if we stopped in the analysis
of value at given costs. Moreover, it is clear that those conditions
never produce any given innovation automatically, so that insertion of
another factor would be unnecessary. Most of the earlier textile improve-
ments in the sixteenth and seventeenth centuries naturally occurred
in the field of the woolen and silk trades, when these were in the van of
activity. There was no technological reason why these should not have
been reformed first in the eighteenth. It would have been profitable
and the fact that possibilities were less enticing, owing to the comparative
scarcity of wool, is no reason why such possibilities as there were should
not have been exploited. Yet they were not or, at any rate, to but a
small extent. The rich and well-established woolen industry lagged
behind, right into the thirties of the nineteenth century. It accepted
progress under pressure and was drawn along by the more active
younger sister in the adaptive way characteristic of the changes in
downgrades and revivals. The New Men and New Firms stand out so
well in this case because the industry itself was new as (in the sense men-
tioned and with the qualification similarly mentioned) the industries
that carry Kondratieff upswings also are in the other instances.

But this was not different in the old industries that took part, particu-
larly in iron and steel (puddling process, H. Cort, 1784; cast rollers,
improvements in blast furnaces and so on)^ and in the many smaller or
subsidiary branches which came along simultaneously — ^papermaking,
watch-making, the making of machine tools (all-metal lathe, 1794),
and others. Nor is the element of Disharmony and Jerkiness absent
in any of these cases. The nature of the task (beyond conceiving the
plan and overcoming environmental resistance) was similar in all these
cases and may be illustrated by Watt’s difficulties.^ Before ironmaster

1 By the end of the Napoleonic wars, cost of producing iron in England was far below
that of any European competitor and its use had spread correspondingly. This success
parallels that of the cotton industry and also has its roots at the beginning of the century
(smelting by coke, Abraham Darby, 1709; Cort’s success was preceded by experiments by
J. Roebuck and Th. and G. Cranage in the sixties; Huntsman’s steel dates from 1750).

* The fundamental idea, the separate condenser, which dates from 1765, was itself a
‘‘critical” achievement, summing up and improving work that goes back to antiquity
and that made great progress during the Renaissance. For us, however, the important
name is Newcomen (1712?), see Professor Usher’s History of Mechanical Inventions, p. SOS.
Smeaton’s work on atmospheric engines, mills, pumps, cylinders, and the water-power
blowing machine (the latter, 1760) should also be mentioned. Watt and his partner, M.
Boulton, saw success in 1782. Their cooperation, their business methods, and the organiza-
tion of their firm makes a most interesting case study for us. It has fortunately been done,
see Roll, An Early Experiment in Industrial Organization, the History of the Firm of Boul-
ton and Watt, 1930. Boulton is for us still more interesting than Watt. It is not correct
to describe their alliance as the alliance of an entrepreneur and a “capitalist.” The career

274

Business Cycles

Wilkinson (who had already improved the boring of cannon) came to
his aid, his condenser was all but unworkable, his cylinders were not
cylindrical, pistons did not fit them, cogwheels and bearings functioned
badly. His machines wasted steam, wore out quickly, and broke down
easily. Even after considerable improvement they came into use very
slowly, and by 1800 the horsepower total of the steam engines installed
by the firm of Boulton and Watt was small compared with that of water,
wind, and animals.

Observations of this kind have induced some historians to discount
the importance of innovation and the actual extent of industrial change,
at any rate until well into the nineteenth century, and even to ridicule
the textbook emphasis on a small number of picturesque instances.
We have no quarrel with this as to the facts, although identification of
innovation with invention and occasionally, also, neglect of the com-
paratively small size of the industrial organism to which changes must
be referred, partly account for criticism of this kind. It is obvious
that a large sector of the industrial world of the time was practically
untouched. Building,^ together with most of its subsidiaries, plus cloth-
ing, would by themselves sufl&ce to establish the fact. Continued
prevalence of the small unit in most industries points in the same direc-
tion. ^ But the inference one might draw from it is, nevertheless, mis-
leading. If we are to form an idea as to the quantitative adequacy of
innovation, we must bear in mind that all it should, according to our
schema, be adequate for, is ‘‘ignition.” What we see on the surface
is largely the effect of what we have called the Secondary Wave, the
phenomena of which can in fact be suflSciently expressed in terms of
general conditions, growing commercial centers, independently given
demand conditions, and so on. To that ignition we must, hence, always

of the Soho works, with their modern division of labor and their almost Taylorized arrange-
ment of the steps of the productive process, then constitutes a second stage, presenting
other, but not less interesting, aspects.

^ Qualification is necessary, however. In the building trade the rise of small men to
ownership of bigger and more efficient firms, particularly if associated with speculative
building — quite common by 1800 — ^will in many cases, though not in all, come within our
concept of innovation. The great development after 1800, strikingly similar to what
happened in the downgrades of the two succeeding Kondratieffs, is typically “pushing
into newly created economic space.’*

2 On the authority of Professor Clapham (op, cit,, p. 70), we put the relation of employ-
ees to employers in London industry and trade at the beginning of our period at “a good
deal less” than two to one. Even according to the Census of 1851 (ibid.) it works out at
83^ to 1 for England and Wales. The rise from the status of a laborer to that of a small
master and from this to “respectability” — a process particularly in evidence in this period
— ^is a most important feature of the social mechanism of that type of capitalist society
and would repay systematic study. It often implies minor innovation.

Histoeical Outlines

275

apply a multiplier before confronting it with statistical findings about
social aggregates. Looked at in this manner, the development in the
cotton trade alone would be adequate to explain a Kondratieff upswing.
We do not hold, of course, that it actually was the only starter.^ But it
was by far the most important one and its action can be clearly followed
up. Moreover, we do not find the symptoms of prosperity distributed
equally or else strewn at random over the system, as we should if the
true explanation were to be found in an autonomous movement of
aggregative and other systematic quantities, such as output, employment,
price level, interest rate, and so on responding to a process of general
growth. We find a characteristic concentration of prosperity in certain
lines in which employment and wages increase much more than in others,
and we see how from there the impulse spreads, meeting, no doubt,
similar though smaller impulses of the same kind in other fields.

That the nature of industrial processes and the complexion of business
changed after 18^0 (assuming that the course of events from 1800 to 1820
was substantially affected by the Napoleonic wars and their aftermath)
seems to the writer equally beyond doubt. Since the difference in the
behavior of aggregates and other systematic quantities cannot be con-
tested — and that this behavior is as it should be according to our schema
will be established in our discussion of time series — ^the only issue before
the reader is, again, whether or not it is correct to attribute that com-
plexion of business to this behavior of the aggregates, itself independently
caused — ^by monetary policy, for instance — or to attribute the behavior
of the aggregates to the industrial processes that shaped the phase of the

1 Koadmaking was, of course, an important item of investment and contributed its
share to that Kondratieff prosperity: it was no longer a new and “carrying” but an estab-
lished thing, which was being steadily developed in and out of prosperity phases, although
it received new impulses in every upswing. The case of construction of artificial water-
ways was different. This was one of the great features of the period. We observe what
might almost be called a mania setting in soon after 1790. Speculative excesses attached
themselves to canal promotion, which also played a conspicuous role in the crash of 1825.
However, the pioneer work that initiated the movement had attained success, established
methods and possibilities, and conquered the public mind before. The first great achieve-
ment (preceded since the end of the seventeenth century by improvement of natural water-
ways), the Duke of Bridgewater’s canal, was begun in 1759, and Brindley died in 1772,
after having worked out a vast programme. We have here another instance of an innova-
tion asserting itself and even acquiring importance before it becomes the carrier of a
Kondratieff prosperity. The Trent-to-Mersey canal, the Birmingham to Wolverhampton
canal, and others all came before our period. Some of them truly wrought “revolutions.”
In other respects, the case is ideally regular: the considerable period of gestation (the Duke’s
canal took about two years to construct) and the expense involved, the obvious effect
on costs of transportation — after the completion of that canal the price of coal in Man-
chester fell to one-half of what it had been before — and on comparative advantage of loca-
tions, make it particularly apt to exemplify the working of our model.

276

Business Cycles

long cycle then ruling. The answer is conaplicated by the circumstance
that we do not deny that the systematic quantities exerted influence — any
quantity exerts influence of its own in a system of mutual interdependence
— or that things would have been different if those quantities had been
made different from what they were by political action. What we do
deny is that the explanatory principle of the sequence of events can
be found in them. And what we have to offer in support of this denial
is the fact that their behavior can be explained in terms, and as a con-
sequence, of the cyclical process. We have already mentioned the
building booms — a building boom, in particular, preceded 18£5 — and
the kind of general increase of physical production which comes within
our concept of adaptive expansion into the newly created investment
opportunities. This process — ^interwoven with the prosperities of the
shorter cycles which added such innovations as the use of the hot-air
blast furnaces (1829) — centers in cotton textiles, coal and iron, and
transportation. It displays both the spread of improvement, notably of
the steam engine, the iron machine, the machine tools, and mechanical
engineering in general, which accounts for the impression voiced by
Tugan-Baranowsky, and the competitive crowding out of older strata of
inadaptable firms and all those people whose economic basis they were,
the hand-loom weavers being a prominent and tragic instance. This
explains depressive situations spotted with success and obviously allows
of description in terms of a movement toward a new state of equilibrium
that would embody the new production functions. The reader is invited
to satisfy himself — ^for example, by applying our theoretical schema to
the facts of the first volume of Professor Clapham’s work — ^that all this,
without the help of any extraneous elements, would account perfectly
satisfactorily for the behavior of social aggregates and other systematic
quantities which, indeed, might be deduced from it : this process would
pull down prices, interest, sum total of profits, money wage rates. ^

The unemployment of the period calls for a short comment. We do
not know exactly its extent in any year of the period, except locally, still
^ Not, of course, money wage bill or real rates. Tbe fact that the former did not fall,
except for very short, deep depressions, negatives the idea that the agricultural depression
can have had anything to do with failing purchasing power of the masses. Theoretically,
even a rising wage bill would, especially if accompanied by unemployment, be compatible
with decreasing money demand for foodstuffs, for the higher income of the employed might
not be spent on food and hence might fail to compensate for the reduced demand of the
unemployed. But in the circumstances of the case and because of the low absolute level
of wages, it is not likely that this played any role. As to money rate of wages, it fell from
its peak (which comes about 1810) to about 1845, the years 1820 to 1824 excepted. It
then remained by, roughly, one-third above what it was in 1780. Real wages, of course,
increased throughout. We shall return to this subject in due course. This is only a sug-
gestion for a preliminary exercise in the application of our model to a given historical
pattern.

Histoeical Outlines

277

less its variations from year to year. But from parliamentary papers
and private estimates we may infer that it was very considerable through-
out, with the exception of the years preceding 1825 and in the beginning
of the thirties, and much greater than in 1780 to 1815, even if we give due
weight to the fact that official and private investigations and comments
primarily refer to years that fall into depression phases of the Juglars
and that they naturally stress conditions in the worst spots. But since
real wage rates rose almost uninterruptedly and since rigidity of money
wage rates cannot, at that time, have played a major role, this unem-
ployment — ^which is what accounts for the darkest hues of the labor
situation of the time — ^must have been primarily technological. In
fact, this was obvious to contemporaneous observers. But total employ-
ment increased, with the exception of years of deep depression, even
in the textile trades, although this increase partly veils that kind of
unemployment which consisted in the replacement of male by female and
child labor.^ The machine did not, in the long run, reduce total employ-
ment or, in general, reduce it in the trades that were being revolutionized.
What it did was to create cyclical unemployment — ^though this might be
of considerable duration — ^primarily, in the sectors that were being
undersold and crowded out, and secondarily, in the innovating sectors
when they felt the repercussion of crises.

Steamers, though perfectly known and also tried out, did not rise
to quantitative importance during the period. According to Porter,
their tonnage was only 51,000 as late as 1837, and the iron ship remained,
in spite of the success of the Manby (1822), in its experimental stage.
But the locomotive, after Stephenson's success, quickly put its com-
petitors in railway traction (horses, stationary engines) out of court,
although its use was prohibited in the bill for the line between Carlisle
and Newcastle^ (1829, the very year of the Rainhill Competition).
The conspicuous success in 1835 induced speculative excesses immediately
afterward, although railway propositions had been sufficiently prominent
before to qualify for the title of “bubble speculations." The Liverpool
and Manchester was the first entrepreneurial feat of national importance
which, indeed, induced not only the “following" — ^part of the essentials
of our schema — ^but all the phenomena of our Secondary Wave. The
contribution of railroad construction to the Juglar prosperity that

^ Some light on this aspect of the problem of child labor can be derived from the dis'
cussions and investigations preceding the Ten Hour Bill of 1847, particularly the Inquiry
of the Commissioners on Children’^s Employment, 1842—1843. See, also, Select Committee
on the State of the Children in Manufactures of the United Kingdom for 1815—1816, and
J. Dunlop, English Apprenticeship and Child Labor, 1912.

* Shares of an iron railway first appear, as far as the writer knows, in the official stock
exchange price list in 1807. That was the Surrey (horse traction).

278

Business Cycles

preceded the crash of 1837 is beyond doubt. But speculative excitement
and its reflex in the talk of the time should not induce us to exaggerate
the importance of the, roughly, thousand miles sanctioned in the boom
itself and the, roughly, 490 miles that according to Levi (History of
British Commerce, 1872, p. 302) had been constructed by 1838, involving
a total expenditure of 13.3 million pounds. The great development
that within a few years created almost the whole skeleton of the English
railway system was the work of the forties. Therefore, we attribute,
in the sense already explained, railroadization to the second Kondratieflf,
although all the essentials of railroad enterprise — ^types of entrepreneurs
and methods of financing included — ^stand out fully fledged in the thirties.

Since limited liability was not definitely recognized as a normal
vehicle of enterprise before the Joint Stock Company Act of 1856,
and since during the whole of our period incorporation of a company —
witness A. Smith, who in this, as in other respects, simply voices preva-
lent opinion — was looked upon as a somewhat exceptional measure to be
resorted to only on the strength of reasons peculiar to the individual case
or class of cases, we cannot expect the industrial revolution to be cor-
rectly mirrored in corporation statistics. Industrial innovation largely
escapes and, even in the chosen fields of the corporate form of organiza-
tion — ^the fields characterized by abnormal size of capital, simplicity of
the commercial side of the task, comparative controlability of administra-
tion and relatively unspeculative nature of operations — ^the true pioneer
work was, at first and unless general excitement broke down inhibitions,
not likely to take that form, because, incorporation requiring parliamen-
tary sanction, it was primarily propositions of previously established
feasability and ‘‘utility’’ that stood a chance. In banking, the field of
one of the most important innovations of the period, spread of the
corporate form was until 1826 barred by the act restricting to six the
number of persons who might associate for the purpose of banking.
In Scotland, where the act did not apply, 7 new banks with a large
number of partners were founded in the Kondratieff prosperity, and
15 between 1800 and 1815. English company promotion in the Kond-
ratieff prosperity centered in canals — also docks, water supply, bridges,
roads — and to a lesser degree in colonial enterprise and insurance.
The quantitative importance of expenditure on canals, in particular, is
presumably not badly reflected by the hundred or more canal acts passed
before 1800.^

But after the turn of the century and in the Kondratieff recession,
Juglar prosperities become clearly marked by the promotions of com-

^ Compare Bishop C. Hunt, The Joint Stock Company in England 1800-1825 and 1830-
1844, Journal of Political Economy for February and June 1935. The writer wishes to
acknowledge the debt he owes to this excellent study.

Historical Outlines

279

parties of a quasi-corporate character. There was what has been
described as a mania in 1807 and 1808 and during those years promotion,
for the first time since the Bubble Act, spread, to a significant though
still minor extent, to the industrial field, (paper, woolens; white flour
milling had preceded — ^Albion Mills, Birmingham Flour and Bread,
London Company for the Manufacture of Flour Meal and Bread).
Some of these schemes were abortive. Others were proceeded against
on technical grounds, but the ice had been broken in spite of a hostile
attitude of important interests which, as in the case of the Gas, Light
and Coke Company, did not always choose its objects welL^ A long
discussion and a period of uncertainty as to the attitude of public author-
ity ensued, which may have been, in part, responsible for the lull in
promotion until the beginning of the twenties. But the prosperities
of the two last Juglars and their spectacular crises again display such
^^manias.” In 18^4 and 1825 we have one outburst. Foreign financing
and mining ventures (Mexican and South American, in particular),
insurance, gas, canals, and finally, a wide variety of trading, building,
and other propositions were offered, many of which foundered on financial
rocks before they had had time to fail from other causes. Of 624 com-
panies floated, only 127 survived in 1827.^ Novelties were not absent
from the list, railroads and steamships being the most conspicuous ones.
But they do not signify. Most incorporations spell expansion on the
lines chalked out in the Kondratieff prosperity or simply expansion into
newly created space without any particular element of innovation or,
at all events, without any beyond size and the company form. The
reader will observe how similar this is to what happened in the eighties
of the nineteenth and the twenties of the twentieth century and how it
agrees with our ideas about the course of events in Kondratieff down-
grades and recoveries.

Because of the legislative barrier before 1826, joint stock deposit
banks appear in the midst of the subsequent depression. No less
than 15 such banks were founded between 1826 and 1830, inclusive,
though 25 were founded in the next three years. Resistance crumbling

^ If we were investigating tlie entire range of the economics and sociology of capitalism,
we should have to emphasize that that opposition came only to an insignificant extent from
intellectuals hostile to the capitalist system, and almost wholly from the industrial bour-
geoisie itself, of which the newspapers, the pamphleteers, and the lawyers were but the
exponents. Nor would it be true to say that this attitude of the bourgeoisie was, wholly
or primarily, due to fear of competition by the companies,

^ See Bishop C. Hunt, op. cit., p. 25, based on H. EngHsh, A Complete View of Joint
Stock Companies Formed in 1824 and 1825, London, 1827. We accept that estimate in
preference to others, on Mr. Hunt^s authority. For what follows, see also the list on p. 27
of companies, formed before 1824, which survived the crisis, and also Tables IV and V,
pp. 362 and 363, in the second article.

280

Business Cycles

rapidly, company statistics cover a correspondingly increasing sector of
economic life during the thirties — though they have not for England
become truly representative until the postwar period — ^particularly after
the act of 1887 (I Viet. c. 78), which definitively sanctioned acquisition
of the privilege of limited liability by administrative assent and headed
towards the principle of registration. But even in 1844, when 947
companies were in existence (in England), there was but one cotton-
manufacturing establishment among them. There were £4 woolen-
manufacturing companies, 9 breweries, 14 producing other foods or
drink, 1 producing railroad rolling stock, 14 in miscellaneous industries.
Eailroads (108), gas and water and other public utilities (4£0), and ship-
ping (51), supply the bulk. Railroads, banks, foreign lending, and
other foreign ventures are particularly associated with major innovations.
The general picture in the thirties looks, from our standpoint, much
like an enlarged edition of that of the years preceding 18£5. It conforms
to expectation from the location of the period in the Xondratieff, except
for the violence of the boom, which entailed corresponding violence of
the subsequent crash (1887) and calls for special explanation.

7. The contemporaneous development in Germany is so different in
almost every respect that we shall understand, although we do not
share, the view of those students of German business cycles who refuse
for that epoch to recognize the presence of any cyclical phenomena,
and of those historians who have set the fashion of dating the beginnings
of modern industry in Germany from 1800 or 1815. It is in fact easier
to discover the contour lines of our process in the quiet times that fol-
lowed upon the Napoleonic period and, particularly, upon the slow
emergence, from 1818 to 1888,^ of a territory large enough to reduce
political risk of investment to bearable proportions. Before 1815
we have the noncyclical impulse which was given to some industries
by the Continental System and understandably called forth a great
number of small and inefficient firms, which collapsed with it. But

^ 1818 is tlie year of the first Prussian tariff which applied to the whole of Prussia and
displayed, at least with respect to other German territories, a distinct free-trade tendency
(10 per cent ad valorem, with higher rates for oversea imports). The tariff reform of 1821
was a further step in this direction, which led up to various conventions with other German
states and eventually to the Zollverein (March 22, 1833; most German states joined in or
before 1838, Hannover and Oldenburg in 1851; 1838 is also the year of the currency con-
vention of Dresden). The reader should observe, however, that no great immediate effect
is above attributed to these institutional changes. They undoubtedly conditioned both
enterprise and growth ever after, although they asserted themselves but slowly in the course
of the century. What they immediately accomplished was only removal of fetters from the
things initiated in, and crippled by, these fetters. More immediate, though in the end
much smaller, were the effects of the conventions that freed navigation on the Elbe (1821)
and on the Rhine (1831).

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281

for the two decades which preceded the breakdown of the Holy Roman
Empire (180S), there seem to be few traces of anything that looks like
a Kondratieff prosperity.

In order to arrive at a diagnosis, we must recall not only that dis-
turbances during the nineties were quite important enough to blot
out the symptoms of such an upswing, but also that the whole of eigh-
teenth-century developments was still under the shadow of the Thirty
Years’ War and its consequences. Traces of even the direct physical
destruction incident to it were in some localities still present at the end of
the century. In many places (Freiberg, Oberharz, and others) lack of
equipment or of the means to provide it, and consequent survival of old
methods and forms of organization, are equally traceable to it, in particu-
lar, the inability to deal — in spite of workable technological solutions —
with the water problem in many mining districts and to carry work to
the greater depths required because of the exhaustion of the easier
accessible levels. Wastage of actual or potential industrial personnel —
the physical annihilation of great part of the bourgeoisie — ^had done
the rest. There can, thus, be as little doubt about the reasons as there
is about the fact of the small scale of industrial ventures and of the
smallness of the success that attended such ventures as were entered
upon. This smallness, then, accounts for the predominance both of
external over internal factors in the German industrial history of that
time, and of agrarian and commercial over industrial enterprise.

This does not mean, however, that our process was absent or confined
to the worlds of agriculture and of commerce, although it does mean that
booms and crises (like earlier ones — ^for example, that of 176S^) were
primarily commercial in a sense in which later crises were not. There
was very little innovatory activity in the textile field. Conditions in
the linen industry — ^throughout that Kondratieff and even beyond —
are sufl&ciently characterized by the fact that as late as 1831 not more
than about 14 per cent of the total of linen looms in Prussia were operated
by people who were weavers and nothing else. Since many who were
‘‘professional” weavers also were cottagers, this somewhat overstates
the case; but it is perfectly clear that practically all linen weaving was
done in the peasant family or else as a Kleingewerhe^ in both cases by the
most primitive methods, and that whatever change there was, was of
the type of growth. Things were somewhat different, however, in the
woolen industry, which not only was more of a specialized craft — ^reach-

^ On that crisis, see Spietiboff, op. dt, p. 48. He denies that it was commercial, and
calls it a credit crisis. This seems, however, to be little more than a question of terminology.
It is true that prices did not react strongly and also that the preceding war and the methods
by which it was financed account for many of its features; but neither fact abolishes more
fundamental similarities. Every crisis is in a sense a historic individual.

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Business Cycles

ing beyond the local market by means of the Verleger^ as did the linen
industry — ^but in places also attained the factory stage. This happened
first, as far as the writer knows, in Aachen, where by 1807 there were
41 cloth factories — ^mostly small ones. Several technological improve-
ments had by then been introduced, though steam, the power loom, the
flying shuttle, clipping machines, and the like did not come until the end
of our period, and even then played too small a role to count quantita-
tively. Before our period, silk had already gone through a considerable
development and had locally reached the stage of larger scale enterprise
(Krefeld), the basis of several industrial family positions. It rather
stagnated during our period. Cotton, really a very old industry, assumed
a new form entirely unconnected with its Renaissance past, though
its eighteenth-century beginnings and even its developments to 1842
look insignificant when compared with English achievement. Most
of the new methods — ^the power loom, in particular — ^were conspicuous
by absence almost throughout and the little we see of them toward the
end of that Kondratieff, when also a few establishments emerged of a
size comparable to that of English mills, was of the type characteristic
of downgrades: copying and adaptive, rather than truly initiating. In
most other industries, handicraft prevailed, even in those which, like the
Solingen cutlery, had acquired an international fame.

The steam engine^ and machinery in general — 863 machines in all
were counted in Prussia as late as 1843; Freund started machine making
in 1812, Borsig in 1837 — ^made headway but slowly, though we are apt
to overlook widely scattered beginnings, of which the one in the Munich
brewery industry (Sedlmayr) may be cited as an example. Several
innovations (such as Senf elder’s lithography in 1785 and 1806; the first
beet-sugar factory in 1796; Koenig and Bauer’s printing press in 1814;
Krupp’s cast steel in 1815;^ first steamboat on the Weser in 1816) no
doubt took long in rising to quantitative importance. Others as, for
example, those in the fields of chemical industry (sulphur, soda, dyes)
or of optical (Fraunhofer’s telescopes) and surgical instruments, remained
insignificant throughout the period, or even in the experimental stage
(Bauer’s electromagnetic machine, for instance). Still others were late
fruits of the last Juglar (Sloman’s four sailing liners which in 1836 took
up regular service between Hamburg and New York). So were railroads
in which private enterprise took an interest almost as early as it did in
England: railroad projects were pressed from the middle of the twenties
(F. Harkort). After an experiment in the neighborhood of Elberfeld
(1826), the first line (Nuremberg-Furth in Bavaria) was opened 1835.

^ There were 7,500 H.P. installed in the whole of Prussia in 1837.

2 The date is somewhat open to doubt. The firm was founded in 1810, as was the firm
of Jacobi, Haniel and Huyssen.

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283

The line Leipzig-Dresden followed and a number of other companies
started construction and/or operation before 1842 (mileage opened till
1840 was 549 km.).

Taken together, all this was more than nothing, particularly, if we
recall, as we had to recall even in the English case, that a considerable
multiplier has to be applied to any such data if we are to form an
idea of total ej0Eects. It is true that most of it was the work of the
prosperities in what, according to our schema, was the downgrade and
revival of the Kondratieff . This accords with the nature of many of the
achievements mentioned — though it is mainly to be explained by the
political setting — and also holds of banking developments that charac-
teristically accompanied them (Berliner Kassenverein in 1824, Bayerische
Hypotheken-und Wechselbank in 1884, Leipziger Bank in 1838). In
order to appreciate at its true value what, in spite of inhibitions and
disturbances, happened before or about the turn of the century, and to
decide whether it was adequate to warrant speaking of a Kondratieff
prosperity, we must add another element to our picture. It has been
pointed out that, within the social structure that emerged from seven-
teenth-century vicissitudes, the State — the Prince and his bureaucracy —
not only meant more than, but also something different from, what they
meant in other countries, and that one of the consequences of this was
not only regulation of industry that amounted to guidance, but also
actual state enterprise. The social stratum that supplied the personnel
of public administration was — excepting the urban republics (Reichs-
stadte) such as Hamburg or Bremen or Frankfurt — ^much superior
in intelligence, horizon, training, energy to the personnel of such private
industry as there was; and this is one of the reasons why it would be as
silly to condemn that public planning in the Germany of that time as
it would be to hold it up as a model for societies of different structure.
That the states built the canals and the roads which in England were
created by private enterprise was natural under the circumstances. The
development which corresponds to the English turnpikes came in the
downgrade, from 1816 to 1841, when the mileage of the Prussian chaussies
trebled. Effects of this investment on expenditure and on location of
industries were similar to what they would have been with private
enterprise, but the mechanism differed, of course, from that described by
our model.

Much more interesting, however, is the entrepreneurial activity of
the principalities in the field of mining and its technological neighbors,
which was the great thing” that carried what prosperity there was. In
the eighties of the seventeenth century mining had in most districts
begun to revive from prostration, and from that time we observe several
modest waves of activity which eventually led up to the developments in

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Business Cycles

tke last quarter of tlie eighteenth.. Here initiative as well as execution
came almost entirely from the princes and their bureaucracy. Reorgani-
zation and the clearing away of obsolete legal structures (as an outstand-
ing example, we may mention the — Prussian — ^Renovierte Bergordnung
for Cleve and the Mark, 1737) could in any case have been done only
by the public authority. But the states went beyond that and even
beyond forcing technological and commercial improvement on lethargic
or impoverished owners. They actually undertook the development
and operation of mines and embarked upon enterprise in the heavy indus-
tries, thus not only directing but replacing private initiative. The way
in which this was done differed less from our schema than one would
suppose. Mines and factories were operated for profit. Financing was
largely on commercial lines. And the entrepreneurial function was as
clearly present and as distinctly vested in individuals as it is in private
industry. Those entrepreneurs were public servants and acted by
virtue of official appointment, but both in type and behavior entirely
conform to the idea of a ‘‘captain of industry.’’ The central authority
left them remarkably free to act, and in most cases ratified their plans
as a matter of course. A single outstanding example must suffice —
Von Reden’s administration of the Silesian district, which covers over
20 years, to 1803. During this time the value of mining products
increased to more than five times, the number of workmen to nearly
five times the figures of 1780; coal mining, which was insignificant before,
was put on a new basis; new iron works (the first German coke oven in
the iron foundry at Gleiwitz in 1796) and two canals were built (the
Gleiwitz and Elodnitz canals) ; and the use of coal was energetically forced
on all sorts of industrial consumers (bakeries, breweries, and so on) by
means of a new selling agency. In the West, the great development of the
early beginnings in the Ruhr (which was then made navigable) and Saar
countries dates from the same period. Though coal and iron were the
main things, there were also in several parts of the country developments
in copper, silver, lead (the latter somewhat interfered with by the sharp
fall in price incident to the reappearance in the market of Spanish lead
after 1815), lignite, and in other branches of mining and of metallurgical
enterprise.

Totals of production, employment, and (as far as it is possible to
judge) expenditure were very small no doubt, though not relatively to the
preexisting industrial organism. Many producers, such as the peasants
who made iron on a small scale and clung to old methods — or had to
cling to them — ^were crowded out but slowly. In the downgrade, how-
ever, results became quantitatively more significant, particularly after
1815. For instance, coal production in the Ruhr and Saar districts
increased considerably between 1800 and 1840, on the basis that had been

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285

laid before. It was not until then that private enterprise began to
develop in the wake of English achievement, although private iron and
copper working in more or less old-fashioned ways, had considerably
increased before — ^in Silesia (there were, for example, 49 blast furnaces
in 1804, mostly owned by territorial magnates) and elsewhere (about
100 iron and copper ‘'hammers ’’ existed, for instance, in the neighborhood
of Aachen, mostly quite small). The first German puddle work and
rolling mill (Harkort) was founded in 1819, ^ Dinnendahrs Friedrich
Wilhelms Hiitte in 1820, after which we observe what almost amounts to
a wave of promotions, especially before 1837 (Laurahiitte in 1835 and
Eschweiler Bergwerks A. G. in 1836, to mention but two internationally
known instances). It is submitted that, considering initial data (the
state of things in 1780) and the ravages of external factors (the course of
events from 1792 to 1815), it is not unreasonable to say that we recognize
the features of a battered Kondratiefi prosperity and of typical downgrade
developments that followed upon it. There seems to the writer to be no
point in refusing to recognize the reality of the process on the ground
that so obviously adequate impediments prevented it from achieving
more and showing up better.

8. In the United States, as in Germany, agricultural and commercial
enterprise (the latter, in the case of the United States, also including
shipping) was the chief determinant of business situations throughout
our period. Also, we must bear in mind that evolution in our sense in
America — and this holds true to this day or in any case to the end of the
second Kondratieff — ^was supported by a rate of growth in our sense
which had no parallel in either England or Germany. Simple expansion
along obvious lines, exploitation of opportunities which, once created,
lay at hand ready and inexhaustible for a mighty host of followers,
and immigration of men and capital in response to those oppor-
tunities supplied a much greater part of the propelling forces here than
anywhere else. Entrepreneurial activity was generally faced with
favorable changes in its data.^ Foreign evolution and growth, on the

^ In Lorraine, the first rolling min was erected in 1803, the first puddle oven, in 1810 by
the De Wendel family. This is one of the rare instances of a family retaining a commanding
industrial position for more than 200 years (from the beginning of the eighteenth century).

® Thus, actual results in general ratified many things that had no claim to ratification
ex vim of the data under which they were undertaken. It is not without interest to remark
that, instead of steadying the march of evolution, these favorable long-time conditions
induced so much boldness in entrepreneurial action and in speculation, that the effect was
the reverse and that vicissitudes ensued in which people frantically clamored for inflationary
seisachthiai and protection to make what already were abnormally favorable conditions
more favorable still. However, our insistence on the element of mere Growth should not
be misunderstood. While very real, it was not anything like so important as the traditional
view would suggest; for much of it was induced innovation or immediate effect of innovation.

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Business Cycles

whole, worked in the same direction. The extension of the wheat and
cotton areas, notably after 1830, was possible without destroying the
conditions for further extension. These facts are too obvious to require
proof or illustration, nor is it necessary to insist on the consequent
dependence of American on English business situations. We will
notice, however, that these conditions, as soon as the troubles of the
eighties of the eighteenth century were over, produced two features
that were prominent in the boom of the nineties as well as in many of
those that were to follow — ^land companies and the speculation in land.

A great part of industrial production was carried on in the farmer’s
home or by workshop crafts throughout our period, as it had been in
colonial times, or it worked under conditions which practically exempted
it from the repercussions described in our model: a sawmill sawing on
toll, located in an agrarian neighborhood, may pay or not, may work or
not, but it has nothing to ‘^compete down,” nor will its processes react
on other industrial organisms — ^the agrarian milieu acts as a shock
absorber. How considerable, nevertheless, industrial enterprise must
already have been before the Revolution and in spite of real and fancied
obstacles that English policy put in its way, is proved by the fact that
embargoes and actual war with the mother country caused so little
serious embarrassment, and that, in particular, domestic furnaces and
forges were quite up to the requirements of cannon casting and of the
other kinds of demand incident to the military operations. Massachu-
setts and Connecticut and the neighborhoods of Philadelphia and New
York were by that time industrialized to a considerable extent; there
had been occasional exports of manufactured products as early as the
middle of the seventeenth century, and industrial towns (Wilmington,
Lancaster) had sprung up while water-power developments were of
quantitative importance at least several decades before our period.
Flour milling, even before the innovations associated with the name of
Oliver Evans, was technologically ahead of the rest of the world. The
construction of glass works by the Virginia Company and then by
‘‘Baron” Stiegel can serve as typical illustrations of our process. There
were some considerable iron works. Textile interests had risen to political
influence. Shipbuilding, like other industries, was fostered by bounties.

We have seen before that the British colonial enterprises, such as the
Virginia and the Plymouth companies, had from the first included
industrial development in their programs. And the War of Inde-
pendence, of course, gave a great impulse to most of this. But up to its
end the violent fluctuations and, particularly, the spectacular crises we
observe must primarily be described in terms of external factors — such
as wars, sudden changes in the political data, English conditions, and so
on, which acted on the industries through commerce — ^rather than in

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287

terms of the industrial mechanism itself. Since external factors obviously
dominate the picture and are naturally stressed by both contemporaneous
and historical reports, an attempt to answer the question whether there
were also genuinely cyclical fluctuations would involve an extremely
difficult piece of analysis which the writer has been unable to undertake.
But it should be observed that the colonial issues of paper money and
the other inflationist policies of the colonies cannot simply be put in
the same class with European government inflations. In part at least,
they stood instead of cyclical expansions of bank credit and, directly
(by loans and subsidies) and indirectly, financed innovation for the
financing of which there were no other means. Some of the breakdowns
which studded that expansion are, hence, more akin to ordinary crises,
and the processes within which they occurred are possibly more akin
to cycles in our sense than we could ever realize if we saw in those colonial
issues nothing but ordinary inflation. The use made of that tool was
often so improvident and unsystematic that the usual comments on them
may be amply justified all the same, but they do not cover the whole
of the case. Contemporaneous observers, as well as some historians,
such as Chalmers and Weeden, may have put the cart before the
horse, and presumably implied a lot of wrong theory, but they were
hardly wrong as to the facts when they associated some industrial
developments, in shipbuilding and ironmaking in particular, with the
paper money, although most of them failed to associate also ensuing
depressions with it. There is, thus, some justification for Benjamin
Franklin’s views on the subject, however indefensible the arguments may
have been by which he to this day grieves and shocks some of his admirers.

Taking account of the previously mentioned disturbances of the
eighties of the eighteenth century, by saying either that they interfered
with the rising tide of enterprise so as to blot out the symptoms generally
associated with prosperity, or that they delayed the rise of the tide until
about 1786 — ^the conditions immediately preceding that year may
partially be described as a postwar crisis — ^we see the setting in of the
process that, fostered by land grants, loans and subsidies, and other
facilities extended to manufacturers and would-be manufacturers by
states and municipalities, was eventually to transform American indus-
tries in much the same way as the corresponding process did in England.
Advance was spread over a wide variety of industries and was in full
swing by the time Alexander Hamilton submitted his famous report.
The main feature, in industry in the strict sense, was the introduction
of power machinery which began to turn the workshop of the craft type
into the factory. As an example we will mention the development of
the cotton and woolen mills in New England and Pennsylvania— the
Beverly Cotton Manufactory was chartered in 1789 — ^which in the

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Business Cycles

nineties culminated in the ‘‘cotton mania/’ the most striking single
phenomenon of what might be termed the positive phase of the American
industrial revolution. This was, of course, intimately connected with
water-power developments. The great Hamiltonian project for the
exploitation of the falls of the Passaic, which after initial vicissitudes^

1 Those vicissitudes and failures that were the lot of many of the foundations of the
nineties, such as the two above mentioned or of the New York Manufacturing, or the Hart-
ford Woolen, were obviously due to the lack of tradition, of personnel of the required type,
and other environmental requisites, and to lightheartedness in financial methods. The
smallness of immediate success has induced many historians to underrate the importance
of those ventures. But they illustrate well one class of difficulties which it is the function
of the entrepreneur to overcome. It would, therefore, be useful to go into details of the
history of those ventures, if it were possible to do so within the frame of this book. In
particular, it would be interesting to analyze in what the entrepreneurial achievement
consisted in each case. In one of the most important classes of cases, the utilization of
water power, it really consisted in providing facilities for secondary enterprise. We
may illustrate by the outstanding, though later, example of the development of the water
power of the Merrimac. First came the success of the Boston Manufacturing Company
at Waltham. The same people promoted the Merrimac Manufacturing and then the Locks
and Canals Company which specialized in providing and selling sites and water power.
Since they not only constructed dams and canals, but also mills and mill machinery, a
manufacturer who was able to buy his factory as it were ready made from them, and had
very little freedom of choice, hardly comes within our definition of an entrepreneur at all.
The towns of Lowell, Lawrence, and (founded by another group) Manchester, which were
created in this way, together with subsidiary industries, are thus the secondary develop-
ments from (in each case) fundamental innovations — a featxire which, more than any other,
is typically American. The figure of F. C. Lowell illustrates this kind of entrepreneur
at its best. He was the leader of a financial and industrial group, and an initiator and
organizer of industrial development. He was, to be sure, also an engineer and even an
inventor. But this is quite secondary.

The ventures of the nineties, though important enough to count in the picture of busi-
ness situations, did not get so far as this. Since they not only actually met with failure
in important cases, but sometimes also did not look very serious from the start, the aversion '
displayed by legislatures against incorporating them is as understandable as is the tendency >
to exclude from the charters the privilege of limited liability when they were incorporated.
This did not amount to a principle. The Newburyport Woolen Manufactory ( 1794 ),’
for instance, received the privilege, while the Locks and Canals on the Connecticut River
( 1792 ) and the Boston Water Works ( 1795 ) did not, though the opinion prevalent was that
companies founded for such purposes as the latter two (and colonial, road, banking,
and insurance enterprises) had a stronger claim to it than strictly industrial concerns.
The question was then, at the beginning of the nineteenth century, much discussed and
legislated on. The legal situation was originally much the same as in England (the Bubble
Act had been extended to the colonies in 1741 ), but the “quasi” or de facto corporation,
i.e., an association that was, excepting limited liability, to all intents and purposes a cor-
poration, made more headway than it could in England, both because the lack of accumu-
lated wealth enforced capital association, and because the cheerful optimism of the people
induced them to shoulder liabilities readily. Practice became, however, very “liberal”
in the 10 years preceding 1815 . After 1820 (Limited Partnership Act of New York in
1822 , similar acts in other states toward the end of our period) things began to move toward
Limited Liability without charter.

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289

eventually created the industrial center of Paterson, may serve as an
example. These water-power developments, together with improved
means of communication — ^turnpikes and canals, partly constructed by
public enterprise — and shipbuilding, made the backbone of the strictly
industrial component of what we interpret as a Kondratieflf prosperity.
Technological innovation, let alone “invention,’’ was not in prominence.
The only one of first-rate importance was the Whitney cotton gin, though
there were many minor ones, particularly in the field of agricultural
implements. Even the introduction of English innovations was at first
but slow. Though, for example, jennies, Arkwright frames, and mules
all came in about 1790, they made very little headway before the turn
of the century.

Whoever looks at quantities only and neglects the distinction between
initiation and development of results, will be inclined, in this case as in
that of England, to date the “revolution” from the first, the second, or
even the third decade of the nineteenth century. That time was, however,
clearly one of derivative development of the type which we associate with
Kondratieff downgrades and revivals. The nature of technological
innovation, in particular, accords with this. Water-power development
went on along the lines previously chalked out, met its great successes,
in spite of the primitive and wasteful pitch-back wheel, especially —
after Paterson — ^in Lowell, Lawrence, Manchester, Holyoke, Philadelphia,
and Fall River, and remained the main source of industrial power to the
end of our period. This, together with what it induced, was the great
industrial feature in the Juglars after 18^0. Steam came in but slowly,
both because of the abundance of water power, and because cheap
freight rates were, for the greater part of the country, a prerequisite of
its extended use. Within our period it had quantitative significance
only in the neighborhood of cheap coal, the introduction of the iron boiler
notwithstanding.

The rise of industry in the Middle West, another feature of this
Kondratieff downgrade, is, however, bound up with it, and its use spread
from there to the South and even into the heart of the water-power regions
and to cotton textiles (Eagle Cotton Mills, 1831). After about 1810,
O. Evans’ high-pressure engines began to compete with the imported
(low-pressure) Watt engines. But the production of engines for indus-
drial purposes in Cleveland and Pittsburgh was, as far as the writer
knows, small even at the end of the period, although it was of more
importance for steamboat use. Since smelting, the other great source of
industrial demand for fuel, met with a plentiful supply of charcoal, which
did not begin to give out until the first decade of the nineteenth century,
coal, though discovered in colonial times and even, in small quantities,
imported from England before 1800, was of little importance until the

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Business Cycles

thirties. Then imports rose, and the technological difiSciilties were
overcome which had stood in the way of large-scale use of domestic coal.
F. W. Geissenhainer’s invention, if this is the word, the introduction of
the hot blast, already successful in England, and coking, all contributed
to the prosperity of the last Juglar, although the great development came
after 1842.

The iron industry in general and rolling in particular had, as we
should expect, expanded in the upswing of the nineties, but they outgrew
the small-scale type and old methods in the downswing. The puddling
process came in 1817, rolling mills became bigger (Pittsburgh) and
began to crowd out forge hammers. But the production of cast steel
in Cincinnati and the output of the crucible-steel works in Jersey and
Pittsburgh, although dating from the upswing preceding 1837, did not
attain quantitative importance within the period. We have here a
typical instance of an industry drawn along by foreign innovation and
increasing home demand, expanding in response to the general march of
things. Downgrade and revival developments in the textiles, particularly
in cotton, were of a difiPerent character because this industry, which
expanded still more vigorously ^Tnto new economic space” during the
first 40 years of the nineteenth century, had created that space itself
and did not merely respond to, although of course, it profited from, the
growth of the environment. In Massachusetts alone about 90 companies
for making cotton and woolen goods were incorporated between 1807
and 1818 (V. Clark, vol. I, p. 266) a fact which, though it does not meas-
ure, yet indicates the rate of expansion,^ greatly surpassed, of course,
after 1820. A number of domestic improvements of the technological
type attended this downgrade process. The most important was F. C.
LowelFs loom (1814), which almost immediately induced a great increase
in weaving by power, the application to woolens succeeding in the course
of the twenties. It was preceded by the invention of “pickers” and
“willows” (according to Mr. Clark, 1807) and was followed by the
Goulding condenser, which revolutionized the woolen industry in the
thirties (Kondratieff revival), and a considerable list of minor new
devices. What we know of quantities of product^ and prices behaved
accordingly.

^ Mr. Clark states, iUd., that between 1800 and 182S eight states incorporated 557
manxifacturing corporations, with an authorized capitalization of over $72,000,000 and
that over half of these were organized during the four war years. It has been pointed out
in a previous note that these figures, although more significant than corresponding figures
for England would have been, are yet an unsafe guide. In particular, the practice of the
states being different, the figures do not tell anything about the relative pace in different
parts of the country.

* Various reports and other official papers, also private publications, supplement to some
extent the very unsatisfactory evidence from the early census. But, of course, such bits

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291

This must suffice for our purpose. In transportation the great
thing was the construction of canals. Within the last three decades of
our period, cost of transportation between the East and the Middle West
fell spectacularly in consequence, both per ton-mile and because of the
saving in time and distance. Philadelphia became the center of a system
of waterways. The canal between the Hudson and Lake Champlain
was opened in 1823; the most important of all, the Erie canal, in 1825.
The truly revolutionary effect of this on physical production, prices, and
location — an ideal instance by which to illustrate the nature and modus
operandi of innovation, in particular the way in which innovation
produces prosperity and depression — ^is luckily so obvious and its quanti-
tative importance so palpable that we need not stay to prove it.^ While
canal traffic reached its peak about the end of the Kondratieff (1840),
railroads — there were about 1,500 miles in operation by 1837 and about
4,000 by 1842 — cannot have been a major factor in the upswing of the
last Juglar, except locally and by the contribution of railroad projects
to the speculative situation of 1837, when they featured along with
banks and land companies.

Demand for rails began before 1830, but the steam locomotive, tracks,
and roadbeds did not get into a serviceable shape until, roughly, 1835.
Comparative slowness of beginnings is accounted for also by the fact that
the entrepreneurial task of breaking down the resistance of the environ-
ment proved astonishingly difficult. Impediments, such as constraint
to pay tolls to canal companies in cases of competition, local jealousies
obstructing necessary connections, and so on, were not overcome until
much later. Public enterprise in the field began in 1836 and 1837
(Illinois, Michigan, Indiana). As elsewhere, the first railroads were
local and sponsored by businessmen in important towns on the coast or
other navigable water, with a view to opening up the hinterland. The
Mohawk and Hudson was an Albany enterprise to cut Troy out of
the transshipment trade between the Erie Canal and the Hudson. The
Baltimore and Ohio was Baltimore’s bid for interior trade, the Charleston
and Hamburg was an effort on the part of Charleston to divert the trade
which went down the river from Hamburg to Savannah. The ‘‘compet-
ing-down element” is thus obvious from the outset, and even absolute
losses — as distinguished from the relative losses equal to the net result
of general development and this competition — ^must have been felt

of information as, for instance, that between 1820 and 1832 spindles in Massachusetts
increased from 52,000 to 340,000, may easily mislead.

^ The developments in the West, largely induced by that innovation, are, of course, but
inadequately characterized by the fact that between 1820 and 1840, the population of
Ohio increased from 581,295 to 1,519,467; that of Illinois, from 55,162 to 476,182.

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Business Cycles

almost immediately, not only by canal and Mghway companies, but in
general by business in towns that lagged behind. Freight rates fell
quickly to — on a rough average — ^three cents per ton-mile which, how-
ever, was still about double the charge on canals, though only one-fifth
of the cost of transportation on a turnpike.

9. For Germany and England it is not easy to size up the role of credit
creation in the financing of innovation during that period. The reasons
for this have been touched upon before. It is not only that credit crea-
tion was in fact of smaller relative importance, but also that there was a
tendency for whatever of it existed to hide, the burden being shifted
to the financing of working capital — current business being run on credit,
thereby setting free funds for ‘"investment.’* But there are plenty of
indirect symptoms. In the case of Germany, we need only look at the
practice revealed in the crisis of 1763 in order to satisfy ourselves that
finance bills were by no means unknown even before our period. We
have also noticed the banking developments after the Napoleonic wars.
In England (B. D. Richards, Early History of Banking in England,
1928; W. T. C. King, History of the London Discount Market, 1936),
trade began increasingly “to lean on banks” in the eighteenth century.
Even earlier merchants and goldsmiths had “bought bills with deposits,”
but with the rise, since 1740, of the country banks, which not only
issued notes but also did deposit business, the contours of the modern
apparatus of credit creation slowly emerge, among them the practice of
interbank deposits, the clearing habit, and the clearing house. There
were 150 country banks in 1776, 350 by 1790, and 721 in 1810. During
the restriction and afterward, these facilities produced such a plethora
of “money” as to give a great impulse to bill broking. The test came
after 1815 and the heavy mortality among banks — ^primarily due to
speculative investment and to lending which was short only in appearance
— ^is witness to our view of the matter. Later developments (joint
stock banking) have been noticed before. In the thirties, wildcats do
not seem to have been confined to the American fauna.

In the United States the case is plain: profits — ^theoretically, a
secondary and derivative source — and the ad hoc creation of means of
payment were obviously the main domestic sources of the ""funds”
which financed industrial and other enterprise. It has been stated before
that after 1780 sound money principles prevailed as far as Federal policy
was concerned. Repayment of the national debt, substantially accom-
plished between 1832 and 1835, was in keeping with this, yet there are
several qualifications to be made, two of which are relevant to our sub-
ject. At no time, first, did the Federal government really support the
two Banks of the United States in such attempts as they made — the
first bank hardly did — ^to acquire the position of central banks and to

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293

exert a restraining influence on loose or even semicriminal practice; in
the autumn of 1833 it even weakened the position of the second bank
and materially helped to urge on private banking by withdrawing its
deposits (about $29,000,000) from the former and distributing them
among the state banks — a measure that was partly counteracted, only
when it had taken full effect, by the Specie Circular (1836), stopping
sales of public land on credit and insisting on payment in specie, which,
under the circumstances, amounted to an official declaration to the effect
that the state banks were not to be trusted.^ And at no time, secondly,
was the Federal government able — at some times it was not willing —
to restrain the states from fostering methods of banking obviously at
variance with the principles of monetary policy it professed. In the
country at large, though with notable exceptions, the inflationist men-
tality that had developed in colonial times continued unabated, and
each depression brought its attack on the monetary system with the
utmost regularity.^ Politics in some states was entirely swayed by
it. For instance, Kentucky founded (1820) the Bank of the Common-
wealth of Kentucky, in order to issue paper money to the amount of
two millions to be lent on mortgages, which was held to be constitutional
in 1835. Pennsylvania in 1840 authorized the banks of the state to issue
three millions in notes redeemable in state bonds.

The first bank of issue, the Bank of North America, was established
in 1782. During the first four years of its existence, it confined itself
to discounting for not more than 45 days. Others followed in quick
succession. According to Gouge there were 21 of them by 1795 and —
in spite of the crash of 1809 — 119 by 1812. In 1829 there were 329, by
1837 the number had increased to 788, a peak of 901 was reached in 1840.
They lent on promissory notes secured by collateral or endorsement,
often on mortgage, keeping very scanty reserves and not caring too much
about such details as the paying in of capital or redemption, in spite of
the facts that there was no central bank to fall back upon and that sup-
porting relations between banks developed but slowly after 1820. The
passionate inflationism of the public mind protected them, although
we also read of complaints about the ‘‘deluge of paper money.” In

^ TBe Independent Treasury Episode of 1840-1841 would liave liad similar consequences,
but it happened to bit upon a quiet situation and seems hardly to have ruffled the surface —
an instance which shows what things of that order mean and do not mean. The Specie
Circular affords the only instance within the period of a measure taken by the Federal
government which could possibly be suspected of having had restrictive or '‘deflationary’^
effects.

* The nature and motivation of the measures proposed are strikingly suggestive of the
measures and arguments of our time. The scheme submitted to the Senate during the
depression that followed upon 1826 may serve as an example. It was proposed to issue
paper money “in order to bring about prosperity and to enhance the value of property.”

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Business Cycles

some communities the attempt to present notes for payment involved
the danger of seizure of the notes or arrest or even danger to life and
limb. Although it is the notes about which we read the picturesque
stories, too familiar to bear repetition, checking deposits were also very
freely created.^ The rule of lending short and acquiring quick assets
broke down from the first — although there were banks and bankers who
kept to it throughout; deviating practice went to very different lengths
in different parts of the country — and was soon challenged on principle
by the copious writings of valiant pamphleteers.^ The notes of many
banks depreciated seriously between 1814 and 1817, suspensions of specie
payments (1814 and 1837, in particular), and failures were of frequent
occurrence. We hear of industrial concerns applying for power to form
banks in order to finance themselves by note issues and some Midwestern
states gave railroad companies such powers for this very purpose.

This detail is significant. It provides a clue to the interpretation
both of that practice and of the inflationist mentality of that time
which made such practice possible in communities that were in other
respects supernormally strict about moral standards.^ Neither of
them can be disposed of by an expression of moral disapproval. Nor
does it help us to criticize them from the standpoint of the classical
theory of banking. Whatever our opinion might be if we placed our-
selves on other possible standpoints, however strongly we may feel it our
duty to condemn — ^from some of those other standpoints — both the
misconduct involved and the public opinion that not only condoned
but fostered it, the fact still remains that we have before us the clearest
historical instance by which to illustrate the function of credit creation.
It was the financing of innovation by credit creation — ^the only method
available, as we have seen in the course of our theoretical argument,
in the absence of sufficient results of previous evolution — which is at

^ Compare Smith and Cole, op. cit„ p. 5.

* Compare, again, Bray Hammond, Long- and Short-term Credit in Early American
Banking, Quarterly Journal of Economics for November 1934.

® It is no part of the author’s intention to “justify” anything, least of all inflation.
What follows in the text attempts to explain or interpret economic fact and is entirely
irrelevant to moral or any other evaluation. But without violating the boundary line
imposed by our purely analytic intention, it may still be stated, first, that as a matter of
psycho-sociological interpretation it makes a great difference whether a given pattern of
behavior is condemned by the conscience of the community or supported by a large and
vociferous sector of public opinion — ^the American banker who resorted to all kinds of
shifts to make it impossible for holders of his notes to present them successfully, did
something which, for this reason, differed from an analogous behavior of an European banker
— and secondly, that under the circumstances “abuse” and “recklessness” must be defined
in terms of bad faith and of lending for the purposes of either fraudulent or otherwise
unsound projects rather than in terms of infringement of the rules of “classical” banking.

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295

the bottom of that ‘‘reckless banking.” This undoubtedly sheds a
different light upon it. Those banks filled their function sometimes
dishonestly and even criminally, but they filled a function which can be
distinguished from their dishonesty or criminality. Sound money men
of all times, hence, threw and still throw away the baby with the bath by
condemning the principles of that practice, however understandable
their clamor for policing and controlling the practice itself may have been.
The people felt this. So did some of the advocates of inflation, though
they were unable to formulate their case correctly. And this goes
some way toward explaining that riddle in the history of American moral
sentiment (also see above, suh 8).

That this is so, we can also see from the long-run behavior of the
level of domestic prices (compare Smith and Cole, op. dt.y charts on pp.
15 and 68; see, also, comparison with British index on p. 66). It is
not as we would expect it to be if there really had been “paper inflation”
sans 'phrase. On the contrary, it is distinctly as we would expect
it to be from the normal working of our model — namely up in the Kond-
ratieff prosperity, and down afterward. Increase of output in the sense
defined in Chap. IV eventually overtook the effects of bank expansion
each time and exerted its downward pull on the price level exactly as
it should according to the modus operandi of our mechanism of innova-
tion. There is no such difference between the behavior of the American
and the British price indices as we would assuredly find if our diagnosis
were seriously at fault. ^

This does not cover the case, however. In 1812 and 1813, then again
from 1834 to 1836, we find spectacular rises which are contrary to
expectation. The first is accounted for by the English war. The second
is due to what, even from our standpoint — and not only from the stand-
point of the classical theory of banking — obviously was excess, i.e.,
more than the usual Juglar expansion. Jacksonian policies — ^the
hostility to central banking or, in fact, any control of credit creation —
may be held responsible for its violence, as well as for the violence of
the subsequent fall. The case provides interesting material for study
with reference to contemporaneous problems. Moreover, we do not,
of course, deny the presence, during practically the whole of the period,
of “reckless banking” either in this country or in England, although we
define its nature differently. There can be no doubt, not only that
unsound and fraudulent schemes were readily financed in many instances,
but also that credit was freely extended for other purposes than innova-
tion, most of which would only pay at rising or, at least, constant prices.

^ The issues of some banks depreciated so promptly in terms of the issues of other banks
that, it is fair to say, it was not the whole of the amount of bank notes created that acted
on price quotations. But this involves only a minor qualification of the above statement.

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Business Cycles

Tlie Secondary Wave loomed large in every Jnglar and many secondary
maladjustments were tlie consequence, requiring additional processes
of liquidation and accentuating those violent crashes which would
have been much milder without them,^ although the vicissitudes incident
to economic development, within a young country of such possibilities,
could not have been avoided entirely by even the most conservative
behavior of banks.

10. Finally, we will try to locate the Juglars. The Eitchins are,
as has been pointed out before, in any case beyond the reach of the
historical information at the writer’s command and can, therefore, be
established from time series only, although some support can be and
has been derived from annals of the general business situation. But
as regards the first Kondratieff, at all events until about 18£0, that
information is not even quite adequate for the Juglars, particularly in
the case of Germany. The reader should recall, moreover, what has
been said in the fourth chapter about the meaning of our dating and the
unavoidable roughness of it. It is for him to judge how far what follows
suflices to make a common-sense case.

In England, a boom followed upon the close of the American war. It
broke in 1788 in a crisis and may, no doubt, be looked upon as a postwar
boom and nothing else. The reason why the writer doubts this diagnosis
is that there were, from the beginning of 178^, indications of a widespread
industrial activity — ^in cotton, in particular — which seems to have gone
deeper than that. However, he does not know. Several years followed
which look like years of an ordinary Juglar depression and revival (the

^ This is not the place to try to strike a balance of ultimate effects of either “normal”
or “reckless” credit creation, and to draw any inferences for monetary policy. It can, no
doubt, be reasonably argued that without that credit expansion — ^and protection — Ameri-
can evolution would have been less rapid and, in an obvious sense, sounder, and that many
of the problems of today would, both in this country and in Europe, be much more manage-
able than they are. But two remarks impose themselves: first, we see again, that effects
of credit creation are not simply or primarily a question of quantity, but mainly depend
on the purposes which credit creation serves and on the success that attends these purposes.
As regards this primitive wisdom, which some of our contemporaries have made every
effort to obscure, the value of the evidence from our period is second only to the value of
the Law case. Second, the reader knows by now that the author is not a wholesale admirer
of Professor Von Hayek’s theory as far as it claims to he a fundamental explanation of the
causes of the cycle. All the more is it a duty to point out that the course of American
events in the twenties and thirties of the nineteenth, not less than the course of events of
the twenties and thirties of the twentieth century, invites interpretation in terms of that
theory. In fact, when we observe the behavior of the price level which was such as to
negative all idea of “inflation” according to one definition, and the behavior of the banking
sphere which spells violent inflation according to another definition, and when thereupon
we further observe what happened between 1836 and 1840, fairness almost compels us to
tender to that eminent economist our most sincere congratulations.

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297

latter covering 1785 and 1786). But the interpretation implied is
frankly admitted to be one of the many non liquet' s in the writer’s mind.
There is no doubt, however, that 1787 was a year of prosperity which
went on intensifying itself to February 1793. It is clearly linked to
cotton innovation and canal construction — ^there were minor features
also, among them the steam engine, which, however, was not sufficient
to count quantitatively. So we date — ^and all doubt there can be about
this turns on the processes of the preceding years — ^the rise of the Kond-
ratiefiE and of its first Juglar from 1787 (inclusive). That there should
have been (a little more than) six years of boom — ^the dent in 1788-1789
does not mean much and really invites interpretation as a Kitchin depres-
sion — ^which, according to our schema, means that business went on
improving right through a Juglar recession and into a Juglar depression,
is perfectly in keeping with expectation for a Juglar that runs its course
entirely on a Kondratieff prosperity. A crisis came, and depression
asserted itself when we should have expected it, but the war with France
came also (February 1793), Measures immediately taken by both
parties to the conflict were such as to account quite plausibly for
both the panic that lasted about half a year and for the depressed state
of things in 1794. But considering the underlying industrial process
as well as its surface symptoms — ^looking, for instance, at the ‘"canal
fever” (the expression is used by Professor Mantoux) and the £5 canal
acts that were passed in 1793 alone — ^we are obviously within our rights
if we conclude, on the strength of common experience, that that sort
of thing would have had the same consequences then which it always has.
That coincidence has nothing astonishing about it; external factors will
precipitate a crisis that may be due, as well as produce one that is not
due.

Revival ensued in 1795 — as short as we should expect from the
Kondratieff phase — and is much more plausibly accounted for by the
cyclical rhythm than by political events in which there was nothing that
looked particularly bright. The course of mihtary operations, dislocation
of foreign trade, domestic unrest, threatening invasion, suspension of
specie payments, and government inflation then command the scene.
But it does not follow that they were the only factors to act. On the
contrary, we know, that the processes of the industrial revolution went
on, in textiles and iron in particular. Since there is no convincing
method, in the present state of information and of analytic tools, to
separate effects, we ought perhaps to abandon the material of the stretch
between 1796 and 1815 as we abandon the material of the period from
1914 to 1919. It seems, nevertheless, that legitimate interest attaches
to a — ^perfectly noncommittal — experiment with our schema. We
take it from experience, not from theory — ^least of all, from our theory —

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Business Cycles

that Juglars are as a rule of a duration of a little over nine years and
consist of four phases, and we try how this schema fits the actual course
of business situations. 1796 would then be the first year of the second
Juglar — ^the one that is astride’^ the Kondratieff turning point — which
would last through 1804 into 1805. The third Juglar, the one to complete
the Kondratieff recession, we count from the first months of 1805 to
about the middle of 1814; the fourth — ^the Juglar that entirely lies in
the Kondratieff depression — ^from about the middle of 1814 to about the
end of 1823. The reader is invited to compare this with, say, Mr.
Thorp’s comments on the individual years, taking account of the differ-
ence in terminology (Mjt. Thorp attaches to the terms 'prosperity and
depression a meaning which does not coincide with ours) and of the
nature and importance^ of the external events. The beginning of a
prosperity phase shows in all three cases, as well as the — obviously
adequate — events that killed it. In the first two cases, revival also
shows distinctly, though in the first it will be attributed to the peace
of Amiens. What Mj. Thorp designates as depression in the second
half of 1803 and in 1804 is amply accounted for by the political factor.
Prices, of course, are no guide during the war.

As regards the time which, according to our schema, would be covered
by the fourth Juglar, the boom in 1814 and at the beginning of 1815 is
beyond doubt. Since this can be interpreted in terms of the effect
of the treaties of Paris and Ghent — although the recovery of 1812 and
1813 came about without any such stimulus — ^the writer does not wish to
insist. But the business history from the crash of 1815 and its aftermath

^ It has been pointed out, in the discussion of the external factors which influenced that
Kondratieff, that economists too often content themselves with indicating — ^for instance,
on time series charts — certain well-known events, a war, “unrest,” an epidemic or even a
fire, without asking the question whether the event was really adequate to exert the influ-
ence which it is implied it exerted. Answer to this question is a distinct task in each case
and, though in some the answer may be obvious, must not in general be taken for granted.
The English declaration of war in 1793, for instance, need not immediately have been
the great disturbance it actually was, and we must not infer that it was from our knowledge
of later events. Military operations were at first not on a great scale. It is the study of
other measures and effects which justifies our statement in the text. Be it added at once
that for Germany the French troubles to the end of the war of the First Coalition did in
fact not amount to “dominating” disturbance. At first, there were operations, troubles,
and dislocations in those parts of the Austrian Low Countries and of Alsace which bordered
on France, and then there were revolutionary movements in the Ehineland. But in the
bulk of Germany things were much as usual. Nor, at first, were preparations exhausting.
In the campaign, for instance, which failed at Valmy, the Duke of Brunswick never com-
manded more than about 80,000 men. As far as German economic life is concerned (we
exclude Austria, even the German part of Austria, though this is not legally correct for that
time), things did not become really serious, except locally, until the turn of the century.
Then, of course, they became so all the more, especially after Jena and Auerstadt.

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299

in 1816 (dealt with before) to the middle of 18£3 fits in excellently, and
this may, after all, suggest the possibility of an interpretation which
would be somewhat more convincing than the monetary one. The
depression in 1819 and 1820 and the revival in 1821, 1822, and the first
half of 1823 were ideally normal from the standpoint of the schema.
There is little difficulty about the last two Juglars—nobody ever has
denied the existence of two outbursts of industrial and financial enter-
prise that broke in two spectacular crises and were separated by what is
very naturally described as a depression and a recovery. We date:
end of 1823 to about middle of 1833, and middle of 1833 to end of
1842. Whether the reader accepts this dating or not, the facts it is
intended to convey are palpable. As pointed out elsewhere, the sixth
Juglar presents irregularities (showing especially in its last phase)
which can, however, be accounted for.

Here we will insert a remark on the crises of 1825-1826 and of 1836 or,
as some authors have it, 1836-1839; there seems no need to add anything
about either 1793 or 1815. Both crises occurred when, taking the
Juglar and the Kondratieff phase together, we should be prepared to find
major dips in prices and values: a Juglar recession on a Kondratieff
depression forms the background of the one, and a Juglar depression on a
Kondratieff revival, the background of the other. But beyond this,
our model does nothing for us except to explain why errors and excesses
should have been particularly in prominence during the preceding years.
Thus it explains conditions favorable to the occurrence of what the
untechnical term crisis designates; but it does not explain the crises
themselves, and still less their violence. This will have to be pointed
out again in later cases : each time we see an economic process which by
virtue of its own consequences annihilates profits and enforces adjust-
ments — ^prolonged ones, particularly in Kondratieff downgrades — ^but
for the phenomena of the crises themselves, which our schema leads
us to look upon as erratic and nonessential, exactly as experience leads
the businessman so to consider them, we have to fall back in each case
upon very untheoretical observations — among them, speculative manias,
foolishness, swindle, and chance occurrences of all sorts. The importance
of some of these elements was enhanced by the fact that foreign financing
and speculation in foreign securities — Mexican and South American
securities being particularly prominent in the first case and North
American in the second case — splayed so great a role, a much more
important role than ever before. Building and, as mentioned before,
promotion booms preceded both crises,^ and so did a spectacular increase
in consumers’ spending. We have also noticed that credit expansion

^ As Tooke noticed for 1833, construction of new mills was at the basis of them.

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Business Cycles

and the increase in the engines of credit creation formed a feature in both
cases, though very much more notably in the second than in the first:
%% banks and insurance companies with a capital of over 36 million
pounds were, however, founded in 1824 and 1825. As the reader knows,
it is to wildcat banking that we attribute the violent movements of
1836-1839, as well as their aftermath. Stock exchange panics led the
sequence of events (May 1825, May 1835) and the impact of depression
on business seemed to come from them. On the surface, it was not the
effects of the innovations on the economic structure that caused the
trouble — and, in fact, they did not cause the crises — but simply over-
commitments, inconvenient calls on shares, failure of expected returns to
materialize, unfavorable gold movements^ incident to foreign financing,
and so on. Hence, it is perfectly understandable that students who
look mainly to the mechanism of crises, should develop a propensity for
monetary explanations, for quite naturally the mechanism of money and
credit will be the first thing to reflect all this and to be affected by it.

We need not parallel this by a discussion of American crises, for we
should have only to repeat.^ As regards dating, we meet, of course, the
difficulty, already encountered, about the beginning of the Kondratieff.
The wave of cotton and water power, of wheat growing, and of a few
minor innovations is obvious. In the early nineties it was certainly run-
ning strongly. But how far back we are to go and how we are to appraise
the relative importance of the various unfavorable external factors that
acted on the industrial process — ^such as Shay’s Rebellion — ^the writer
feels unable to say. Nor do our difficulties stop there. We are able to
follow, from 1788 or 1789, the rising tide until the last quarter of 1796.
Till then there were only the financial troubles of 1792, which did not
amount to much. Prosperous conditions continued to prevail in the
South after 1796, but in New England preponderatingly unfavorable
situations followed until a rally in 1804. This makes a picture of one
big two-phase cycle with smaller fluctuations of an erratic character
in its second half. But all it really shows is that aggregative contour
lines and the complexion of general business situations are unsafe guides

^ Harvests have also been blamed. As the reader knows, we do not object to this on
any principle. But there was nothing wrong with English harvests, as far as the writer
can see, in the case of 1825-1826 — which shows that crises and depressions can come about
without that element. As regards 1836-1839, the first really bad harvest (failures in 1836
were but local) was in 1838, and any cyclical influence was mitigated (though the misery
was not) by high price. The rich harvest of 1835 spelled, it is true, suffering in the
agrarian sector.

* But since the plan finally settled on for this exposition leaves no room for the crises
of colonial America, which present many interesting features, it may be useful to supple-
ment this regrettable lacuna at least by a reference to Mr. Clark’s first volume. See, also,
Osgood, The American Colonies in the Seventeenth Century, 1904-1907.

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301

to the deeper things in the economic process. The reason for that
impression is not far to seek. The American general business situation
was at the time largely a function of European war demand. Farmers,
merchants, and shipowners were dependent on it. In 1797 and 1798
trading was imperilled by privateering and the country was on the
verge of a war with France. This passed and trade recovered, but the
peace of Amiens meant nothing less than a catastrophe, sending down
prices, inducing failures and idle tonnage. All this impinged on the rest
of the organism through a highly precarious banking situation.

The same factors acted the other way again in 1805 and 1806, but
the Jeffersonian embargo (December 1807 to March 1809) exerted, of
course, a strongly depressive effect. February 1811 brought the Non-
intercourse Act to life again, then came the war with England and the
damage it did to trade and shipping, and the stimulus it gave to domestic
manufactures, followed by the reverse state of affairs (enhanced by
European crop failures) in and after 1815, until the crisis which broke
out in the last quarter of 1818 liquidated, for America, the abnormalities
of the Napoleonic time. But, once more, that an organism lives in a
stormy environment which tosses it and alternately benefits and injures
it does not prove that it has no life of its own. How strong that life was,
shows on occasion, for instance in 1793, which was a year of prosperous
business, although trading and shipping interests were affected con-
siderably by the events in England, or in the prosperous conditions that
prevailed in the South while the trading and financial centers suffered.
In the situations of 1795, 1807, and 1814, however much colored they were
by the influence of foreign situations, the specifically American compo-
nent may yet be recognized and linked to industrial processes and, as
their complement, banking developments. Since, however, the question
could in any case only be whether or not there were traces of the endo-
genous rhythm of economic life, we need not insist. The tentative dating
is: 1787-1794, 1795-1804, 1805-1813, 1814-18^2.1 There is no doubt
about the period which, in case we accept this, would have to be called
the fifth Juglar: 1823-1831. Nor is there any doubt about the reality
of that unit in the evolutionary process which ran its course in the
thirties and early forties: 1832-1842, as the writer thinks. But, as in
England, it displays many irregularities.

For Germany, existing material is still more inadequate or could, at
aU events, be collected only through an amount of work which the writer
has been unable to undertake. That there was, between 1780 and 1800, a
wave of entrepreneurial activity (public and private) seems certain,
however. As has been indicated, there is also some evidence of another

^ Comparison with Mr. Thorp’s Annals is again invited.

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Business Cycles

that started somewhere after 1804 but was crippled by political events.
While these tatters suflBice to reveal indications of a larger movement,
such as the Kondratieff, they do not suflSce for an attempt to subdivide
it. That movement is somewhat different from the period from 1814 to
1822 which bears a family likeness to its English counterpart, though this
cannot (save in the case of prices of articles of international trade) be
due to foreign influence. And it is very different from the following
twenty years which clearly show two waves of activity. * There is some
doubt about their exact dates, but not about their reality. We date
1823-1831 and 1832-1842, on the strength of indications, some of which
have been presented above. The writer feels no hesitation in calling
them Juglars, Some interest attaches to comparing them with the two
that correspond to them in England. Of course, they were much more
modest affairs — ^the developments in mining, iron, steel, cotton manu-
facture, agrarian industries (distilling, brewing, in the latter Juglar
also sugar refining) cannot, even relatively to the economic organism, be
put on a level with English performance. This would, in itself, account
for milder crises. But there were no crises. The nature and the mecha-
nism of the process were the same as in England and it produced recession,
fall in prices, and losses, yet — ^the troubles in Hamburg in 1836 and 1837
were not very serious — ^nothing amounting to either panic or deep depres-
sion, Obviously, this was due to the absence of speculative excesses, of
foreign financing of any importance, and of “reckless banking.” The
simple home truth implied in this will presently be reemphasized by other
instances. It may be trite, but it is important.

CHAPTER VII

Historical Outlines

II. 1843-1913

A, The Period 1843-1897. — This period covers the second of our
Long Waves. We have learned before that there is some difference of
opinion among those students of the business cycle who use that concept
at all, as to whether the forties are to be included with the first or the
second, while some historians date the beginnings of what they, along
with everyone else, feel to have been another economic revolution, from
earlier developments.^ The reasons — ^justifiable, all of them, from the
different standpoints taken by individual investigators — should be clear,
as should be those which we have for our decision which needs, however,
qualification in the case of the United States. The important thing is
that nobody doubts the reality of that revolution which in nature and
importance is perfectly comparable to the one that occurred in the last
two decades of the eighteenth century, and that nobody could fail to
associate it with what we call the railroadization of the world, which
obviously was, though not the whole of it, yet its outstanding feature.
The latter statement particularly applies to this country, the Western
and Middle Western parts of which were, economically speaking, created
by the railroad. For England and even for Germany the importance of
their own railroads was absolutely and relatively much smaller, and for
them our statement should be modified to read that railroad develop-
ment in the world was the outstanding feature that dominated economic
activity in those countries also. On the importance of the changes
wrought and of the subsidiary developments induced, it is superfluous
to insist. Nor need we stay to show more fully than we did in the course

^ The second volume of Professor Clapham’s Economic History of Modern Britain, for
instance, covers, under the title Free Trade and Steel, the period 1850-1886. This roughly
falls in, as to the former year, with Kondratieff's dating. Similarly in his Economic Devel-
opment of France and Germany 1815-1914, the year 1848 stands for more than a merely
expository division. But on the whole, historians are inclined, as is perfectly natural
from their standpoint, to let “modern” developments begin with either the English indus-
trial revolution, or the end of the Napoleonic wars, or the early railway age.

303

304

Business Cycles

of unfolding our theoretical schema, how railroad construction produces
both prosperities and recessions — with the latter, situations which easily
slide off into depressions — and, in particular, simultaneous cycles of differ-
ent span. But the reader should not fail to work this out again step by
step. For railroadization is our standard example by which to illustrate
the working of our model. The comparatively long periods of gestation,
both of the individual line — each is an innovation within our meaning of
the term — and of the sectional or national system — ^which, as such,
constitute innovations of a higher order — the quantitative importance
of the expenditure involved, the consequent dislocation of all the data
of economic life, the new investment opportunities and the new possibili-
ties that are created for further innovation, and the (cyclical) disturbances
in turn caused by these, combine to make the essential features of our
evolutionary process more obvious in this than they are in any other
case. More easily than in any other can the usual objections to our
analysis be silenced by a simple reference to obvious facts.

1. While railroad developments in the forties, particularly in England,
are our chief reason for dating the beginning of the second Kondratieff
as we do, it is not, of course, implied that railroads were of no cyclical
importance after 1897, which would, for this country at least, be as untrue
as it would be to assert that the cyclical role of cotton textiles ceased in
1842. Innovations which ‘‘carry’’ a Kondratieff, continue to contribute
to the next, just as we have already seen that they develop — as did, for
instance, railroads themselves or at least one of the “great things” of
the third Kondratieff, electricity — ^from beginnings in the downgrade
and revival of the preceding one. Yet there is little difference of opinion
about dating the end of the second Kondratieff. What difference there
is turns on months or, at most, a year. This comparative agreement is,
of course, due to the strong testiraony of aggregative and systematic
series and to the unmistakable complexion of business, which at that
time emerged from what has come down to posterity as the Great Depres-
sion. But it can also be justified from the nature of the business processes
behind those series.

The properties of the social pattern as revealed, for example, by the
foreign, social, and financial policies of the great nations, also lend
support to the view that 1897 may, symbolically as it were, be taken to
mark the end of an era and the beginning of another, quite irrespective
of our particular — and particularly narrow — ^purpose. Although the
whole process we are analyzing in this book is essentially the process of
capitalist evolution — economic evolution as conditioning, and being
conditioned by, the institutional pattern of bourgeois society — ^yet the
second Kondratieff has a special claim to the epitheton bourgeois. By

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305

this we mean that the interests and attitudes^ of the industrial and com-
mercial classes controlled policies and all manifestations of culture in a
sense in which this cannot be asserted for any preceding or any subsequent
period. In Europe this did not as a rule — ^the earliest case, that of
France under Louis Philippe (Laffitte, Perier, Thiers, Guizot), comes,
however, before our period — amount to conquest of the place at the helm
of public affairs. Even in England Gladstone was an exception and the
lists of his first two ministries have a very aristocratic tone (Disraeli
of course defies classification). In Germany the genuinely bourgeois
element in responsible office was insignificant, Miquel being the most
important instance. But, although Bismarck’s attempts at official
cooperation with the bourgeois class were thwarted by various cir-
cumstances into which we cannot enter, his policy — ^primarily, but not
only, his economic and financial policy — courted the industrial and
commercial interests.

In England there were, until the discovery of new sources of political
power by the radicals of the Chamberlain-Dilke type, hardly any other to
court even for politicians who, like Gladstone himself, cultivated the
good will of the masses and actually appealed to them. Opposition to
capitalism” there was, of course. But it had no economic significance
beyond the various measures of ^"Sozialpolitik,” which nowhere went
near to vital nerves and which were enforced against such bourgeois
resistance as there was — we are prone to overrate it by taking phraseology
at face value — by the noncapitalist strata above the bourgeoisie rather
than by the masses below it. This is particularly true of Germany,
but it is also true of England (Lord Ashley, Disraeli’s tory-democracy) .
Socialism coxmted for so little that its exponents, actually overlooking
the possibility that cabinet office could ever come to them in the most
unexciting and unrevolutionary way, framed its policies on the hypothesis
of permanent exclusion from power, thus creating for themselves what
presently amounted to the perplexing problem of Millerandism. So
safe, and so convinced of its safety, was the bourgeoisie, that it went
politically beyond the lengths compatible with the survival of its economic
and social pattern. It cheerfully believed that the masses, if only suffi-
ciently educated, would see the excellence of the bourgeois world and
support it by their votes, entirely forgot how much it owed to the protec-

^ Interests and attitudes are not the same thing, nor do the latter follow from the
former: for instance, it sometimes is, and sometimes is not, both to the objective and to the
putative interest of the bourgeoisie to prefer peace to war. That class sometimes decides
for the one and, at other times, for the other. Independently of this, however, it is a fact
that the bourgeois type of life creates a mentality better suited to peace than to war and,
hence, an attitude averse to war.

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Business Cycles

tion of precapitalist elements in the social structure and was blissfully
unaware of the explosive forces that gathered below the surface.

2. The rule — ^in the qualified sense just indicated — of the bourgeoisie
and of bourgeois rationalism extended, as could easily be shown, to the
religions, the arts, the sciences, the style of life, to everything social in fact,
with the single exception of the Catholic Church, which hence became
an object of aversion and of temporarily successful attack. AU that
matters for our purpose, however, is the fact that the bourgeois world
behaved politically in such a way as to minimize external disturbance of
our process. What institutional change of the kind relevant to our sub-
ject there was, grew much more clearly out of the immediate economic
situations than such changes did at any other time, so much so that our
way of defining, and dealing with, external factors becomes more impos-
sible than ever if looked at from the standpoint of any other than our
purpose. In order to show this, we will take England for standard and
'paradigmay and confine ourselves to the headings: Free Trade, the Bank
Act, the Company Acts. The first, which stands also for a series of
supplementary measures, such as the repeal of the Navigation Act, as
well as for a fundamental principle of policy in general that asserted itself
in many ways in the current management of affairs, was primarily the
outcome of a diagnosis of the national interests of the moment which
seemed to call for new outlets for the newly created productive power and
for the relief of social tension. Wider aspects and visions of more remote
effects were not absent, to be sure, and their presence — and the way in
which the necessities of the moment were made to serve them — ^makes,
together with the sacrifice by a ruling aristocracy of its own economic
interest, the unique historical greatness of the Peel policy.^ But the
profit motive and profit effect of this move to take the fullest advantage
of the existing industrial superiority of England is obvious all the same.

For us it is important to note that English free trade undoubtedly
increased the long-run efficiency of entrepreneurial activity but hardly
affected the cyclical rhythm beyond, on balance, reducing the amplitudes
of fluctuations. In the forties it probably exerted, during its gradual
introduction and afterward, a dislocating effect, which may have been
responsible for the failure of that epoch to display to the full the regular
symptoms of prosperity. Neither the increase in values nor even the
increase in corrected values of exports of British products from 1847 to
1874 can be attributed entirely to the free-trade policy, as some enthusi-
asts have held. Growth and evolution would account largely for it.
The case for a more generous view of the effects of free trade must,

^ That its social value and its moral implications were sneered at by socialists then and
afterward is but another testimony to their reahty.

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307

therefore, rest on the (defensible) argument that growth in our sense, as
well as evolution, would have been crippled without it.

The Bank Act of 1844* gave effect to views which the experience of
the late thirties had made irresistible. It would have spelled restriction,
had deposit banking not sufficiently developed before. As it was, little,
if anything, of the general complexion of business in the forties — or ever
after — can be attributed to it:^ it presumably did not do much more than
kill a form of credit creation that for technical reasons was dying in any
case. This is perfectly compatible with the fact that the system worked
with considerable friction each time ‘‘pressure” arose from other reasons.
The Humble Petition of the Merchants, Bankers and Traders of London
against the Bank Charter Act (July IS, 1847) does not really charge
more than this, and the action taken by government^ perfectly logically
confined itself to what practically, though not legally, amounted to
amending the act. Thus we need not list the measure among the major
factors acting on the cyclical process of evolution, except as an element
of the general sound money tendency of the times. Some points about
the behavior of the Bank within the limits of the act will be noticed in
our discussion of the relevant time series (Chap. XIII).

The Companies Registration Act of 1844, permitting incorporation
by double registration without limited liability, the Limited Liability
Act, permitting the same with limited liability, and the Joint Stock Com-
panies Act of 1856 (extended to banks in 1858 and to insurance companies
in 1862), which marks the definitive victory of limited liability (the act
of 1862 was mainly a codification and of little moment in itself) supply
another instance of institutional change that merely formulated the logic
of an economic situation. While, of course, the development of the
latter — ^which, however, forms part of the process described by our
model — ^is of great importance, the legislative change itself is of com-
paratively small importance in such cases. The opposite view derives
spurious verification from an optical delusion similar to that which
tempts us when we behold the increase in value of English exports after
1847. There was undoubtedly a spurt in company promotion after
1856 and an even greater one after 1862; but since those periods fall
into Juglar prosperities, we must guard against the inference which we
might feel inclined to draw,

^ The investigation on which that statement is based has been carried out by Mrs. M.
Shaughnessy Gordon.

2 Treasury Letter over the signatures of Lord John Bussell and Mr. Charles Wood, of
Oct. 25, 1847, ** recommending” to the directors of the Bank to enlarge, at a rate
of not less than 8 per cent, the amount of their discounts and advances, and assuring
them of indemnity for any infringement of the existing law that might be involved in
doing so.

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Business Cycles

Muct the same applies to the other two countries. In Germany, the
Zollverein and the Norddeutsche Bund developed into the Empire.
Economically, this mainly meant further removal of fetters and further
reduction of the political element in the risk of investment, which tended
to make entrepreneurial effort more productive than it otherwise would
have been. Summing up, as it did, previous development, it can hardly
be said to have acted as an external disturbance on preexisting structures.
After 1871 , policy was quiet and peaceful, and an undercurrent of free-
trade opinion was present throughout — ^though fought against with
increasing success by agriculture and the heavy industries from 1870 on,
when the duty on pig iron had been reduced to a nominal amount and
the duty on cattle repealed — and asserted itself once more in the Caprivi
treaties toward the end of the period. This is all the more remarkable
because the ‘‘immediate’^ arguments for free trade that propelled English
action did not apply to the German case. Bismarck’s motives for turning
toward protectionism ( 1878 ) were not so much economic — ^though Ameri-
can wheat had its share in converting him — as fiscal (in the budget of
the Reich for 1878 , revenue from import duties figured at 106 millions
of marks in a total revenue of 536.5 millions) and political (the idea of
strengthening by tariff walls the bond that united the new Empire).
In and around Germany the last tolls fell that hampered traffic on
the waterways (on the Sound in 1857 , on the Scheldt in 1868 , on the
Rhine in 1867 , on the Elbe in 1870 ). The Suez canal ( 1869 ) was, of
course, an innovation (as new trade routes mostly are) though an external
factor for our three countries.

The reform of the Prussian Bank ( 1846 ) was intended to be, and in
some respects was, an improved edition of Peel’s Act. The changes
incident to its transformation into the Reichsbank did not alter the
general financial conditions of enterprise to any marked degree,^ the
less so because the Reichsbank did not embark upon any active policy of
control within the period under review — ^various details will be noticed
in their places. Nor was the substitution of a gold for the silver stand-
ard — a national currency (the silver Thaler) had been established before
in 1857 — ^the great disturbance it is sometimes held to have been.^ The

^ The Bank of Prussia filled the fimctions of a Central Bank as then understood. The
reform also spelled definitive defeat of the free banking school in Germany, but some of
the small principalities set up banks of issue, whose notes circulated beyond their territories.
This was stopped in 1875, when this power was confined to a few institutions in the major
states and subjected to limitations even in their cases. There is thus some analogy also
between the German legislation of 1875 and Peers Act, The contemporaneous increase
of banking facilities of other types made, as it did in the English case, that operation innocu-
ous to business.

* The old question of the effects of the demonetization of silver here crosses our way.
We cannot go into it beyond stating that it, of course, affected trade with countries that

Historical Outlines

S09

joint stock company was by about 1870 as entirely freed from fetters —
at all events in many states — as it was in England, so much so that this
must be listed among the causes that contributed to the severity of the
crash of 1878. This experience led to some retracing of steps, but the
act of 1884 did not seriously interfere with that freedom.

As for the United States, the free trade that really mattered was
the free trade within the country. Compared with this — and the
economic history of the Middle West and West is no doubt the greatest
historical example of free-trade achievement — ^the regulation of foreign
commerce, very important during the first Kondratieff, steadily declined
in economic, although only temporarily in political, importance. In
spite, however, of that fact and of the influence of the South, protection
was retained throughout. Fiscal considerations had their part in deter-
mining the increases of 184^ and the reductions of 1857, but the long-
lived Walker Act of 1846, which may be taken to represent what to
Americans seems to be moderate protection, still kept all the more signifi-
cant items at £5 or SO per cent ad valorem. After the Civil War, duties
on wool and woolens again moved into the center of the political game
about the tariff (1867). The law of 187£ and the general revision of
1888 brought small reductions, but the McKinley tariff of 1890 gratified
manufacturers (worsted manufacturers, in particular), while giving
to the farmers a full measure of protection to wool, the only thing pro-
tectionists had to offer to them. The Wilson Act — ^the most courageous
deed of a courageous man — abolished the tariff on wool and reduced the
duties on woolens on the average from 91 to 49 per cent, only to provoke
the violent reaction embodied in the Dingley tariff, which, unfortunately

remained on the silver standard. The larger problem, much discussed at the time, whether
free or regulated coinage of silver would have influenced cyclical fluctuations — it was the
standard remedy for them in the eyes of the monetary reformers of the time — should
undoubtedly be dealt with here. But it can be treated in the same way as the analogous
question in all other cases of additions to currency or to credit facilities: silver would have
set a higher level of prices and accentuated both prosperities and depressions without alter-
ing the cyclical rhythm itself. There is, however, one point about bimetallism which must
at least be mentioned: as long as there is free coinage of both silver and gold at a fixed ratio
of values and as long as neither of the two has driven out the other, there will be a mecha-
nism of automatic regulation of the quantity of legal tender. The metal the market value of
which is less than the value fixed by the legal ratio will tend to flow into circulation, while
the other will tend to flow out, thus increasing the supply for its nonmonetary uses. This
mechanism actually worked in the forties and fifties, with France as its center. It can work
only within limits which would probably — ^though this is not certain — ^have been trans-
gressed by later developments in silver mining, even if bimetallism had been as generally
adopted as the various monetary conferences of that period suggested. But the principle
(sponsored by no less an authority than Walras) is not, on that account, wrong. The
question is, however, of but secondary importance to the analysis of this book and will be
taken up again in the writer’s treatise on money.

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for the standing of free trade in the public eye, happened to come at
the threshold of the third Kondratieff, as the reductions of 187^ and 1883
had come at the threshold of crises.^ As far as the writer is able to see,
this policy may have alleviated temporary difficulties for some indus-
tries — ^while changes such as that brought about by the Wilson Act
certainly created some disturbance — but on the whole it hardly influenced
the march of things substantially. It never was a major factor in cyclical
turning points and still less turned depressions into prosperities or vice
versa. Its provable influence on trends is confined to a small number
of industries, and there is something curiously unreal about the place
it held in party politics and in the thought and talk of a large sector
of the community.

The currency troubles incident to the Civil War will be mentioned
presently. In the sphere of banking, the outstanding institutional
change was the creation of the National Banking System, about which
we might repeat, mufatis mutandis^ what has been said above about
Peel’s Act and the German Beichsbank. Two developments which
almost amounted to institutional changes should be noticed, however.
One was the rise of the New York banking center to something like the
position of a central bank. The other was the gradual reform of banking
practice, in some states — ^for instance in Louisiana (1842) — enforced by
law, in others, like Massachusetts, by the banking community itself.
In New York the safety fund and bond security systems were improved;
in South Carolina and some Middle Western states serious banking also
prevailed, although ‘‘bogus” and “mushroom” banks, the notes of
which were dealt in at discounts up to 90 per cent, were still frequent
in the West and the South. The National Banking Act did much,
directly and indirectly, to improve matters further and, until the setback
caused by the early practices of trust companies, progress in that direc-
tion was all but unbroken.

It is neither possible nor necessary to discuss the details of the fiscal
policy of our period, but it is necessary to advert to its spirit. In the
United States, the tariff as a rule took care of Federal expenditure and
even yielded surpluses so large as to be almost embarrassing, except
during the Civil War and some years after it.^ In England the income

^ These are good instances by which to illustrate the dangers of arguing by coincidences,
in particular in explaining business situations by external factors. They are so valuable
because it is plain that those measures cannot be held to have produced the cyclical phases
that happened to follow upon them. This should make us careful in other cases also.

® The tax on the output of manufactures was then a considerable burden. The per
capita tax, however, cannot be considered as heroic. Repeal of war taxation failed to
bring about the reduction in prices expected from it — a fact which constitutes valuable
comment on the “deflation” of that time.

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311

tax reappeared for good, but throughout the period behaved with the
restraint of a newcomer not quite certain of his right to a place. In
Germany the same holds true for the various state income taxes which
were introduced or reformed and among which MiqueFs Prussian income
and property tax (1891) was the supreme achievement. The writer
has been told, though he has not been able to verify it, that Miquel
believed an income tax which in the highest brackets asymptotically
approaches 5 per cent to be dangerously high. The practice of German
municipalities of levying an additional percentage for their own purposes,
which was soon to make even that income tax a serious burden, did not
develop within our period. All this, of course, implies acceptance of
the bourgeois schema of things economic. No group that had any
political significance doubted anyone’s right to his private income or
inheritance. Income was earned primarily for private purposes and the
state and other public bodies were to take away as little as they could.
Taxes were a necessary evil, to be confined to amounts and to be laid
on in ways that would as little as possible interfere with the disposal
of returns as it would have been in their absence. Retrenchment or,
at all events, economy was meritorious in the management of public
affairs; saving or accumulation, in the management of private affairs.
Supported and controlled by the approval of the political powers —
which, however, let us repeat, were in Europe not as a rule bourgeois
themselves — ^the bourgeois worked and saved — ^within a firm framework
including a safe and sound monetary system — ^for an indefinite family
future, and invariably took as long a view as he could afford to take.

These are the principles behind the splendors of Gladstonian finance
or the six budgets for which Goschen was responsible. Peel was the
patron saint. Compared with the performance of these three, all other
English and, with the exception of Miquel, all German ministers of
finance were distinctly mediocre and at times seriously below par — even
Disraeli was mediocre qua financier — but not one of them deviated from
the creed. We are neither analyzing nor evaluating cultural patterns.
But it is obvious that this finance and the general policy of which it
was an element had much to do with the results displayed in the behavior
of our physical series.

3. The bourgeois Kondratieff spans a long list of wars, foreign entan-
glements, revolutions.^ Space forbids explanation of why they seem to
the writer to have been, even in a deeper sense than that which is implied
in the narrow purposes of this book, factors external to that social pattern.
But we may point, by way of indicating the line on which the argument

^The behavior of gold — the Californian and Australian discoveries certainly were
external factors since, primarily at least, they were due to chance — will be more con-
veniently considered at other turns of our way.

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312

ia support of this contention would unfold, to the fact that Sir R. Peel
— Peel again — inaugurated and Gladstone — again Gladstone — ^fully
developed that consistent policy of dStente which in England has never
been seriously challenged since, not even by the primarily phraseological
"‘imperial policy’’ of Beaconsfield, and which could be shown to be the
most perfect expression of the economic and cultural structure of capitalist
society. We will, however, confine ourselves to discussing the importance
of a few instances, or types of instances, for the working of the mechanism
of economic evolution. There is, first, the group of what, from our
standpoint at least, we may designate as minor ones, such as the various
frictions that arose between this country and England. Some of these
the business community rightly refused to take cognizance of; others
caused small ripples. Even disturbances involving military operations
come within this category, such as the war between the United States
and Mexico which, through the payments of the latter to the former,
exerted some influence, though only on short-run money-market situ-
ations, for some time after its close. The detailed study of time series
has, of course, to take account of this type of disturbance, but it is safe
to say that no major effects are overlooked by neglecting them here.
Minor also, for this country — if we except effects on immigration — ^was
the repercussion from the continental revolutions of 1848, the troubles
in Russian Poland, and even from most other European events, however
momentous they were in themselves. This country was not, to be sure,
a world sufficient unto itself; but the nature of those events was such as
not to interfere materially either with agricultural exports or with capital
imports.

For England, the continental disturbances of 1848 were economically
a more serious matter. They cannot be left out of the picture of her
economic situation. The Crimean War, the Mutiny, the American
Civil War, and the Turko-Russian War complete the list of major
external factors of this type. Egypt and the Soudan, South African (our
period ends in 1897), and other colonial troubles did not amount to
serious disturbance of the general domestic business situation nor did —
this is more astonishing — ^the Italian and German wars. The money
market, through gold flows and otherwise, was undoubtedly affected in
each instance, but beyond this, little injury to our process is provable.
This was due, not only to the great elasticity of that economic system,
but also to the fact that public finances and money never did — ^nor were
they expected to — ^get dangerously out of order. Even where business
and external disturbance coincide, we must be careful not to attribute
too much causal importance to the latter. Moreover, in almost every
case, negative effects of political disturbances were, partly at least,
balanced by positive effects, for there were nearly always interests that

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313

profited by them. This was so even in tbe case of the cotton famine
which fell so heavily on Lancashire yet failed to produce — ^though there
was much suffering — anything like a general depression, or even to blot
out the symptoms of the contemporaneous Juglar upswing.

German business and, in particular, German money market situations
show, of course, the imprints of all European events very clearly, both
of political disturbances and tensions (in the eighties, the effects of
strained relations with Russia) and of economic fluctuations abroad,
particularly of English crises. The German wars created the unified
territory and hence powerfully influenced economic trends in the long
run, but otherwise they disturbed the flow of economic life much less than
one might expect. The Danish war was a small affair. The Austrian
war was too short and not exhausting enough to cause prolonged devi-
ations. It was different, of course, with the French war. But even in
that case only one major problem arises, the effect of the indemnity
which to the amount of 4,990 million francs was actually paid in cash or
exchange, 742 in the former and the rest in the latter. Payment was
effected with astonishing promptness and ease, mainly from two great
borrowing operations in 1871 and 1872. The transfer was much facili-
tated by the facts that about 2}>i billions were subscribed by foreigners,
Germans among them, and that there were at the disposal of French
capitalists more than sufficient foreign assets which were readily saleable.
The strain, thus distributed over a very wide area, did not anywhere
outside of France assert itself to a really uncomfortable degree. The
French commodity balance in foreign trade also became ‘'favorable for
four years — ^to the amount of 1.1 billion francs in all — as we should
expect from the classical theory of foreign payments. The effect on the
German business situation is clear from the use that was made of the
indemnity. A small part (150 million francs) was hoarded in gold by
the imperial government. An amount, estimated at 750 millions, helped
to provide the basis for the new gold currency. The rest paid for debts,
war pensions, fortresses, and so on. It is obvious, and has often been
pointed out, that this increase of monetary wealth gave an additional
impulse to the excesses of the prosperity of those years, and in part
accounts both for the violence of the crash of 1873 in Germany and for
its leniency in France. In fact, it is reasonable to suppose that the
safety reserves for a gold currency being ready at hand not only meant
that the pressure was avoided that otherwise would have attended their
accumulation, but also that credit conditions were eased beyond that.
And it is certain that a still stronger effect in the same direction was
exerted by the replacement by cash of a considerable part of government
obligations, and by the increase in unproductive expenditure on war
pensions, armaments, and so on. Here, then, we have not only a case

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Business Cycles

that illustrates very well the effects of adventitious ‘‘liquidity’* in general,
but also a causal element (obviously an external one) in the pattern of
one of the three greatest crises, as well as depressions, within the whole
stretch covered by our material, the postwar time included. It is inter-
esting to note the modus operandi of that element. As far as either our
facts or our schema will permit us to judge, it did not alter the cyclical
rhythm. We should have expected prices to rise and a period of super-
normal promoting and other business activity to set in without it. The
mechanism of prosperity was actually in full swing before, and a major
setback would have been due in any case. What that liquidity did was
to accentuate amplitudes by facilitating the operations which we com-
prise under the heading of Secondary Wave and by widening artificially
the scope for error and misconduct.

4. By far the greatest and the most interesting “external disturbance ”
of the period was, however, the American Civil War. Barring the
physical injuries to the productive apparatus of the country, which (again
illustrating the difference between misery and depression, or welfare and
prosperity) had very little cyclical importance^ (what cyclical importance
they had was in the prosperity direction, for reconstruction supplied the
basis for a postwar boom), its effects bear a striking resemblance to the
effects on this country of the World War of this century. We have an
understandable financial and commercial earthquake at the beginning,
and stringency and stagnation lasting almost to the end of the first
year of hostilities. Then, helped by a good crop, a typical war boom
developed in response to government demand supported by the issue of
the greenbacks. The conflicting forces of the postwar boom and of
postwar hquidation impinged on a rising cyclical (Juglar) tide which in
this case it is very easy to distinguish from the effects of the external
factor, because it was so clearly based on a development that had nothing
to do with the war — ^railroad construction. Most of the effects and
after-effects of the war were drowned in the rise and break of that wave,
and although some of the fluctuations in the last sixties have to be
attributed to them, neither the cyclical rhythms nor trend results were
affected enough to become unrecognizable. Even the difl&culties in 1866
and 1867 were not due to postwar adjustments alone. But the question
still remains what importance we are to attach to the monetary element
during the seventeen years of the greenback standard.

Again — as in all such cases, the English one after 1815 and the
American one after 1918, in particular — ^it is a matter of definition

^ Physical destruction of plant and stock was quickly repaired — J. Stuart MiU com-
mented on this — as it always will be so long as the capitalist engine is intact. What mat-
ters economically in such cases (morally, other things matter much more) is impairment of
the capitalist motive power and mechanism, rather than physical loss. And that motive
power and mechanism had in this case not suffered at aU.

Historical Outlines

315

whether we can speak of deflation at all. In our sense there was none,
for there was neither net contraction of the volume of the circulating
media nor any pressure on the money market, such as we might expect
would attend a policy of raising exchanges to gold parity. A sector of
public opinion was in favor of both, and Secretary Hugh McCulloch’s
report of December 1865 actually envisaged both. Looking upon green-
backs and compound-interest notes in the most orthodox light, he
proposed to fund them by means of bond issues and in fact set about
retiring them out of surplus revenue. This policy at first met with an
astonishing amount of approval, both from the President and from
Congress. But it was presently curbed by the act of April 12, 1866.
Retirement actually effected was quite small and more than compensated
by the expanding circulation of the national banks’ notes. ^ The Secre-
tary was probably right when, several years later, he stated that but for
the Treasury’s monthly statements nobody would have known that there
was any retirement at all. What eventually happened was what his
successor and Congress professed to aim at — ^the economic organism was
allowed to grow into its monetary coat.

Pressure on the money market was — ^with but few local exceptions —
also avoided through various favorable circumstances. No great efforts,
such as might have crippled business success, were needed to restore the
Federal budget to order. On the contrary, it was possible to begin
reducing the Federal debt from its 1865 peak of 2,675 million dollars.
The situation of banks was further eased by the emigration of American
bonds to Europe, which set in almost immediately, and by other foreign
credits which became available to American business; but it was strong
from the beginning. In 1866 national banks held legal-tender reserves
to the amount of 211 millions, against deposits of 539 millions. This is
but one symptom of a fact that is most important for the diagnosis of
the inflation as it stood at the end of the war. It had not taken full
effect, ix.y it had never gone beyond that stage in which part of the
swelled receipts are being used for increasing cash and paying off debts
— ^it had never become ‘‘wild.”^ Part of the rise in prices in 1864 was
not the mechanical effect of the quantity of greenbacks but was due to
the impediments to production and trade and to speculative anticipation,

^ At the close of the war, 431 millions of greenbacks were outstanding. The resumption
act still authorized a maximum of 346,681,000 dollars (see W. C. Mitchell’s History of the
Greenbacks and D. R. Dewey’s Financial History of the United States). National bank
notes in circulation rose, with fluctuations, to 352 millions in 1882. Decrease to 162 mil-
lions in 1891 had various technical reasons, among which the spread of the habit of payment
by check was the most important, and thus does not mean a reduction of the amount of
circulating media. Also see D. C. Barrett, The Greenbacks and the Resumption of
Specie Payments, 1931.

2 The only circumstance that seems to contradict this is the practice of exchange houses
that developed in 1864 of quoting in gold instead of in currency. But this was due not to

316

Business Cycles

and the whole of the fall to the end of 1865 (a fall of, roughly, £2 per cent
of the level of September 1864) was simply the reversal of this, an adjust-
ment to the actual amount of fiat, not the consequence of any stringency
or pull at the monetary rein.

On the whole, industry emerged from the period of hostilities in a
liquid state, though not so much so as it did in 1918. Banks, being still
more liquid, soon began to expand credit in the rising wave of prosperity.
Loans and discounts of national banks increased from 500 to 900 millions
from 1866 to the end of 187£, while loans of the New York City clearing
house banks moved around a fairly even level till the end of 1869.^
This is not contraction. Moreover, the monetary element obviously did
not depress output which, on the contrary, made new records throughout
the period to the Resumption Act — except in 1871, 1874, and 1876 — and
increased by 50 per cent per capita, in spite of the huge wave of postwar
immigration. It did not prevent increase of money wage rates to 187£,
nor decrease in rates of interest, nor even lax habits of lending and
speculative excesses. As far as it has anything to do with Black Friday
and the crisis of 1873, it was not through stringency but through its
opposite. The inference seems to be unavoidable that stabilization of
the dollar at the peak of the gold premium or, in fact, any devaluation,
would have enforced continuance of inflation, still more excesses, and a
still more severe crisis. This is not to deny that the fall in greenback
prices — ^rapid to 1871 — spelled hardship for large sectors of the com-
munity, the agricultural sector in particular^ — wheat fell to nearly half
the 1866 price by 1870, cotton to less than half within a year — ^nor that,
although the monetary factor evidently accounts for only a minor part
of this, devaluation and continuing inflation would have brought tempo-
rary relief to those sectors.® Finally, the importance for our under-
standing the nature of the cyclical process of evolution, of this case of
prosperities accompanied by prices that were not only falling (1866-1880,

any “ flight from the dollar” but simply to the rapid and erratic changes in the price of gold
which made quotations in currency technically unworkable.

^ For this and the following statements, as well as the general statistical picture of the
period, see W. M. Persons, P. M. Tuttle, and E. Prickey, Business and Financial Conditions
following the Civil War, Review of Economic Statistics, Prel. vol. II, 1920.

2 The woolen textile industry also saw its war profits vanish. But objective facts do
not, in general, bear out the description of business as “depressed” and “unsatisfactory” —
which epithets frequently occurred‘in the press of that time. Cotton and iron, in particular,
expanded vigorously (see Report of the Commissioner of Inland Revenue for 1867). The
general picture exactly fits our idea of a Eondratieff recession. The complaints probably
mean reduced profits.

® The discussion of the behavior of price level in that period will be resumed in Chap.
VIIL

Historical Outlines

317

at an average rate of about 4 per cent per year) but also expected to fall,
cannot be too strongly pressed upon the reader’s attention.

5 . After 1878 progress toward full ratification of the gold standard,
which eventually came in 1900 (Gold Standard Act of March 14), need
not have been difficult. If, nevertheless, it proved to be so, this was not
due to any hitches in the working of the monetary or the economic
system, but to the temporary success of the silver interests. This
“external factor” — and the case illustrates well in what sense and why
politics can be considered as an external factor — from 1876 to 1896
repeatedly threatened to block the road and adversely influenced business
situations mainly in two ways. First, both American and European
business opinion, seeing some and anticipating further success of silver
politicians, tried to prepare for possibilities and responded in a way
which should be highly instructive for any mind at all open to factual
evidence about the economic — ^let alone moral — ^importance of safe and
stable currency conditions. Second, the mechanical effect, as distin-
guished from the effect on anticipations, of the silver actually bought
was to jeopardize the gold position of the country, which but for this
would have been very favorable throughout. For instance, from 1891
to 1893 there was an export of gold to the amount of $155,000,000 for
which neither the unsatisfactory crops and prices of 189£ and 1893 nor
any other element in the situation will fully account. The Treasury,
then the only guardian of the national gold reserve, had, for both reasons,
to face a task that at some junctures (1884 was the first) looked hopeless.

The currency factor was a major source of weakness during the
vicissitudes of 1893 and was primarily responsible for what proved a
specifically American catastrophe, not otherwise fully motivated, in 1896.
But while silver thus undoubtedly influenced cyclical situations, it did
not do so in the manner we should expect from a perusal of the Bland
(1878) and Sherman (1890) acts. The provisions of the former, although
the free-coinage clause — ^free coinage of silver had been abolished in
1873 — was defeated in the Senate, were in themselves quite sufficient to
impart an “inflationary” impulse to the system. Yet the price level
continued to decline from 1886 on, as mentioned above, even more than
in England. The explanation lies in the policy of the Treasury. The
passing of that bill really meant a drawn battle: the sound money front^
had had to give way, but it stuck to the guns of the gold standard. In
moving, as it were, on the resultant of these two component forces, the

^ The reader will observe that for our purpose it would not make any difference if that
expression, which is intended to be neutral, were replaced either by “the conscience of
America and “all decent or serious people'* or else by “criminal usurers," “capitalist
exploiters."

318

Business Cycles

Treasury, while obeying the letter of the law, buying silver in the amount
required and doing something toward putting it into circulation, at the
same time did its best to prevent it from taking effect. The issue of
small greenbacks, for instance, was discontinued in 1885. Some gold in
the New York associated banks was, at the same time, replaced by silver.
Besides, silver was allowed to accumulate in the Treasury's vaults and
thereby was “sterilized.'' This policy meant sailing close to the wind,
but it succeeded because of several favorable circumstances.

As has already been pointed out, barring the effects of the silver
experiment, the gold position of the country was favorable, in some years
that might have been critical exceptionally so. Moreover, the fall in
interest rates induced an increase in United State bond prices, which
backed the notes of national banks. The value of the right to issue notes
being decreased thereby, the amount of national bank notes outstanding
shrank by about £00 millions during the eighties — a process which was,
of course, quickened by the Treasury’s policy of debt redemption.
Finally, the surpluses which made that policy possible also facilitated
accumulation of idle silver. Whatever may be thought of the spending
of 300 million dollars or so on the purpose set by the Bland act, effects
on prices and on the rhythm and the trends of the cyclical process must
have been small, if not altogether absent. The same, or almost the
same, is true of the Sherman Act, which much more obviously suggests a
compromise between the necessity of satisfying the silver interests and
the wish to keep the gold standard — ^notwithstanding the declaration
about “the established policy to maintain the two metals on a parity
..." It is particularly significant that the monthly amount of silver
to be bought (4,500,000 ounces) was to be paid for in “treasury notes”
which were legal tender in every respect but redeemable in gold or silver,
as the secretary might see fit. Tactics veil intentions. But facts seem
to warrant the interpretation that the leaders of the gold party, faced
with an attack which was irresistible because some of them and many of
their followers needed the support of the silver party in order to gratify
their own protectionist desires, decided to reculer four mieux sauter on the
strength of two observations and a hope. The observations from recent
experience were, first, that the Treasury could stand a lot of strain and,
second, that silver could be turned into redeemable fiat — ^which is the
way that in fact, though not in law, it had been worked under the Bland
Act — and thus prevented, for a time at least, from swamping the mone-
tary system. The hope, according to this interpretation, was that
tactical and economic situations would sooner or later arise in which the
dragon might be killed. They had not long to wait. Eighteen hundred
ninety-three came and brought repeal.

Historical Outlines

319

B. The Agriculttiral Situations of the Period. — ^These situations sum
up and reflect both one of the outstanding results of capitalist evolution
and its repercussions, with a clearness that leaves nothing to be desired.
In a first approximation, the story of the way in which civilized humanity
got and fought cheap bread is, for our period, the story of American
railroads and American machinery^ (toward the end of the period, dry
farming must be added). We will at once notice some points which in
part account for peculiarities in the modus operandi of these two inno-
vations. First, the policy of land settlement entered upon after the
Civil War greatly helped to propel the process and stands in a relation
of interaction with railroad building. It increased and it directed toward
the land a stream of immigrants which, but for it, would have flowed in
more slowly. This qualifies, but does not invalidate, the sweeping state-
ment just made: neither immigration nor land policy comes entirely
within our schema, but neither of them is independent of the process it
describes. Second, those two innovations did not arise in the agricultural
sphere. Transportation service was wholly, agricultural machinery
mainly, the product of industrial initiative. This entailed an important
consequence, particularly obvious in the case of transportation. Typi-
cally, a railroad opened a region, built elevators, prepared many things
for the would-be farmer, sometimes even furnished instructions about
products and methods. Any hardy couple which was at all of the type
embodied in Grant Wood’s "'American Gothic” — and many which were
not — could go out to the Middle West or the Far West and know exactly
what to do and how to do it. Therefore, the agricultural effects of each
railroad asserted themselves with a rapidity which would have been

^ Some o£ the developments in the field of agricultural machinery will be mentioned
later. Exact estimate of the labor-saving effect is diiEcult, even if confined to the saving,
per unit of product, of labor on the farm or, perhaps, owing to the large local differences in
actual practice, impossible. For the nineteenth century there are many data, some
obviously unreliable, about the saving in individual operations. The Thirteenth Annual
Report of the Commissioner of Labor ( 1898 ) contains a very comprehensive estimate which,
owing to its date, it is very tempting to use. The writer has, however, come to the conclu-
sion that he cannot take upon himself the responsibility for using it. Such inquiries as he
has been able to make have convinced him that that very important desideratum of Ameri-
can agricultural economics is not only unfilled but not likely to be fiUed for the span of
that Kondratieff. But Mr. Leo Rogin’s analysis should be mentioned (The Introduction
of Farm Machinery, University of California Publications in Economics vol. 9 , 1931 ).
Two periods of great increase of production — 1867-1880 and 1890-1898 — are, however,
clearly associated with either older machinery (McCormick’s reaper, Cahoon’s seeder)
coming widely into use or new machinery being added (disk drills, separators, self-binders,
big threshers, and many others). Reduction of cost through labor-saving appliances, not
increase of yield per acre, was what this mechanization aimed at and achieved. Increase
in total output was brought about by increase in acreage.

S20

Business Cycles

altogether impossible in the case of a genuinely agrarian innovation, and
this tended to shorten periods of agrarian prosperity in our sense. ^

For America, however, the consequences were, third, mitigated —
during by far the greater part of the period even reversed — by the fact
that wheat and cotton production faced a world-demand schedule that,
in real terms, shifted upward all the time. If that production had been
monopolized instead of being perfectly competitive, it might still have
been during that Kondratieff the best long-run policy to extend acreage
and to produce simply as much as possible. For the time being, and
before competing sources of supply were opened (Argentina in particular),
progress in shipping and fall in ocean freight rates worked in the same
direction. But, fourth, those consequences were intensified by the fact
that in agriculture the ‘^old firms’’ in our sense are not eliminated so
quickly as in industry but go on producing much longer. This is the
phenomenon which, if there were not objections to using a term which is
associated with so much faulty reasoning, we should call agrarian over-
production. Although the old, on which those innovations would, if our
process had been allowed free sway, have passed sentence of economic
death, was mainly located in Europe, some effects of this type show also
in the Northeast of this country. But dairying, vegetable growing, and
so on then, before the time of modern refrigeration and canning, afforded
much more compensation than they do today, and New England farming
was able to contract by the comparatively painless method of the farmers,
without ceasing to be farmers, moving to the West at the expense of
abandoning investment.

In order to bring out a very simple but also very important point,
we will, for the argument of this paragraph, assume that there are not
any chance variations in crops or any effects on yield per acre of inno-
vations — ^which are assumed to act on costs and acreage only — so that
the latter remains constant from year to year. Then we can say that for
American agriculture, taken as a whole, variations in earnings and vari-
ations in prices of products were indeed very different things and that, in
particular, falling prices were perfectly compatible with rising earnings
— ^to some extent even the condition for increase in earnings from sales to
Europe. But it is also true that for considerable sectors, and for many
individual cases in all sectors, money earnings were, under our assump-
tion, simply proportional to prices. These sectors and individuals were
bound to suflPer from any fall of prices below the level to which their

^ The case was not one of innovation without profits (compare the third chapter) or of
cycles without prosperity phase (compare the fourth chapter). But both profits and pros-
perities in our sense showed rather in the railroad and in the industrial than in the farming
business. What farmers earned (in good times) was of the nature of exceptionally high
wages.

Histobical. Outlines

321

locations and methods were adapted. Such a fall must occur by the
working of our process and is, in fact, an essential part of the mechanism
which spreads the fruits of progress and redistributes productive resources
in accordance with the requirements of the new situation. It would have
occurred even if there had been no other innovations: agrarian develop-
ments alone would have been sufficient to depress the general price levels
but all other innovations worked in the same direction.

Now, because of the favorable shift in European as well as American
demand, mentioned above, and because of those other innovations,
agrarian prices did not substantially decline, during our period, relatively
to other prices. As far as this goes, even those farmers whose earnings
were proportional to prices of products suffered only to the extent to
which the prices of what they bought were retail prices which did not
fall as much as the wholesale prices they got, and to the extent to which
protection prevented nonagrarian prices from reacting as they would have
done without it. It was debts, particularly debts incurred for the
acquisition of the holding, which gave to the fall in the price level its
sinister connotation. This would have been so in the absence of any
speculation in farm land and even if nobody had ever bought a farm in
erroneous anticipation of rising product prices. But both these factors
added dark hues to the picture. This seems to do justice, and at the
same time to assign limits, to the view which links agrarian prosperity
and distress simply with prices. According to Technical Bulletin £88,
U. S. Department of Agriculture (D. L. Wickens), £7.8 per cent of all
farms operated by owners were mortgaged in 1890, to 35.5 per cent of
their value — ^figures which, while showing the seriousness of the situation,
also show that at least three-quarters of all farms (for among the mort-
gaged ones there must have been some that carried the burden without
distress) cannot have been vitally affected. There were other debts
besides the mortgages, of course, for which the writer has not been able
to make or get any reliable estimate; but these were mostly short-term
bank debts and, in all normal cases, amenable to current adjustment.

This analysis supplies the theory of what is generally known as the
agricultural depression^ of the last quarter of the nineteenth century,

^ Space forbids elaboration, and this may well create, particularly in tbe mind of agri-
cultural economists, an unfavorable impression. We have not been able to point out for
instance, that owing to the ** economic lag of agriculture,” the farmer gains more in improv-
ing and suffers more in worsening conditions than the manufacturer, that the increase in
land values which occurs during a boom intensifies difficulties afterward, that marketing
cost being sticky, farmers' incomes rise more in booms and fall more in depression than
prices at centers of trade, and so on. But nothing of this alters our argument. Tor a
very good exposition, the main results of which apply very generally, see C. Dampier
Whetham, The Economic Lag of Agriculture, Economic Journal for December 1925.
Also H, Belshaw, The Profit Cycle in Agriculture, Economic Journal for March, 1926.

322

Business Cycles

whicli bears, mainly because it occurred in about the same segment of
the Kondratieff, so unmistakable a family likeness to the agricultural
depression of the post-Napoleonic period. For America, it should be
dated 188£ to 1890, for in 1891 the acreage harvested again starts expand-
ing, and 1877 to 1881 were years of either good harvests or good prices or
both, the bumper year, 1879 (rich crop plus high prices owing to failures
in Europe) and 1881, the year of maximum price of wheat (119.2 cents
per bushel, December farm price) being among them. The reader will
observe that the monetary factor has not so far been assigned any
independent (causal) role, our analysis having been exclusively in terms
of the process described by our model. It is, indeed, believed that this
explanation accounts for the essentials of the case. But by itself it is,
nevertheless, inadequate for the period 1848-1869.

Californian and Australian gold was, of course, a factor in the expan-
sion and in the behavior of prices during that time. The rise in prices
to 1866 and the incident speculation in farm land induced an agrarian
postwar crisis — see preceding section — ^which, however, lasted three
years only. But after that our process is subject to much less disturbance
and is much more nearly adequate to explain the course of things. From
1866 to 1880, the acreage harvested increased from 15.4 to over 38
millions. This is quite enough to bear out the view taken. ^ The long-
run tendency of prices accords perfectly, though short time peaks and
troughs occur irregularly in response to variations in American and

1 Exception to the above analysis will be taken, not only by those economists who make
agrarian prosperities and depressions (these terms do not now carry the technical meaning
assigned to them in this book) wholly a matter of the behavior of money, but also by some
who do not. The latter may hold that by our neglect of the decrease in gold production in
the seventies and eighties, we make outselves guilty of a one-sidedness similar to that of the
purely monetary explanations. This is not so. The gold factor is not neglected but,
though only implicitly, fully taken accormt of. It is not mentioned explicitly, except for
the fifties and sixties, because it was only then that it played an autonomous role. Nor do
we deny that the monetary factor could have behaved, or have been made to behave, in
such a way as to avoid that fall in price level. Any effective inflation would have done
that and brought relief to debtors, agrarian and other. What is objected to, in any diag-
nosis of the agrarian depression which n^akes gold production the central fact about it, is
that not only does it look merely at the agrarian problem, failing to see it as an element of
the process of economic evolution, but also that it looks even at the agrarian problem only
from the standpoint of a single surface fact. And what is objected to in the motivation of
any policy — ends of policy we neither espouse nor object to — ^based on that diagnosis, is
that it not only looks at the agrarian problem exclusively from the standpoint of the interest
of the agricultural producer, but even neglects all the real problems of that producer. To
avoid misunderstandings, the writer wishes to say what may be gleaned also from other
remarks in this book — that he is not out of sympathy with measmes in support of a healthy
class of bona fide farmers, and does not think it ought to be allowed to perish. But there
are ways of helping them without interfering with the efficiency of the capitalist machine
and without producing consequences other than those that such a policy is intended to serve.

Historical Outlines

323

European harvests. Prices of farm products in general rose (see Warren
and Pearson’s index. Prices, p. 26 ) fairly steadily from 1843 to 1857 — a
rise which almost exactly covers the prosperity phase of the second
Kondratieff — and then fell, as again they should have done according to
our schema, to a level in 1861 (75, on a 1910-1914 basis), somewhat
above the level they again reached at the time when the effects of the
Civil War disturbance were substantially digested (1878 : 72). They
continued their downward course, as we should expect, to 1896 (56).
The minimum in December farm price of wheat (48.9 cents) occurs in
1894 (cotton was near its minimum in the same year) and in 10 years,
during the period from the Civil War to 1897, it was below 75 cents. Of
these, nine years were between 1884 and 1897, the fall after 1891 being
again associated with increase of acreage.

As stated above, English and German agriculture drifted during that
Kondratieff, as far as the money crops go, substantially into the dismal
position of the Old Firms in our model. In the upswing and to the
beginning of the seventies, the effects of the prosperity phase, enhanced
and prolonged by the new gold — ^the Californian and Australian gold
discoveries were indeed a stroke of luck for English free-trade policy —
prevailed, but as soon as those factors ceased to act and ocean freight
rates, after 1873, started on their downward course (their minimum, for
our period, which occurs in 1894, is little more than 20 per cent of the
figure of 1873), an agrarian depression set in, in a sense in which there
was none, except locally, in the United States. If it be correct to make
the impact of American (later, also Argentinian and Australian) products
the mainstay of the explanation we must find the situation particularly
serious in free-trade England. So we do. The total of the income from
ownership of land in the United Kingdom, as published in the Statistical
Abstract, is for various reasons not quite satisfactory evidence, but it is
still significant that it fell from its maximum, which occurred in the late
seventies or early eighties, practically (though of course with fluctuations)
until the World War. English agriculture was again — as in the twenties
of the nineteenth century — saved from disaster by her system of land
tenure, which prevented resort to credit for the acquisition of land. This
accounts for the orderly retreat. But such retreat was actually necessary
(farmers and agricultural laborers were, in 1881, 13 per cent of the
population), though the total area in cultivation did not decline. Adap-
tation was, however, not only by abstention from expensive investment,
such as in drainage. There was, also, further improvement in crop
rotation, machinery, and concentration on certain high-grade products
— ^beef and mutton among them; these products were also sheltered by
the preference of the English consumer — ^for which there was no serious
competition until the nineties, although there was some for dairy products.

324

Business Cycles

In consequence, we again find in the depressive picture a considerable
number of brighter spots. For instance, Cheshire, Lancashire, Devon-
shire, and Northumberland seem to have borne up well.

In Germany, protection (1879, increased 1885 and 1887, reduced
1891), complicates diagnosis. It was by no means an unmixed benefit
to German agriculture as a whole. The bulk of the peasants, most of
whom were not sellers of grain to any vital extent, reaped little advantage
and some of them who bought fodder suffered from it, as did the fattening
establishments in the Northwest. There is no doubt, of course, about the
effects on the medium-sized and large estates, particularly in the East,
both of the imposition and increase and of the subsequent decrease of the
import duties. These estates had, in the times of rising prices and rising
land values, run into debt to a very considerable extent, and, speaking
from their standpoint, we have hence to date the agricultural depression
— ^which, like the English one, is not primarily an element of the
cyclical process but due to the impact of what for these countries was an
external factor, foreign innovation — ^with reference to prices, from
1873, when the increase that had begun in 18^3 came to an end, to about
1896 (according to the index of the Institut fiir Konjunkturforschung)
with an acute phase from 1880 to 1886. Land values did not fall, how-
ever, or did not fall enough for such data as we have to show the fact.
Also, that indebtedness had in part been incurred for productive purposes,
of which some come within our definition of new production functions,^
though others were ameliorations which yielded but little surplus over
interest: many of the larger estates went through complete reorgani-
zations, improved machinery was widely used, new methods of fertilizing
came in, agricultural industries continued to expand (sugar production,
for example, was very lucrative most of the time, although the price of
sugar—artificially pegged before the Brussels Conference— fell to 1906).
Producers were, therefore, able to meet falling prices by increased output,
which did not, under the circumstances, necessarily defeat its purpose.
There was another reason for reacting in this way to falling prices. More
than in industry, the element of effort elasticity asserts itself in agri-
culture. If incomes fall the agricultural producer may, under the
stimulus of higher marginal utility of income, respond by greater exertion
and more careful management. For both reasons incomes did not fall
as much as prices. On the other hand, one feature of our process was

^One of the most important branches to be improved was potato growing. Since
prices of potatoes fell less than those of grains, the great increase both in acreage and in
yield per acre must have considerably alleviated the situation. The writer takes the
opportunity to recall that in Germany rye, and not wheat, was the standard material for
bread. This was, though not unaffected, yet less affected by American wheat. But there
was the Bussian competition instead.

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325

just as mucli in evidence as in England, the industrial entrepreneur's
demand for labor. Those German landowners who had to rely mainly
on hired labor began to suffer from the agricultural laborers ‘‘flight from
the land,” although in the East this was in part met by resort to Polish
labor.

The peasant was not much affected by the latter difficulty. He was
also probably less deeply in debt, although ample credit rope had been
provided for him to hang himself.^ If he was unencumbered, prosperity
and depression meant little to him. Moreover, butter and pork kept up
very well throughout — ^which fact, incidentally, is in itself sufficient to
negative the idea that failing purchasing power of the masses had any-
thing to do with such plight of agriculture as there was. The new
methods, however, and in particular the new machines, did not help him
much and would not have done so even if they had all been applicable to
his holding and if he had been the acme of alertness. For as far as they
were labor-saving they would not — ^his own and his family's labor being
part of his overhead as it were — ^have improved his competitive position.
As to relative prices (“purchasing power”) of his products, he was all
right as far as his prices were retail prices, which, of course, was much
more often the case than in England, let alone America. When they
were not, his purchasing power during the eighties declined as against
the articles he bought. The statistics of foreclosures do not give a clear
picture before 1886, but indications suggest that the percentage of mort-
gages foreclosed was never serious either for small or for large agricultural
holdings.

The effects of the fall in agrarian products on the standard of life of
the masses — ^much greater than those of the fall that the first Kondratieff
had brought about in cotton fabrics — ^need no comment.

C. Railroadization. 1. While for this country railroadization was still
more obviously the “big thing” or “backbone” of the bourgeois Kon-
dratieff than for the other two, it really got under way, if we judge by
mileage added, in 1849, i,e., about six years later than in England. The,
roughly, 1720 miles added in 1840, 1841, and 1842 failed to produce any

^ Even the Reichsbank was forced throughout its career to countenance, directly but
mainly indirectly, extensions of credit to the agrarian interests which it would never have
thought of countenancing without the political power behind the applications. The excel-
lent organization of agricultural credit culminating in the ‘‘Preussenkasse’' and the way
in which the savings of the small man were, through the saving banks, forced into agrarian
channels, are other instances of a policy that never dared to face fundamental issues. It
was in Germany, however, (K. Rodbertus) that the truth began to dawn that the ordinary
forms of credit are not a safe thing to handle for either peasant or Junker. The legal insti-
tutions of the Grundschuld and Rentenschuld were the first fruits of this discovery, and useful
as far as they went.

326

Business Cycles

of the symptoms of prosperity and were, moreover, the leavings of the
boom of the thirties rather than the first installment of new develop-
ments. The New England railroad boom which contributed so much to
Boston’s prominence at that time (connection with the Erie Canal and
Buffalo) began in 1847, but meant little until 1849. By not dating
accordingly — but the reader is welcome to do so; it does not make any
difference to the analytic schema presented — we are acting on the theory
that the irregular twin peak in the thirties upset the course of events^
which would otherwise have been more like that in England or Germany
and that we are but ‘^reconstructing the temple in ruins” if we date as
we do. The ruins in question or, without metaphor, the indications that
guide us, are the time series; receipts from land sales began to increase
in 1842, deposits (Due Depositors: New York City Banks) and stock
prices soared in 1843, when also prices started to rise (see Smith and
Cole, op. cit,; about prices in particular see charts 17-22). Liquidation
of the excesses associated with wildcat banking stunted, according to
this view, the beginnings of the prosperity phase of the new Kondratieff,
and this accounts for the mildness of the setback — ^the strong term crisis
is hardly applicable — at the end of 1847, Several good crops, English
free trade, and the Californian boom helped to shorten the ensuing
depression, which covers not quite a year (1848) and to accentuate
revival, which — still according to that theory — also made up for what the
stunted prosperity had failed to bring about.

Transition to the prosperity of what, then, has to be counted as the
second Juglar was effected in an atmosphere of boom, unusual expansion
of credit and speculation, particularly in land and railroad stock, to all
of which Californian gold (since 1850) and the favorable development of
foreign trade lent their aid. The warrant for speaking of a new Juglar,
although the curve of new (less abandoned) mileage displays nothing but
a dip in the year from which we date it (1852), is in the shift of building
activity from New England to the Central Atlantic and the Middle
Western states, which clearly meant a distinct new step within the
Kondratieff process: this statement should be compared with the dis-
cussion on possible relations between longer and shorter cycles in the
fourth chapter. The reason why we do not attach more weight to the
setback which occurred as early as autumn 1858 and lasted through 1854
and (almost to the end of) 1855 is that it seems to have been entirely
due to speculative excesses — ^in part, no doubt, fostered by the new gold
— and to their repercussion on railroad construction. Therefore, we date
prosperity plus recession of that Juglar from the beginning of 1852 to

1 Clement Juglar's authority may be quoted in support, see Crises Commerciales, 4th
ed., p. 468.

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327

the second half of 1856.^ Finally, the reason why we do not attribute
to gold anything beyond excesses and reaction to excesses (and such
disturbances as the failure of the rates of interest to rise promptly and
“tight’’ situations consequent upon this) is that the railroad construction
was clearly under sail before the Californian gold began to act, and that,
looking at the data of the situation, we do not see any justification for
holding that that process would, barring those excesses, not have run its
course or produced its effects without it. Part of the rise in price
level we do attribute to it.

The quantitative adequacy of expenditure on railroad construction
is beyond doubt: the trackage operated reached about 30,000 miles by
1860, and the capital debt of railroads alone then was about 900 million
dollars; for actual cost of construction, there is no reliable estimate, but
it certainly exceeded that sum,^ of which about three-quarters were spent
in that decade. Beyond doubt, too, is the truly revolutionary effect of
the mileage opened. Freight rates fell drastically and by 1854 averaged
between two and three cents per ton-mile. The entrepreneurial function
consisted, in this case, not so much in visualizing possibilities — everyone
saw them and speculated on them — or in the solution of technological
problems — ^the locomotive functioned sufficiently well by that time and
was thenceforth improved almost automatically by a series of typically
“induced” inventions, and no major problems impeded the building of
the lines — as in the leadership of groups, in successfully dealing with
politicians and local interests, in the solution of problems of management
and of development in the regions the roads opened up. It was “getting
things done ” and nothing else, a variety of pure entrepreneurship stripped
of all accessories. But this entrepreneurship was often split between
several individuals and is not always easy to attribute to any single one.^

2. As regards financing, we must distinguish the task of creating
the conditions of profitableness of the enterprise from the task of

^ If the reader compares the above with Mr. Thorp’s grading of the individual years, he
will find that there is little difference between his and our appraisal of the facts. But
again it must be pointed out that there is considerable difference in terminology. In
particular, he describes 1856 as a year of prosperity (to the last quarter, for which he also
notes depressive symptoms) while for us this year ends the recession and ushers in the
depression phase of that Juglar. It is hence important to remember that conditions which
justify speaking of prosperity in the usual sense of the word are by no means incompatible
with our idea of a Juglar recession (in our sense) which lies within the prosperity phase of
a Kondratieff.

2 The report of President Schuyler of the Illinois Central to his board estimates at 16.5
million dollars — StS,570 dollars a mile — the cost of construction for 700 miles. But for
that decade of rapidly rising prices, actual costs must be put much higher than that.

® In many cases, the promotor was the entrepreneur in our sense or, at all events, the
first of the entrepreneurs who took hold of a line. But sometimes he was not more than
a financial or political agent.

328

Business Cycles

providing the money for construction. That the first should have
been a distinct task is due to the fact that the Middle Western and
Western projects could not be expected to pay for themselves within a
period such as most investors care to envisage. Many of them meant
building ahead of demand in the boldest acceptance of the phrase and
everyone understood them to mean that. Operating deficits for a
period which it was impossible to estimate with any accuracy were part
of the data of the problem. In a sense, any construction under such
circumstances implies ^‘overdoing it.’’ But this concept is hardly applica-
ble to a situation in which, without producing some of the effects of over-
doing, the thing could not have been done at all. Under different
environmental conditions and with a political structure different from
what it was, those circumstances might have constituted a strong case
for railroadization’s being planned and executed by the national govern-
ment, as it was in Russia by the imperial bureaucracy. State enterprise
was, in fact, prominent in the early stages of American railroad develop-
ment; but by that time it had failed.

Since many projects that were obviously socially productive (in
Professor Pigou’s sense) were not at that time paying propositions,^
additional sources of revenue, or contributions to the costs, had to be
found. Where it proved possible to secure subsidies or loans amounting
to subsidies, this at the same time helped to solve the problem of financing
construction. 2 But the solution presently hit upon in the case of the
Illinois Central Railroad, the donation of land by Congress (1850; the
immediate grantees were the states of Illinois, Mississippi, and Alabama)
did not.^ Previous profits or domestic savings being inadequate, railroad

^ The above statement involves several theoretical questions, into which it is not possi-
ble to enter here. Still less is it intended to imply anything about desirabilities. It is
certainly true that the strong desire of the people to see quick development of the railroad
system, no matter whether due to lofty patriotism, business calculation, or the interests of
speculators in land, led to a policy which accentuated booms and crises. It is also true that
the statement that something is socially productive and yet not a paying proposition,
although all its productiveness comes within the business sphere and is universally under-
stood, always requires the most careful scrutiny.

2 So did the guaranty of capital and interest of bond issues, such as was granted after
the Civil War to the Southern and the Union Pacific. Legally, these were no guaranties
but loans of United States bonds. But economically they were nothing else but guaranties
and exactly similar in nature to the guaranties of railroad bonds by European governments.

5 Prom 1850 to 1856 such land grants amounted to 20,000,000 acres. This policy went to
much greater length later on, until its abandonment after the crisis of 1873. The Northern
Pacific alone received 40,000,000. The method has often been criticized adversely. But
it was not only a special case of a much more general policy of encouragement of enterprise
that goes back to colonial times, but also, given the economic and social conditions of the
time, the most economical as well as most logical method to bring about the result desired,
hence belongs neither in the class of futile measures — i.e., measures that by virtue of their

Historical Outlines

329

construction was, therefore, mainly financed by credit creation. From
the standpoint of the United States, foreign buying of American railroad
bonds amounted to this — even if the bonds were paid for out of, say,
English savings — as did European credits extended in anticipation of
bond issues or simply as overdrafts. Foreign investing was at times
heavy. According to the estimate given in Sumner’s History of the
American Currency, English investments in this country (not only in
railroads) amounted to about 400 million dollars before 1857. Overdrafts
(though mainly for what purported to be ‘‘regular” commercial credit)
were granted, in many cases, with almost unbelievable freedom and
carelessness. Domestic credit creation was even more freely resorted to.
We do not know its amount, but we can, in most cases, trace it in one or
more of the following forms: direct lending by banks to companies
against their notes or on bonds to be sold later to the public; financing
the subscriptions of the promoting groups or of the public (in which case
we must, as has been repeatedly mentioned before, also take account of
the fact that a customer may borrow for other purposes because by
subscribing he binds means which would otherwise serve these); and
financing speculation — there is a significant coincidence between the
increase of railroad stock prices and of deposits in 1S52. The fact that
credit, created ad hoc by both the preexisting banks and the many new
ones that emerged, to a large extent financed railroad and other inno-

nature cannot produce tLe results wMch. it is desired to produce — nor in the class of wasteful
measures — ^if we define these as measures which produce the result desired at the dispro-
portionate sacrifice of productive resources or together with results which partly or wholly
counteract the desired ones. The idea underlying it is to apply part of the values which
an enterprise will create hut which will not accrue to it (to some extent this happens in every
case) to the purpose of recovering part of its costs. This is, in itself, perfectly sound eco-
nomics. Colonization was not impeded, but furthered, thereby; “monopolistic exploita-
tion’’ of settlers seems to the writer to have been little more than a political slogan. That
policy really amounted to no more than the removal of the obstacle which the national
dominium eminens of land put into the way of evolution. And it was discontinued as soon
as the development of the milieu made it unnecessary — as shown by the case of the Great
Northern, which was a success without it, and by earlier instances. Now, although all
of this is nothing but factual analysis which the writer is prepared to defend on purely
scientific grounds, he still confesses to a wish to avoid the addition of unnecessary differ-
ences of opinion between his readers and himself to those that are unavoidable. He there-
fore begs leave, because of the implications the argument of this note seems to carry, to
drop for a moment the analyst’s overall and to state his conviction that had it been politi-
cally leasable to entrust an ideal civil servant with dictatorial power over all railroad
matters and all the land, this individual would have produced the same ultimate results at
incomparably smaller economic and moral costs. But the point is that no such individual
was possible in the milieu of those times and that, had he been possible, he would have
been lynched immediately by the very people whose pocketbooks and cultural attitudes
he would have been protecting.

330

Business Cycles

vation, has often been emphasized and never been contested. The
reader should refer, for instance, to Dunbar’s famous essay on the crisis
of 1857 (republished in his Collected Essays). We may illustrate, how-
ever, by one instance, the case of the Illinois Central Railroad.^

The burst of speculation which occurred in the Middle West in the
twenties and thirties and led up to the peak in land sales in the middle
of the latter decade, had really no other basis than everybody’s conviction
of the imminence of great developments. What these developments
were to be and which part of the region would lead in them was in this
case entirely indefinite, no particular locality holding any particular
advantages. Preferential positions had to be created, largely by political
action, and an anarchic struggle ensued between local communities, each
controlled by its own group of speculators — ^railroad and canal projects,
which for the moment were mostly bubbles, being the chief bones of
contention. Moves and countermoves in this struggle constituted state
politics and dominated the state legislature of Illinois, which under the
circumstances was the only possible source of powers and means. Plans
of a central railroad, which came to nothing, emerged in 1818 and 1835.
The Internal Improvement Bill, passed in 1887, provided a little over 10
millions for the carrying out of various railroad and waterway projects,
one of which may be looked upon as a second attempt to do what eventu-
ally was done by the Illinois Central Railroad Company. This time a
beginning was made, but it soon ended in collapse and discredit. Another
attempt to make headway was made in 1843, when a charter was granted
for the Great Western Railroad Company, which after failure was
renewed in 1849. Soon after this, however, the campaign in Washington,
first for a right of preemption of land, and after that for a straight land
grant, met with success and the Illinois Central Railroad Company was
chartered and organized in 1851.

There is no need for any comment on the nature of the proceedings
which thus inaugurated the colonization of a great part of the country,
or for explanation of what the entrepreneurial function so far consisted
in. The financial group which eventually found themselves in control of
the enterprise (the same which had bought the Michigan Central in 1846)
were well connected and by no means lacking in seriousness. Their
methods and attitudes were fully up to the standard of their time in such
matters. The charter, which among other things provided that 7 per
cent of the gross income was to go to the state, cannot be said to have
failed to take account of public interest. But the fact had to be faced
that there simply were no means available at all commensurate with
building costs, which were budgeted at 16 }^ millions. On the stock,

1 The following two paragraphs are based on P. W. Gates, The Illinois Central Railroad
and Its Colonization Work, Harvard University Press, 19S4.

Histokical Outlines

331

which at first the group had thought of keeping to themselves, they
looked very much in the light of what in French finance is termed 'parts
de fondateurs or, to use an American expression, of velvet. They were
businessmen who had their means and more than their means engaged in
other ventures, and their behavior but too well illustrates our theory of
the logical primacy of created credit in the financing of innovation.
They did, however, pay in an assessment of £0 per cent on the first
million of stock, and both the directors and their business connections
took £ millions of bonds, to be paid for by installments. They thus
proved that they meant business, but it is not unfair to suspect that the
money they actually paid was borrowed from banks. This was the war
chest with which they embarked upon surveying. They also induced
the Michigan Central, which they controlled, to enter into an agreement
to carry, in consideration of certain concessions, another £ millions of
bonds of the Illinois Central. The fundamental idea, however, was from
the beginning to sell, or borrow upon, mortgage bonds secured on the
land grant and the right of way plus improvements. This method then
was a recognized one and for a time became still more so — in other
cases existing contracts of a nonexisting enterprise were used as security
— and it was far from being disapproved of, so long as it did not coincide
with fraudulent representations. They offered these bonds in England
and, in spite of the refusal of the Rothschilds and the Barings, succeeded
in forming a syndicate. The means so provided ran out by 1855, when
the promoters had to take additional bonds. Further calls on the
stockholders and borrowing on short-term notes became necessary before
the work was completed in 1856. Embarrassments were not ended
thereby, and in 1857 catastrophe was — even apart from damaging
revelations — perilously near, but the company, under the able manage-
ment of an extraordinary man, stood its ground and, with sales of land
developing steadily, consolidated its position. The effect of the line on
the development — or, rather, the economic creation — of its territory and
the whole country needs no emphasis.

3. Our analysis contains all the elements necessary for a diagnosis
of the crisis of 1857. It will be convenient, however, to add a few minor
points and to round off the picture, in order to show once more how what
we consider the fundamental mechanism of fluctuations combines with
accidents and incidents not inherent to its logic. To begin with, the
crisis was an international one, commercial and financial relations
between our countries (and others) being strong enough to synchronize
events remarkably and to play a large role in shaping the surface. But
it is nonetheless a fact that fundamental explanation could run for each
country in terms of its own development. Second, the crisis coincides
with, or rather lags behind, the upper turning point of that Kondratieff.

S32

Business Ctcles

All statistical indications combine to support this finding, which is all
the more remarkable because gold production could have been expected
to interfere with their behavior. It actually did to some extent, but
not enough to alter the fundamental contour. This happened later,
when the Civil War and other external factors make it possible to speak
for Europe of a ‘‘rising trend in prices up to 1873. But in the United
States wholesale prices (see the unweighted index of Smith and Cole,
op. cit.y p. 100) recovered only moderately in 1859 from the sharp fall
in the preceding year and then continued to fall until the first quarter
of 1861.^ Although gold thus failed to keep up the price level, it had,
as stated before, undoubtedly a share in bringing about the preceding
rise. This influence was exerted partly through the expenditure of
gold miners and partly through the additional facilities for credit creation
it provided. But through the whole of the upswing we observe recurrent
situations of stringency, which is exactly what we should expect. The
case shows very well how easy money, due to the action of external
factors, will on a rising tide of business always produce stringency and,
hence, is the most ineffective of means to prevent recessions.

Third, the increase in gold production and what, without explaining
again, we term reckless banking actually do account for many surface
phenomena. In particular these factors account for the sharp and short
panic that followed upon the failure of the Ohio Life and Trust Company
on Aug. 25, 1857, after which 150 banks failed up to Oct. 17: there was
a spectacular run on Oct. 13, It is only natural that public attention
concentrated on this, and that many writers at that time and later simply
formulated the popular theory that the whole catastrophe was due to the
shortsightedness of banks which called in loans in a panicky way. Although
neither this contraction nor the preceding “recklessness’* provide funda-
mental explanations, it should be emphasized that both played a very
real role in the “abnormal liquidation” that ensued and that our theory
neither requires nor justifies any attempt to discount their importance.
Difference of opinion arises only if it be held that either the credit expan-
sion or the credit contraction was the essence of the matter, and that with-
out either of the two everything would have been well. But we may go
some way with those more careful analysts of that situation who pointed
to a number of auxiliary factors which intensified the boom and the
removal of which intensified the depression. One of these factors — ^the
speculation in land — ^went to lengths entirely out of proportion with what
would have been a normal incident of the contemporaneous development
and must hence be classed as a separate factor requiring in turn special
sociological explanation. Stock exchange speculation played a smaller
role. Railroad stocks reached their peak toward the end of 1852 and

^ In Germany where the peak of wholesale prices comes earlier, recovery from the fall
in the crisis took place to but an insignificant extent, although there was then no further fall.

Histobical Outlines

383

then fell sharply to the end of 1854 in the course of what in September of
that year amounted to a financial panic and entailed a considerable num-
ber of failures. The air being thus cleared, no speculative crash occurred
afterward and the abrupt fall in the crisis of 1857 gave way to partial
recovery within the year. Another factor was of course the import of
capital, of which the unfavorable balance in commodity trade between
1850 and 1857 was a symptom. This certainly contributed to making
the situation more sensitive than it otherwise would have been. The
very good wheat and cotton crops of 1855, which were sold at favorable
prices, also gave an impetus to all sorts of activities which then added
to the difficulties of liquidation. Of other causes contributing to the
slump there is a long list.

Fourth and finally, however, there cannot be any doubt in this case
of the reality of the fundamental explanation following from our schema.
This has so often been emphasized by the most unsophisticated of writers
that we can confine ourselves to a few remarks. Eailroad construction
was the main but, as we shall see later, not the only factor that carried
that wave of evolution. Taken together, the innovations of the period
and the adaptations they enforced explain primarily the turn of the
Kondratieff . Again, as in earlier cases, it is not claimed that they explain
the crisis also, except in the sense that they make it understandable that
speculative furors broke out and that error and misconduct accumulated:
they thus furnish a reason why the situation became so sensitive as to be
easily turned into a crisis by unfavorable events or by troubles arising out
of those weak spots. The actual picture of the crisis could never be
understood from innovations alone. It must be remembered also that
many things in that upswing — railroad construction in particular — were
done under the influence of artificial stimidi, by which we mean that a
number of them would not have been undertaken at all or would not have
been undertaken just then and on such a scale without encouragement
from the political and the financial sphere. No critique is implied by this.
On the contrary we have said before that the term overdoing must be
applied with caution. But this accounts of course for some of the diffi-
culties of the ensuing situation and also for the presence of a Hayek effect :
in a very obvious sense the period of production was lengthened beyond
what the economic organism could stand for the moment.^

4. We go on. At the time of the crisis the Juglar turned into depres-
sion. There were many failures in 1858, prices fell sharply, and construc-
tion decreased further — exports and imports nearly balanced for the fiscal

1 Critics of the practice of credit creation (as, for instance, Professors Hayek and Mach-
lup) may in particular point to the destruction wrought by the crisis, in support of the
thesis that credit creation helps as much to destroy as to create. There is some truth in
this, but also the lasting achievements of that Juglar prosperity could hardly have been
attained without it.

S34

Business Cycles

year. In spite of easy money, good crops in the South (five successive
supernormal cotton crops, in 1859 also coupled with high prices), and all-
round activity, the general atmosphere, as recorded by the press of that
time, was anything but cheerful until into 1800; but revival asserted
itself, below this surface, from the beginning of 1859. The fact that this
revival differed so much from its predecessor (1850, 1851) we attribute
primarily to the underlying Kondratieff which had by then completed its
prosperity, and entered upon its recession. This recession underlay the
shorter ups and downs of those years and shaded off into the Civil War,
the approach of which intensified, although it did not altogether create, the
troubles of 1860.^ The war dominated the third Juglar (1861-1869;
diagnosis of 1861 is doubtful owing to political events) and of course
interfered both with the behavior of our series and the processes behind
them, displacing peaks and deferring steps in industrial development,
thus crowding them into the years immediately preceding 1872.

^ In 1859 imports again approached the 1857 level — ^for the second half of the fiscal year
they were even considerably higher — ^and there was a vigorous expansion of bank loans,
with specie in banks declining, that led to stringency in the fall. Moreover, new banks were
founded and captal of banks was increased in the West (which until 1860 suffered from
bad crops and liw prices of breadstuffs). These Western banks, mostly modeled after
the New York Free Banking System, but with much less sound and stable securities to back
their issues and with arrangements about redemption amounting to evasion (see Dunbar,
Economic Essays, p. ii97), rapidly became a source of weakness of the situation, although
the hanks in the South, particularly in Louisiana, and, to a lesser extent, those of New
York and New England were stiU in a strong position. The Western record crop of 1860
and other favorable circumstances might have availed to prevent trouble, but for the politi-
cal situation. Its seriousness was first realized in the South, the banks of New Orleans
beginning to restrict and to look askance at Northern paper in August. This affected
New York banks, while in the West many banks got into trouble through the decline in the
bonds of Southern states that formed a great part of the basis of their note issue. There
was a premonitory panic in the New York Stock Exchange in October, in spite of easy
money. After the presidential election on Nov. 6 — we cannot enter into the interesting
phenomena incident to the disturbance of the exchange between the North and the South
which immediately followed — ^panic and disorganization spread through all sectors of the
country’s economic system, of no greater industrial significance, however, than the panic
of 1914. The one point calling for notice is the novel method which was resorted to in
order to handle the situation and which constitutes a more important step in the develop-
ment of banking than many a reform act. The 50 New York banks which formed the Clear-
ing House Association decided on corporative action, in order to extend credit instead of
restricting it, by means of practically pooling their cash reserves and creating clearing-
house certificates against deposit of adequate security including receivables, to be accepted
in settlement of claims between themselves. Only one bank held aloof. Success was
complete and almost immediate. Boston followed with similar results; in other parts of
the country banks had to suspend. Both the device and its success are highly instructive.
The latter, never again quite repeated, although this bit of central bank policy thenceforth
became part of the household remedies in such situations, was precisely due to the fact
that there was not much wrong with either the industrial or the banking situation and that
disturbance by an external factor was all that had to be faced.

Histokical Outlines

SS5

New trackage (minus abandonments) in 1869 began its unprecedented
increase, which reached a peak in 1871. The success of the first trans-
continental route, which had been pushed as a war measure to link
California to the North, led the way and indicated what was to be the
particular feature of this boom. We have again the same pattern of
entrepreneurial activity and financing: promotors securing options of
right of way, having the company chartered and endowed with land
grants, selling the options to it and taking securities in payment, finally
placing the bonds — ^the stock being commonly treated as a bonus — in
order to provide the means for construction, and buying equipment on
installments through equipment trust certificates. In case of success,
issue of further securities would then become possible to consolidate the
situation. Failing this, there was reconstruction. In almost every
major instance, promotors might have plagiarized the Duke of Welling-
ton's (alleged) saying at Waterloo, ‘'Bliicher or the night." The Bliicher
in our case was primarily English (and other European) capital, which
took the responsibility for a great part of the 2 billions^ which are said
to have been expended on American railroads from 1867 to 1873. A
very efficient machinery ^ for pressing European capital into the service
had by that time replaced the individual efforts of earlier times.

Two things are perfectly clear. First, that development which
quantitatively outstripped the one of the forties and fifties as it was
outstripped by the development in the eighties (the all-time peak in
miles added comes in 1887) was a typical downgrade development within
the meaning of our model. It was a Juglar prosperity superimposed on a
Kondratieff recession, a new step in what no longer was fundamentally
new, but a process of carrying out what had previously been initiated.
Railroad construction was now swimming with the stream in a sense in
which it had not been before. What was to be done, how it had to be
done, was chalked out, and all the characteristics of induced or completing
development were present. This left plenty of problems for the indi-
vidual case, but they were comparatively easy to solve, further eased by
the growth of the environment, and of the type which is characteristic of
‘‘exploiting investment opportunity" and “pushing into new economic
space." Moreover, the general features of the period support this inter-

1 The estimate is, at best, very rough, and cannot be said to give more than an order of
magnitude. No doubt is possible, however, as to the adequacy of that expenditure to
account for all the major features of the boom.

* The names of Peabody and Morgan are only the most prominent ones in a long list.
But that firm, both when it was Peabody and when it had become Morgan, more than any
other succeeded in establishing a position and prestige quite independent of the American
business which, of course, buttressed their position in the latter. Witness the loan to the
French government in 1871, a transaction the very success of which veils its boldness.

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Business Cycles

pretation. There was a great building boom. The well-being of all
classes in the years 1869 to 1873 of which we read (and which we are able
to verify as far as our information goes) — the fact in particular that wages
rose and wholesale prices fell while the former had risen less than whole-
sale prices in the early fifties — ^is obviously due to the expansion of produc-
tion which our schema leads us to expect in every Kondratieff recession.
But it is not less clear, in the second place, that that method of financing
which so well illustrates our theory, was handled with such carelessness as
to make it an additional cause of the situation of 1873. It not only
induced but really also presupposed abnormal speculative activity and
could not without it have gone to anything like the lengths it did.

The phenomena of the Secondary Wave were developed to an unusual
degree thereby, and errors and cases of misconduct became possible which
our model does not account for per se. The Gold Corner, Black Friday,
bank failures, campaigns between stock exchange operators, and other
purely financial incidents were symptoms of this, and it becomes under-
standable that even as regards the railroad business these things were more
obviously in evidence than the underlying process and that it seemed as if
construction had been brought to a stop and the success of existing lines
had been jeopardized by them rather than by any “logic of evolution.”
But even so, nobody can deny, and as a matter of fact nobody ever did
deny, that railroad construction had temporarily exhausted possibilities —
a formulation which is more correct than the more common phrase of
things having been overdone — ^and it should be easy to see that this,
together with the dislocating consequences immediate and ulterior, for the
economic system, of new construction was what created the situation in
which the Secondary Wave broke, and with it untenable credit situations
and speculative bubbles all over the field of industry and commerce.

Although the abnormal liquidation which has come down to posterity
as the crisis of 1873 clearly first broke out abroad (in Vienna), and the
American scaffolding received its first decisive shock on the wire of
foreign credit, our diagnosis seems to stand. It is not astonishing that
the impact was primarily on the new, instead of on those elements that
progress had made obsolete. For, as was pointed out in our theoretical
chapters, this will always happen if the new things stand on a slender and
the old things on a safe financial basis. Thus, the role played in the
drama by the Northern Pacific failure does not any more contradict
expectation from our model than does the fact that, in general, danger
signals first became visible in the railroad field. Railroad stocks reached
their peak in 1869, i,e,, in the revival of the preceding Juglar, were no
more than steady in the boom of 1871, and declined in 1872 while indus-
trial stocks rose. Tightness of money, smallness of bank reserves, a
premonitory panic on the stock exchange in October 1871, all link up with

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337

railroad finance, as do tlie slackening in increase of exports and tlie sharp
rise of imports that occurred in 187^. Once the panic had broken out in
the fall of 1878 — ^up till then general business kept up well — ^the typical
sequence of events followed. Speculation in land and stocks collapsed,
prices fell, exports increased, imports decreased, firms of all types failed
in large numbers, the stock exchange had to be closed, banks suspended
payment, unemployment became serious almost immediately. We shall
not repeat what has been said in the discussion of the crisis of 1857. The
fact is significant, however, that, as far as mechanisms go, there would
have to be repetition.

But this time the breakdown was much more serious and a prolonged
depression followed. It is hazardous to rely on statistical evidence for an
appraisal of relative severities of crises, because equal reactions of identical
symptoms may mean very different things at different times, and presence
or absence of others may be accidental or due to difference in the handling
of the situations. As far as mere figures go, however, some aspects, at
any rate, of the depression were quite as dark in 1873 to 1877 as they were
in 19^9 to 1983. Data about unemployment, for instance, are, it is true,
entirely untrustworthy and incomparable. But if we could believe in the
figure, mentioned by some authors, of 8 millions of ‘^tramps ’’ (in the winter
of 1878 to 1874) then this, considering the smaller quantitative importance
of the industrial sector and the absence at that time of any tendency to
exaggeration, would indicate that relative unemployment was actually
worse than it was during the recent world crisis. Prices fell less abruptly
than they did in and after 1980. But this is because their downward
movement from the Civil War peak had not, except in 187^, been pre-
viously checked. The decline was more gentle then because it was more
even, but it was not smaller if we consider, as we must, ultimate results
and not only what happened in the crisis proper. Th'^^ political comple-
ment also was similar, granger movement, agitation for inflation, strikes
and riots being, if we take account of differences in social and political
structure and attitude, more than fair counterparts of corresponding
phenomena in the recent instance, although in the bourgeois Kondratieff
they were handled in a different way.

5. According to contemporaneous report, 1874to (thefirsthalf of) 1878
were years of almost unrelieved gloom. But adjustment and the elimina-
tion of untenable positions went on steadily, and the path was cleared for
recovery. The process is well reflected in the figures of railroad construc-
tion. It touched low point as early as 1875 and suffered another setback
in 1877, but there was significant increase in 1876, both in new trackage
and in locomotives built, in the midst of a renewed outbreak of failures
and a great fall of railroad stock prices. Thus the tide began to turn
before either people’s ‘‘depressed state of mind” had changed for the

338

Business Cycles

better or surface mechanisms had ceased to work in the downward direc-
tion, also before the revival on the stock exchange (1877). It was the
improvement in the objective elements of the situation which turned both the
psychic states (expectations) and the mechanisms (cumulation of depres-
sive effects and that sort of thing), and not vice versa. Nor was it
external circumstances which stopped the downward course. Crops were
good in 1878, but prices of wheat and cotton were low and improvement
in any case set in before good crops became a certainty. The system
recovered of its own and this in the face of steadily declining general 'prices.
We date the fourth Juglar 1870-1879.

Now the eighth decade of the nineteenth century lies, according to
our schema, entirely within the depression phase of the second Kondratieff ,
which turned from recession into depression about 1870.^ A whole
Juglar as well as the prosperity and recession of another which began with
1880, therefore, completed their course on what statisticians would call a
downward trend. And this is our explanation of the severity of the crisis,
the depth of the subsequent depression — which is, in all respects, as
strikingly similar to the one of 18^6 to 1830 and the one of 1929 to 1933 as
were the prosperities that preceded them — and the fact that gloom and
difficulties persisted far into recovery. All three cases were characterized
by the fact that the shorter wave had to subside to what was a falling
level while, in other cases that did not lead to such breakdowns or pro-
longed depressions, it had only to subside to a rising level. The writer
does not see that this does violence to any facts nor does he see how it
could be contested — ^the more so, because the same could, as far as formal
contours go, be put as well in terms of theories more satisfactory to other
students. As an explanation, however, it might be held to be tautological.
So it would be if, after having described statistical contours by means of
the three-cycle schema, we turned around and called this description an
explanation. But we do not do this. We explain those contours in terms
of an industrial process which shapes them.

In the case under discussion, nobody can doubt the reality of the
particular process that constituted the Juglar in the course of which
the crisis occurred. Nor is it farfetched to say that the larger process —
mainly associated with railroad construction — ^within which the events of
1870 to 1873 constitute a step, had so revolutionized the economic system

^ THs turn occurred, therefore, before the last boom whicli preceded the great crisis.
Without unduly stressing the regularities which form the basis of our schema, we should
recall that this is perfectly in accordance with it, since it makes the beginning of a Kon-
dratieff depression coincide with a Juglar prosperity. The reasons why an “about” should
be inserted are, on the one hand, that the gentle sweep of the Kondratieff displays broad
heights and depth and not any peaks or troughs, so that precise statistical location is always
difficult, and, on the other hand, that aftereffects of the Civil War must be taken into
account.

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339

that liquidation, absorption, adaptation — all of what these terms mean
can be clearly observed — ^was an unusually long and painful aflPair. If
objection to the three-cycle schema be insuperable, we do not insist on it.
The facts remain, whatever the merits or demerits of the schema by which
we present them. But what it is necessary to insist on is, first, that
in the other two cases which are in an analogous position on the two other
Kondratieff s and stand in approximately the same time relation to preced-
ing industrial revolutions, we also find similarly severe and prolonged
depressions and, second, that we do not find such depressions in any other
case.^

As soon as paralysis due to the shock was over, expansion of physical
production resumed within the Kondratieff depression, as we should
expect. Railroad construction, going on to be the carrier of the cyclical
movement, soared from 1878, to a peak in new trackage in 188^ and (from
the fall to 1885) to the all-time peak of 1887 (nearly 13,000 miles). This
almost gives, if the lag is taken into account, the history of the cyclical
fluctuations of that period. But this does not mean now, as it did before,
that the relation of railroad construction and general business was pri-
marily one of cause and effect. On the contrary, the more an innovation
becomes established, the more it loses the character of an innovation and
the more it begins to follow impulses, instead of giving them. Besides,
Kondratieff downgrades and revivals precisely display a wide variety of
induced or completing innovations which develop and carry to their
limits possibilities opened up before, of which railroad building was but
the most important. Accordingly*, railroad construction, increasingly
settling into a predetermined framework and exploiting preexisting invest-
ment opportunities, became during the period under discussion much
more (though not yet entirely) a function of railroad business and, hence,
of the rest of the business organism than it had been before, and the
relation became substantially one of mutual dependence. However, the
railroad industry had not sown its wild oats as yet, either as regards
boldness of advance or as regards financial methods.

Traffic and earnings had revived by 1878 (1877 marks the low point in
the latter), which we consider as the last year of the recovery phase of the
fourth Juglar. Then they strongly increased, with general business, to
1881, when the flow of new capital into railroads reached the peak cor-
responding to the peak in miles added that occurred one year later.

^ The above refers to the stretch of time between 1787 and 1934. Further back the
writer does not dare to make any positive assertion. But we have seen reason to thinV
that the crisis of 17SiO was comparable in severity (and the subsequent depression in dura-
tion) to the cases envisaged above. If so, then it becomes relevant to remember that there
were very strong reasons for believing that that crisis also stood in a similar time relation
to a preceding industrial (and commercial) revolution.

340

Business Cycles

Investment continued, though at a decreasing rate, until 1883, when it
experienced a check, with the Juglar turning into its recession (1882),
followed by a depression in the ordinary course. But although the above
shows that we make as full allowance for the influence of business on rail-
roads as we do for the influence of railroad construction on business,
railroads still set the pace. It would not be correct, in particular, to
emphasize the part played by the crops of 1878, 1879 (this one, as men-
tioned before, accompanied by high prices), and 1880 to the point of
making them the main factor in railroad construction. They constituted
a favoring circumstance. But farm products (animal products included)
after all made up less than £0 per cent of total tonnage hauled, and average
range of variation was roughly 5 per cent.

We may date Juglar depression from the end of 1883. It lasted
through 1884 and 1885 and is marked by a crisis in the former year,^
panic on the stock exchange, strain in the money market necessitating
issue of clearinghouse certificates, failures of banks and stock exchange
firms, unemployment, and so on. The author sincerely sympathizes
with critical readers, but feels unable to suppress the fact that according
to the schema the Kondratieff would have been due to embark upon
revival in that year, and his belief that this accounts for the further fact
that neither severity nor duration of that depression were at all compara-
ble to the severity and duration of the events of 1873 to 1877, One point
calls for attention, however. In expounding the working of our model we
have laid stress on the fall in the price of new products, which is a major
piece of the mechanism that conveys the results of progress to the masses.
We also saw that this fall, though as a matter of general theory it should
primarily affect competing industries as well as old firms in the same
industry, will also react on the innovating industry itself, especially if it
stands financially on slippery ground and if further steps in the path of
evolution begin to compete with the creations of earlier steps.

The history of railroads affords a good illustration for this. Freight
rates began of course to fall at a very early stage, but they still averaged
about £34 cents in 1868, Then they fell sharply, though at a decreasing
rate, to 1874, when they averaged 1.8 cents, and still more sharply during
that depression. They increased slightly in 1878, but reached the one-
cent level in 1885. Now this process was perfectly normal, but it upset
many a financial structure in the railroad business. And because of the
imperfections of competition in this industry, it did its work by way of
spectacular struggles between controlling groups, which exercised the

1 There were corresponding depressions in England and Continental Europe. But the
Trench crash of 1882 was a local affair and exerted little even of indirect influence on the
American situation. The tightening of money in the fall could be accounted for by
American conditions alone: America was becoming economically autonomous.

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341

public mind and set everybody talking about freight wars, cutthroat
competition, discrimination, and the evils of unregulated enterprise, to the
exclusion of what the thing really meant. As a matter of fact, it paved
the way to consolidation, efficient administration, and sound finance,
thus ushering in the last step of America’s railroadization.

It took another Juglar, however, to accomplish this (1889 to 1897), the
last one to be dominated by the railroad industry, although the days of
new companies had passed. Some of its features have been and will be
discussed in their various places, when also certain difficulties of dating
and interpretation will be mentioned. For the moment it is sufficient to
note that the crisis of 1893 has in a sense more claim to be called a crisis of
railroads than has any other. While the preceding crises of that Kondra-
tieff were railroad crises primarily in the sense that railroadization played
the leading role in the process of economic evolution which produced the
situations that developed into crises, and railroads were but secondarily
affected, the case of 1893 was primarily a crisis of the roads themselves —
roughly one-quarter of which (measured by capital) went into the receiv-
er’s hands. Earnings fell off in 1894, when for the second time in the
history of American railroads there was an absolute decrease in traffic,
and construction displayed the lowest figure since 1851. Duration of that
depression — abnormal for a Juglar in a Kondratieff revival — and irregular-
ity of ensuing fluctuations, though also conditioned by external factors,
are substantially accounted for by the effects of that house cleaning in
what had then become an ‘‘old,” and after the World War was to become
a declining, industry. A final boom in construction and new organization
was still to follow and to contribute to the prosperity of the next Kondra-
tieff^* — ^as the leading innovations of every Kondratieff seem to do — ^which
carried mileage to about £50,000 by 1910. After that year, net construc-
tion rapidly decreased to zero and below.

6. It is convenient to insert here what it is necessary to notice about
the railroad development in the two other countries. As stated above, it
would not be so nearly possible for them as it is for the United States to
write their economic history in that period in terms of railroad construc-
tion and its effects — steam and steel, in general, with railroads as the most
important special case, would make a better heading. For England, the
business of financing (to a lesser degree, of initiating) foreign railroad
development soon became more important than was domestic construc-
tion. Only the first Juglar of the bourgeois Kondratieff was dominated
by it; after the second, it almost drops out of sight for the purpose in hand,
however important railroad traffic and finance remain throughout.

^ In various parts of the world great things were still being done in the railroad field
during the years preceding the World War; but they did not, except by way of the
London and Paris money markets, directly influence developments in our three countries.

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Business Cycles

This is of course primarily due to the fact that the great thing to be
done” was of much smaller size than in this country and hence was more
quickly accomplished. The heroic age of genuine railroad innovation
that revolutionized the economic system was entirely over by about 1860,
when (in Great Britain and Ireland) about 10,000 miles were in operation.
This mileage increased by roughly 50 per cent in the next decade and again
by about 50 to 1910 (increase at rapidly falling rates continuing into the
postwar time) . But this it did within a framework previously established
and within the great concerns which could go about the task of expansion
and completion on the basis of calculable returns. Innovation was of
course not lacking; but it was of a subsidiary kind — ^the various achieve-
ments that improved speed, safety, comfort — ^which did not greatly
matter cyclically.^ Thus English railroad development from about 1860
on was a consequence of growth in our sense and of innovation elsewhere
in the system, responding at every step to existing conditions, rather than
an active factor of evolution. The accumulated wealth of the country
also eased matters, and bold finance was much less necessary than in
America. In fact railroads constituted one of the main outlets for savings
and within the period qualified for the investment of trustee’s funds.

This does not mean that there were no difficulties or miscarriages or
public outcries over one thing or another. The committee of 1853 hinted
at discrimination, for the suppression of which an act was passed in 1854;
the committee of 187£ discussed amalgamations; rates and fares were, of
course, a standing grievance; and so on. But by comparison it was easy
going in this, as in other respects: the Railroad and Canal Traffic Act
of 1888 was a very conservative measure. Another element of the situa-
tion — competition of railroads with canals — deserves to be mentioned.
Turnpikes and all interests connected with transport by road also suffered,
in many cases to the point of extinction. But whether or not this was
quantitatively sufficient to have any cyclical influence, the author has not
been able to trace it. Most of the really important effects of railroads on
old firms in our sense were not exerted by any direct competition with
any of them, but through their influence on location in general. Canals,
however, afford an instance of direct competition that counts quantita-
tively. Some were in an impregnable position and have retained their
business to this day. Several of these flourished and paid high dividends
throughout the period, while others (for instance, the Manchester Ship

1 This was because they were, looked at from our standpoint, mere improvements on
an existing innovation, substantially complete and workable without them. Some were
much more original than was the railroad itself, and also of considerable importance for the
railroad-using public. But this did not make them factors in evolution as by us defined.
The reader should make use of the case in order to add precision to, if necessary to correct,
his idea of our concept of innovation.

Historical, Outlines

343

Canal) were actually constructed toward its end. But by 1880 the role of
most of them was over, although the financial position of many was so
very sound that they were able to carry on and to earn some quasi-rent
by drastic reduction of rates. Decay, therefore, came gently to them and
did not create financial trouble. Precisely, however, because they could
afford to reduce rates without bankrupting themselves, they were danger-
ous competitors to the railroads, which, as imperfectly competing big
units are prone to do, in many cases tried to bring them under their con-
trol. This policy met with some success until the late fifties and was then
abandoned, presumably as much because of its costliness and the superi-
ority of railroad transportation, by that time established even in the case
of transporting coal, as because of public resistance, which was fostered by
industrial interests.

Up to about 1860, however, railroads were the great innovation. The
course of events in the forties, in particular, centers in the "'railway
mania,” the one full-fledged railroad boom which England experienced.
In 1847, the peak year for investment during the forties, capital actually
raised by the issue of shares and loans ^amounted to 40.7 millions of pounds
(to which correspond 1,182 miles opened in 1848), while, for the financial
year 1846-1847, ending Apr. 5, taxable income (J. C. Stamp’s compara-
ble series, see British Incomes and Property, p. S18) was 209.6 millions.
But the quantitative adequacy of even the smaller figures in the preceding
and subsequent years (1844, 6.7 millions; 1845, 16.2; 1846, 87.8; 1848,
33.2; 1849, 29.6; 1850, 10.5; 1851, 8; 1852, 16; 1853, 9.2; 1854, 12.9; 1855,
11.5) is beyond the possibility of doubt, as is the importance of the number
of persons employed on lines under construction (peak, 1848 — 188,000).
As was mentioned before, direct credit creation — short borrowing
by railroad companies from banks — ^played an incomparably smaller
role than it did in America. More important must have been, though we
lack data to verify this, credit creation for the financing of subscriptions
and for the speculative acquisition of shares. When the speculative
excesses were nearing their high-water mark, which occurred in October
1845 (the peak in promotion came in 1846 if we measure it by mileage
sanctioned by act of parliament), business funds were to some unknown
extent applied to the payment of subscriptions, and many small people
depleted their cash reserves. The former practice would in many cases
involve resort to bank credit as well as produce a strong tendency to
annihilate the deposits thus created by a speedy repayment of loans. The
prosperity of 1845 and 1846 gave some opportunity for such repayments
and there is nothing in the facts we know about the banking processes of
that time to negative the possibility that they played some role.^

1 Compare Tooke and Newmarch’s History of Prices, vol. V, pp. 348, 352, and 356.

2 Tooke attacked great importance to tke saving or retrenckment of consumers’ expendi-

344

Business Cycles

Projectors or promotors as a group hardly differed much from the
American type. Only part of the projects were at all serious, as may be
inferred from the fact that Parliament passed only a fraction of them,
which is not wholly accounted for by the large number of mutually exclu-
sive ones. Of those that were passed, again, only a part were actually
proceeded with and even some of these failed in their early stages. At
first, projects were simply for new lines, but soon a second type of innova-
tion emerged, amalgamation. Such attempts at “rationalization’’ and
at creation of monopoloid positions — ^we remember that our concept of
innovation covers such cases — ^had occasionally occurred before, as early
as in the thirties. But it was the construction boom of the forties which
brought them to the fore or indeed made them unavoidable. This was
the main field of the activities of George Hudson,^ the railway king who
gave the decisive impulse by his success with the Midland (1844). The
London and North Western followed, later the Lancashire and Yorkshire,
the North Eastern, and others. Thus that time not only created the
skeleton of the English system, but also its leading concerns. Rate wars,
again illustrative of the way in which reduction in the price of the new
products or services is achieved in the absence of perfect competition,
occurred as an incident of this. Knowledge of the strong position of the
enemy contributed to make them comparatively mild affairs, however.

Symptoms of prosperity in the technical sense — in which prosperity
is not only not identical with welfare, but in important respects rather its
opposite — ^predominated for nearly five years (end of 184^ to middle of
1847) without any major interruption; thus they cover both the prosperity
and the recession phase of that Juglar, the setback in railroad speculation
which occurred in October 1845 indicating roughly where we are to look for
the dividing line between. This and the absence of the typical phenom-

ture, that was forced, during the years of heaviest construction, on the holders of shares by
the calls for further installments. He believed that these retrenchments “more than
counterbalanced the effects of so large a distribution of wages.” Although lack of data
prevents exact verification, we may safely assert that there was aome truth in this. There
is no doubt that it was a time of dogged determination to finance all that could be financed
from current receipts. That diagnosis is perfectly compatible with ours.

1 The type, his behavior, his rise and fall are full of interest for us. Originally a small
man, entirely unconnected with the technology, economics, and finance of the railroad
business, a linen draper from York, he had and contributed one thing only, but one of
supreme importance — the knack of putting things through and of bending other people’s
wills to his purposes. He would have made an immensely useful member of the Council
of Commissioners of the People in a bolshevist state. As it was, he handled Parliament —
absurd though it was to speak of the state being run by the railroads — and impressed the
good bourgeois by “associating with peers,” in the eyes of many doubtless his supreme
adbievement, though it is easy to see that he was never re^u. The misdeeds that eventually
swept him from his leading position were rather primitive. He was obviously no adept of
the higher arts of swindling.

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345

ena of recession are what we should expect on the rising tide of the under-
lying KondratiefiF, and are in keeping with the analogous observations in
the cases of the first Juglars of the first and third Long Waves, But we
should have expected that the depression phase of the Juglar would also be
crippled. Instead, we find it fully developed, extending over a little more
than two years. This is all the more remarkable because, with due
respect for the absolute amount of swindling (though there may not have
been very much of it relative to the total of transactions), and recklessness,
it is impossible not to recognize that a great part of the preceding innova-
tions were very soundly financed and that credit creation was kept in
narrow bounds. Perhaps the first effects of free trade and the political
troubles of 1848 may be trusted to explain. The crisis itself, which came
at the turn of the Juglar into depression, obviously was a railroad crisis —
although there had been other innovations, very important developments
in coal mining, for instance, being directly induced by the new transport
facilities — both as to fundamental causation and as to surface mechanisms.
The revolution in industrial location had begun to assert itself, spelling
losses and bad business for large sectors. And the financial require-
ments of railroad construction, precisely because it was not possible to
curtail them quickly, pulled at a great many spots in the financial struc-
ture — ^most perceptibly, though not exclusively, through the railroad calls.
Speculative positions that had to be liquidated, mismanagement, errors,
and the phenomena of the Secondary Wave, which had been accentuated
by favorable developments in the foreign trade of the country (United
States, China), played their usual role, gold movements — ^those in pay-
ment of the food imports incident to the failure of the wheat and potato
crops in 1846 may have had a direct effect on price level, of the kind
described by the classical schema — ^and financial transactions (Baring
loan to the Bank of France, 1846), rather more than their usual role.
What panic there was, disappeared when the Bank Act was suspended,
although bankruptcies were frequent into 1849 (many, such as the failure
of grain houses and of some merchants trading with the Continent,
were unconnected with the crisis, however).

The element of overdoing or, more correctly, of exhaustion of imme-
diate possibilities^ reveals itself in the fact that new railroad capital,
raised by shares and loans, touched its low point as late as 1851, though
Juglar revival had set in by the end of 1849. This was followed, however,
by a sharp increase in 185^, the first year of the second Juglar: we have

^ The situation does not seem to contain any Hayek effect, although the money rate of
interest rose but weakly; for it cannot be said that the new investments were made unprofit-
able by a subsequent increase of it. Professor v. Hayek, however, would presumably
accept this, and point to the large proportion of that investment which was actually financed
by genuine savings.

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Business Cycles

here a new wave of railroad innovation, whicli, among other things,
brought new trunk lines (such as the South Western) into existence —
also, another big amalgamation (North Eastern, 1854). However, it was,
absolutely as well as relatively, of smaller importance than the preceding
one and was no longer more than the heaviest individual item in a much
larger movement. The crisis of 1857 could not primarily be accounted for
by it.

7. For Germany railroads meant much more than they did for England.
The revolution they wrought in her economic system in some respects
almost suggests analogy with America; and so do, in some cases, the
financial methods of the early stages. Public enterprise on a nation-wide
scale was one of the economic policies advocated by some of the earlier
champions of national unity, and a dream of Bismarck’s early manhood.
In some states it was embarked upon from the beginning and more or less
adhered to throughout. But not so in Prussia, where government acted
upon what later it became the fashion to call — ^with some derogatory
implication — Smithian principles. The creation of the German railroad
system was, hence, substantially the work of private entrepreneurs,
although a bureaucracy, supremely efficient, quite above temptation,
entirely independent of politics, did much, in many ways besides exerting
discretion in chartering, to prune promotion, to sober finance, and to
steady advance.

Later on, the temper of the times changed, however. As regards the
empire, Bismarck’s ideas were, by the resistance of the states, reduced to
the creation of an Imperial Railroad Office in 1873, which did not mean a
great deal, and to the acquisition of the lines in Alsace-Lorraine; but in
Prussia they eventually had full sway. Under the Maybach administra-
tions, the Prussian State (which in 1866 had acquired the state railroads
of the states then annexed) bought up about 5,000 kilometers of private
roads in 1879, about 8,000 in 1882, and nearly 4,000 in 1884 (in the subse-
quent 20 years another 3,400 were added, which practically completed the
nationalization), while no more private companies were chartered. Con-
struction was thenceforth done by the state, which unified rates, rational-
ized administration, and achieved what was in the whole world looked
upon as the standard example of successful public enterprise. The com-
pliment, while very well deserved, must not be overdone. The main work
was accomplished by 1875, i.6., if we take account of the lag in railroad
construction, by the end of the prosperity phase of the fourth Juglar;
private industry continued to offer to, in fact almost to force upon, the
state-managed railroads a stream of improvements — ^particularly improved
types of locomotives, cars, brakes, safety devices — so that the merit, as far
as that goes, is reduced to not resisting and to displaying an intelligent
demand; and conditions, both technological and commercial, were quite

HisTORiCAii Outlines

347

exceptionally favorable in a thickly populated, predominantly flat coun-
try. From the early eighties new construction went on with hardly any
reference to cyclical situations, but the difference, in this respect, from
contemporaneous development in England was not so striking as one
might expect.

Private enterprise, which ruled from 184^ to 1879, faced problems that
only in degree differed from those in America. The proportion between
existing and potential possibilities was in Germany more favorable beyond
comparison. But existing means were not much less inadequate for the
financing of the great innovations that loomed in the immediate future
than they were in America or, to put the same thing into a slightly different
form, the sum total of capital in the business sense plus current saving
minus what was applied to consumptive purposes was at any point of time
substantially absorbed or tied up in the current economic process and its
growth. Hence credit creation, as far as it was not replaced by English
lending — ^which, let us repeat, would, from the German standpoint, have
been the same as domestic credit creation — ^may be expected to show,
almost, in the role assigned to it in the ‘‘pure’’ edition of our analytic
model. So it does. In all those cases in which the piece or innovation
that was within the reach of the individual entrepreneur, was capable of
being divided up in such a way that each partial success could finance the
next step — and this was so in the case of many industrial firms and family
positions that gradually acquired national and international standing —
that element is naturally less in evidence and, in some instances, even
absent, but the phenomenon stands out unmistakably all the same, so
much so that no economic history of Germany would be complete, or in
fact, understandable, without it. The German, or Franco-German,^
solution of the problem may be conveniently inserted here.

^ This is our only opportunity of mentioning the CrSdit mohilier. It cannot be said to
have been the first specimen of its type. The Belgian SocUti gSnirale for instance (182Si)
was much the same kind of thing and similar practice dates further back than John Law.
Nor should it be said that it was the model of the German concerns of this type. For at
least one of them preceded it, and the logic of the situation would presumably have asserted
itself without any model to copy. But the brothers Pereire certainly were the first modern
pioneers to attract international attention to the possibilities and dangers of that form of
banking. Nothing fails like failure, however, and the fundamental conception was mixed
up with error and misconduct in its execution by a not unnatural gust of uncritical wrath.
For an analysis that comes nearer to understanding, see A. Plenge, Grundung und Geschichte
des Credit Mobilier. J . E. Pereire rose as a railroad man. He promoted and built the
first steam railroad in France and took a leading part in the French railroad ventures of the
thirties, forties, and fifties. So far, he was an entrepreneur with an unusual bent of mind —
coordinating his activity with ideas of social reconstruction of the St. Simon type. Perhaps
it would come nearer the truth to say that he realized, consciously though somewhat
fantastically, the ultimate meaning and consequences of capitalist enterprise. The credit
mohilier^ conceived as an engine for promotion — or innovation — on a large scale, and in

348

Business Cycles

In England presence of a huge mass of previous profits and other
factors not only reduced the actual importance, but also veiled the role, of
credit creation in financing innovation to the point, on the one hand,
of making it a difficult task to bring it out in its true proportions and,
on the other hand, of eliminating it completely from the range of vision of
orthodox English banking theory and practice. In America the ordinary
type of banks in the sense of that English doctrine — and the American
ideas as to what a bank should be, were fashioned on the English model
hopelessly though this was at variance with American conditions and
practice — ^was made to serve the purpose in a way which from the stand-
point of that type and those ideas was simply malpractice. In Con-
tinental Europe, in Germany (and Austria) in particular, this element was
not absent. And whenever it showed, it was always disapproved of,
on the ground that bank credit should be confined to short-term commer-
cial operations; for the official theory of banking was no less English in
Germany than it was in America. The practical difference between this
view of the function of banks and what we are about to describe must not,
however, be exaggerated. The link between the two was the lending on
the stock market, which was always looked upon as a part of regular
banking operations. Stock exchange speculation, especially, and the
speculative holding of newly issued stock were in all countries largely
financed by banks, which therefore always served the purpose of financing
long-time investments, at least in this indirect way, even if in no other.
The novelty about the practice of those French and German promotion
banks, consisted only in the directness with which the problem of financ-
ing innovation was faced and the energy with which regular banking
business was made ancillary to it. While elsewhere this use of short-term
credit, created ad hoc, led to a situation in which it was up to the entre-
preneurs to look (unless receipts were coming in very quickly) for some
method of funding and thus consolidating their position, these “indus-

tMs respect akin to what the writer believes to have been the essence of John Law’s plan,
as well as to the French and German promotion or industrial banks, was founded in 1852.
The financial idea, namely, financing enterprise by bonds to be issued by the bank and to be
substituted for the stock of the new creations, was, however, never sanctioned by govern-
ment, and in this sense the venture was a failure from the first, though on the surface popu-
lar success was spectacular. It is true that many of the propositions financed were not
successful, or not sufficiently so — this is always the crucial point about any such venture —
but it must be said that many difficulties, intimately associated with ultimate failure, would
never have arisen, had that financial plan been carried out, which was not in itself imsound.
It should be borne in mind that the credit Tnobilier was not an investment trust in the
English or American sense. It is often interpreted so, but this interpretation misses
the essential point. Nor are the American private banking firms and financial houses the
same kind of thing, although they often did that kind of business, first in the railroad field,
then especially in the field of industrial mergers.

Historical Outlines

349

trial” or ‘^promoting” banks provided machinery to do this themselves.
They took care of the necessary issues of stocks and bonds, thus helping
the enterprise to redeem its short debt and providing it with additional
means. In order to effect this they were ready to take those stocks or
bonds for their own account, not only if they were unable to place them, but
in the ordinary course of their business routine. Thus they were able to
await developments before making an offer to the public and even, in
many cases, to keep a parcel for good. When eventually they placed the
securities acquired, they again financed the private investors so that,
temporarily at least, the transaction often meant no more than a shift in
assets. The money-market aspects of this will call for our attention at a
later stage. All that is important to realize now is how short-time credit
creation was thus made to dovetail with long-time investment in a way
which almost perfectly expresses the economic nature of the process of
financing innovation.

The close connection between banks and industries which naturally
arose out of this has so often been commented upon that it is more impor-
tant for us to qualify than to emphasize it. If a bank holds a controlling
or, at all events, an important part of the capital stock of an industrial
concern and acquires, as it then naturally will, all its current banking
business, and if the fortunes of the concern and the price of its shares are
associated with the bank’s name and pecuniary interest, much closer
supervision becomes of course necessary than would be the case if the bank
were in a position to deal with every single transaction with the concern
individually and simply on its merits. But although this supervision in
many cases amounted to initiative and even to compulsion (such as enforc-
ing mergers of, or at least understandings between, competing enterprises,
all customers of one bank) and although direct interest in an enterprise
undoubtedly often was the motive for deviation from sound practice, the
influence of banks did not in general go so far as that. The functions of
entrepreneurs and banks and the essential opposition of their interest
were not necessarily or regularly abolished, and the honorific positions on
the board of industrial concerns usually granted to ojficers of the financing
banks were apt to give to the financial press and to the social critic a
very exaggerated idea of what those ‘"huge compounds of capitalist
power” really meant. It is amusing to note that bank executives were
sometimes quite pleased to have the public believe in the reality of their
power. This belief and the corresponding resentment were injurious and
dangerous to them. But they also flattered their vanity. The efficiency
of that engine for the purpose of financing and supporting new enterprise
is, however, beyond question.

The first great banking concern of that type was the Schaffhausenscher
Bankverein (1848). The Bank fiir Handel und Industrie zu Darmstadt,

350

Business Cycles

which, is the one that was most nearly a copy of the Credit mobiUer, fol-
lowed in 1853. There was an outburst of such foundations in 1856,
when the Discontogesellschaft, which had in 1851 been founded for
quite another type of business, joined the ranks. The Mitteldeutsche
Kreditbank, the Berliner Handelsgesellschaft, the Norddeutsche Bank in
Hamburg, the Hamburger Vereinsbank, theLeipziger Credit- Anstalt, and
others then saw what for some of them presently proved to be a rather
melancholy light. But most of them were able to hold on through surf
and breakers, which shows that both their structural idea and their prac-
tice were not so unsound as they seemed to many observers. We will add
that they expanded vigorously in the boom that preceded 1873 and after-
ward, and that the system, later on mainly modified by mergers, was
completed by the foundation of the Commerz- und Privatbank in Ham-
burg (1870), the Deutsche Bank (1872), the Dresdner Bank (1872), and
the Nationalbank fiir Deutschland (1881). It should be recalled, how-
ever, that during the boom of the fifties another machine for credit crea-
tion experienced its last stage of development: many small states were, as
mentioned above, only too glad to charter additional banks of issue.

This financial apparatus was a powerful help to railroad development
from the beginning of the second Juglar onward, but during the forties it
had not yet come into existence. Nor, as far as the writer knows, was
capital import from England of much importance then. Hence, financing
from genuine savings must have played a much greater role than it did
later. This fact lends its distinctive character to that Juglar, particularly
to its prosperity phase, and accounts for many of its features. Railroad
construction and developments in subsidiary industries dominated the
picture fully as much as in England. Trackage increased from 549 kilo«
meters in 1840 to 6,044 in 1850, which was a greater relative increase than
in England or in the United States; but speculation and other secondary
phenomena were much less marked than in those countries and the crisis of
1847 was correspondingly milder. It is true that in March and April
there were diflficulties in Hamburg, that bank notes were presented in
Berlin and the Rhineland, and that the Prussian bank had to borrow from
the government; but this did not seriously threaten the financial structure.
The troubles would have displayed still smaller proportions had not the
political disturbances of 1848 added a spell of depression which cannot be
accounted for by any known economic facts. Comparison between the
course of events in Germany, England, and the United States may hence
be used to form a rough idea about the answer to be given to the question
as to what part of the phenomena that constitute a crisis should be
attributed to the essential features of the evolutionary process in our sense
and what part to the secondary phenomena which are undoubtedly
induced by it but are no necessary elements of it.

Historical Outlines

351

There is, however, an atmosphere about those years which is anything
but cheerful and this is particularly true of the years of boom. Although
bad harvests and other adventitious circumstances partly account for it,
for the fundamental explanation we must look to our process itself.
Prussian statistics prove beyond doubt — although, of course, they are far
from complete — ^that consumption actually fell for years together while at
the same time production and sale of equipment goods increased. Spiet-
hoff (op. ci^., p. 48), while recognizing the extraneous circumstances
mentioned, which also worked in that direction, concludes that we have
here an important historical example for the independence of prosperity
from consumption. Since the case is statistically and otherwise not
beyond doubt (but it is a fact that saving banks* deposits increased all the
time), it is perhaps hazardous to add that those years also aflPord an illus-
tration of what prosperity really means and what its features would be if
it were not, in general, overlaid by the joyous optimism that comes from
speculative gains. The reader is invited to judge for himself. Elsewhere
we use the case in this sense.

Three more Juglars were still to come in which railroad building loomed
large. It increased again during the fifties, nearly 5,500 km. of trackage
being added up to 1860. The crisis of 1857 does not, on the surface,
display the influence of the railroad situation so strongly as the American
crisis did. Nor were railroads quite so dominating a factor as they were in
America. But it must be remembered, also, that methods of financing
were comparatively sound and that the dislocating effect on the preexist-
ing economic system was not anything like so great. The next decade
accounts for nearly another 8,000 kilometers, and from 1870 on Germany
experienced her last railroad boom. Further construction, which carried
the 33,838 kilometers that existed in 1880 up to the figure of 63,730 in
existence in 1913, was almost wholly the work of the states, but would
^ have been ‘^induced and completing’* extension in any case. We need
not stay to prove the quantitative importance of expenditure on railroads,
which, however modest the factor by which we multiply it, obviously
was the most important single element in the cyclical fluctuations, at any
rate to 1873. The peculiar type of entrepreneurs who emerged to create
the German railroads, and extended the sphere of their activity to Austria
and the Balkans, will be commented on later.

D. Some Features of the Development of Manufactures in Our
Countries. —

1. We begin by going on with Germany. In interpreting the statis-
tical record of quantities of commodities and services produced, which it
is not our intention to present until later — details cannot be presented at
all — account must, as everywhere, be taken, for the whole span of the
Kondratieff, of growth as influenced by the progress in transportation by

352

Business Cycles

land and sea.^ To dispose of the latter, the first German steamer crossed
the Atlantic in 1850 — a great innovation, of course, and expressive of a
development in Bremen and Hamburg that played a not insignificant,
though local, role in the first, and still more in the second, Juglar; yet it
was not, in itself, particularly remarkable either technologically or com-
mercially. German shipping was scoring a number of minor successes,
the great concerns of a later time were forming or reforming — especially
the North German Lloyd, founded in 1857 by a merger of several concerns
of moderate size — and were invading what for them were new realms of
trade. All this implied many innovations (every new route is one), but
all of it was on a small scale, insignificant if compared with contempora-
neous American or English, or later German, development. Its impor-
tance consisted in breaking the ice, solving threshold problems, creating
conditions for further advance, preparing quantitatively important suc-
cess, This success came within the period, but practically wholly in the
recession, depression, and revival of the Kondratieff. And it is easy to
see that, in fact, it was of the nature of downgrade expansion and down-
grade innovation, induced not only by what had been done before in the
same industry, but also by the evolution in other lines of industry and by
the favorable change in environmental, particularly political, conditions.
During the boom that broke down in 1873 — and contributing to it —
the mercantile marine of Germany slowly struggled across the million-
ton line, mostly wood and sail, the small fraction of steam tonnage in
great part foreign built. The latter rather more than doubled to 1880,
then trebled to 1890, about doubling again to the end of the century, when
it was all steel and almost entirely the product of domestic yards and
domestic ship-engine factories. Most of it was owned by about £4
Hamburg and Bremen concerns, the Norddeutsche Lloyd and the Ham-
burg- America among them. It is perhaps unnecessary to list the types of
innovations involved — ^the Stettin shipyard for instance was one of the
most important of them, though it had nothing to do with ‘‘invention’’ —
to show their opportunity-exploiting character, or to dwell on the impor-
tance of the expenditure and of its direct and indirect effects (dislocation

^ Construction of roads and canals and, what was still more important than the latter,
improvement of natural waterways, went on throughout the period. All of it was done by
public authority, from public resources, on noncommercial lines. The Prussian chaussSe
system developed steadily beyond the lines indicated in the previous chapter, especially
from the eighties onward. This is also true of canals, construction or completion of which
reaches far into the third Kondratieff. Improvement of natural waterways was carried
to much greater length, and by 1895 over one-fifth of total German traffic was by inland
waterways. This innovation was, in fact, one of the major features of the downgrade and
revival of that Kondratieff and amounted to a complete change in the data of railroad
transportation and domestic commerce in general. Investment rose into considerable
figures, Its ** induced and completing’* character is dear.

Histobical Outlines

353

was mainly by facilitating imports, but not otherwise significant).
Nevertheless, two remarks suggest themselves.

First, that development was not so astonishing as English observers
— or the English press — seem to have felt it to be. It was only part
of the process by which during that time, in the German territory and
with the German nation, anthropological and sociological possibilities
reasserted themselves after the break which had interrupted development
for more than two centuries. Interpretation must take account of the
spring resuming its form (though something in it remained paralyzed)
after removal of the weight. Looked at in this light, that development is
not at all astounding. A similar statement may be made about any line
of German development. Conditions being provided, security and space
being guaranteed by the Hohenzollern empire, Germans readily and, as it
were, naturally, took to industrial and commercial tasks on a large scale,
and many old attitudes and traditions that had not been quite extin-
guished, revived in new forms. The question arises how such a fact is
related to our schema. It certainly imparts to German series what might
be termed a special trend due to the influence of favorable changes in
environment. These have nothing to do with entrepreneurial activity.
But enterprise, itseK the inheritance of bygone ages, supplied the mecha-
nism by which these new conditions asserted themselves. It was simply
attended by success greater than it would otherwise have had. There is,
hence, no reason to think of this factor as exerting an influence distinct
from our process — and no reason to expect that the evolutionary process
presents, on that account, any new problems.^

This set of facts is as German as its repercussions are English, and as
immigration, the conquest of the frontier and so on are American. In
all countries, however, and in Germany not more than in the other two,
we again observe, in the second place, that expansion of production, that
pushing into economic space newly created, which is characteristic of
Kondratieff downgrades and revivals and which is as strongly marked in
that Kondratieff as it was in the first, and will be seen to be in the third.
We know the phenomenon and the reason why it is not the prosperity
phase of a cycle which gathers in the harvest in terms of increasing real
wealth, but the others. All that needs to be mentioned is that the instance
under discussion is particularly enlightening because it has come to be
known as the Great Depression. ^ The use of the term varies. Most

^ It will be seen that tbe above analysis yields another contribution to our treatment of
data and of external factors.

® It is, indeed, a great satisfaction to notice that in one of those Revisions in Economic
History which are so excellent a feature of the Economic History Review^ Mr, H. L. Beales
(October 1934) deals a vigorous blow to the implications, so long uncritically accepted,
which the term carries with the majority of students. The historian’s evidence, entirely

354

Business Cycles

people will, tlie writer believes, apply it to 1873-1896, which makes it
roughly cover depression and revival, or to 1873-1886 which almost
exactly covers the former. The case of Germany is, in this respect,
peculiar only because her Kondratieff prosperity was crippled by various
circumstances while the harvest phases were accentuated by the facts
mentioned above. The latter is true also — mutatis mutandis — of the
American, the reverse of the English case.

Since German industrial development was to a considerable extent
conditioned by railroads, it is in this light that German urbanization^
and the conquest of her home market by her industries must be looked at.
Much of it was subsidiary to railroad developments or directly induced by
them. This holds true not only of some branches of the machine indus-
try, such as locomotive building — ^it was in the forties that the firm of
Borsig made its big stride — ^but of all, and still more true of coal mining,
iron, and steel. The prosperity of the forties carried output of coal to not
more than roughly 5,000,000 metric tons, however, and the great expan-
sion in absolute quantity came in the downgrade of the Kondratieff, or
more precisely, in the upgrades of the Juglars superimposed upon that
downgrade, which is exactly what we should expect, if we take account of
the cyclical nature of part of the demand for coal (consumption in homes
was, in the last two pre-war decades, only about per cent). Relatively
it rose by roughly 50 per cent in each decade from 1870 to 1910 (in 1896 : 85,-
690,000 tons). Lignite was neither a new commodity — ^it is first men-
tioned, as far as the writer knows, in 1549 — nor did it enter upon its career
as a chemical raw material within our period, but it also swam with the

free as it is from any theoretical bias, should go some way toward convincing economists.
The well-known and much-quoted Third Report on the Depression of Trade also fails, by
the facts actually presented, to bear out its title fully, although it refers mainly to two really
depressed years.

1 The process of urbanization is very clearly cyclical. It should be mentioned that its
pace is not quite exactly depicted in the statistics, which, even after the improvements
incident to the foundation of the empire, remained unsatisfactory in various respects.
Classifying aU places above 2,000 inhabitants as urban and all below that figure as rural
is not only arbitrary but, if taken to indicate the distinction between industrial and agri-
cultural sectors, misleading.

We take the opportunity to add that the three occupational census (1882, 1895,
1907), which naturally constitute one of the main sources of our sketch, differed in method
and are neither strictly comparable, nor entirely reliable. Variation in the number of
gainfully employed women, for instance, is in part due to differences in the wording of
instructions. It is, however, broadly true that the number of people employed in agri-
cultural pursuits remained fairly steady, so that the bulk of the increase in population was
absorbed by industry and (until the last years of the century) by emigration, which reached
its high-water mark between 1880 and 1885 and then fell off (from 1895 to 1905 there was
net immigration). The number of people attached to agriculture (Berufszugehorige) was
in millions: in 1882, 15.94; in 1895, 15.44; in 1907, 14.92.

Historical Outlines

355

stream. Briquette production was a feature of tlie downgrade, increasing
from 754,000 tons in 1885 to 3,061,000 in 1895; but the increase to £1,418,-
000 tons occurred within the prosperity phase of the third Kondratieff.
Otherwise, innovation in the field of coal mining consisted in the creation
of larger units and in the increased use of machinery — ^particularly for
reaching greater depths and for sorting — only partly novel.

The case of pig iron, or the iron industry in general, enters into the
same class. It was in the forties that the foundations of its modern
structure were laid. The fifties brought new developments. But the
great increase in absolute quantities came later, in the downgrade of the
Kondratieff: 5£9,000 tons of pig iron in 1860, nearly 4,7 millions in 1890.
The great leap was in the sixties and early seventies — ^from 1873 to 1877
iron consumption fell by 50 per cent. True to form, output and number
of concerns increased in Juglar prosperities and decreased in Juglar depres-
sions, but in each prosperity productive capacity was so much increased
that recessions and revivals display as a rule greater absolute increase in
output than the preceding prosperities. This of course, inverts the
Kondratieff picture as to absolute quantities — ^though not as to rates —
but should easily be seen^ to conform to expectation. We shall return to
the matter when discussing the time series. Innovation in this field
consisted in commercial, locational, and organizational change rather
than in the introduction of major technological novelties, and the type of
entrepreneurs — ^many of whom were members of old industrial families —
corresponds to this. In 1847 methods were as yet quite primitive. Use
of coke did not spread before 1850, and it was only by 1870 that charcoal
was (substantially) supplanted. In the downgrade of the Kondratieff,
development of this type loomed large, also in the neighboring industries
of ironworking and engineering, the boom in which was an important
feature from 1870 to 1873.

Steel of course presents a different picture. In its modern functions
it was a novelty and the product of technological novelties. German
figures were swelled by the annexation of Alsace and Lorraine, which
meant not only increased possibilities, but also acquisition of several
leading steel concerns already in existence (de W endel, Dietrich) . Increase
in output was however striking independently of this. But the most
important innovations came from abroad, so the Bessemer, the Siemens-
Martin^ open-hearth, and the Thomas basic process. Not until the last
overcame the difficulty incident to the comparative scarcity of non-

1 The reader wno desires to acquire command of our model as a working tool for the
analysis of concrete situations should carefully discuss the case, which is more instructive
than others, in order to satisfy himself that this is so (see Chap. IX).

® The writer supposes that Sir William Siemens counts as an Englishman for our pur-
pose, though Werner von Siemens remains a German.

356

Business Cycles

phosphorous ores, did German steelmaking really get into its stride.
Again, this was a typical downgrade development. We confine ourselves
to adding a few data which constitute landmarks in the progress of Ger-
man enterprise in the iron and steel field. Krupp, who was also the first
producer of cannon from cast steel (1856), introduced the Bessemer
process in 1861. Others followed quickly. Borsig constructed the first
Siemens-Martin work (1864). It is interesting to note in this connection
that great firms at that time began to push into the higher stages of their
process — ^the innovation of vertical integration.” The firm of Borsig for
instance acquired coal, iron, and other mines in Silesia (1847), built blast
furnaces in the sixties, as well as a puddling plant and a rolling mill, and
so developed from a locomotive factory into a “mixed” steel concern.
The same tendency is observable in many of those entrepreneurs or, as we
might say in this case in spite of our proposition that the entrepreneurial
function is essentially personal, those entrepreneurial families that created
the German heavy industries, such as the Stinnes, Haniel, Harkort,
Funke, Stumm, Grillo, Bochling, Guilleaume, Pastor, Bocker, Henckels,
Mannesmann, Talbot, and Thyssen. Cartels and “communities of
interest” developed here and there, in rails for instance, before 1873, and
then quickly became a dominating feature of the group of industries the
evolution of which was, as Mr. Robertson pointed out long ago, particu-
larly prominent in what, according to our count, was the penultimate
Juglar.^

In the fields of finished steel and nonferrous metal products there was,
as we have seen, an old tradition to start from, on which much effort to
apply new improvements was brought to bear. The Solingen cutlery
trade, older than, but still sufficiently similar to, the Sheffield trade, may
serve as an example. Though a large part of it remained in the craft
stage and another part in the domestic industry stage throughout the
period, the innovation of factories came in during the second Juglar, at
first into forging only, later on into everything else. These factories were
small or of medium size, many highly specialized, all of them transfor-
mations of the artisan’s shop, some the creations of entrepreneurs who
had been artisans themselves — a type not uncommon in Germany even
at a later time. About Nuremberg and other centers of metalworking
similar statements could be made. The quick rise of the armament,

1 Compare Banking PoKcy and the Price Level, p. lln (1st ed.). Mr. Robertson was
one of the first theorists of business cycles to recognize what to historians always has been a
matter of course, that innovation had something to do with them. In that note he definitely
links up individual cycles with evolution in particular industries. In referring to the
^‘boom of 1882” he may have been thinking primarily of England, but the statement is
much more obviously true for Germany, although there seems to be no point in emphasizing
the particular year.

HiSTORICAI^ OuTIilNES

357

machine, and machine-tool industries, which almost suddenly emerged
in the prosperities of the forties and fifties, and rose to equality with,
and even to superiority over, their foreign competitors (American harvest-
ing machinery is the most important exception) during the three subse-
quent Juglars, was in part due to that tradition, which accounts for the
presence, from the first, of an ample supply of workmen of the locksmith
type. These industries afford examples of entrepreneurial activity which
are particularly instructive and illustrate to perfection certain aspects of
the working of our process, both as to how these innovations intrude into
the system and as to how they affect it. We cannot enter into the matter,
however, and will confine ourselves to stating that, according to the
census of 1882, more than half of the men employed in the division of
‘‘machines, instruments, and apparatus” worked in concerns employing
50 workmen^ or less. The large concerns were, of course, in ship-
building, structural material, and so on, and many of the smallest ones
were only repair shops. It is, nevertheless, significant to note, particu-
larly by comparison with the census of 1907, that, throughout that
Kondratieff, small-scale enterprise — ^the entrepreneur who was his own
engineer, buyer, salesman, personnel manager, efficiency expert — counted
for so much in one of the most conspicuously successful fields. It is
important to visualize the type, to put him side by side with the railroad
promotor and to realize that both, and all that comes between them,
enter into our concept of ‘Hhe” entrepreneur.

The modern German textile industry is a product of that Kondratieff.
Introducing methods that had already been successful abroad, mechaniz-
ing by means of partly imported machinery, setting up new factories,
especially solving the problems of the large-scale factory, exhausts the
bulk of entrepreneurial achievement in this field. There is little techno-
logical originality about this, although much organizational and com-
mercial energy. Each Juglar brought its installment, none was dominated
by textile developments. The old silk industry revived in response to
increasing wealth, but did not display any innovating activity until
mechanized mass production — ^both in silk proper and in spinning waste,
also in dyeing — came in. This entrepreneurial achievement was a
feature of the last Juglar. Linen decayed, being crowded out by cotton.
Both in this respect and because of headway made by the factory and the
power loom, this industry affords a particularly drastic example of how
the New crowds out thp Old. The process of elimination did its work
substantially in the downgrade and revival of the Kondratieff, although

^ It should he observed that German statistics define a large-scale concern (Grosshetrieh)
by the criterion of employing more than 50 hands. So very unreliable and modest an idea
of what a large concern is, may obviously prove misleading in arguments about the relative
growth of the large-scale unit.

358

Business Cycles

the census of 1895 still showed some remnants of the old domestic indus-
try, both of the independent small man and of the putting-out type, and
although the decay of the latter had, with all the misery incident to it,
set in during the first Juglar.

Similar statements may be made about wool — the factory and
mechanization having substantially won out, by 1895, in spinning and,
though not quite so much, in weaving — except that in this case a great
modern industry emerged. The quick decay of domestic wool production
after 1870 helped rather than impeded this development, for otherwise
protection for the raw material could hardly have been avoided. As it
was, cheap wool from overseas, particularly cheap tops for the worsted
industry, which was a novelty, greatly facilitated matters. It was mainly
a downgrade development, though the power loom began to gain ground
in the forties. Even in cotton weaving the hand loom and the domestic
system persisted throughout — ^about M per cent of hands employed were
counted in those categories in 1895 — ^but in cotton spinning there was
quick development toward the mechanized large-scale concern during
the second and third Juglar, and further concentration during the fifth
and sixth. Clothing and bootmaking remained predominantly crafts
throughout the period, even putting-out and large-scale retailing meeting
with great resistance, while the small man” enjoyed official favor that
had much to do with his survival in the downgrade {MitteUtandspolitik'^) ,

Building activity was in proportion to industrial expansion and to the
rate of increase in wealth and population. We have seen theoretical
reason to expect that, while industrial and commercial building is of
course positively associated with all, and particularly with Juglar, cycles,
dwelling-house building should, owing to its dependence on the mortgage
rate, display an opposite tendency. This is, on the whole, what we find,
although the statement calls for various qualifications. In particular, it
is clear that where innovation implies migration, workmen’s and other
dwellings will in some places be constructed, along with industrial plants,
during prosperities. This in part explains, more perhaps than the short
interruption of building activity during the Franco-German War, the

^ The measures that went by that name and the measures that were advocated by the
craftsmen and their representatives present a good example both of the resistance that
innovation meets with and of one type of defense that threatened strata resort to. We
have observed them in England ever since the sixteenth century, and we can observe them
today, not only in Germany. How far they were really effective in alleviating transitional
difficulties it is hard to say, because modern industry did not simply crowd out those older
forms of production but at every step also offered new possibilities to them — cheap semi-
finished products, for instance, openings for retailing activities, better tools and power, and
so on. Also, the attitude of the public helped, particularly in Germany. There was a
strong dislike of any but custom-made garments or shoes. In the case of large-scale
retailing, anti-Semitic tendencies also helped to protect the small man.

Historical Outlines

359

building boom wMch preceded the crisis of 1873 and has in its violence
never been equaled in German history, either before or after. There was,
however, another reason for it. Technologically the building trade as
such did not materially change throughout our period, although brick
production did: the ring oven (Hoffmann-Licht, 1858; improved in
1869, after which it rapidly spread) and a brick-pressing machine (1854)
were fundamental innovations.^ The steel-concrete building (1867) did
not until the third Kondratieff play any great role. But the obvious
tendencies of the time gave scope to another type of innovation — ^specu-
lative building, ahead of immediate demand, often implying the develop-
ment of whole suburbs or quarters, always implying speculation in sites.
Banks were founded for the purpose of financing business of this kind —
the mortgage banks (Hypothekenbanken) got into diflSculties over it in
the middle of the seventies. Trade in building material became a
matter of speculation. Homes and apartment houses were commonly
built and bought on credit. Analysis of this boom of 187^ would lead
to a diagnosis similar to the one we shall arrive at in the case of the
American building boom in the twenties of this century. All that matters
here is to realize its exceptional character. The development of German
cities, taken as a whole, remained, however, a typical feature throughout
the KondratieflE downgrade, and was in keeping with all its other character-
istics. We will notice, in particular, the importance which public-utility
enterprise — ^gas, water, and means of transport — acquired especially in the
eighties. Municipalities increasingly embarked upon it, and at the same
time began also to expend heavily on other public works, thus quickly
running up what then was thought to be a formidable load of debt. In
this respect, phraseology has changed more than practice.

Again we observe the phenomenon that called for attention in the last
two Juglars of the first Kondratieff. The same place that was then
occupied by railroads, was in the downgrade of the second Kondratieff
filled by the chemical and electrical industries. They were — ^together
with other innovations, such as the rubber development, turbines,
internal-combustion engines, and so on — ^to carry ” the third Kondratieff;
but, unlike those others, they achieved enough success to reveal their
possibilities and to play some role, though not a major one, before the
second had drawn to its close. The beginnings of Germany’s chemical

1 Compare G. Clausing, Die TJebererzseugung in der Ziegelei von 1867 bis 1913, No. 4 of
Spiethoff’s Beitr^ge zur Erforscbung der wtscbaftlichen Wechsellagen, 1931. This
excellent study follows the course of events in the brick industry, cycle by cycle, and dra ws
a most interesting picture of bow, with small capital requirements (a ring-oven brickwork
producing 23 ^ millions of bricks per year used to cost, including machinery, about 100,000
marks) and an inelastic but highly variable demand, things work out under competiuon
and also under combination.

360

Business Cycles

industry go far back, and both tradition and other conditions that have
often been emphasized, perhaps overemphasized, may be adduced in
explanation of later successes. But in our period, that practical chem-
istry which counts — or counted at that time — ^for industrial purposes was
further advanced in England than in Germany. Great original innova-
tions were not absent. For instance, the coke oven became the source
of coal tar, and ammonia and coal-tar dyes were first produced in 1846,
azo dyes in 186S. But the production of ammonia was no more than
84,000 tons in 1897 and the dyes (though alizarin met with success in
1876 and artificial indigo had been invented in 1850) did not triumph
till later. More important were the developments that followed from the
discovery of the potassium deposits (Stassfurt, 1861; production started
in 1863; others were discovered later). But on the whole, chemical
production — ^both of basic materials, such as sulphur (from pyrites),
sulphuric acid (innovation: contact process, success in 1888), sodium
chloride, benzol (commercially successful by 1849), and of finished prod-
ucts, such as fertilizers, matches (safety match, 1855), explosives, paper
(wood pulp^ treated by the soda or the sulphate process), oleomargarine
(1868, but not of importance until the nineties) — ^followed rather than
preceded the general evolution of the environment and foreign achieve-
ment (^.^., Solvay process, 1879). Enterprise was, in accordance with
this, of a type similar to that which prevailed in the textile industries.

The occupational census of 1895 is the first to recognize the existence
of an electric industry. By then it employed 26,000 men and had revealed
possibilities — ^both as to light and as to power — ^far beyond its actual
performance. The particular relation between invention and innovation,
the entrepreneurial type, the problems of financing and marketing it
presents, and the revolution it wrought would repay more attention than
we can bestow on it. To recall a few familiar facts, Faraday’s discovery
in 1831 of induced currents (the fundamental principle of the dynamo)
was, in the same and the following year, applied by H. Pixii to the genera-
tion of alternate current (with permanent and rotatory magnet) ; in 1833
Gauss and Weber displayed their magnetoelectric telegraph at Gottingen;
in 1833 and 1835 followed the work of Saxton and Clark on rotation of
coils; in 1845, Wheatstone’s substitution of electromagnets; in 1849,
Nollet’s magneto machine; in 1856, Werner Siemens’ shuttle-wound
armature; in 1860, Pacinotti’s ring armature (reinvented by Gramme in
1870); and in 1867 the full-fledged ^Mynamo” emerged. After that,
improvements followed quickly (Hefner, Brush, Thompson, Edison),
Deprez’s experiment in transmission of several horsepower over telegraph

^ Manufacture of paper from wood pulp met its first successes in 1803; the cement-lined
pulp digester, in the early nineties. G. Keller’s invention started a development of some
importance in 1845, wHch linked np with the rotary press (1846).

Historical Outlines

361

wires meriting particular notice. It was repeated in Frankfurt (0. Miller,
1891) on a much wider scale, £00 horsepower being transmitted over
180 kilometers. Experimental use for lighting purposes (Faraday and
Holmes, 1858) had been made by then; but up to, say, 1873 (end of reces-
sion of the fourth Juglar), electricity was of established importance only
in telegraphy, though soon afterward the telephone widened its field
somewhat. Telegraphic appliances and cables were the chief item in the
program of the firm of Siemens and Halske when it was founded in the
forties. It was a success. The history of the man and of the firm is, of
course, a classic in the collection of the student of innovation. We will
mention another instance — equally characteristic, although wholly
different — ^that of the former iron manufacturer Emil Rathenau, who in
1883 formed the Deutsche EdisongeseUschaft. In the seventies and
eighties, however, America led, and most of the special-purpose firms
that sprang up in Germany at that time were not very important. None
of the great technological conquests, such as the electric tram displayed
in Berlin 1879, electric steel, and the electric supply stations, achieved
quantitative importance during our Kondratieff.

One of the main shortcomings of this sketch is its failure to do justice
to a characteristic feature of Kondratieff downgrades and revivals: the
unmanageable variety of minor changes — ^induced and adaptive in the
main — ^that in those phases spreads over the whole system and is as
difficult to follow up as it is important. We must confine ourselves to
indicating briefly the course of cyclical phases. We have already disposed
of the first Juglar; but we have also seen that the next three were primarily
propelled by new railroad construction and its effects. The second rises
clearly in 185£ (there is, except for the terminology which follows from our
schema, no difference of opinion about this), when industrial conditions
were such as to make it quite clear that another period of investment
would in any case have come about irrespective of the new gold.^ Rail-
roads, iron, steel, machinery, the emergence of a modern textile industry
and of the type of financial institutions mentioned above, formed the core
of the innovations of that period and were obviously adequate to induce
all the investment and to produce all the phenomena of that prosperity
which in 1856 tapered off into what contemporaneous reports describe as
overproduction. We shall have little difficulty in identifying this as
the effect on total output of those innovations and their subsidiaries.

Some of the factors being absent which in England rolled up the
Secondary Wave to such dimensions, the ensuing crisis was milder. There

^ On tbe other hand, it wonld not be correct to argue simply that gold could not have
influenced the German price level or otherwise given an impulse to German industrial
development because Germany (the German States) was not then on the gold standard.
Very little reflection will show that. Moreover, silver production also increased.

362

Business Cycles

was, however, a panic in Hanoiburg at the end of November 1857. Many
bankruptcies followed elsewhere, and 1858 displays all the features of
depression, although the price level did not strongly react — ^this, of course,
was partly owing to the new gold and partly to the phase of the underly-
ing Kondratieff which was just turning into recession. The year 1861
completed recovery, and 1862 started the new Juglar (again there is no
difference of opinion about the fact that a new Aufschwung set in, see
Spiethoff, op, p. 51), which could be described in exactly the same
terms but for the American Civil War, which affected Germany less, and
the Danish and Austrian wars, which affected her more, than they did
England. The Prussian Bank rate was at 7 per cent in the last three
months of 1864 and again from October 1865 to February 1866. Diagno-
sis is hence uncertain; the general aspect of things nevertheless warrants
the statement that the Juglar turned into recession in 1864 and into
depression in 1866. There was no crisis, however, merely a flutter before
the war. The year 1867 is generally looked upon as one of depression,
although, contrary to expectation, prices continued to rise. Things
distinctly improved toward the fall, from which we date revival, although,
like Spiethoff who counts the whole of 1868 as Stockung, we have to note
an abnormally short duration of depression. Kevival went on, gathering
momentum in 1868 and 1869, and the prosperity phase of the fourth
Juglar may be dated from the beginning of 1870.^ There is some uncer-
tainty because transition to buoyant activity was so quick and smooth.

This as well as the shortness of the depression of the previous Juglar —
which, however is partly also accounted for by the fact that the dis-
turbances in the first half of the sixties interfered with, and thereby pro-
longed, the processes of prosperity and recession — is perhaps due to the
fact that the fourth Juglar was again a railroad cycle, the last one in
Germany. It seems plausible to argue that, since it was a step in the
same direction, the stage was set for it and people found it easy to rush
forward from the beginning. This would also explain why finance was
not so sound as, by comparison, it had been in the three preceding prosperi-
ties and why the Secondary Wave rose to unprecedented dimensions.
There was first a setback due to the Franco-German War, but then
prosperity resumed in an environment of understandable joyous optimism
— ^there is no reason not to admit this element where there is provable
warrant for it — and postwar spending. The period is known as the
‘‘ promoter’s time ” {Grunderzeit ) . Enterprise, spreading from the railroad
business^ and allied lines, extended lightheartedly to everything imagi-

^ If, again, account be taken of difference of terminology and descriptive arrangement,
our dates accord with those of Mr. Thorp, see Business Annals, p. 206.

* The type of entrepreneur that then came to the fore as it never had in previous pros-
perities and never did again to the same extent, had very little affinity with the type that

Histoeical Outlines

363

nable, both methods and schemes being clearly fraudulent in many cases.
The building boom has been mentioned above. Iron, steel, and machin-
ery made a big stride. So did textiles. Consumption of iron per head
more than doubled. Mushroom banks — ^many little better than bucket
shops — ^sprang up. Everyone knows that often-painted picture. Specu-
lation reached its high-water mark early in 1872 and then began to decline,
stock prices giving way in September. The ‘‘crisis” broke in Vienna on
May 8, 1878, in a most dramatic way and lasted for about half a year. In
Germany there was a great epidemic of financial and industrial bank-
ruptcies, but much less panic.

Again, the reader is invited to observe that this picture — or rather
the picture that would be drawn, had we space to do so, since the few lines
above can hardly be called a sketch — excludes none of all the historical
facts of the case. We do not aim at an one-cause explanation of any
concrete situation, and a full report would, as far as contours and details
of that situation go, run on much the same lines as all the others that have
ever been published,^ The “crisis” itself, in particular, which we hold
to be no part of the logic of our process, we could only describe in such
terms as reaction to excesses, swindle, cumulation of depressive effects

created and organized German industry. Nor has it an exact counterpart in England or
America. Yet the larger sized individuals of that species were by no means simple /at'^ewr^.
The railroad man, Strousberg — who was arrested when public and political opinion, which
had been not only patient but complacent for a time, at last began to turn against promoters,
and whose arrest brought down what was considered as his house of cards — may serve as
an example. After more modest beginnings, he launched out on large-scale railroad enter-
prise that extended beyond Germany. The method he gradually evolved — one which
became typical also in other fields — was this: he acquired a concession and sold it to a
syndicate that founded a company, to which the concession was in turn resold at a profit,
payment being effected in shares. Preferred shares were then issued, as soon as possible
introduced at the stock exchange, and unloaded on the public to finance construction
(insiders frequently cleared out as early as at that stage). This construction he undertook
himself by way of what was called Generalenterprise, that is to say, at a fixed price per mile,
profiting on the purchase of materials and so on, which as far as possible be again paid for
in shares. The roads were not, as a rule, badly built, at least in Germany, where the
authorities saw to that. But financial difficulties were likely to arise even during construc-
tion, and the slightest shock to confidence was bound to spell catastrophe. Yet there was
real achievement in much of this. Strousberg’s roads were not ill conceived; and it is very
difficult to say whether there was bad faith in his case — ^his glowing fancy prevented him
from seeing anything except the most rosy possibilities, and it was said of him that he would
never, during his whole career — even while people believed him, and he believed himself,
to be fabulously wealthy — ^have been able to realize a net worth from his assets. He told
his own tale in a book entitled Dr. Strousberg und sein Wirken.

^ We must, however, notice with regret the astonishingly small amount of scholarly
effort that has been directed toward a subject which is obviously not uninteresting. There
are a few antiquated standard works upon which most later writers rely. First-hand
research, of later date, there is very little.

364

BpsiNESs Cycles

(bankruptcies inducing others and so on), and the like. All we have to
add from our standpoint is, first, that such description takes hold only of
the surface, of the phenomena of what we call the Secondary Wave, which
is an “understandable incident’" to a particular link in the sequences of
situations created by an underlying process of evolution. The reality of
this process and the particular innovations by which it asserted itself
stand out in this case with an unmistakable clearness. The extent of the
catastrophe and the duration of the ensuing depression is, again, accounted
for by the location of that Juglar in the Kondratieff and again suggests
analogy with the cases of 1825 and 1929. This analogy is much less con-
vincing than in the case of the United States, because in Germany there
was not so spectacular a crisis or spiral in either of these two instances.
Substantially it holds true, however. Price level behaved, from 1857 to
1878, contrary to expectation. According to our schema it ought to have
displayed a tendency — ^interrupted in each Juglar prosperity, no doubt —
to fall. Gold must be held responsible for that, and gold plus the French
indemnity for the abundance of credit and the excesses of speculation.
We may hence use the case to demonstrate the consequences of such
abundance and of conditions — ^there was at the time of course no policy
aiming at that goal — ^which overbear a systematic tendency of prices to
fall. Clearly gold production did not, previously to the crisis, slacken in
such a way as to entitle us to speak of any scarcity as a causal factor, even
if there were any theoretical justification for doing so.

That depression is usually held to have lasted through 1879. But we
can easily see in the German case, as we saw in that of America, that
recovery started in 1877, when industrial conditions brightened up and
iron production ceased to fall. This recovery was so weak and halting,
however, and such a depressive atmosphere persisted throughout its
course, that we have little quarrel with that statement, provided it be
understood that this use of the term depression does not carry the tech-
nical meaning we have given to it. Now, explanation of this phenomenon
follows much more completely from our schema than does the explanation
of the “ crisis.” Change, revolutionizing everything in German economic
life, had come about in the three preceding Juglars and in the prosperity of
the fourth, and long-time effects had begun to tell. Germany had
become an industrial nation: a powerful apparatus for the production of
industrial equipment had been built up, all industries had been expanded
and reshaped and were ready to pour forth their products. Prices high
enough for the new firms in an industry were much too low for the old
ones. This spelled bad business, loss, death for large strata of the
economic structure, some of them vocal — as, for instance, the stratum of
the artisans and small men in general — others silently decaying. For the
moment possibilities for advance were obviously exhausted and the

Historical Outlines

365

milieu had to adapt itself as best it could. This adaptation was a painful
process, particularly in a country that had been so little ‘"capitalistic’’
as late as 184£. No wonder, then, that investment dropped to almost
nothing, that unemployment prevailed, that the vicious spiral cut deeply
into what for the time being was a very unresisting organism. The char-
acteristic features which are conveyed by the phrase 'poverty in plenty very
naturally emerged — only there was no paradox about it.

• The two last Juglars display some afterefiPects of that shock as well as
the influence of the agrarian situation which we have dealt with before.
We know the reason why gold cannot be relied on to contribute signif-
icantly to explanation: it is more than doubtful whether, taking gold
production together with contemporaneous banking developments and
changes in the habits of the public, there was any net effect at all. The
fundamental fact is again in the location of those Juglars in the Kondra-
tieff which in the absence of any major disturbing factors fully asserted
itself. We should expect great increase in output, an indefinite number of
induced improvements in technique and organization, the "‘pushing into
newly created economic space,” adaptive investment — and all of it on the
lines chalked out before. This is what we find and what readily accounts
for the fact that upswings are so much less marked than downswings.
Increase in real wealth, greater expenditure of municipalities, easy money,
and unemployment, all fit into this frame.

The fifth Juglar begins in 1880, with a moderate wave of new incor-
porations. Iron and steel reacted to the impulse of the Gilchrist Thomas
process (success in 1879), which of course greatly improved the possibilities
of German production. And utilities, textiles, and machines made
another stride. But however important that innovation — ^there were
others in the same field — ^the prosperity was weak (if measured, as Spiet-
hoff measures, by consumption of iron, it was very weak,^ though strong
enough to turn the price level upward for more than a year). In the
second half of 188£ it turned into recession, then in 1884 into a depression,
which was not a severe one, however, with iron, steel, shipbuilding,
textiles, and other physical items increasing practically all the time.
That depression was fertile in cartels. Revival came in the fall of 1886
and took its normal course.

From the very beginning of 1889, a reversal of the falling temdency
of the price level and an increase in pig-iron consumption beyond the
rate of 1873, indicate the rise of the last Juglar. It was characteristically

1 Mr. Thorp, p. 209, actually speaks, for 1880, of a ‘*mild depression.” But surely this
overlooks the downward trend of many indices which gives additional importance to any
upward deviation. In view of recent discussions, it should be observed, however, that
there would have been no less justification than there is at present for economists to
talk about the exhaustion of capitalist possibilities.

366

Business Cycles

what we should expect a last Juglar to be — Juglar of odds and ends.
The electrical industry perhaps counted for something, though certainly
not for much. Another feature, novel in its extent though not otherwise,
was capital export — Germany beginning to take a hand in the ‘^capitali-
zation” of noncapitalist countries. In part, this consisted simply in the
acquisition of foreign securities, but to a much greater extent than French
capital export it implied actual enterprise abroad and hence orders for
the German equipment industry, in spite of failures and losses. For the
rest, there was induced and completing innovation in steel — electric steel
was a really new thing, however — and textiles, coal and gas — ^in the latter
the Welsbach invention supplied an additional impulse. There was also
considerable (public) railroad construction. Perhaps it was owing to
repercussions from London that recession set in as early as the autumn
of 1890, though prices continued to rise into 1891. The turn into
depression occurred early in 1893, partly again from extra-German
causes, to which the German organism had by then become much more
sensitive than it had been before. Depreciation of foreign securities was
a really serious matter and created difficulties in the sphere of credit for
which there was no adequate industrial reason — ^production of pig iron
and of textiles continuing to increase. Difficulties in business were of a
particularly trying kind. For years together, many firms led a profitless
life on the verge of bankruptcy and struggled on amidst what to them
seemed hopeless overproduction. But there was no “crisis” either in
1890 or 1893, and toward the end of 1894 things began to straighten them-
selves out. Nobody talked overproduction in 1895, and the stock
exchange once more enjoyed a temporary boom. In 1896 (second half)
prices and interest rates recovered, return to normality was the obvious
tendency all round. And 1897, although it shaded off into prosperity,
gives, on the whole, a very fair idea of what a neighborhood of equilibrium
looks like in reality. There is nothing astonishing in the unusual length
of this recovery phase.

2. With the more familiar history of the English industrial revolution
of that period we will deal as briefly as possible, using what has been said
about Germany as a plane of reference. The two outstanding differences
should hence be mentioned^ first. England was a fully industrialized
country of accumulated wealth from the start. As far as this goes, her
cyclical fluctuations should have been milder than the cyclical fluctuations
in “younger” countries, in which bold advance and catastrophic setback
are more likely to alternate and credit creation must be resorted to much
more. Rates of increase cannot be so spectacular. Moreover, the rise
of competitors must affect not only relative but also absolute positions and
cyclical situations, if the industrial apparatus has been fashioned with
respect to a given state of foreign competition. From the standpoint

HiSTOEICAL OuTIilNES

367

of welfare there may be, and generally will be, compensation and more
than compensation; but this does not entirely dispose of the argument
that nationalists and protectionists began to press during the last two
Juglars. In diagnosing English business fluctuations and their result
trends, this must be kept in mind.

England also, on the one hand, was a capital-exporting country from
the start, and, on the other hand, grew more and more dependent on
imperial and extraimperial foreign trade. For both these reasons, her
cycles tended to shape in function of foreign business situations and her
^‘crises” as well as financial booms to originate in foreign events. The
states of her industrial organism were so profoundly affected by her
capital export because, unlike the French and like the German case, a
great part of it meant actual enterprise embarked upon in foreign coun-
tries. Acquisition of foreign securities, which increased in absolute and
relative importance from the beginning of the sixties — capital export to
this country being before that time the outstanding item — also acts on
commodity trade and hence on industry, but financing foreign enterprise
of conationals does so in a much more direct and effective way. From
1875 to 1890 export of capital (and income from abroad) increased
strongly and in a relation to cyclical situations which is perfectly under-
standable.^ Later, it fell sharply during the last stage of the Kondratieff
revival.

Value of exports of British and Irish produce rose from 1847 to a peak
in 1874 (after which it fell to 1879, owing to the fall in prices). Under the
circumstances this could defensibly be taken as the most important
economic fact of the period and the most significant rate of increase.
In a sense it was. But it should be observed how readily any such state-
ment lends itself to faulty interpretation: it is tempting to say that, given
the situation prevailing in 1842 and Free Trade, such a development would
automatically follow, as to trends as well as to fluctuations, and that there
is hence neither need nor room for an autonomous mechanism of cycles.
Most students would in fact, even if they admit the explanatory value of
the latter, list foreign trade and innovation as two separate — ^though
perhaps interacting — ^factors. Such a view would, however, overlook not
only that the increase in exports can only to a minor extent have been due
to free trade plus such growth as would have occurred independently of
innovation, and that every inch of ground beyond that had to be con-
quered by what was industrial or commercial innovation within our

^ See Jenks, Migration of British Capital; Hobson, Export of Capital; Eeis, Europe:
the World’s Banker; also, Clapham, op. dt., vol. II, p. 234. Eor |)oints of theory, reference
should be made to Professor Taussig’s standard work on International Trade. The ques-
tion of the relation of capital export to cyclical situations will be touched upon in Chap.
XIII.

368

Business Cycles

meaning of the term, but also that the industrial apparatus of 1842 obvi-
ously would have been unequal to the task and that its transformation
was a necessary prerequisite for that development of foreign trade, which
therefore was but a form and result of innovation acting upon the data
created by free trade. In other words, barring the factors of English
growth, the upper limit of which is certainly below the rate of increase in
population, of foreign growth, and of foreign innovation, England’s
foreign trade and industrial progress were not two different things, but
only different aspects of the same process.

Having previously disposed, however inadequately, of railroads and
canals, we will recall their pivotal importance in breaking up old and con-
ditioning new industrial structures — ^the fundamental fact about cycles
throughout the first half of that Kondratieff — and go on to notice develop-
ments in shipping and shipbuilding, which, besides opening new outlets
for English products, were the chief factor in all the possibilities and
realizations incident to cheap food and cheap raw materials — the fall
in the prices of which was one of the most outstanding features of the
bourgeois Kondratieff and nowhere so important as in England. Apart
from the commercial and organizational achievements involved, such as
the foundation of big concerns (for example, the Cunard in the early
forties), which rationalized shipping and reduced the tramp to a modest
role, the main thing was, of course, the iron steamer. Its career brought
United Kingdom (registered) tonnage from less than 3 up to more than
8 millions in the period, or approximate carrying power adjusted for
steam (see Usher, Growth of English Shipping, Quarterly Journal of
Economics for May 1928, p. 467) from a little over 4 millions in 1850 to
nearly 31 millions in 1900, or shipping cleared in foreign trade {ihid.y
p. 469) from a little over 2 millions in 1840 to nearly 28 millions in 1900.^
It established itself in the fifties, quickly crowding out the wooden paddle
steamer: the ill-starred City of Glasgow which heralded the innovation
was launched in 1850. The steel ship was an achievement of the penulti-
mate Juglar, though attempts in this direction date from the early sixties.
Along with it came size, the screw, better boilers, and, with boilers that
could stand it, the application of the high-pressure expansion (‘‘com-
pounding”) engine, which was definitively successful (though worked out
and applied before by John Elder in 1854) in the early eighties, greatly
reducing cost of fuel and increasing carrying capacity. Everything
else, the long series of induced improvements in particular, is for us of
minor importance. The tremendous upheaval caused by this develop-
ment in all conditions of production and trade may be inferred from the
ensuing fall in freight rates.

^ There were about 900,000 steam tons in 1865, compared with nearly 5 millions of sail,
but by 1875 they had increased to nearly 2 millions and by 1885 to about 4 millions.

Histokical Outlines

369

A few points that are of interest for our subject may be briefly noticed.
First, we neither can nor need tell the story of the Great Eastern (iron;
paddles and screw; six years from design to launching, in 1858), the
great premature innovation in size. Its complete failure, which is not
accounted for by any obvious faults in technique or in the commercial
idea, is so good an illustration of the nature of the entrepreneurial task
and the conditions of entrepreneurial success that it repays careful study.
Second, the history of the steel screw steamer equipped with a ^‘corn-
pound’^ engine affords an ideal example of the resistance of the environ-
ment to innovation, which is not everywhere so obvious in that period.
Silent refusal — stubborn precisely in its lack of motivation — insistence
on, and exaggeration of, initial difficulties and blemishes; the setting up
of unreasonable standards (the Admiralty in particular surpassed them-
selves in this) ; strategic use, for no particular reason, of antiquated rules
and regulations; resistence of threatened interests — all these, had we
space, could be delightfully displayed to show the realistic virtues of the
idea that innovation comes, if at all, by rushes. Third, like the railroad,
the steamer was first thought of for carrying passengers and mail, which
was by no means self-evident or logical. As it was, the iron steam
freighter was a distinct innovation of the third Juglar, made possible
by the previous success, in the second, of the iron steam collier. So
was the partial conquest of trawling, which ushered in a new epoch in the
history of fishing and whaling. And, fourth, the case serves well to
exemplify various forms of adaptation by ‘‘old firms,” some of which
are not usually met with. One of them is, however, very regular indeed,
though its success in prolonging the life of an “old method” was in this
case exceptional.

There are to this day instances in which it would pay to build a sail-
ing ship or a ship so constructed as to be able to use sail when convenient,
rather than a steamer, even if all other things were equal. But they
are few and cannot have been very numerous in the latter part of our
period. What carried English sailing tonnage to its peak (1875) and made
the sailing ship survive throughout, was extrarational preference or
habit, the existence of shipyards equipped for the purpose, the imper-
fect economic mobility of seamen who were really sailors and would serve
for low wages, the possibility of taking up other, partly new, trade
routes when old ones had to be yielded to the steamer — a very good case
of “old firms” being gradually pushed back into the dusk. But much
more interesting is another type of adaptation which was temporarily
quite successful. What the new ship did for English shipping, both
qua iron ship and qua steamer, was not only to offer a more efficient
substitute for the wooden sailing ship, but also to wake up the producers
of the latter. English yards had gone to sleep on the laurels of a bygone

370

Business Cycles

time, and were inferior in performance to American and French, yards
for at least half a century. Now they tried new designs and several
minor improvements, and somewhat shook off the trammels of tradition.
They even reacted by an innovation of their own — ^the ‘^composite”
(wood on an iron skeleton), which flourished in the fifties and sixties.
The purely iron sailing ship dates as far back as the iron steamer and
does not come within the same class.

We will now exclude everything except coal, iron, steel, machinery,
and textiles, although this will fatally impair our picture, since our
choice of topics excludes not only some of the newest industries, such as
electricity — ^no great loss however in England’s bourgeois Kondratieff,
although electric light and telephone companies were a feature of the
Juglar that culminated in the early eighties — and rubber — ^this omission
deprives us of one of the classical instances of entrepreneurial struggle
and entrepreneurial achievement, the case of the firm of Thomas Hancock
(first patent for the elastic wrist band in 18£0, some success before 1837,
vulcanization in 1843, success on a considerable scale in the fifties) — ^but
also removes from our view the changes and petrifications alike in a
great number of those medium-scale industries which really constituted
the core of competitive society and which are particularly important in
the processes of Kondratieff recessions, depressions, and revivals. The
loss of the stories of gas, chemicals, cement, beer, paper, and glass is
particularly regrettable.

Technologically coal was, of course, the basis of the whole develop-
ment of that Kondratieff. But the coal-mining industry itself displayed
very little initiative. This is not difficult to understand, considering
the type of owners and the security of their position: here we have indeed
an instance which almost verifies, on the one hand, the idea some econo-
mists entertain of the capitalist-entrepreneur and, on the other hand,
the idea other economists have of economic development consisting of
industry’s being drawn along by widening markets, realizing external
and internal economies which fall into its lap in the process. It moved
along slowly with a considerable lag, and some of the improvements we
observe were forced upon it, for example, by the teaching of some inspec-
tors of mines since 1850. As canals had done before, so the railroads
widened the area of production, in fact, from the middle of the thirties.
The monopoloid position on the Tyneside was thereby broken up and
no other could develop, so that competition or rather what we have
called a disorganized market ensued, price falling promptly. During the
same time coal experienced another type of competition, which was to
become very much more serious in our own time. In the same sense
in which we can say that a labor-saving device competes with labor, it
can also be held that coal-saving devices, more economical machines
and furnaces, began to compete with coal. Capitalist development

Histobical Outlines

871

abroad which made coal — South Wales coal, in particular — an important
article of export (excluding coal for use of steamers in foreign trade, the
yearly average of exports in the early eighties was over £0 millions, in
the early nineties nearly 30 millions of tons) somewhat atoned for this;
the severity of the depression of the coal trade in the eighties nevertheless
reflects the effects of both kinds of competition, which were of course a
much-needed boon for the heavy trades at that time.

The second and third Juglars brought deeper pits, inducing more eflS-
cient winding machinery (which in the fifth was improved, among other
things, by steel cages and ropes coming into general use), scientific
ventilation (the great step in introducing mechanical fans of foreign
invention was in the sixties), and better methods of haulage underground.
Mechanical coal cutting came in very slowly though a workable machine
was patented in 1861. Output per man employed increased, how-
ever, by something like 50 per cent, from 1851 (if we start from W. St.
Jevons^ estimate in The Coal Question, 1865) to 1881, though it declined
subsequently.

There was not much progress in coking or in the utilization of heat and
by-products, but pig-iron production displayed more initiative of the kind
that is of ‘"igniting ’’ importance to cycles. The steam hammer (Nas-
myth) definitively conquered in the forties, and the integrated concern,
controlling production from the ore to the finished or semifinished article,
began at the same time to intrude into a world of medium-sized firms.
New ore districts were opened or developed in every Juglar — Stafford-
shire, Wales, Derbyshire, with Scotland as the new development, were the
main sources in the first and second Juglars; Cumberland, Lincolnshire,
Northampton, the North East came to the fore in the third, fourth, and
fifth; foreign ore in the fourth and fifth — ^the location of pig-iron making
was adapted to changing conditions, and there was considerable improve-
ment in methods of production. The hot blast was known long ago
(Neilson, 18£8), but took the whole Kondratieff to pave its way into use,
against enormous resistance if we can trust contemporaneous observers,
such as L. Bell, Utilization of waste gas, which, with the increased
temperature it made possible, and with increased size of furnaces, about
doubled output per unit of outlay, was first practiced in the Middles-
borough district (J. Vaughan). Here we have a definite New Man and
New Firm, which in two successive Juglars (the second and third) carried
out two definite innovations, and thereby set the standard and enforced
adaptation by the Old Firms in the industry for the rest of the period.
There is some doubt about the timing of that process of adaptation, some
districts resisting more than others. The lessons of prolonged “bad
times ” were necessary to convert recalcitrants who resisted as late as the
eighties. But there is no doubt about that general contour line and about
the increase in output which ensued in the Kondratieff depression.

372

Business Cycles

The great new thing in that field, however, was steel. Its career up to
the eighteenth century is not an English story, although B. Huntsman and
A. Crowley — ^both genuine entrepreneurs, yet without the following to
make them important for the cycle — began production by novel methods,
and steel forges in Sheffield were one of the minor features, in the upswing
of the first Kondratieff. After the Napoleonic wars, England began
exporting. Springs, high-grade tools, blades, and so on were then the
only finished products for which it was used, and there the matter (sub-
stantially) rested until the time of H. Bessemer. The situation, the man,
the kind of achievement, the economic success illustrate in such excep-
tional purity one of the types that enter into our concept of entrepreneur
that much more attention than we can bestow would be desirable,^ as it
would in the similar cases of William Siemens and Gilchrist Thomas. To
begin with, though he was called a professional inventor, his outstanding
invention can hardly be called a scientific novelty. The use of the air
blast for refining and of manganese and, of course, the converter, were old
and common knowledge. Real genius, but of the typically entrepreneur-
ial kind, was in the vision of the vast possibilities for cheap steel. He
applied himself to the task by putting those things together and adding a
number of contrivances which eliminated the hitches, altering his ""inter-
mediate aims ” as he went along. Failure of the method to work with
phosphoric iron and also other difficulties seemed for a time to bar prog-
ress. As soon as they were removed, mainly by recourse to nonphos-
phoric ores, another kind of failure came to illustrate the theory of
enterprise: hardly anybody in England would buy a license, though
some people on the Continent did.

Bessemer now took the line, much more consciously and according to
reasoned plan than entrepreneurs do as a rule — and hence in our model —
of going straight into the citadel of the enemy, to Sheffield, in order to
produce and undersell. There, steel that was good, though not as yet very
cheap,2 eventually saw the light of the market (1858) and was a financial
success from the first. The plant of his firm wrote itself off even more

^ Sir Henry Bessemer’s Autobiograpliy makes very interesting reading and is strongly
recommended for study. But it must be remembered that in some respects Bessemer, as
well as Sir 'William Siemens and Gilchrist Thomas, was not typical at all. It is not typical
to start proceedings by reading a paper to a public audience about what one is going to try.
As far as this goes, he belongs to a minority which is as small as it is distinguished. But
this should not prevent us from recognizing the fact that, in the respects that matter to us,
he is no exception, but only one of the most brilliant specimens of what is an extremely
large genus — a genus that includes innumerable humble ones.

2 Especially for other producers who had to pay for the license. But it was not very
cheap for the firm of Bessemer himself, because nonphosphoric ores were comparatively
expensive and his productive apparatus was not the ideal of rationality. The superiority
of his product as compared with iron rested, at first, entirely upon quality.

Historical Outlines

373

quickly than plants do in our "^pure model/* The immediate victory,
however, was gained, not so much over the enemy it had been his
intention to attack, but over the producers of wrought iron. Beyond
such things as cranks and shafts and the like, there was indeed successful
experiment. Bessemer himself and many followers — ^the phenomenon
of the host following in the wake of the innovator stands out very well —
were soon trying their hands at rails, ropes, plates for ships. But
resistance and the price still limited steel to what was comparatively
a modest role during the sixties. Even at the top of the fourth Juglar
production of steel ingots was not more than about million tons,
although steel had won out in rails, and foreign (Spanish) ore had come
in to fight the rising price of the raw material — this, the consequent
change in the location of the industry, and the alliance with smelting
constituted, in fact, another innovation that was effective in the early
seventies.

The path of the successful competitor of the Bessemer method,
William Siemens* open-hearth process, was still more arduous. His
regenerative furnace, patented in 1861, technologically successful at
Montlugon in 1863, was at first a commercial failure. In 1867, however,
the Great Western had its old iron rails converted at Siemens* Sample
Steel Works at Birmingham. In the same year, the Londore Siemens
Company was formed and the Martins of Sireuil — under license — suc-
ceeded with the direct process. In 1868, the London and North Western
adopted the process at Crewe. In 1869, the method was worked on a
considerable scale in England as well as on the Continent (Verdie, de
Wendel, Krupp, and others). But production of open-hearth steel
was still not more than 77,500 tons in 1878 — it increased to 436,000
by 1882, and to 2,400,000 by 1896, when the Bessemer process accounted
for 1,800,000. Final success, powerfully helped by the Thomas-Gilchrist
invention (1879), which released the phosphoric ores and, by its imme-
diate adoption, showed how completely the battle of steel had been won,
came in the eighties. Until the boom that culminated in 1882, output
of puddled iron had — disregarding the depression after 1873 — either
not fallen at all, or fallen no more than it might in any case have been
expected to fall from the quite abnormal peak in 1872. This was due
to the fact that steel entered a field which was rapidly expanding and
which it expanded still more. In such cases, which in the capitalist
process are anything but exceptional, the ‘‘competing down’* of the old
is naturally much mitigated. But from the setback after 1883 the
puddler’s product recovered no more.

The quantitative effect of steel on the cyclical process of evolution
cannot, of course, be gleaned from steel figures alone. The revolution
which it wrought and which extended to practically all parts of the

374

Business Cycles

economic organism was much greater than they suggest, because of the
increase in the efficiency of steam-driven machinery and of tools in
general which it induced: better plates, rails, and structural material,
and so on were only a part — ^perhaps in the end a minor one — of its
performance. Whitworth’s compressed steel, patented in 1865, began
to play a role in the early seventies, Armstrong’s hydraulic machinery —
elevators, drawbridges, cranes, pumps — ^put in an appearance in the
forties and at the beginning of the eighties triumphed in the field of
maritime armament. Ordnance, rifles, small arms, and munitions
were all greatly improved in the first and second Juglar, partly under the
impulse of American achievement, and entirely new developments
transformed the Birmingham industry^ during the second and third.
Woodworking, textile, grain-milling machinery — ^roller machinery estab-
lished itself in English flour milling only in the seventies and eighties,
a rather belated, though still genuine, innovation — ^tin-canning and
refrigeration, hence food preservation, the sewing machine — ^practically
borrowed from America during the fifties — and other mainly American
machinery that in the eighties began to turn bootmaking into a mecha-
nized mass-producing industry, self-acting screw machinery — ^the use
of which, illustrating a familiar proposition about the results of falling
average cost, led up to the monop oloid position of Nettlefold and Cham-
berlain — ^the bicycle, manufacture of which rose to quantitative impor-
tance in the eighties (it was patented for E. A. Cowper in 1868), and a
thousand other things that gave the reins to steam were partly or wholly
the effect of steel. Of course, all of them remain innovations, including
mere borrowings from abroad: they were simply in part conditioned by
the steel innovations. Several quite new departures already mentioned —
the dynamo, for instance, or the internal combustion engine (the improved
Otto engine was a feature of the early eighties) — ^which, once established,
quickly called many new firms into existence, ought to come in for
discussion, but cannot.

One other development should be mentioned because of the peculiari-
ties it presents. It is the increase in exactness and standardization,
and in the use of interchangeable parts which so greatly improved quality
and facilitated mass production at rapidly falling costs, Whitworth
(d., 1887), who in many respects followed up the earlier work of Maudsley
and, after modest beginnings in the thirties, conquered fame and success
in the forties and fifties, was the leader and hero of the movement.
Many steps simply constituted ordinary innovations, the individual
entrepreneur introducing the improvement and reaping his profit in the

^ The writer acknowledges indebtedness to Mr, G. C. Allen’s work on the industrial
development of Birmingham and the Black Country, which represents a type of analysis
very important for the understanding of business cycles.

Historical Outlines

375

ordinary way, a particularly ‘^pure^’ kind of profit too, since anyone
was able to ‘‘work to gauges” or to push a standardized specialty if he
wished to. But there was something else. Whitworth himself and
his many pupils not only did such things, but also preached them.
They were not mere entrepreneurs — some of them were not entrepreneurs
at all — ^but also reformers who taught their ideas as a doctor or a scientist
would. If everyone in the trade had promptly listened to them, there
would have been no profit and no crowding out or competing down. As
it was, progress went on largely through the influence of associations
and exhibitions, and on a much broader front than is usual with innova-
tion. The case thus illustrates that turn in our theoretical discussion
(Chap. Ill) at which we envisaged the possibility of profitless advance
and prosperityless cycles.

The textile industries, the standard example of competitive capitalism,
did not boil over with individualistic initiative quite so much as one
might expect. Although they did not behave like coal mining, they
conform very closely to our idea of an established industry running along
an established path. Their great expansion in the period is due mainly
to favorable conditions not of their own making — ^though, of course, not
independent of innovation in other sectors — and many improvements
were offered to them or forced upon them from outside. The theory of
“external economies,” though not really satisfactory even in this case,
may well have some subconscious roots in the observation of this pattern.

The woolen industry derived a -new impulse from the innovations
which drastically reduced the price of wool from the forties on — ^for
Australian and, toward the end of the period. La Plata sheep farming
was itself an innovation and induced by other innovations (progress
of ocean transport). It derived another impulse but, in part, also
experienced competition from the success of what was not quite a new
substitute, but became a very effective one — shoddy, use of which was
the outstanding innovation of the time in the field of utilization of waste
products. This gained ground somewhat subterraneously but quickly,
also from the forties on, although it had already been the object of
adverse comment soon after the Napoleonic wars. Both impulses had
an awakening effect, and the great technological innovation of the age,
the wool-combing machine, was an immediate success (Heilmann,
then, perhaps independently, Donisthorpe and Lister in 1851; improve-
ments by Noble and others followed quickly). This entrepreneurial
achievement was a feature of the second Juglar and centers in the per-
sonality of Lister, who mechanized, on a royalty system, wool combing
aU over Europe. Since the method was highly labor saving and since
the product presents as close an approximation to the perfectly com-
petitive pj^ttern as we can hope to find in industry, we have here, assem-

576

Business Cycles

bled for us in a practical case, almost all the characteristics which went
iuto the construction of the fundamental and simplest form of our
model.

The only other innovation that we must mention, the mechanical
condenser, also came in during the fifties, but met with much greater
resistance. The innovating period, in which a minority of leaders took it
up, was in the sixties. The old billy was being crowded out in the fourth
Juglar, although it took a long time in dying. In some cases this was
due to the fact that efBcient machinery in this field often is a minor
consideration: in the production of fancy goods, for instance, design
and clever marketing are of so much greater importance that it often
does not pay to bother about technological perfection. Examples are
frequently met with in all textile industries — ^there are even now branches
of the silk trade in which taste, a flair for the logic of fashion, and the
knack of being in the market a fortnight before the others will spell
success which the most ideally equipped firm may be powerless to attain.
But mainly the explanation is in the presence of many small or medium-
sized firms which were inelBScient but unencumbered and could muddle
on indefinitely. The hand jenny and the hand loom persisted for the
greater part of the period and even toward the end of it there seem to
have been firms which used not only antiquated power machinery, but
no power machinery at all. Worsted was much more progressive and
became well mechanized in the fifties. The jute industry also developed
to quantitative importance in the second Juglar. There is little paradox
in calling it the one innovation of note that occurred in the field of linen.
Silk lingered on. The hosiery and machine-lace industries expanded
vigorously in the Kondratieff downgrade.

American raw material and falling cost of transportation propelled
the cotton industry. It stood in need of such incitement. Its first
achievement in the period was not an innovation but an adaptation —
completion of mechanization, the weeding out of wooden machinery,
and so on. Even the self-actor was still in the innovating stage in the
early sixties and did not conquer until the early seventies. The improved
hand mule survived still longer in the finer counts, on the low wages of
old people. Really new was the combing machine, which was intro-
duced in the fifties. The American ring spindle featured in several
Juglars successively, but did not win out until the end of the period.
Still, there was entrepreneurial activity, and the competing-down process
within the industry never ceased: the turnover of families and firms,
the '‘vertical mobility of labor,’^ was considerable throughout that
Kondratieff and even afterward, and output per head more than doubled
(according to von Schulze-Gaevernitz, The Cotton Trade) during the
perigd*

HisTORiCAii Outlines

377

A closer analysis than can be presented of the course of cyclical
phases in England would be very interesting and would also aflPord a
series of instructive exercises in the application of our model to patterns
that differ widely from each other and display to very different degrees
the influences of external factors on the complex organism of an ^‘'old’’
capitalistic country. The first Juglar, dealt with before, is the only one
to admit of a simple diagnosis. We date the rise of the second, as
Professor Spiethoff does, from the beginning of 1852. The influence of
Californian (1848) and Australian (1851) gold must again be kept in
mind throughout, because it must be held responsible for certain abnor-
malities in the market rate of interest — ^the failure to increase promptly
at the beginning, in particular — and partly for the intensity of the rise
in prices, the Australian gold also for the additional stimulus it gave to
English exports, notably of consumers^ goods. All this — and the
Crimean War (March 1854 to March 1856) which, though the (roughly)
70 millions of expenditure it entailed were to about 50 per cent covered
by taxation, exerted some inflationary influence — ^prepares us to expect
a crisis of more than usual severity. 'T'he impulse imparted to exports
and imports by the change in institutional data — ^the introduction of
free trade — acted in the same direction. The economic process cannot
be described in terms of railroadization only, but the 4,000 miles added
during the Juglar probably represented an investment of not much less
than 150 million pounds and were certainly by far the biggest individual
item, especially if we add investment in foreign, particularly American,
railroads, which made the situation sensitive to the fate of the latter.
But as we have seen above, other innovations, in shipping — and, partly
incidental to this, the development of oversea markets — in the iron and
textile industries and expansion induced thereby, particularly in coal
mining — output of coal rose from 34,000,000 tons to 66,645,450 in 1856 —
were of equal or greater importance in the explanation of the recession
which, clearly due to the impact of the new products, set in by the middle
of 1854 and lasted through 1855. During 1856, however, the war asserted
its effects in producing a hectic boom which disturbs the picture. It
broke in the following year, when the tide of depression was running
strong. The year 1858 presents the regular features of depression, and
1859 and 1860 present those of a regular recovery.

The third Juglar, 1861 to 1869, is of course distorted by the cotton
famine and other repercussions of the American Civil War.^ Steel began
to count, and so did various minor things, for example, cement, but in
the main it was a textile wave that started. A great wave of flotations,

^ Mr. Thorp aptly expresses this, {op. cU., p. 165) by describing the years of the pros-
perity phase and of incipient recession by the heading, uneven prosperity. The cotton
famine itself presented no other features than those which one would expect.

378

Business Cycles

wrongly attributed to the Company Act — it set in before and the out-
burst of 1863, 1864, and 1865 merely marks a boom that could have
occurred without it — gives a general idea of the range of innovating
activity, mining and cotton manufacture leading in 1860 to 186^, and
hotels, land, and buildings in 1863 to 1865^ but, much more than this,
an idea of how far such excesses travel from the contemporaneous eco-
nomic processes that really matter. Flotations of foreign government
loans also began to play a leading role: first sign of an approaching
rentier stage? Now, a setback in cotton and the aspect of the money
market — ^though not employment; here the expected effect was perhaps
merged in the fluctuations caused by the cotton famine — indicate the
advent of recession in the second quarter of 1863. Depression was
delayed, owing to the stimulating effects of the cessation of hostilities
in this country, and did not come before the beginning of 1866. But
until then promotion and stock exchange spebulation were booming.
Financial malpractice went to lengths not previously experienced in this
Kondratieff, not only with promotors, but also with established concerns,
several railroad companies among them. By August 1866, over 200
companies were in liquidation and, as in 1847 and 1857, the Bank Act
had to be ‘^suspended” under what had by then nearly become routine
conditions. The sorry tale of fraud and foolishness need not detain us,^

^ Cf. H. A. Shannon’s most interesting paper. The First Five Thousand Limited Com-
panies, Economic Journal for January 1932.

® The failure of the company that, on the basis of a very reticent prospectus, had been
floated to take over the business of Overend, Gurney and Co., on May 10, 1866, which did
not start the crisis but the panic, deserves a passing remark, however. The Gurneys were
a Quaker family in the woolen trade of Norwich and took up bill broking in the last quarter
of the eighteenth century. They came to London at the beginning of the nineteenth and
built up a most solid, regular, and conservative banking business to about 1850. Then,
in the hands of a new generation (H. E. Gurney and D. W. Chapman) the house drifted
into what was euphemistically called financing business, mostly, it seems, by way of
accepting equity interests for unrepayable loans, in the hope of getting rid of them by means
of floating companies. The leading partners, more strenuously devoted to their pleasures
than to their business, very likely did not fully realize what the firm was doing. And still
more likely is it that they, too, believed in prosperity plateaus (see W. T. C. King, History
of the London Discount Market, 1936, p. 242, et seq.).

Two further remarks suggest themselves. First, the Gurney firm became, once it
had drifted into financing industrial enterprise, no doubt the kind of thing which we tried
to visualize when discussing the French and German banks of the moUlier type, and thus
made itself guilty of a mortal sin against the spirit of English banking. The true charge,
however, is not in this, but in their inability to acquire sound propositions. As in every
single one of such cases (from John Law on) it was not the “system,” not the use of short
“funds” for long purposes as such, which brought disaster. Any storm of this kind that
firm would have been able to weather. That formula is inadequate and fastens upon a
secondary element of the case. The real trouble was that the iron works, shipping ven-
tures, and so on which their agents had procured for them, were no good. Second, the case

Historical Outlines

379

but one point is of interest. Apart from the doings of what has aptly
been called the financial underworld, there was no obvious reason why
the breakdown should have been as severe as it was. That whole Juglar
is, to be sure, within the Kondratieff recession, but no industrial or
commercial facts are known to the writer to account for it — ^pig-iron
production made a new record^ in 1868, which year, together with 1869,
makes a fairly normal revival phase. The inference is that promotion
and speculation played, more than they usually do, a causal role. But
there is more danger of exaggerating than of overlooking this.

The fourth and fifth Juglars are inscribed to steel. As regards the
former, it is necessary to recall, on the one hand, that innovation merely
‘‘ignites’’ and that quantity is added by the secondary processes and, on
the other hand, that steel means more than another commodity would —
in particular it meant new machinery, a new type of ship, and so on.
As regards the latter, the quantitative importance of steel is so obvious
as to make that reminder unnecessary. In both cases, but especially in
the first, textile developments and many minor ones counted for much.
But again, and more than ever, foreign enterprise and capital export
were among the main features of the situation. International finance
had, by the end of the sixties, grown to new dimensions. Foreign
government loans then enjoyed an increasing popularity with the invest-
ing public which they had not enjoyed before, and a technique developed
of handling such transactions on a large scale, many of which were of a

not only illustrates well how the mechanism of a crisis works in detail — every plan of recon-
struction, however plausible at the moment, being disavowed the next day by further
shrinkage of values — ^but also one more type of third-generation incapacity which leads
into such predicaments. One, at least, of the partners may be assumed to have had mis-
givings when it would still have been possible to take losses resolutely and to save the house.
But he seems to have been unable to muster the energy that would have been required in
order to take such a course, and to have deluded himself with hopes, perhaps also to have
yielded to representations, ai^d to have hesitated. The writer could not prove every word
of this, but such is his impression. If it was so, the case enters into a very large class. It
is mostly in this way that such things happen. They happen even if foreseen by the actors
in the drama. Small men can get themselves, at times, to survey a situation as a whole and
to diagnose it correctly. It takes a personality of unusual power to act on such diagnosis.
The opportunity may be taken to mention that companies of the cridit mohilier type were
a feature of that Juglar. They did not call themselves banks, however. Some were serious,
for example, the General Credit and Finance Company of London, founded by an Anglo-
French group of standing in 1863. Others were not, such as the Credit Foncier and Mobilier
of England, the foundation of Grant alias Gottheimer, and more than half a dozen others.

^ This is the main reason why we date as we do. Mr. Thorp, evidently influenced by
the state of the cotton industry, labels 1868 as depression. He further mentions “extensive
unemployment.” It was, in fact, greater than in 1867 but only by of 1 per cent, and
smaller by 4 per cent than in 1858, Professor Spiethoff dates prosperity from the beginning
of 1869.

380

Business Cycles

doubtful nature from the start or became doubtful as soon as borrowers
realized hLOW easy it was to get new money in order to pay for the old.
The importance to England of foreign business and political conditions
increased proportionately. Our sketch amply proves that it would not
be correct to attribute her cycles to repercussions from abroad; but
her manias and crises were to a considerable extent conditioned by them.
This is all that we need to add to what was said about 1873 and its after-
math in the case of Germany. Fundamentally, the diagnosis is the same
— England, too, had an industrial revolution to liquidate. Many
other points, such as the building boom from 1869 to 187^ and the
excesses of speculation, were also present in both cases. But England
suffered much more from the American crisis. And the ensuing depres-
sion and the conditions in the eighties displayed, as stated before, the
influence of German competition.

The prosperity phase of the fourth Juglar covers 1870 — as in Ger-
many, a short upset occurred in the financial world when the war broke
out — 1871, and the first half of 187^. Recession was cut short by the
panic on the stock exchange, the passing of which but served to show up
the underlying industrial situation. Again we find that most observers
speak of unrelieved gloom lasting through 1879, and in a sense this is
entirely justified. But the same explanation and comment apply as in
the case of Germany. And only the fact that in such cases swimmers
often drown in sight of land — ^that epidemics of failures sometimes recur
from no other cause than that most moribund firms do not immediately
collapse but first hold out for a year or two — ^prevented revival from
asserting itself in 1 878. The following year brought substantial improve-
ment. In 1889 begins the prosperity phase of the fifth Juglar. Owing
to its position in the Kondratiefl^, it asserted itself, as in Germany, so
weakly that tie year is not generally recognized as one of prosperity,
although it is by Professor Spiethoff and although the new impulse in
the steel trade is obvious.^ That phase lasted to the fourth quarter
of 1882. Recession and depression then covered almost exactly two
years each. Before the Juglar embarked upon the latter, there were
failures and generally a state of things which might easily have turned
into a crisis. If none ensued, this was primarily due to the sobering and
solidifyiag effect of the decline of prices in the preceding prosperity.
Output increased most of the time, and 1887 and 1888 were years of
recovery of the normal type. Iron and steel were active enough for
Professor Spiethoff to label 1888 as a year of prosperity.

1 Mr. riiorp speaLs of rapid improvement, first quarter, checked by fall of commodity
prices. It is submitted that this statement, as the one occurring in the comment on 1873 —
expansion cbecked by high money rates — ^implies a theory and does not simply formulate
observation. We disagree with both, although we admit the historical association.

Historical Outlines

381

Undoubtedly, 1889 and 1890 were such years. They form the
prosperity phase of the last Juglar, in England as in Germany, a Juglar
of odds and ends that mainly summed up and completed. Some of its
features, not covered or not quite covered by this statement, should be
added. The great developments of the following period, in electricity
and chemistry in particular, already began to show. The shadow of
the approaching building boom is also discernible. From 1894 onward,
there was large investment in breweries and distilleries which, by 1898,
the first year of the third Kondratieff, carried them to the front rank of
English industries. Revival brought a considerable boom in bicycles,
which culminated in 1896, a typical case of recovery quantitatively ful-
filling the promise of possibilities created before. The new gold dis-
coveries and the outstanding innovation in the production of gold,
the cyanide process, asserted themselves, among other things, in greatly
increasing exports to South Africa. The picture of the surface of affairs
was much influenced by a violent boom in South African mining (1895),
followed by a still more violent one in Westralian mining, during which
81 Westralian companies were floated (April 1896), while between Mar. 1,
1894 and Sept. 30, 1896, 731 Westralian gold-mining companies emerged,
offering nearly 76 million pounds of capital for subscription. In this
connection, one more innovation requires mentioning, if only to remind
the reader that it was an innovation in our sense, or rather, a series of
them. After having consolidated the bulk of South African diamond
mining into the De Beers Company, Cecil Rhodes in 1889 organized the
British South African Company, which was to found Rhodesia. Here
political and business action become rather hard to distinguish. The
foundation of the De Beers Company, as well as the combination of the
Deep Level Mines on the Rand into the Consolidated Gold Fields was
undoubtedly an enterprise in our sense. But Rhodes was also for a
time prime minister of the colony, and many of his actions and plans
transcend the business sphere as distinctly as does Dr. Jameson’s attempt
to innovate by means of a raid (1896).

Export of capital had greatly increased from 1885 and again in 1890,
after which it rapidly shrank to 1895. Again we observe the prominence
of the borrowing by foreign governments of doubtful standing, assiduously
patronized by even the best of financial firms. The deeper meaning for
the economics and the sociology of capitalism that is sometimes attributed
to those transactions does not concern us here. But they landed the
prosperity phase of this Juglar in a financial panic of which it has been
rightly said that it was over before the public had become aware of it.
There was plenty of reason, independently of any untoward event, for a
fall in stock prices — ^that phenomenon was due in the ordinary cyclical
sequence. But it was accentuated by the fact that the firm of Baring

38 ^

Business Cycles

Brothers, which, enjoyed a position and looked back on a past in many
respects similar to that of the Gurneys in 1866, had tied itself up in
Argentine securities it had failed to place while carrying on a large
short-time banking business and holding millions of deposits against
its simple acknowledgment. In order to meet prosperity demand in the
regular business, it had to liquidate its security holdings, and then, on
Nov. 8, to appeal to the Bank. The latter had recently, by means of a
more active policy, strengthened its hold on the market and was per-
fectly able to render assistance. Leading city men were in a ‘‘blue
funk,’’ some of them almost hysterical; but on the advice of Goschen, a
guarantee syndicate was eventually formed, enabling the Bank of
England to guarantee in turn the liabilities of Baring Brothers. The
firm was reconstructed in due course, and no panic or panicky restriction
ensued. The case is as illustrative of certain shortcomings of the finan-
cial machinery of capitalism as it is of the kind of thing that can be
really handled by central bank action.^

The Juglar recession of the years 1891 and 1892 was overshadowed
by that shock. Although English pig-iron production, which had been
8.3 millions of tons in 1889, fell to 6.7 millions of tons for 1892, this is
only what we should expect, and the same applies to the increase in
unemployment and the fall in prices. Not much was wrong with the
industrial and commercial organism; but the losses on securities were
tremendous and persistent, in international securities hardly less than in
1873. It was from the financial sector, therefore, that the darkest
hues of the picture came. Depression set in by the middle of 1893 and
again it was the link of international finance which both anticipated
and intensified symptoms: the crises in Australia and the United States
probably account for as much of a crisis in England as there was. Revi-
val came strongly in the summer of 1895 and ran its course to the end of
1897. Money was very easy throughout — in the year of depression,
1894, the open market rate in London fell to %6 of 1 per cent, and in
1896 3 per cent consols reached 1133^. The years of revival display
results and conditions of the bourgeois Kondratieff at their best. Hardly

^ Governor William Lidderdale seems to deserve full credit for the change in the policy
of the bank mentioned above and the consequent power for remedial action. But as
regards the action itself which was taken in the emergency, the Goschen Papers (see Life
of Lord Goschen by A. D. Elliot, 1911, vol. II, pp. 170, et seq.) make him look a good deal
less heroic than some admirers would have him look. He seems to have lost his nerve
and to have appealed for help to Goschen, then Chancellor of the Exchequer, who very
properly refused any state aid and coolly indicated the way to a solution. Credit for the
success seems to be largely due to him. The “preposterous’’ which occurs in his diary
by way of comment on that application, characterizes to perfection the attitude of an
officer of state in the time of intact capitalism, as do his admonitory speeches about that
time. Moreover, refusing help is often the best method of helping.

HisTOKicALr Outlines

38S

any other period gives us as good an idea of what, economically and
sociologically, the immanent tendencies of capitalism really are.

3. We have seen that, for the United States, a history of the cyclical
process could, in the period of the second Kondratieflf, be written
almost exclusively in terms of railroad development. Inserting immigra-
tion of capital and men — about 14 millions immigrated, from the end of
the Civil War to 1900 — ^harvests, and the Civil War, we would get
practically all the fluctuations and trends there are. By 1897, “net
capital’’ of the railroads stood at $9,168,07^,000 (a little over $50,000 per
mile in operation). Everything else turned on the roads and was either
created or conditioned by them, and large-scale financing found its
main object in them. But we must not exaggerate. The railroads
did not teach Americans capitalist methods and attitudes. These, as
well as large-scale industrial enterprise, existed before. Nor were the
industrial processes of the period mere adaptations to, or exploitations
of, the conditions created by the roads. Scarcity of labor and wealth of
natural resources presented problems and conditioned achievements
of their own. These — efficient labor saving machinery, in particular —
became characteristic of American innovation, which no longer inter-
nationally lagged but increasingly began to lead during that Kondratieff .
We must, however, confine ourselves to a few points which will help to
round off the picture.

In that environment which contained no large, antiquated structures
it is not easy to find decaying industries. Whaling, which steadily
declined (with one short interruption) after the sixties, is, however, one.
It affords a good example of the mechanism that draws resources toward
new goals. Shipping in general reflects, apart from coastal, river, and
lake shipping, the same tendency. During the first two Juglars, in the
days of the clippers and also during the fifties, the American merchant
marine had almost defied competition in the Atlantic trade. But it
lost much of its ground during and after the Civil War, in spite of many
attempts and in spite of subsidies. This was not due to any short-
comings in shipbuilding, which was more progressive than the English
and repeatedly competed successfully even as to price. America simply
turned away from the sea. We will merely note that in the construction
of the wooden sailing vessel America was supreme, and that this was a
feature of the prosperities of the forties and fifties. ^ The iron steamer,
also the iron sailing ship, was being successfully built in the prosperity

^ Tonnage built in the United States rises, with very well-marked Juglar fluctuations,
around an approximately straight-line trend until the Civil War (peak, 1855). The trend
fronoi 1860 to 1914 can he well represented by a catenary, the upgrade of which after 1890
about balanced tbe downgrade to 1890. In 1914 begins ascent to the all-time peak of
the World War.

384

Business Cycles

of the fourth Juglar (John Roach and Son, Cramp and Sons), and ship-
building was conspicuous by precedence in the processes that started
the fifth — in fact it was active already in 1877. In the fifth and sixth,
the all-steel ship established itself and the triple-expansion engine put
in its appearance. Colliers, tankers, greatly improved coastal and river
steamers, after 1890 battleships, also continued to give employment,
and in 1891 one of the greatest yards of the world started launching
(Newport News Shipyard and Drydock Co.).

Coal mining, though perhaps to a greater degree the object of active
enterprise than it was in England, was more pushed along than pushing.
Developments of new districts, availing themselves either of existing or
ad hoc created new transport facilities, constitute in the American case
definite innovations and contribute to definite prosperities. For anthra-
cite this was true before our period — an outstanding instance being
the Lehigh Coal and Navigation Company — ^bituminous coal first
featured in the forties, during which steam began to push out water
power — a process more characteristic of that Juglar than railroads were.
Coking did not play any role and was done in very primitive ways until
the prosperity that preceded 187S. Then it developed in the Con-
nellsville field, producing mainly for the Pittsburgh district. Production
spread and went on growing during the depression and made a big stride
in the prosperity of the penultimate Juglar. The census of 1890 enu-
merates 13 districts. But to the end of that Kondratieff (and beyond)
the wasteful beehive oven prevailed.

The use of petroleum for other purposes than lighting is, like elec-
tricity, a “carrying innovation of the next Kondratieff, and was in the
incubating stage during the second. “In 1878 a vaporizing device for
burning a residuum of petroleum and coal tar in conjunction with super-
heated steam was tested at the Brooklyn Navy Yard, Nearly nine
years later, an oil-burning locomotive • • • was reported to represent
the first practical application of this fuel to land transportation. The
following year oil was used at the plant of the North Chicago Rolling
Mill Company.” (V. S. Clark, op, cit,, vol. II, p. 517). All sorts of
applications were experimented with and by-products gained rapidly in
importance (gasoline, lubricants); but none of them was a major feature
of entrepreneurial activity during that period.

Petroleum for lighting purposes was one of the great innovations —
a New Commodity in our sense — of the second Kondratieff, and all the
features of an innovation of this type stand out very well.^ It had

^ Petroleum for lighting and petroleum for other purposes are really two different
commodities. This is well illustrated by the behavior of the price. While petroleum was
used mainly for lighting, i.e., almost exactly from the beginning of its career to 1894, the
history of its price is explainable by means of the schema: initiating stage, diffusion,

Historical Outlines

385

been used occasionally before, but wells were first drilled in 1859 (drilling
and pipe lines were the two great innovations of the period). In the
very limited field it entered, it first competed out kerosene (made from
shale and coal) as well as other illuminants (for example, whale oil).
Later it had to meet gas and electricity, which eventually competed
it out in turn. Quantities, prices, profits behaved in the process as
we should expect. The first wave of this innovation starts in — and
helped starting, of course — ^the prosperity of the third Juglar. As a
result, there were 194 refineries by 1865, mostly in Ohio (the biggest
enterprise being that of Rockefeller, Andrews, and Flagler), Pennsylvania
and New York. The expansion thus induced went on in the Juglar
downgrade and revival, powerfully propelled by the discoveries in Cali-
fornia, the price of refined and still more of crude petroleum falling
accordingly. Pipe lines and tank cars also emerged at that time and
consumers’ resistance was speedily overcome. The regular situation
of the Juglar downgrade led to the organization of the Continental
Improvement Company (1868), which developed into the South Improve-
ment Company (1872). The fifth Juglar then brought the completion
of the organizational innovation that was to set the outstanding example
for other industries,^ the Standard Oil. It remained a ‘Hrust” for a
decade only, and independent refineries continued to exist. But the
ideas of the centralized management of an industry, of running it as a
unit according to a plan, and of acquiring control of some of its condi-
tioning factors — ^railroads, in particular — ^persisted.

Gas was also a major element in the entrepreneurial activity that
carried the second Kondratieff — ^though it had a much more important
previous history than had petroleum — and similarly completed its career
substantially within the period. In England gas is reported to have been
first used for lighting a house as early as 1792. Boulton and Watts’
installation at Soho (1804) made it widely known. London began
using it in 1807, and most of the larger cities followed suit in 1816-1819.
In this country Baltimore adopted it first, in 1816, New York in 1823,
Boston in 1828; and there were many other installations previous to the

absorption, and with well-marked cyclical fluctuations it fell as we should expect. Then
its price began to rise according to a new law expressive of the new uses. Similarly, two
branches of the smoothed curve of output can be distinguished, though the break does not
stand out so clearly.

^ In 1884 it was followed, though on a much lower level of efficiency, in the cottonseed
oil industry (American Cotton Oil Trust), which never really conquered. In 1887 the
Southern Cotton Oil Company was founded, a many-plant concern which was to play a
great role in the industry. The cotton-oil case is particularly interesting because of the
complications and changes in the competitive position of the product. Cyclically, it was
important throughout the last three Juglars. Its innovating stage was in the late sixties
and early seventies.

386

Business Cycles

crisis of 1837 . But it was in the forties that the first great wave set in.
The process lasted into the seventies — ^the westward expansion of the
country continuing to supply new objects, though in the East it was
substantially completed by the end of the first Juglar, when coal gas
also began to supplant gas from rosin and whale oil. Municipal initia-
tive and regulation, naturally much concerned with this commodity,
accounts for the deviations of investment from the cyclical schema.
Prices were still high for the private household, partly because of the
discrimination in favor of the public consumer (the city rate in Baltimore
was, for instance, in 1848 $1 per 1,000 cubic feet, as compared with $4
for private consumers). The great difficulty which hampered enterprise
at the beginning, the lack of an adequate meter — ^there were many
inventions for the purpose made before — ^was definitely overcome in
1843 . Until 1872 , gas was distilled from coal — a process that was to
regain importance when markets had been found for the by-products —
but in that year water gas was patented. This innovation, although
introduced in Philadelphia the year after, entered upon its career in the
eighties. Carburetted water gas was successful in warding off the attack
threatening from kerosene, and the Welsbach mantle (preceded by the
Bunsen burner, 1855 , and the Lungren mantle, 1881 ), in deferring defeat
by electricity for about a decade. In the fifth Juglar, also, gas began
to invade other uses besides lighting. There was a considerable develop-
ment of gas motors, gas stoves appeared in 1879 , circulating-tank water
heaters in 1883 (the improved Buud heater came in 1897 ).

Another competitor arose, however — ^natural gas, which had been
used for lighting before our period (Eredonia, New York, 1821 ) and had
conquered considerable ground in this capacity. It had sometimes a
price advantage over manufactured gas and always other advantages
which made it preferable for industrial use. This began in the boiling of
salt brine in West Virginia ( 1841 ), but the first important case was its use
in Pennsylvania iron works in 1873 . The first pipe line of any length
(pipe lines of over a thousand miles are a postwar development) was
opened in 1875 . The big wave of this innovation was an important
element of the penultimate Juglar and culminated in a boom in 1886 .
Its importance from our standpoint consists in the fact that it shifted
industrial location, newly creating several centers, and powerfully
affected the coal situation in Pennsylvania, Ohio, Indiana, and Kansas.
But production of the wells of that district then rapidly declined. We
will add here that the great increase in the use of natural gas about 1908
accounts for the break in the curve of sales of manufactured gas that
occurred at that time.

Technologically, iron-ore mining was a simple affair; nor does its
progress call for any comment. It was, however, the obj*ect of entre-

Historical Outlines

387

preneurial activity in two ways. First, there was the task, absent in
other countries, of exploring and developing a district before mining
operations could be started. Northern Minnesota (1884) may serve
as an example. Transport questions and new commercial combinations
attended the development of the Lake Superior districts: the Marquette
range in the second Juglar, the Menominee mines in the fourth, the
Gogebic mines in the fifth (1885) — ^the Mesabi mines belong to the next
period. Second, there were organizational innovations in the eighties
and early nineties, some horizontal combinations, which for the greater
part failed — ^the Lake Superior Consolidated iron mines, 1893, however,
was also (primarily) a horizontal combination, although it owned its
ships and linked up with the railroad interests of its shareholders — and
the vertical ones which arose from the intrusion of the steel concerns.
The competing-down process was, to a great extent, geographical. We
have seen that this was so in many other cases and that it explains
certain features of American cycles and certain local result trends: it is
essential to notice that this rise and decline of industrial centers is part
of our cyclical mechanism. The case in hand presents, of course, one
of the most familiar instances. Migration of the iron industry from
New England, New York, New Jersey, and Pennsylvania (which as
late as 1880 produced nearly half of the 4 million tons of iron then put
out) to the Central Western states and to the South was in part condi-
tioned by ore and coal developments. Output of the Lake Superior
district increased roughly from 1 to 9 million tons between 1870 and 1890.
Together with the ores of Alabama and Tennessee, the Champlain ores
and imports from Spain (also from Greece, Asia Minor, and Cuba),
it brought price down to roughly one-third during that time.

This rapid shift of the centers of iron production was one of the reasons
why from the time of the Civil War there was, even in prosperity, so
large a percentage of idle furnaces, which is thus seen to have nothing to
do with any inherent tendency to overproduction or overcapacity. The
furnaces in the districts that were being competed down simply did not
disappear at once. But there was also rapid technological obsolescence
during the last three Juglars : up to 1850, when the drop bottom came in to
facilitate the handling of the cupola furnace, there had been hardly any
change since colonial times. Charcoal furnaces had to go, though they
did so slowly.^ Coke and bituminous coal furnaces adopted the same
improvements that were being introduced in Europe — ^the introduction
of the fuel-saving regenerative stove was one of the most important of
them — and grew in size and efficiency. This is the reason for the failure
of attempts made after 1873 to limit output by agreement: the up-to-date

^ The writer has been told that in Germany the last charcoal oven was laid ofi in 1896.
But this can only have been a solitary instance of chance survival.

888

Business Cycles

firms were perfectly able to produce at a price which fell, with fluctuations,
from 187^ to 1897. The great stride in absolute quantities (not logs)
was a feature of the penultimate Juglar. It becomes still more impressive
if we consider that by then the iron-saving effect of the use of steel had
already asserted itself.

In spite of the fact that the fundamental principle of the Bessemer
process was independently discovered in this country (W. Kelly, 1851),
introduction of this process was one of the achievements of the prosperity
which preceded 1878. Only eight firms had adopted it by 1875, though
a few other Bessemer plants — ^running into the depression with their
period of gestation — ^were then being built. Other novelties came at the
same time, but the open-hearth process was not among them. It was
still an innovation in the last Juglar, when the Homestead works took
it up (1888). The same applies to the Thomas-Gilchrist process,
although the license for America had been bought in 1881 by the Bessemer
Steel Company.^ Alloys (chrome and nickel steel) put in an appearance
in the seventies and eighties, but more effectively in the last Juglar,
in which also the Harvey armor-plate process was developed in works
built for the purpose. Steel casting was then greatly improved. Scrap
was coming widely into use as a raw material of the steel industry.

Organizational innovation may be instanced by the two outstanding
cases. The first Bessemer plant in Pittsburgh was the Edgar Thomson
Steel Company, in the foundation of which the iron-manufacturing firm
of Carnegie Brothers took a leading interest. This was the first of a
series of conquests (Homestead, Union Mills, Duquesne) which in 1891
culminated in the foundation of Carnegie Steel. An equally compre-
hensive structure of the vertical-combination type had by then been
erected in the Illinois Steel (1889 or 1891, since it grew to full size in
the latter year). The Colorado Fuel and Steel dates from the same
epoch. Consumption of iron and steel reached a cyclical maximum
in 1890. Then a decline set in which eventually issued into the crisis
of 1898, in which 32 failures occurred to the end of June, among them the
failures of concerns so considerable as the Philadelphia and Beading Coal
and Iron and the Pennsylvania Steel. In itself, this does not show more
about the nature of that crisis than do the railroad failures; but taken
together with what has been said before, it seems to justify the diagnosis

1 The picture of tlie cyclical rhytlun of innovation could, of course, he much improved
if space allowed going adequately into the history of iron and steel oroduction. For
instance, puddling was, till the end of the seventies, competing with the Bessemer process.
During the fourth Juglar, its position was strengthened by two inventions which deserve
notice. The Ellershausen process and Banks puddling mill (John Fitz, 1857) spread
during the sixties, its superiority over the English two-high mill mainly resting on American
labor conditions. There were half a dozen other improvements in rolling about the
same time.

Historical Outlines

389

that that, crisis was the ‘‘abnormal liquidation*^ of positions which had
become inadaptable in the course of an evolution that primarily centered
in iron and steel.

Tools, mechanical objects of use, and machinery are among the things
which it is very dijEcult to quantify and the importance of which would
not be adequately rendered by quantity even if we could quantify them.
The importance for the cyclical process and for the resulting trends of that
bold originality which characterizes American achievement in this field
and to which European industry owes so much, is obvious but hard to
follow up in detail, because it covers a wide surface and because it con-
sisted much more in devices to make things work economically and
efficiently, than in spectacular “invention.** Export statistics reveal,
by the sixties, how very wide that surface was and how far it extended
beyond what had become American specialties, such as sewing machines
and agricultural implements. Locomotives and “unspecified machines
and other iron and steel products,** taken together, were more important
than either. A few instances must suffice. Though “quantity** came
in the downgrade, foundations were laid and leading innovations intro-
duced in the upgrade of that Kondratieff — as has been observed by
Professor Kuznets (Secular Movements in Production and Prices,
P. 27).

Cyrus McCormick*s invention is usually dated 1834, but he himself
tells us that his reaper got into really workable shape by 1845.^ Innova-
tion — ^the “carrying into effect’* — ^was an element of the second Juglar.
Induced improvement and diffusion contributed to all the other Juglars
up to the organizational innovation which occurred in the last (foundation
of the American Harvester, 1890). Other steps in the mechanization
of agriculture — some have been mentioned before — could readily be
inserted.^ Still more than in other cases, the fact of — and the reason
for — ^progress going on in cyclical jerks is evident.

The sewing machine (invention by E. Howe in 1846), produced in its
practical form by the Singer concern in 1850, also was one of the innova-
tions of the second Juglar, and had already become an international

1 There is some doubt about priority. Hussey, according to his statements, definitively
succeeded in 1847, but may have had worked out all essentials before 1845. See L. Rogin,
Introduction of Farm Machinery, 1931, and the review by W. T. Hutchinson in the Journal
of Political Economy for Jime 1932.

* Improved tools began to replace the old spades, hoes, and rakes at the beginning of
the century. G. Wood’s plough (1819), J. Deere’s roUed-steel plough (1849), and Pen-
nock’s seed drill (1841), satisfying obvious and urgent wants, found their way into use
along with very many other devices. Corn planters and hay forms came in after 1860;
1868 brought Appleby’s twine binder; after 1870 a sort of combine was used in the Pacific
states. The industry of farm implements had risen to considerable importance by 1850,
trebled value of output to 1860, and quadrupled it again to 1890.

390

Business Cycles

success in the third. Except for its application to bootmaking, to be
noticed presently, its effects on the system were different from those of
the majority, and similar to those of a minority, of innovations. Since
it can be used by the individual worker, it did not in itself induce the
regular competing-down process, though it wrought a revolution in
eflSlciency. Specialized forms of it, facilitating increased division of
labor, did, however. We may proceed to notice some of the industries
of metal consumers’ goods in which innovation consisted in successful
standardization, specialization, and mass production — blocks (New
Haven), clocks and watches (also Connecticut, and Waltham, the dollar
watch competing successfully all over the world), and small arms (for
example, Colt) were all in their innovating stages either in the first or
in the second Juglar and became established in the next one. The
pioneer concern in the field of watches, the American Watch Company,
struggled with the problems of mechanical watchmaking in the fifties —
1857 found it insolvent — but was highly successful in the sixties, when
the host began to follow (New York Watch, National Watch, in the next
Juglar: Illinois Watch, Rockford Watch, to mention a few). Type-
writers reached the manufacturing stage about 1873. No notice was
taken of them in the census of 1880, but there were thirty factories
in 1890.

Woodworking and metalworking machinery (circular saw, revolving-
disk cutting machine), Blanshard’s copying lathe. Sellers’ planing and
bolt-screwing machines, the milling machine and the turning tool, wood
screws, precision gauges, nuts and bolts, the dry-clay brickmaking
machine, Blake’s machine for stone breaking, the continuous-feeding
printing press, the typesetting machine (working indifferently in the
sixties), great improvement in boiler making, the Corliss engine, later
the Porter-Alien engine for electric dynamos — all that this medley
stands for had, with few exceptions, its initial struggles and successes
in the Juglars of the Kondratieff upswing and its diffusion in the Kondra-
tieff downswing and revival, as we should expect. Quantitative impor-
tance in the cyclical mechanism is certain, and in the cases, frequent in
New England, in which this type of industry formed the core of industrial
agglomerations (the cases in which the Marshallian speaks of external
economies), even obvious. Large concerns emerged (Axe and Edge Tool,
1889; National Saw, 1893). The principle was the same in all cases. It
consisted, even, in applying labor- and power-saving devices to the pro-
duction of labor- and power-saving devices themselves. Everything was
subordinated to cheapness. Where wood was cheaper, it was used.
Painting was preferred to polishing. Englishmen called these machines
flimsy. But standardized mass production was the result. Very few
branches remained unaffected. Cigar making was one of these.

Historical Outlines

391

We will choose the boot and shoe industry as an example for the
revolutions which machinery wrought in consumers’ goods industries
during the second KondratiejSf. No machines were used in the American
shoe industry^ before our period, though in some towns a fairly advanced
division of labor had turned to good account the ample sources of the
raw material and the developed practice of tanning. Wooden pegs
for fastening soles were used, however, from 1800, and in 18£0 a peg-
cutting machine was introduced. The rolling machine for hardening
sole leather, 90 times as fast as hammering by hand, came in 1845, and the
Howe sewing machine as such meant a step in the mechanization of the
industry, since cloth uppers were much used for women’s shoes as late as
the eighties. Its adaptation to upper leather sewing (1851) is said to
have quadrupled the output per man. The same year brought the
machine that pegged around a sole in one minute. A number of other
innovations were introduced in the course of subsequent Juglars, in
fact about 4,000 patents were taken out between 1850 and the end of
our period. The most important was the McKay sewing machine
(1858; practical success in 1860), which is still used on two-thirds of
the total output of shoes, and on nearly all women’s shoes. This innova-
tion then induced the ‘^avalanche” in the Kondratieff downgrade — a
truly typical case in this as in another respect, for the nature of entre-
preneur’s profits is well brought out by the practice, then established,
not to sell shoe machinery but to lease it.

By 1895 there were 4,000 McKay machines in use, turning out
about 120 millions of pairs. They had been improved in 1867 and are said
to have reduced costs of sewing on soles from 75 to 3 cents a pair. The
Goodyear welt-sewing machine (invented in 1862), which became
practical in 1877, was 54 times as fast as welt sewing by awl and needle.
But its success was a matter of the last Juglar, and within our period it
did not get beyond 25 millions of pairs (1895). The Cable screw bottom-
ing machine for heavy shoes (1869), the heel-building machine (1870;
by 1889 there were 200 establishments in this country producing heels
only), the standard screw bottoming machine (1875), which is still
used, substantially complete the story for our period. We will, however,
add that the success of the lasting machine, the feature in shoemaking
of the first Juglar of the third Kondratieff (in general use by 1900,
though patented in 1882) increased output per workman twelve times
at least. The net fall in monetary labor cost which that list of innova-
tions brought about from 1850 to 1900, was from $408 per hundred pairs
to $35. There was no further reduction after 1900. Horsepower
installed increased from about 3,000 in 1869 to about 50,000 in 1899.

^ The writer wishes to acknowledge the help derived from a study made for him by
Dr. E. M. Hoover on technological developments in that industry.

392 Business Cycles

But the number of wage earners employed increased steadily until
19S3.

The cyclical behavior and the resulting trends in the major textile
industries is not, as in England, completely described by the schema of an
established industry that expands with the environment, innovating
moderately in the process.^ But some of its traits are present ^ in the
cases of cotton and wool, the former of which was, of course, also propelled
by the development in the production of its raw material. Worsted,
though experimented with in the thirties by the Lowell Company, was
practically a new industry. Not much success attended its beginning
in the first Juglar, but it got into its stride as one of the major innovations
of the second. Combing was then done by hand. The combing machine,
although invented, was not yet a success. After the Civil War the
Lister comb came in, and even in the eighties this machinery was largely
imported. Expansion of the worsted industry was a feature of the last
three Juglars of that Kondratieff.

As regards cotton, the impulse of innovation came — apart from migra-
tion to the South, which first became important in the eighties — ^from
machinery. In this respect the case would be analogous to that of the
shoe industry, were it not for the fact that textile men had a much larger
share in the evolution of their machinery than had the shoe manu-
facturers. They displayed much more initiative in ordering it and they
took a hand in producing it,^ although the production of textile-mill
machinery as a distinct industry dates from the beginning of the century.
In Worcester, Paterson, Lawrence, Fall River, and Philadelphia this
specialty, and all the specialties within this specialty, had risen to con-
siderable importance in the downgrade and revival of the preceding
Kondratieff. This simply continued on an increasing scale in the forties

^ Though the few facts we are going to present are within the range of the most common
knowledge, the writer wishes to acknowledge obligation to Professor Arthur Cole’s standard
work on the American Wool Manufacture.

2 The reader will, it is hoped, excuse the pedantry and observe again: It is always
possible and perfectly sound analysis to explain the expansion of an industry by an appeal
to Growrth in our sense, in this case also to such external factors as immigration of men
and capital. It is also permissible, in dealing with any single industry, to include within
the phrase, expansion of environment, innovation outside of that industry, although this
phrase then does not any longer connote a single distinct process. But it is not permissible
to take expansion of environment in the latter sense as a full explanation of the develop-
ment of any individual industry as far as this development implies changes in production
functions elsewhere.

® The Lowell group in particular, besides producing textile machinery for their own
mills, from the first also sold to other people, to whom, as we have seen in the preceding
chapter, they also offered sites and water power, thus exerting a function of leadership for
which there are not many parallels. But by the sixties its role had almost become a matter

bisi nrV .

Histoeical Outlines

393

and afterward. Technological development in the cotton industry
itself lies between the two great specifically American innovations, the
introduction of ring spinning (invented in 1828 or 1831), which spread
in the period, and the Northrop battery loom (successful by 1894)
which properly belongs to the third Kondratieff. The eighties were the
time when Fall River flourished, although it lost its iron industry.
Many interesting incidents, for example struggles between different
methods of production,^ should, if space permitted, be noticed in that
process of expansion. But it went on almost uninterruptedly and there
was no vision about it of possibilities differing in kind from what, at
every step, actually was. In this sense it is true that the great things
had by then been done. There is, hence, much less reason for us to
stay with the case than there would be for the purpose of general economic
history. Investment does, as a matter of fact, cluster in prosperities
and contributes to them, but they are in this period, from the standpoint
of this industry, independently given ‘^conjunctures” with which it
swims but which it does not initiate by its own operations.

In the downswing and revival of the Kondratieff came the great
expansion of output, and in the depressions, particularly those of the
middle seventies and the middle eighties, there were losses, failures,
shutdowns, complaints about overproduction. One point about these
spells of bad business merits attention, viz,, the fact that they impinged
with so very different a severity, not only on different districts — ^the
astonishingly great difference in wages, taxes, costs of power and raw
materials might account for that-^but also on different firms. In 1883
for instance, when “overproduction” began to show itself, some firms
were losing and restricting, others paying high dividends and working
overtime (the young worsted industry was booming). From this we
may infer that in spite of the standardization of mills — ^which also was
one of the major novelties of the period — ^there was a good deal of differ-
ence in the production functions (including commercial combinations) of
individual firms, which was due to inconspicuous innovations of the type
that a Kondratieff downgrade is apt to induce. In consequence, costs
probably differed widely and a competing-down process was running
strongly. If this be true, it would follow that there was nothing in the
general outcry about overproduction — ^those crying out, simply, who
were not able to keep the pace and whose concerns were being made
obsolete — although the surface presented a picture almost ideally con-
forming to the conceptions of the theory of overproduction.

^ See M. T. Copeland, Tlie Cotton Manufacturing Industry of tlie United States, 1917.
In spinning there was not much that was new after the third Juglar; Wade’s bobbin holder,
an important progress in spooling, came during the fourth, however. No major changes
occurred in bleaching and printing.

394

Business Cycles

Tlie woolen industry suiffered from tte price of its raw material, and
althougli consumption of wool nearly doubled from 1870 to 1890, there
were few major new developments. The Goulding condenser (1826)
had come before; the Crompton mule was applied to the production of
cashmeres and woolens from the beginning of our period; in 1841 a
new loom for carpet weaving was invented (E. Bigelow), which, improved
and developed in various directions, practically started an important
carpet industry that, after its innovating stage in the fifties, expanded
throughout the period; an invention for card cleaning was made in 1853;
the seventies saw the transition from the spinning jack to the mule.
Shoddy, cotton mixtures, progress in dyeing, and, of course, the great
innovation of ready-made clothing (victorious in the fourth Juglar) —
all lent their help. The industry felt crises, particularly some of them,
such as the one of 1857, very acutely — ^more acutely than the writer is
able to explain. Behavior in the Kondratieff downgrade and revival
as compared with the behavior in the Xondratieff prosperity is according
to expectation.

In the last three Juglars, but particularly in the last one, production
of fertilizers (phosphates) made considerable strides. The dogged
survival of the use of charcoal in the production of iron led to the dis-
tilling of the timber and to the production of acetates as a by-product —
an innovation of the penultimate Juglar, as was the production of soda
by the Solvay process. Manufacture of sulphuric acid on a large scale
begins with the third. The stories of the American sugar refining
industry, which, for the time being, eliminated (1887) in a combination
that controlled 90 per cent of the production, and of the American
Tobacco Company (1890), highly interesting though they are, cannot
be dealt with here. Nor can developments in the industries of glass
(tank furnaces were an innovation of the last Juglar), cement (Portland
cement — innovating stage in the fifth and sixth Juglar), paper (new uses:
paper collars, paper carwheels; new processes: mechanical and sulphite
pulp, successful in the eighties), and rubber (rubber boots, rubber
reclaiming; substantial consolidation in U.S. Rubber Company and
Mechanical Rubber Company, both 1892).

But we cannot, as we could in the case of England, pass over the
beginnings of the electrical industry. Both names and investments are
too big for that. Since, however, the former are so familiar, we can con-
fine ourselves to noticing, in passing, the type of entrepreneur to which
they belong and of which they are among the best instances.^ Since

1 Again, one naay greatly clarify one’s ideas about the problem how development is
generated by the capitalist system, by a perusal of F. L. Dyer and T. C. Martin, Edison,
His Life and Inventions, 1910. For one type of difficulties, see voL I, Chap. XIII, A World
Hunt for Filament Material. For an instance of comprehensive vision, Chap. XIV,

Historical Outlines

395

the first Morse patent was taken out in 1840 and telegraph lines extended
as far as Pittsburgh in 1847, the commercial history of electricity actually
dates from the beginning of that Kondratieff. Telephones began their
career in 1877, when A. G. Bell floated a company for the exploitation
of his patent, adopting the policy, similar to that of the McKay shoe
machinery concern, of leasing the instruments. Percentage increase
of telephones connected was very rapid in the prosperity of the penulti-
mate Juglar, then slackened to 1895. In 1897 over 500,000 were installed
(as compared with £0, £00,000 in 1980). An electrical equipment
industry — motors, electric wiring, and so on; not exclusively telegraph
and telephone appliances — ^produced, according to census, values of
£.7 millions in 1879 and of 9£.4 in 1899 (not including machinery and
supplies made in establishments belonging to other industries). In
the latter year, kilowatt-hours produced were a little over 8 billions; in
1980, 96 billions.

Electric current for light and power dates really from 188£, when
Edison^s hydroelectric station in Appleton, Wis., his thermoelectric
station in New York, and the one in Chicago went into operation. By
then, the Edison Electric Light Company (1878) and the American
Electrical Company (later, the Thoms on-Houst on Company; E.
Thomson in 1886 patented electric welding) were already in existence;
and electric light, according to the principle of C. S. Brush, had been
installed in a few cotton mills and in San Prancisco. The arc lamp and
Edison’s incandescent lamp then competed with each other. In 1886
W. Stanley constructed the first station using alternating current.
Problems of transmission were being solved. In manufacture, electric
power was coming into use, especially in cotton mills, from 188£. This
established all the fundaments of the technique, bore down resistance,
and prepared the great development that was to follow and to turn
revival into a Kondratieff prosperity. But quantitatively it did not
signify. Only traction did. Here the name of Sprague should be
mentioned. After a number of more or less experimental ventures,
an electric tram service was installed at Richmond in 1887; then this
innovation spread rapidly. In Massachusetts, for instance, 1,400
miles (including sidings) of overhead trolley street railways were con-
structed from 1890 to 1897 (see E. S. Mason, The Street Railways in
Massachusetts) . ^

A Complete System of Lighting. For a delightful illustration of entrepreneurial psychology,
the story of the failure of the New Jersey ore venture, retold in F. W. Taussig, Inventors
and Money-makers, 1915, p. 17. The reader’s attention is called to the latter book which
expounds many points relevant to our subject in a masterly way.

^ Trams in general were substantially an achievement of the second Kondratieff — the
bus was one of the downgrade of the first Kondratieff. In Philadelphia, for instance, the

396

Business Cycles

Not only the teclinological but also the financial and organizational
bases were laid during the last two Juglars. The Edison Electric Light
and the Edison General Electric .(1889) were successful and had a number
of subsidiaries, some of them abroad. Then there were the Westing-
house and the Thomson-Houston concerns. When the latter coalesced
with the Edison General Electric (General Electric, 1892, capital 50
million dollars), which by that time, at Schenectady and elsewhere,
employed over 6,000 hands, a concern emerged that controlled practically
all the more important patents, supplied 1,277 stations and 435 traction
companies operating nearly 5,000 miles — ^in itself a powerful engine of
economic revolution.

Since we sketched the course at the Juglars when describing railroad
developments, and since we have so framed the above comments on
American industrial history as to make it easy for the reader to insert
innovations in their proper places, we need not now add a detailed survey
but only a bald calendar. With the qualification mentioned, we take
1843 as the first year of the first Juglar, its prosperity lasting until the
middle of 1845, its recession until the end of 1847, its depression covering
1848, and its revival, 1849, 1850, and 1851. The prosperity and reces-
sion phases of the second (1852 to 1860) ran from the beginning of 1852
to the middle of 1856 (irregularities making it difficult to distinguish
between them); depression lasted to the end of 1858; and 1859 and 1860
make up the recovery phase. The rise of the third Juglar is blurred by,
and uncertain because of, political events, and so is its course. We simply
count it from 1861 to 1869, on the strength of the aspects of the period
1867 to 1869, which seems to conform to our idea of a revival as modified
by those external factors. The prosperity phase of the fourth Juglar
(1870 to the middle of 1879) covers 1870, 1871, and the first half of 1872;
the recession phase, the second half of 1872 and 1873; the next three
years form the depression; and 1877, 1878, and the first half of 1879,
the recovery phase, the beginning of which was still under the clouds
of the preceding storm. The fifth Juglar covers the period from the
middle of 1879 to the end of 1888. Its prosperity lasted to the middle
of 1881; recession, from the middle of 1881 to the end of 1883; depression
covered 1884 and the greater part of 1885 and was followed by more
than three years of recovery. The sixth Juglar (1889 to 1897) illustrates
our proposition about the irregularity of panics or crises. The course
of things in the last quarter of 1890 and the first half of 1891 interrupted
and distorted what, nevertheless, we consider as the prosperity phase

oldest companies received tteir charters in 1857 and there was an outburst of promotions
after 1858. Horses and mules were used until 1885, then the underground cable. From
1893 on, trams were electrified. In financing, holding companies began to play a role during
the fourth Juglar.

Historical Outlines

397

of that Juglar, The rest of 1891, 189£, and the first half of 1893 make
up the recession; the second half of 1893, 1894, and the first half of
1895, depression. Revival then set in — and symptoms shaded off, by
the end of 1897, into a new prosperity — ^but 1896 interrupted its course,
though in a way which can be satisfactorily accounted for.

E. The First Sixteen Years of the Third Kondratieff (1898-1913). —
The sixteen years preceding the World War — analysis of the events of
1914, very interesting in itself, would not throw any additional light on
our process — cover a little more than the prosperity phase of the Kon-
dratieff, the whole of its first and about half of its second Juglar. An
application of our schema which involves, as it must in this case, speaking
of a Long Wave that is still incomplete, will no doubt seem hazardous,
to say the least. The future course of events may entirely fail to justify
the hypothesis that this implies. But evidence tending to justify it will
presently be submitted, and we shall also have the opportunity to test
it by confronting the expectations that follow from it with postwar
facts. For the moment, it is sufficient to agree that a significant ‘'break
in trends’^ occurred about 1897 — ^few people will deny that; there is
even not much doubt to cloud the exact date — and to state our thesis
that what caused it was once more an economic revolution, analogous
in every respect to the "industrial revolution” of textbook fame and to
the other revolution, which was wrought by railroads, steel, and steam.
By speaking of still another economic revolution we are not departing
from prevalent opinion — ^hardly even by making it the basis of our anal-
ysis of the cycles which occurred during the period — ^for the New Indus-
trial Revolution has become a very common phrase by now. Again we
observe the tendency, noticed in the case of the first Kondratieff, to
apply that phrase to the downgrade — ^which in this case, since the war
dominated all things while it lasted, practically means the postwar
period — ^rather than to the span which is the subject of this section. To
do this is right and wrong in the same sense in which it was right and
wrong in the other case, and not only does not contradict our view, but
in one vital point actually lends support to it: for the reason why more
of "revolution” is found in the postwar period is precisely that results
show more obviously in the downgrade than they do in prosperity,
exactly as they should according to our model.

In the same sense in which it is possible to associate the second
Kondratieff with railroads, and with the same qualifications, the third
can be associated with electricity. In order to see this statement in
its true light, it is necessary to observe, first, that it refers to ignition
only and does not imply that all economic changes of our period are
due to electricity — growth and the phenomena of the Secondary Wave
would in any case have to be added; second, that quantitatively very

398

Business Cycles

important derelopments were either simple continuations, or continua-
tions induced 1)7 the impact of the new things, of the innovations that
carried the second Kondratieff; third, that electricity was not the only
new thing and that several others of first importance were as independent
of it as the new shoe machinery was of railroads; finally, that electricity,
though an innovation in our sense — ^the same sense in which railroads
were innovations in the second Kondratieff in spite of the railroad boom
of the thirties — ^yet has had, as we have seen, a previous industrial
history going hack to the forties, while its history as an invention goes
back to Volta at least. It seems idle to ask whether the importance of
electricity was greater or smaller than that of steam. ^ It has certainly
created new industries and commodities, new attitudes, new forms of
social action and reaction. It has upset previous industrial locations
by practically eliminating the element of power from the list of deter-
mining factors. It has changed — ^rather, is changing — ^the relative
economic positions of nations, and the conditions of foreign trade. Only
a small fraction of this, however, asserted itself in the sixteen years
under discussion, although all the fundamental conquests and extensive
investments were then made, and all the bases were laid. Not before
1908, completely not before 1914, did installations of power, even in
this country, spell the victory of electricity. Immediate cost advantage
was at first small, in many cases negative — as it was, for example, in
the case of the all-steel ship — ^and reciprocating and similar steam engines
kept often more than their own, a most interesting case, in its complexity,
of reaction to innovation. Even in lighting, electricity was expensive,
and the difficulty arising from the necessity of supplying current for
disproportionately great peak loads, hence at a low percentage of average
utilization, was overcome but slowly.

1. For want of a more adequate label, we will speak of the Neomer-
cantilist KondratieflP. Few will deny that the social atmosphere char-
acteristically changed about the late nineties, though not everyone who
recognizes that change will be ready to grant the claims we make for the
^‘symbolic’* year 1897, and most people will also agree with the pro-
position that those changes were of two kinds — ^the one represented by
such symptoms as the recrudescence (as we should say from the stand-

^ Professor Kuznets, whose opinion is entitled to onr greatest respect, considers it to
have been smaller and includes this estimate among the instances by which he illustrates
liis tendency toward retardation of industrial growth (Secular Movements in Production
and Prices, p. 29). But the saving in the cost of power is obviously no adequate measure
of the contribution of electricity, though we shall quite agree with him in looking upon
this as a relevant measure of part of it. However, his remark refers to data of 1907 and
neither that nor any other contribution of electricity had by then shown its true dimensions,
any more than textile machinery had by, say, 1807. Kesults do not show in Kondratieff
prosperities,

Historical Outlines

399

point of the typical political attitude of the times of the second Kon-
dratieff) of protection and the increase in expenditure on armaments,
the other by such symptoms as the new spirit in fiscal and social legisla-
tion, the rising tide of political radicalism and socialism, the growth
and changing attitudes of trade unionism, and so on. Both kinds of
changes asserted themselves differently and at different times in different
countries. In America (Dingley tariff, 1897) protectionism meant little
more than another victory of a tendency that had been present from the
first; in England, no more than a slow change of public opinion on the
subject of free trade. The new Labor party in the English Parliament
did not at first count greatly, but all the more significant was the change
in the attitudes of what was still known as the Liberal party that mani-
fested itself after Sir Henry Campbell-Bannerman’s victory in 1905
and produced old-age pensions instead of the reduction of the income tax,
the ‘‘people’s budget,” and unemployment insurance. In Germany the
power of the Social Democratic party increased, expenditure by muni-
cipalities began to be a serious matter, and the social insurance item
rose to 1.1 billion marks in 1913, while in America there was little of all
this beyond social legislation in some states (Wisconsin) and a general
hostility to “big business,” satisfied for the time being with prosecutions
under the Sherman Act and regulation of utilities. Whatever we may
think of the importance or unimportance of immediate economic effects,
looking back today, it is impossible to mistake the significance of these
symptoms of a changing attitude toward capitalism.

The deepest problem of the economic sociology of our epoch is
whether those tendencies — ^for our purpose we have a right to speak of
two — ^were not fundamentally one, and whether they grew out of the
very logic of capitalist evolution, or were distortions of it traceable to
extracapitalist influences. In Chapter XIV this problem will again cross
our way. For our present purpose the following comments suflSce.
First, those tendencies, whatever their nature, sources, and relation to
each other, hardly asserted themselves strongly enough in prewar
America to have to be listed among the main factors that shaped Ameri-
C8n economic history. The Cuban war — and what Europeans loved to
call American Imperialism, in general — conditioned not unimportant
innovations, but it is here assumed to have had no great influence in
distorting any cycles*

Second, in the case of Germany, the only way in which those tend-
encies asserted themselves significantly was in expenditure on armaments.
Since this was mainly financed by taxation and gvenuine savings — ^the
German central authority, unlike the individual states, borrowed freely —
it certainly diverted toward consumptive purposes sums that otherwise
would primarily have financed additional investment, for we must

400

Business Ctcles

remember that that expenditure coincided with a Kondratiefif prosperity
in which savings are promptly spent. Hence, it made Germany poorer
than she would have been otherwise, and her money market still tighter
than we should expect it to have been in any case during a Kondratieff
prosperity. Symptoms of this show clearly enough in the difficulties
the government met with in the bond market. But precisely because
of this, no stimulating effect on the rising tide of prosperity can have
been exerted by that expenditure — cycles were substantially what they
would have been without it and resulting trends in quantities were, during
the prosperity phase of the Eondratieff, probably not much affected,
although that diversion of resources might have told in the subsequent
phases, had the effect not been lost in the upheaval of the war.

The case of England, third, was different. Both actual burdens
and anticapitalist attitudes were such as to make it impossible to dismiss
a limine the hypothesis that they may have had something to do with
the fact that England did not take part in that prosperity as vigorously
as the other two countries did. We shall briefly return to this in our
discussion of the postwar period. Meanwhile, it should be added, for
the comfort of those who abhor any such statement, that for our purposes
there is very little practical difference between it and the much less
objectionable proposition, that social radicalism and decreasing energy of
entrepreneurial activity are interdependent and that both of them are but
symptoms of the same deeper cause. The Boer War, vigorously as it
was financed in accordance with English tradition, would, however,
account for some deviation of the course of events from that in the other
two countries, quite plausibly until the year in which the Campbell-
Bannerman government took office.

Of the multitude of facts that these remarks are intended to cover,
some at least must be mentioned explicitly. English and German
war budgets — ^for all budgets from 1899 on were to all intents and pur-
poses war budgets and the World War could have been, and to the knowl-
edge of the writer actually has been, at least in one instance, predicted
from their figures alone — were the main, though not the only, factor to
cause gold currencies to work with increasing friction, in spite of the,
roughly, 7,000 tons of gold that were produced from 1898 to 1910.
The phenomenon, so obvious in the postwar period, that the world
grew out of humor with gold because it told unpleasant truths, became
first observable then. Advocacy of the gold exchange standard, actual
policy that tended to conform to its principle, an almost bullionist
struggle for gold,^ in Germany also the ‘"reform” of the bank act (1908)

^ This alone suffices to reduce to modest proportions the autonomous influence tliat gold
can have exerted on business situations. The behavior of the English Bank Rate, which
wti-8 steadily over S per cent, is conclusive evidence in this respect.

Historical Outlines

401

were some of the symptoms. More immediately important in their
short-run effects on capital movements and currencies, however, were
other shadows of the approaching war. The Moroccan and the Bosnian
crises had a powerful influence on the structure of international financial
relations, though on the surface this showed more clearly in other coun-
tries than in our three — ^for instance, in the Austro-Hungarian Monarchy.
The Russo-Japanese war, the post-bellum policy of Japan, and the
revolution, the armament and the railroad development in Russia,
loading respectively the English and French money markets with large
commitments to loans that could not be relied on to produce correspond-
ing productive assets, added to the strain, which no doubt was eased by
the increase in gold production. Finally, whatever we may think of the
intra- or extracapitalistic origin of some of the tendencies, so pregnant
with human suffering, that then began to assert themselves, there cannot
be any reasonable doubt that the capitalist evolution of the previous
Kondratieff now produced, as one of its rationalizing effects, what the
writer personally considers — ^without being able to go into the reasons —
to be the most obvious symptom of the decay of a civilization, a fall of
the birth rate in the upper strata of society. In the case of Germany
this was associated with so rapid an increase of wealth and economic
welfare that emigration practically ceased.

£. American agriculture has to be listed among the industries which
added important developments on the lines chalked out by the innova-
tions of the second Kondratieff. Since some of the problems of the
agricultural depression of the third will have to be taken up in the
chapters on the postwar period, we will here merely recall the agricultural
conquest of the Far West, completed by the end of the century, improve-
ment of agricultural machinery (big threshers and combines for instance),
increased use of gas engines — flight tractors came into use in the first
decade of the century; 3,000 were sold in 1914 — ^the beginning use of
electric power — ^total horsepower employed rose by S2 per cent from
1899 to 1909 — and rapidly increasing consumption of fertilizers (from
under 2 million tons at the beginning of the period to over 7 millions in
1914; no correction need, for that time, be made for variation in plant
food content). All of this increased wheat acreage by about one-third,
as between the average of the last decade of the second and the average
of the first decade of the third Kondratieff, and also yield per acre.
Cotton increased its acreage still more and similarly displayed increase
in yield per acre. German agriculture contributed, in spite of important
strides on the road of technological improvement (the great new things
however worked themselves out in the downgrade after the war), very
much less obviously to the processes of that Kondratieff prosperity. But
it profited by it, and was put in a position to do so to the full by greatly

402

Business Cycles

increased protection of grains and meat (Biilow duties), which, though
injuring not only the masses, but also wide sectors of the peasantry and
even some types of large-scale agrarian enterprise, induced an increase of
acreage east of the Elbe, partly on poor soils, that was in some degree
responsible for the difficulties after the War. Though complaints never
ceased and legislation and other favors, particularly as to credit, were
always clamored for, the state of German agriculture as a whole was,
according to any ordinary standard, flourishing throughout those 16
years. Developments in England, although extremely interesting from
other standpoints, do not present any features that would have to be
noticed from ours.

3. The last installment of railroad construction, a typical instance of
completing development on established bases and in part merely the
reflex of the sharp rise in net earnings which set in during 1897 and
continued until 1911 (with peaks in 1904, 1907, and 1910 — ^this is a
systematic series in our terminology), contributed substantially to the
prosperity phase in this country, very much less, even proportions
guarded, in Germany and England. In America about 70,000 miles
were added and ^"net capital” increased from a little over 9 billions in
1897 to 15}i billions in 1918. There is thus reason to speak of another
railroad boom — secondary phenomenon though it was, in spite of its
quantitative importance — and to remind the reader of the meaning of
this way of fitting things together. Ignition and quantitative importance
do not necessarily go together. Quantitatively or statistically, the
processes of every cycle are always contributed to by the completion
and the working of the inheritance of preceding evolution, even as they
hand over their own contribution to the next cycles. If, on the strength
of ideas formed by the pedagogical simplicity of our ‘‘pure model,”
the reader should find anything in this to contradict the principles of
our analysis, then the writer has, in spite of all repetitions, failed to convey
his meaning. All he can do about it now is to recommend that the reader
carefully reflect on the case in hand.

The ‘"induced” or “completing” character of railroad achievement
during that time shows not only in construction — in the commercial
nature of the new trackage and the fact that it was largely built in
response to existing demand within an existing framework — but also,
and still better, in other elements. The great clearing of the ground
that the crisis of 1893 and its aftermath had effected, brought control
over many roads into new hands. New types of men took hold of them,
very different from the type of earlier railroad entrepreneurs. Some
of them were not entrepreneurs at all, but simply efficient administrators.
According to Mr. H. Jerome’s index (Mechanization of Industry, 1984)
“product” per man-hour in steam railroad operation rose from 104

Historical Outlines

403

(base, 1800) to 138.9 during the period 1895 to 1910. The new adminis-
trations improved tracks and roadbeds, raised horsepower installed
(between 1899 and 1909) from roughly £1 millions to roughly 45 millions,
accepted improvements in safety devices, began to accept automatic
train control and mechanical stokers, new types of locomotives and cars,
and thus evolved the railroad service that since has come to be looked
upon as a matter of course, though many of these things — ^the electric
and the oil-burning locomotive, in particular — did not spread until the
postwar downgrade.

As far as the new men (no need to mention the familiar examples)
were not administrators, they were organizers and financiers. In both
these respects, 1893 had indeed left many problems. The situation
may even be said to have set a definite task to which the financial groups
that had carried out the liquidation and reconstruction, and the executives
they had put into power or accepted, now applied themselves. This
task was one of consolidation in a very comprehensive sense of this word
and it implied, in many cases presupposed, consolidation in the particular
sense of combination, amalgamation, and merger. What the public
and the political world saw and felt about was, on the one hand, the
creation of new economic positions invested by the imagination of the
man in the street with a power that was both immense and sinister and,
on the other hand, the spectacle of financial maneuvers and of the
struggles between financial groups that offered as much food for the
prevalent propensity to gamble as for moral indignation.^ Since it is
these aspects which still dominate the economic historiography also
of the industrial ‘‘merger boom,” it is necessary to point out that for
us the latter means something which the public mind either did not
realize at all or entirely failed to link up with those financial operations:
new production functions, reorganization of large sectors of the system,
increase of productive efficiency all round. Mergers must, therefore,
be listed among the innovations that carried that prosperity.

4. Of course, consolidation was not a new phenomenon. Railroad
systems, in particular (in England we have met them as early as the
forties), had been built up before, and industrial combination had begun
in the sixties and been a featime of the late eighties. New, however,
were the scale, some of the methods, and, to a certain extent, the mean-
ing. In all cases, whatever the legal garb (which however soon con-
formed, in the holding company, to the economic nature of the thing)

1 Neither that attitude of the public mind and the discovery by the politician of its
political possibilities, nor actual measures taken (prosecutions under the Sherman Act, the
Hepburn Act, and so on) are relevant to the purpose of this study. They are however
important for the sociology of capitalism and, in particular, of the rise of that hostility
which today prevails in the public mind.

404

Business Cycles

those mergers meant new units of control, new principles of management,
new possibilities of industrial research, and, at least eventually, new
types of plant and equipment — also, new locations — intended to achieve,
often built to exceed, the absolute optimum of known, if untried, tech-
nology. The productive capacity that was thus created and could
not have been created without them ranks high on the list of the factors
that explain the torrent of products that broke forth in the postwar part
of the downgrade. It is hence not correct to call those combinations
monopolies simply,^ without adding that they were monopolies of a
special kind, very different in theory and practice from the genuine case.
What such combinations, provided they go far enough, might mean
for the mechanism of the business cycle has been pointed out, under the
heading of trustified capitalism, in the third chapter. As a matter of
fact, however, the course of events in the period under discussion and
its statistical picture hardly bear out the expectation — quite defensible
in itself — ^that the cyclical movement would be substantially altered
by their policies. This statement requires the following qualifications,
which do not, however, invalidate it: individual prices were frequently
deflected (those of steel rails, for instance) from the course they would
otherwise have taken, though this did not amount to more than what
combinations of the same or different type (cartels and so on) had done
at all times; the combinations frequently included firms which otherwise
would presently have been competed out of existence, and thus may be
said to have provided a method for the elimination of the obsolescent
elements of the system that obviated the death struggle by anticipating
its results. Once formed, the giants in some cases, though not in others,
threatened the life of outsiders — ^both new and old — also in other ways
than by their technological and commercial superiority. ^

Difficulties arise in some cases in settling who the entrepreneur was.
In the two outstanding instances in the railroad field, all the criteria

^That is, however, precisely what is done and what has been done from the first.
Compare the Petition of U. S. Government vs. Northern Securities Company et al., quoted
in 193 U. S. 197, i55. The Attorney General did not take account of any other
aspect than the “monopoly” and the danger of “the entire railway system of the country”
being “absorbed, merged and consolidated.” It has been pointed out before that this
attitude was specifically American and that, in Continental Europe at least, that argument
would have entirely failed to arouse sensation.

* That superiority has often been denied. It is, of course, true that mere size is not
necessarily an advantage and may well be a disadvantage. Judgment must turn on the
merits of each case. But statistical evidence to the effect that smaller concerns often do
better than the giants should not be uncritically accepted. The smaller concerns may now
often be in the position of the new, and the giants in the position of the old firms in our
model. It is held above that the big concerns (there may be exceptions, of course) implied
technological and organizational improvement when they were founded. It is not held
that they retained their advantages until the present day. Our theory would in fact lead
us to expect the contrary.

Historical Outlines

405

were present in the two leading naen (Harriman and Hill). One of them
was as much an organizer and reformer of administrative routine as he
was a stock exchange leader. But this combination of aptitudes only
serves to show how rare, with this kind of innovation, must be the cases
in which one man can be said to have been ‘Hhe’^ entrepreneur. The
industrial function which amalgamations fulfilled was in most cases entirely
divorced from the task of bringing them about. Yet that traveling
salesman who turned into a promotor of combinations was no mere
financial peddler, though he probably understood little and cared less
about anything except a profitable deal in industrial properties. In
some cases, bankers played a leading role, although one must be careful
not to overrate the initiating importance of an agent whom negotiations
place in the limelight. The Mercantile Marine, which, among the
transactions of first importance, came nearest to being a bankers’ venture,
was no success. The steel combine was almost exclusively determined
by the dominating position of the Carnegie concern and practically
dictated by its head. The average banker’s contribution was a sub-
ordinate one and consisted mainly in forgetting what banks exist for
in capitalist society.^

^ The capitalist agglomerations of the period, the mergers and their financial sponsors,
will by many be considered as the very incarnation of Finanzkapifalismus in the sense of
R. Hilferding. They will be interpreted as a new stage of capitalist exploitation, closely
linked to Imperialism — capitalist groups (the “capitalist class'’) conquering, by concerted
action, the productive apparatus so as to be able to wring the maximum of surplus value
from the masses (also, which Marx himself did not stress, by exploiting them as consumers),
and to subject to their control government and politics, in order to secure protection of the
home market and enslavement of the working classes, then to go for, say, Cuba, in order
to provide opportunity for capital, which restrictive policy at home would make redundant,
and to open new sources of surplus value by the more primitive methods of exploitation
possible in more primitive environments. This is a rough statement of the Neo-Marxist
theory of the imperialist stage of capitalist evolution, which has certainly the merit of
having attempted to visualize the facts of a historic epoch from the standpoint of one great
principle. Since the cyclical process is not an incident but the whole of what is specifically
capitalistic in economic life, it would really be our duty to enter upon a discussion of that
theory, and either to accept it or to develop a theory of our own, elements of which are, in
fact, implied in the construction of our model. But this cannot be done within the frame
of the present work, into which the device of operating by means of “external factors”
has been introduced precisely in order to exclude those deeper problems and to concentrate
attention on a more restricted task. If, of comse, financial groups as a matter of fact did
wield control over production and politics of the kind and to the extent that that theory
presupposes, it might not be possible thus to restrict our discussion. And in this sense, it
can be said that we have not really succeeded in skirting those questions, but are implying
a definite answer to them, namely the answer that the rule of the financier over industry,
still more over national politics, most of all over international politics, is a newspaper fairy
tale, almost ludicrously at variance with facts. But so far as we need this proposition in
order to justify our modus procedendi, it is largely established by our analysis of industrial
evolution.

406

Business Cycles

The movement started in 1898, immediately after recovery from the
troubles of 1896. The year 1899 saw it in full swing, especially in iron
and steel. The big events came in the first years of the century ; then
1907 called a temporary halt. The policy of the Union Pacific may seiye
as an example from the railroad field, which will at the same time con-
tribute to the understanding of the crisis of 1907. Obviously it was
no mere attempt to secure a monopoly position as such — ^whieh, as
must have been clear to anyone, could never have been exploited in tke
sense of the classical theory of monopoly price — or simply financial
piracy, but an attempt to build a system so circumstanced as to realize
maximum economy, and to make it yield surpluses through this increase m
efficiency. The way was found barred at the very beginning : the most
important link in that system, the Chicago, Burlington, and Quincy, knl
been conquered by the Northern Pacific and the Great Northern. By
this transaction the “collateral trust bond^’ — ^not new in itself — came
into prominence. The buyers of the stock of the Chicago, Burlington,
and Quincy handed it to the Northern Pacific and the Great Northern
at a price almost 50 per cent above what it had sold for before the buying
began, and this price was paid in bonds that were issued by these two
companies and then gradually sold to the public.

In other cases, we will add at once, corporations were formed for the
purpose of acquiring controlling parcels and issuing their own. stoeh or
bonds against them. This is the American form of a method of acquiring
industrial control, which in the time of giant units became quite general,
though it nowhere else went to the same lengths, and nowhere else so
directly produced new industrial structures. The German form
differed mainly by virtue of the role of the credit mobili&r banis. But
some of the institutions that were called “special banks’’ in Germany
were fundamentally nothing else but such holding companies, while the
great industrial concerns, in the electric industry for instance, though
in a more conservative way, lived and worked on exactly the same
principles as their American relatives. For reasons too obvious to
detain us, there was much less of all this in England, the English banks
in particular keeping much more firmly to their ideas of what a bank
should be. These things are familiar. But it is important to realize
how they fit into our schema of entrepreneurial activity and the cyclical
mechanism. Control is an empty phrase. It acquires meaning only
in connection with the particular purpose for which, and the effects
with which, it is acquired and exerted (compare the analogous proposition
about credit creation or saving).

When, as stated, the Union Pacific interests saw the road blocked,
they tried to unseat the blockaders by acquiring a controlling parcel

Histoeical Outlines

407

of the Northern Pacific itself. What strikes the observer is not this
move as such, but the absolute disregard of costs and consequences
that characterized its execution.^ The managers of the campaign
acted like some generals in the World War and even, like a few of these,
took pride in doing so. The Union Pacific troops were set to storm the
concrete trenches of the Morgan position, perfectly impervious to frontal
attack. Europeans helped, against their will, by selling short when the
attacked stock soared, and by lending, though English banks tried to
discourage this whenever the purpose was detected or suspected. The
Northern Pacific Corner of 1901 ended in a draw from which an under-
standing emerged (Northern Securities Company, to be presently prose-
cuted under the Sherman Act), but the harm done to the financial
structure and to the international position of American currency and
credit accounts for a sequence of events that lasted through 1903 (‘‘rich
men’s panic”) and was serious enough to affect somewhat, though not to
the extent one might have expected, the industrial processes below
that surface. We note two things. First, innovation in the formative
stages of trustified capitalism will regularly produce such events owing
to the fact that large-scale financial operations of a type entirely lacking
in the mechanism of innovation in competitive capitalism are in this
case necessary for the entrepreneur to get his hand on the wheel. It
would always do that even in later stages, if there were not the alternative
method of the rise of new men to leading positions within the giant con-
cerns, once these are formed. Second, the maneuvres and excesses of those
as of earlier times, and hence the crisis that ensued, are not simply
accounted for by the fact that in one way or another they served, or
were induced by, the purposes of large-scale innovation. Crises, be it
repeated, are historic individuals, into the making of which enter many
peculiarities of individuals and environments, besides external factors.
Our model explains, it is believed, the underlying process and even,
in most cases, approximately the location in time of the turning points,
and the modus operandi of the features peculiar to each situation. But
these remain distinct facts and exert distinct consequences, all the same.
In the case in hand, for instance, a less speculative-minded public, a
banking system of firmer tradition (its organization, deficient elasticity,
and the like, which have been so much stressed, is by comparison quite
a minor matter), entrepreneurs less bent on immediate financial success
and less free from inhibitions would of course have made a great difference

^ The idea itself and that method of giving effect to it are of course entirely different
things. Quiet buying, making judicious use of depressive situations, might have led to
success in so short a time as 10 or 20 years; but 10 or 20 years are indistinguishable from
eternity for the American mind.

408

Business Cycles

to, among more important things, the behavior of our time series and
would have eased, among more important ones, the difficulty we have
in dating Juglars in that period.

Another aspect is best displayed by the next step in the Union Pacific’s
financial career. After the dissolution of the Northern Securities
Company, it had no interest in holding the parcel of Northern Pacific and
Great Northern stocks which had come to it in the liquidation, and it
began to sell out, acquiring, up to the middle of 1906, about 56 millions
in cash and on call. This sum was obviously assembled by way of
preparing a new campaign in the fields, this time, of the New York
Central, the Santa Fe, and the Baltimore and Ohio. In this campaign,
what we may term seriousness of 'purpose is, at least from the standpoint
of the Union Pacific itself, very much less obvious than is the deliberate
fostering in 1906 of a speculative craze that had already set in. We note
first, the spending of the Union Pacific’s funds for this campaign and the
straining of its credit to the extent of 75 millions borrowed on notes;
second, the fact that banks offered less than no resistance to this bor-
rowing and not much resistance to speculators’ borrowing in general;
third, that, European capital being drawn to this country by high rates
and prospects of speculative gain, an additional relation between the
American and the European short-money markets, normally inoperative
at that time, was set up which was bound to act as an ideal conductor of
repercussions. The importance of such things is clear and so is the
consequence that for us follows for the diagnosis of 1907.

5. Industrial mergers displayed similar phenomena and call for but
little additional comment. The theory of their financial construction
may, in case innovation consists simply in the cheapening of the costs
per unit of a product already in use, again — since we have met such
cases before — ^be formulated like this. Entrepreneurs’ profits may be
expressed as the difference between the present value of a set of factors
of production, evaluated with regard to the net returns they are expected
to yield if used within a given new production function, and the present
value of the same set, evaluated on the basis of the net returns they are
expected to yield within their old one. In the limiting case of perfect
competition and perfect absence of friction they can be bought at prices
corresponding to the latter while, until competition steps is to reestablish
normal relations of values — ^in accordance with the theory of imputation —
the products of the new combination that is being envisaged would also
sell at their old prices, hence, at more than cost. Suppose that the
factors required for a new combination consist of the plants of a number
of independent going concerns — these can never be used as they are,
but we now only wish to clarify a principle — and that these concerns
can be acquired at prices corresponding to the conditions prevailing

Histobical Outlines

409

in tte preceding neighborliood of equilibrium. Tben we get estimated
entrepreneurial profits hy deducting these values from those higher
ones which the plants are expected to realize within the new combination.
If we further assume that in payment of the former, bonds (or preferred
shares, or bonds with common shares thrown in as a bonus, to supply the
motive or an additional motive for selling out) are issued to vendors and
that profit expectations are embodied in common shares, we have the
rationale of a method which in itself but expresses the economic logic
of the situation. Its peculiarity so far consists only in the facility it
affords for cashing unrealized profits which may never be actually earned
and which, even if they eventually are, exert, by being cashed in advance, an
influence on the monetary part of the mechanism entirely different from
that which profits exert in the ordinary case. In particular they must
be financed, unless that common stock is held indefinitely by the founding
group and its associates. This may for instance be done by the savings
of the public or by credit created in order to enable the public to buy.
The various aspects of this are left to the reader to work out.

Attention is called especially to the effects that, thus applied, saving
will have on producing excesses in consumption as far as those non-
existent but realized profits are spent on consumers’ goods. As far as
they are not, these savings probably fulfill their normal social function of
improving the productive apparatus, although, even if everything had
always been done with ideal correctness^ the private interest of those savers
who bought common stock would, in many cases, have been better
served by a game of poker. It is perhaps not superfluous to add that,
apart from such sales to the public of the securities created, mergers
as such — ^as distinguished from their industrial programs — did not
require any funds. This is one reason why it is idle to speculate about
where the ‘‘huge sums” came from that figured in those capital transac-
tions. Already for 1899, for instance, stocks and bonds alone of new
industrial combinations that were “absorbed by investors” are said to
have amounted to nearly 3.6 billion dollars,^ three-quarters of which
was common stock. This does not mean, of course, that existing funds,
let alone savings, were actually spent on those stock and bonds to any-
thing like that amount. Some vendors kept their bonds, and some
“entrepreneurs” their stock. Nor was there new investment if, instead
of keeping them, they sold in order to buy other securities with the pro-
ceeds, for this was equivalent to an exchange of securities. And even
as far as they simply sold for “money,” against existing or ad hoc
created deposits, that money was, of course, not bound or absorbed by

1 See V. S. Clark, voL III, p. 7. Mr. Clark’s figure is from the Financial Chronicle for
Mar. 24, 1900*, but it seems to refer not to combinations but to companies and not to sales
to investors but to incorporations.

410

Business Cycles

the transaction. Any sums thus withdrawn from their channels were
speedily returned to them again, as we shall see in our discussion of stock
exchange processes in Chap. XIII. As far as that goes, it was not the
supply of ""capital” that was exhausted in 1907, but the supply of folly.

That interpretative schema is, of course, entirely independent from
actual financial practice. The vast scope for irresponsibility and mis-
conduct which is inherent in that method and immeasurably increased
by the fact that the evolution of an environment’s system of moral ideas
and legal safeguards tends to lag behind its economic evolution, is mainly
relevant for the explanation of the details of particular situations which
so easily veil, to the eyes of many students, the fundamental facts under
a surface of ""shortage of credit,” ""lack of confidence,” ""hoarding,”
or ""shortage of reserves.” Combinations of all types emerged all over
the industrial field — some will be mentioned later — ^but we will confine
ourselves, for the purpose of illustration, to one instance only — one which
presents the essential features with unusual clearness — ^the United States
Steel Corporation (1901). As stated before, the financial construction —
the form was simply that of a holding company — ^was practically deter-
mined by the Carnegie Company which in the Juglar recession of 1900
was tactically in a still more advantageous position than it had been
before and not only impregnable to attack, but also perfectly ready
to attack, itself — such an attack was actually expected and, in fact,
announced in the shape of an extensive program of new construction.
In order to apply our schema to the case, we must recognize that the
chief vendor combined the role which it assigns to vendors, with the
function of the entrepreneur who creates — in this case, had created —
the future possibilities (or a great part of them) so that securities trans-
ferred to him would represent both the value of (his share in) his plant
as it was, irrespective of and previous to the new combination and the
additional value of capitalized expected profits. To a minor degree
this applied also to other vendors who, in fact, were less favorably treated.
So far, deviation from our schema can only have resulted from the
possibility that fixed interest bonds of the new corporation formed,
within the ""payments” to vendors, a larger part than they should have
according to the relation between preexisting and expected values. This
is all we would have to say, had the vendors kept their common stock.
But it was clear from the outset that this was precisely what they — or
most of them — did not wish to do. In order to gratify them, a syndicate
was formed and a market was created by methods of high-pressure
salesmanship that included ""matching orders” and the like. This
seems to have been more than ""cashing unrealized profits.”

The further career of the United States Steel Corporation is, owing to
its central position in the typically cyclical industry and to the accuracy

Histoeical Outlines

411

of the information it puts at the disposal of the public, a subject of
commanding interest. Only one remark is necessary here, however.
The 301 millions of bonds were, of course, a heavy burden, but the
1,018 millions of capital stock were no burden at all. If our diagnosis
of the economic nature of this stock (or a great part of it) be true, absence
or smallness of dividends would not be a sign of bad financial health;
and their gradual dwindling and final disappearance is what would have
to be expected from the standpoint of our theory. As a matter of fact,
so far they have not dwindled to zero. But we also observe that the
concerns’ real earning power over time — i.e.y earning power independent
of short-time fluctuations and of the effects of the rise in the level of
prices and of such events as the World War — ^was kept up only by inces-
sant ‘^ploughing back” of surpluses^ and by a sequence of innovations,
mostly minor ones. The case is thus seen not to contradict, but on the
contrary to illustrate, our thesis that no structure of real capital is ever
the source of permanent net returns, although this proposition is, in
strict theory, true in the case of perfect competition only.

6. We return to what, in the sense defined in the introduction to this
section, is the backbone, though not more than the backbone, of the
purely industrial processes of this Kondratieff. That is to say, the stage
having been set before, both technologically and economically, the electric
developments that we observe in the later nineties, spreading their
effects over the industrial field, would in themselves have been sufficient
to produce what we call a Kondratieff prosperity and to impress a
dominant contour line on, or to provide a unifying tendency for, the
successive business situations of that time, although independent innova-
tions in some sectors, completing developments in other sectors, growth,
external factors are just as important for the analysis of actual long-run
results and more important for the analysis of short-run situations. To
save space, we will neglect the progress of the telegraph, the telephone
(numbers of telephones installed in 1897, 515,200; in 1914, just over
10 millions — estimates by W. M. Persons, An Economist’s Appraisal
of Domestic Electric Refrigeration, no date), and of electric lighting
(arc lamp, incandescent lamp, metallic filaments), the two last of which
practically exhaust what advance there was during the prosperity phase
toward the electrification of the household, which became so important
a downgrade development. The essential thing was the production of
electric power: 3,150 million kilowatt-hours in 1899 (no figure is known
to the writer for 1897) and 19,652 million kilowatt-hours in 1914 (estimate
by Edison Electric Institute), no year showing decrease and only 1908
the same figure as the preceding year.

1 Compare John B. Williams- The Theory of Investment Value, 1938. A most inter-
esting case study on United States Steel is presented in Chapter XXIL

412

Business Cycles

Soon after the turn of the century long-distance transmission, the
triphase current, the spread of the steam turbine (which did not, however,
get beyond ^,£78,000 kilowatt-hours in 1912; its great career was a down-
grade development), improvement of hydroelectric motors, construction
of hydroelectric and thermoelectric plants of ever-increasing capacities,
and the victory of the big power stations over the plants of individual
industrial consumers became the leading features of the period, which
also persisted, on the much larger scale characteristic of Kondratieff
recessions and depressions, in the postwar epoch. As mentioned before,
hydroelectric enterprise had started on a large scale in 1895, when the
plant at Niagara Falls went into operation. It supplied industrial
power from the first and in 1900 embarked upon a still more ambitious
program. In New England (Holyoke Water Power Company), on the
Mississippi (Keokuk), in Montana (Great Falls), on the St. Mary’s
River (Consolidated Lake Superior Company), on the Pacific Coast,
in the South (many local companies; Southern power Company, 1906,
the first one of importance beyond its neighborhood; Alabama Power
Company; the plant of the Aluminum Company in Tennessee; then an
interesting development of transmission lines that led to a cooperation
between several systems in the Southern Appalachian region, buying
current from each other and helping each other in cases of breakdown
and so on), the foundations were laid, during the first two Juglars of
the third Kondratiefl of the electric system of the country, as the founda-
tions of its railroad system had been laid during the first three Juglars
of the second Kondratieff.

Only in exceptional cases did large-scale electrical enterprise proceed
from the industrial consumer, the outstanding instance being the Alumi-
num Company’s venture. New industrial enterprise proceeded from
electrical enterprise also only exceptionally, the outstanding case being
that of the Consolidated Lake Superior Company, which set out to
create — from nothing, or not much — a whole industrial district by taking

P^lp ^^4 sulphide production, copper refining, and steelmaking.
Comment that would well illustrate some properties of our model is
invited by the plan and its execution. The former was perfectly sound
and the latter perfectly competent from a technological standpoint.
The water power, the ores, the timber, were all there and their role
within a comprehensive scheme was easy to visualize. But this is not
enough. One essential peculiarity of the working of the capitalist system
is that it imposes sequences and rules of timing. Its effectiveness largely
rests on this and on the promptness with which it punishes infringement
of those sequences and rules. For success in capitalist society it is not
sufiScient to be right in abstracto; one must be right at given dates. In
this lies one of the difficulties of remedial policies and one of the reasons
for doubts as to the efficiency of socialist systems.

Histokical Outlines

413

The general rule was that industries availed themselves of and
expanded on the new supply of power. Cotton (later also other)
textile and paper mills, the metallurgical and the chemical industries
installed electricity. Some iron-works, however, used their furnace
gas for thermoelectrical purposes. A most important development
ensued in steel. This movement was well under way before the first
Juglar had run its course, but assumed much larger dimensions later
on as the price of current fell. The superiority of new over old plant
was considerably increased because in many cases — that of cotton mills,
for instance — different types of factory buildings were necessary in order
to take full advantage of the installation of electric power. Electrical
equipment was produced by the General Electric and the Westinghouse
concerns and also by many other firms, some dating from the eighties
(as, for instance, the Electric Storage Battery Company). Some of the
most important ones were highly specialized (Electric Boat Company,
National Carbon Company). Electric dynamos gained ground fairly
rapidly; the water turbine less so. Both the General Electric
and the Westinghouse exported successfully and also started enterprise
abroad (British Westinghouse in 1899 ). But total added value under
the census heading of Electrical Machinery and Apparatus was only
about 180 millions in 1914 . A great feature of the first Juglar were
electric trams, of which about 25,000 miles were built up to 1907 . The
competition of the motorcar and the motorbus then stepped in to dim
prospects. Though maximum of trackage was not reached until 1917 ,
they were no longer of cyclical importance after that year; but until
1907 they were in the foreground of speculative interest and railroads
were so concerned about the danger to their local traffic that one great
system impaired its financial position in the attempt to buy up lines
in its territory. The equipment of the London Underground Railway
was supplied by American firms ( 1897 ). Finally, it should not be
forgotten that in 1914 there were still above 40 firms fighting the losing
fight of the electric automobile.

The writer frankly despairs of his ability to give, within the space
at his command, anything like an adequate picture, both of the ramifica-
tions of the transforming influence of electricity and of the other innova-
tions which — ^independently of it or induced by it — grouped themselves
around it and, together with it, set a pace to output of producers’ goods
that, in spite of ^‘responsive” extension of capacities, repeatedly resulted
in steel and even coal “famines” or conditions approaching serious
shortage.^ These conditions were particularly remarkable in the case

^ This strain on a productive apparatus, that at the same time was being expanded at
an unprecedented rate reflects, of course, the fever induced by the proceedings in the sphere
of finance and speculation and was, in this sense, a harbinger of future dijficulties. But it
does not seem correct to argue that the mere fact of full (or more than what should be

414

Business Cycles

of coal, because bydroelectricity itself and many other innovations
were obviously so fuel-saving that something like technological unem-
ployment of coal (which did come about, demand for coal as a chemical
raw material notwithstanding, in the downgrade) could reasonably
have been expected: consumption of coal in the Edison Chicago works,
for instance, was 6.9 pounds per kilowatt-hour in 1900, and ^.87 pounds
in 1913. We must confine ourselves to a few desultory remarks.

7. First, we remember that steam engineering reacted to electricity
in two ways, by the improvement of competing engines — of the com-
pound (reciprocating) engine and of high-pressure boilers (superheating) ;
the Diesel motor did not as yet play any considerable role — and by
offering the completing steam turbine (turbogenerator). On both
lines it would be possible to array, in descending order of importance, a
vast amount of new industrial activity. The reader recalls that the
entrepreneurial role and the change in production functions that defines
our concept of innovation, are both capable of many gradations. They
include Edison and Carnegie achievements, but also achievements
that may be exemplified by a man who first, or among the first, carries
our the idea of letting cars on the drive-yourself system. And those
who follow the pioneers are still entrepreneurs, though to a degree that
continuously decreases to zero. The doings of all of them must be
visualized if a correct idea is to be formed about the nature, role, and
quantitative importance of innovation. Nonelectric engineering enter-
prise in the epoch of electricity fills densely the whole scale, but crowds
particularly in the middle range. All types of toolmaking were, for
instance, in a process of transformation in which firms producing special-
ties rose and fell quickly. Of large-scale enterprise in this field and of
this kind, the two plants of the American Bridge Company (1902)
may be mentioned, but the whole huge development in steel shapes,
though mostly under the control of the steel concerns (the Bethlehem, for
example, bought H. Grey’s patents of the steel section, which was so
great an improvement in the rolling of big beams for structural purposes),
really belongs here. Railroad locomotives and rolling stock, bicycles,
agricultural machinery, ships (not to forget battleships, W. Cramp and
Sons), ail had their minor innovations directly induced or indirectly

called full, that is, optimal) employment of resources would sufiSce to bring about the upper
turning point. Increase of physical output is not necessary to prosperity. For its symp-
toms to persist, it is sufficient that people try to increase output. In fact, if it cannot for
the time being be increased, this would only accentuate those symptoms, and any rise in
cost would always be at least compensated for by an increase of prices of products, until
new products emerge. That such periods of superheated atmosphere put also a strain on
the moral and social framework of society and are productive of serious problems is per-
fectly true, but that is another matter.

Historical Outlines

415

conditioned (via creation of new demand) by the “carrying’’ ones.
We proceed, however, to the second great innovation of this Kondratieflf.

The automobile industry^ affords a good example of a purely entre-
preneurial achievement turning to new uses not only existing resources
but also existing technology, viz,^ the Lenoir-Otto internal combustion
engine, the principle of interchangeable parts, the possibilities offered
by steel developments and modern machine tools. Among modern
industries it also was, in its beginnings, almost in a class by itself with
respect to financial methods. Its own productive process consisted in
assembling intermediate goods which it was possible to buy on credit
(on 60 to 90 days’ open account, for instance), so that the resulting
product, sold for cash, could directly pay for itself. Later on, the
retailer, or institutions that financed him, came in to bridge the gap by
remitting not only in advance of his sale to the consumer, but also of
delivery to him. Thus, the manufacturer need not borrow at all from
banks and may still induce expansion of deposits to an extent amounting
to inflation. No better instance could be found to show how credit
creation for the purpose of innovation can hide. This industry, though
not a starter yet one of the most important carriers of this Kondratieff,
revealed its full meaning for the economic process and for civilization —
it has altered the style of life and the outlook on life probably more than
any prophet ever did — ^in the downgrade span after the war, exactly as
cotton textiles asserted themselves fully in the downgrade of their
Kondratieff. In the prosperity it did not get so far.

The problems of assembling were solved in Germany and France.
G. Daimler and K. Benz produced vehicles in the eighties; Elwood
Haynes, C. and F. Duryea, R. E. Olds, by 1893; A. Winton, in 1894.
Half a dozen small companies, with a quantitative importance prac-
tically equal to zero, were founded in the next six years by these men
(Duryea Motor Wagon Company, 1896; Winton Motor Company,
1897). Registration in this country totaled 8,624 in 1899, and in 1900
the Olds Motor Works of Detroit started what to them seemed mass
production, reaching the figure of 4,000 in 1903. Ford, somewhat
hampered in the nineties by a struggle with the Selden patent — ^this
and similar struggles soon led to an understanding about pooling non-
essential patents and to a considerable measure of cooperation which
it would be interesting to analyze — ^reached incorporation stage in 1903
($100,000 capital, $28,000 paid up). Mortality among pioneers was
as high as in such a ease we would naturally expect. With the (tem-

^ The writer acknowledges his debt to Professor R, Epstein’s monograph on The Auto-
mobile Industry and to Mr. Seltzer’s Pinancial History of the Automobile Industry.
Compare also Fraser-Doriot, Analyzing our Industries, and Mr. Clark’s History of
Manufactures.

416

Business Cycles

porarily) successful ones, profits paid for expansion. Along with the
gasoline car canae the gasoline mower. The first bus routes and stage
lines were established about 1905. Between 190£ and 1907, 3££ com-
panies started operations. In the latter year, 8,423 cars were sold for
about 5 }^ million dollars, of which 1 million was profit. The year 1908
closes the first stage.

In that year innovation turned against itself. The great new thing
appeared in the shape of the light and cheap four-cylinder Ford car for
the masses, which drove from the field many of what by then were old
firms in our sense. That the increased mortality — ^the modal firm
founded in 1902 lasted until 1910, and the modal firm founded in 1908,
also — was mainly among firms under four years of age, does not con-
tradict this statement, because in a period of such rapid change a great
many new foundations will start on a plan that has already become
obsolete, although the failure of others was no doubt due to unsuccessful
innovations of their own. General Motors, founded in 1908 (Durant),
provided the first occasion for bankers to enter the field (1910), which
until then had been entirely outside their sphere of influence and sub-
stantially remained so to the war. Ratio of net profit to net worth,
though declining, remained on a level about twice as high as in the post-
war period and equal to, according to Professor Epstein’s estimate, six
or seven times the ‘‘normal rate of interest.”^ Prices, also declining,
moved on a level still further above that of the twenties, which loose
statement applies even if no account be taken of the difference in quality,
which defies comparison, and of the change in the price level. Product

^ That suffices to give an idea, although both the meaning of normal rate of interest in
this connection and comparison with it of net worth are not free from doubt as to signifi-
cance. It should be observed that these high, in one case at least spectacular, profits —
they were profits in the full sense of our definition of the concept and a very good instance
by which to illustrate it — were earned, despite the fact that the period of gestation of the
automobile plant of the time was quite short, so that there hardly was a span during which
spending on plant could have exerted influence undisturbed by the impact of additional
products, while in all other respects it is clear that entry into the industry was perfectly
unimpeded. The case thus serves to show that neither prolonged gestation nor bars to
entry are so essential for the emergence of profit as might be thought — although in many
cases both do play a role. It also serves to show what it is that prevents competition from
stepping in promptly and effectively and how realistic the fundamental distinction is
between the behavior of the mere economic man and the entrepreneur. Enticement for
entry was not wanting. Nor was there any friction to hold back would-be competitors or
any lack of promptness among them. There was nothing but the diffiiculty of doing a new
thing and making a success of it. Competitors crowded along and, in an industry requiring
but little capital, not only hovered around, but actually entered the field. Only, most of
them failed to produce a car that would sell at a price covering cost, there being absolutely
no other reason for this than the one embodied in our theory of entrepreneurial activity.
Coincidence of high mortality and high profits ideally expresses this situation.

Histobicax. Outlines

417

per man-hour {Monthly Labor Review, 1930, p. 502), whatever it may
mean in such a case, rose (logarithmically) more sharply between 1909
and 1914 than ever before or after. Designs became more stable, parts
more standardized, after 1912— the year that closes the heroic age of the
industry. In 1914, 338 firms (the 1914 census of manufactures gives,
however, 415, not counting producers of electric vehicles) produced a
total of 573,114 cars (Bureau of Foreign and Domestic Commerce),
to which Ford contributed almost one-half. The importance of
the industry and of its demand for the products of other industries
was, therefore, perfectly adequate to ‘'ignite^' the second Juglar, although,
even in 1914, value added was only 210.6 millions. Subsidiaries devel-
oped quickly. In 1914, 971 firms existed producing bodies and parts,
and motors infused new life into the rubber industry.

Also in this country, there had been a considerable amount of enter-
prise in the field of rubber clothing fabrics in the thirties of the nine-
teenth century, but it ended in failure and disappeared in the crisis of
1837 to 1839. Vulcanization accounts for a new start that was a minor
feature of the first Juglar of the second Kondratieff (from 1842, on).
The next event, following upon a long period of quiet and rather passive
expansion, was the merger that combined 10 concerns into the United
States Eubber Company (incorporated in 1892), which conquered more
and more ground in the Kondratieff prosperity under discussion (later
on it also acquired plantations of its own). This industry felt the
impulse of the new demand from the motorcar innovation soon after
1908, when production of tires (fabrics; the innovation of high-pressure
cords, which in 1913 were only 2 per cent of total tire output, did not
become important till 1918), tubes and other accessories began to count
in production programs.^

The oil industry also became almost a subsidiary to the gasoline
engine. In 1899, only 12.8 per cent of crude oil on stills went to the
production of gasoline, kerosene still absorbing 57.7 per cent; but in our
period the former and the use of oil for fueling purposes in general
approached their postwar importance. From the standpoint of the
industry, this was but a favorable external fact, without which decay
would have been unavoidable, and the considerable development during
the period — ^value added in petroleum refining increased from about 21
to about 71 millions between 1899 and 1914, and output of crude petro-
leum from about 60 million to nearly 250 million barrels between 1897
and 1913 — ^was primarily a case of ‘‘being drawn along’’ or of passive

1 The third new industry, rayon, met during the period under discussion with so little
success in this country — the companies that were founded from 1897 to 1911 were unquali-
fied failures and the American Viscose, founded in 1911, was a foreign-owned enterprise —
that we need not mention it at all.

418

Business Cycles

adaptation. The rise which occurred in prices bears witness to that.^
Pipe lines, tank ships, and tank cars were no longer novelties. There
was progress in the methods of prospecting, in drilling to greater depths —
the rotary drill came after the war — and in rational treatment of oil
fields by gas and water pressure. Refining was still done in "‘skimming’’
and in complete straight-run plants, and gasoline yield from crude was
still only 18.6 per cent in 1914 — ^the cracking process was to increase it
and hydrogenation to raise it to 100 per cent in postwar times. Profits
were high all the time and partly financed new investment, particularly
within the Standard Oil concern. Its dissolution by judicial decree in
1911 did not, within our period, affect the division of labor between the
constituent companies, although it did so later.^

Among old industries, glass production was thoroughly revolutionized
by innovations that were almost entirely independent of anything that
happened elsewhere.® Up to 1898, slow introduction of tank furnaces
had been practically the only change that had come to the bottle-glass
blower’s old trade for decades, and this had left his function untouched.
In 1898 came the semiautomatic machine, which, though it eliminated
blowers, still required skilled labor; and in 1905, the completely automatic
(Owens) machine. A later development, which we shall not have occa-
sion to mention, started in 1917 (“feed and flow” machine). Almost
simultaneously the window-glass production was mechanized (cylinder
machine, J. H. Lubbers, 1903, introduced about 1905). Again a later
development, the steel process (Colburn, Fourcault), should be mentioned
here. A minor innovation was migration (from Pittsburgh to Indiana and
Ohio), mainly motivated by the desire to use natural gas. While value
added (in the group of stone, clay, and glass products) increased, between
1899 and 1914 by ^04 per cent, employment fell strongly and per^
manently. For instance, employment in the bottle (and jar) industry
was, after a spectacular increase of physical output, even in 19^5 only
three-quarters of what it had been in 1899. In other respects the case

1 As regards prices of crude oil, this was in spite of the fact that production was highly
competitive — ^in fact, various circumstances, natural and legal, combined to make it almost
perfectly so and to force everybody to produce what he could. The Standard Oil concern
never controlled more than 33.5 per cent of output (1898), and mostly much less (in 1907,
for instance, 11 per cent). Its position rested entirely on the pipe lines and on refineries.
That is why pipe-line companies were subjected to the obligations of common carriers in
1906.

® As mentioned in the preceding section, production of natural gas started in the middle
nineties on the increase that was to carry consumption, mainly for industrial purposes, to
1,918 billions of cubic feet. In 1900 it was 509 billions. A number of innovations in the
industry make it necessary to include it in the list of those that contributed to the third
Kondratiefi, particularly to its second and to postwar Juglars.

*See G. E. Barnett, Machinery and Labour, 1926.

Histoeical Outlines

419

was normal. We find quite as much increase in physical output and
quite as much fall in price as we have a right to expect (in our period;
later on, 1919, a restriction of output agreed on by the industry prolonged
the life of the ‘‘hand branch,’^ see Jerome, op, cit,, p. 99).

This is interesting, because the industry was by no means untouched
by the merger movement or by the tendency toward giant concerns
irrespective of mergers. The American Window Glass Company, which
controlled a considerable part (nearly three-fourths) of the capacity,
was incorporated in 1899. The first thing it did, however, was to reduce
prices drastically. No doubt this move was not only interpreted by
observers, but even motivated by the executive, as an attack on actual
and potential competitors, intended to cut throats and to establish a
monopoly. But the point is — ^barring the question, already treated by
Marx, of how far motivation is relevant to the social meaning of behavior
— ^that even if such monopoly position had been attained, i,e,y if the result
had really been to leave but a single seller in the industry, that seller
could never have behaved according to the theoretical schema of monop-
oly without losing that position. The implications of this resolve the
paradox of modern industry, which, while struggling for monopoloid
control, yet surpasses all historical records in efficiency as measured by
physical output, as well as the other paradox that, monopolistic tendencies
notwithstanding, our schema fits statistical fact not less well in the period
of “big business^’ than it did in more competitive times (see Chap. X,
Sec. D). Other branches of the glass industry also display instances
of the tendency toward the big concern (Pittsburg Plate Glass, 1895;
National Glass (tableware), 1899).^

We pass by paper. There was little change in production functions —
though much expansion of output — except what is implied in the use of
hydroelectric power and in some interesting amalgamations (such as the
International Paper Company in 1898 or the American Writing Paper
Company in 1899). We also pass by printing. Hoe’s revolving-cylinder
press had won out by the sixties; it was developed later on; color printing
and typography came in the eighties and nineties, as did the Mergenthaler
linotype and the Lanston monotype and automatic type casting, but the
advance beyond that belongs to the downgrade of the third Kondratieff.
Finally, we pass by the developments in the chemical industry: progress
in the production of heavy chemicals, use of electricity, mergers.

We must, however, make a remark on cement, developments in which
induced enthusiasts to speak of a cement age. As a matter of fact, the

1 The American pottery industry, though expanding behind the walls of the tariff was,
in this period as it had been before, “inefficient and slow to improve.” See H. J. Stratton,
TechnologicaljDevelopment of the American Pottery Industry, Journal of Political Economy
for October 1932. Things did change after the war, but not very much.

Business Cycles

increase in output is as striking as tiie fall in price that accompanied it,
in spite of the protective duty, the absence of perfect competition, the
violent booms during which it occurred, and the fact that owing to the
contemporaneous innovations in building (steel-concrete) the demand
curve for its product shifted upward still more than it would have done
under the mere influence of general conditions of prosperity. The rise
of the industry dates, as was mentioned in the preceding section, from
the fifth and sixth Juglars of the second Kondratieff and development
simply continued during the period under review. The first stride had
been made in the middle eighties, when the price of Portland cement
started on its downward course in response to a fall in costs and output
began to increase. About ^.7 million barrels were produced and the
factory price was $1.61 in 1897. Output was over 88 millions, and price
was $0.93 in 1914 — still lower, in fact, if improvement of quality is taken
into account. Absence of distress in the industry suggests that money
costs per unit must have fallen, and fallen fairly generally for the large
majority of firms, to something like the German level. An innovation
of the last Juglar of the preceding Kondratieff, the rotary kiln— which
conquered, and increased in size, as soon as it became more economical
through the use of powdered coal — and more powerful grinding machinery
must be responsible. Competition by natural and slag cement may
have had something to do with the promptness with which the benefit was
handed over to the consumer. Many new firms — but no giants —
emerged, and we can repeatedly follow up progress from higher prices,
which threatened the manufacturers’ margins, to lower prices a few
years later, which did not.

How remarkable that is and how closely it was associated with the
conditions characteristic of a new and innovating industry we can see
from a comparison with the cotton industry. This also expanded, cotton
consumption roughly doubling in the period. Nor was innovation
absent. The Northrop-Draper loom came into its own in this period
and the Crompton (1905) and Knowles (1910) looms were then new.
Ring spindles were improved with considerable success as to the reduction
of cost and, as mentioned before, electricity lent its aid. Yet the price of
print cloth rose from 1900 to and above the level of the second half
of the eighties: the character of the old established industry that is
drawn along by the environment asserted itself. There were some
amalgamations — ^New England Cotton Yarn Company; American
Thread Company; also an attempt to form a cartel: Fall River print-
cloth pool, 1898 to 1901 — ^but they do not call for comment. The feature
in woolen textiles was the large worsted mill — ^the carded-wool industry
declined even absolutely — ^but, partly because of the high price of the
raw material, there were no developments that need detain us. Silk

Historical Outlines

421

made considerable headway, largely by innovations which, in part at
least, overcame the difficulties incident to the American labor situation;
but this was only continuation of what had been achieved before.

Of course, all the industrial processes of the time reflect themselves
in the development of iron and steel. But they were to a much lesser
degree initiated by it than the processes of, say, the eighties. We have
already noticed the relation — a relation of give and take — ^between
electricity and steel and the role of the latter in the merger movement^
and we will but add a few outstanding facts. In mining, the old iron-ore
districts declined and the Lake Superior ores dominated the market.
The innovation was the development of the Mesabi range after the
technological and transportation problems incident to the quality and the
location of that ore had been successfully overcome. Also the period
saw the rise and decay of the tendency toward complete vertical integra-
tion — although integration to the extent of combining mining, railroads,
docks, and fleets proved successful and may be considered responsible
for part of the great increase in productive efficiency that occurred —
andjseveral attempts at organization of the trade. The really decisive
fall in the prices of ores occurred, however, before our period.^ Prices
of pig iron rose very considerably and the inference that there was no
great reform in its production function is borne out by the history of the
industry, which, as far as direct use of iron is concerned (wrought iron),
naturally declined. Output of pig iron rose in the Kondratieff upswing,
but not much more, even in the high tide of prosperity, than it did in the
eighties. This is due, of course, to the fact that the same quantity
went so much further than before.^

All the significant progress was in steel. The open-hearth process,
the use of scrap, basic steel, and alloys are the main headings. The
first three can hardly be called novelties. Moreover, in the case of the
open-hearth process, it was largely consumers’ demand, particularly
from producers and users of structural material, that gave it the victory
over the Bessemer process. New plants — ^the Gary plant, for instance —
hence adopted it as a matter of course, although, for many individual
producers, it still involved innovation to dismantle their Bessemer plant
and to throw in their fortunes with the (basic) open-hearth process. It

^ The reader’s attention should be drawn to Chaps. Ill and IV of the third volume of
Mr. V. S. Clark’s work, which contain histories of a number of leading steel concerns that
are full of interest from the standpoint of the cyclical process, particularly those of the
Lackawanna, the Bethlehem, the Republic, the National, and the United States Steel.

2 This illustrates one of the ways in which a wave of development prepares the ground
for the next. But it should be noticed that this is not identical with the observation, made
by some theories of the perpetuum mohile type, that the low depression prices of raw material
induce recovery.

® That fact must be borne in mind in judging “retardation,” see Chap. IX.

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Business Cycles

should be observed in passing that the open-beartli process, working with
scrap, gave a new stimulus to the smaller concern, because the economies
of large-scale production were much less than in the Bessemer plant.
Alloys, which were to gain such great importance, were practically new.
They had scored their first successes in the eighties, especially for forgings
(crankshafts for the Boston Elevated, for instance, or the moving parts
of the pumps of the Calumet and Hecla mines).

The important development, however, with which the Bethlehem
steel was particularly associated, came in our period. High-speed
cutting steel for the machine shop and various other specialties, for motor-
cars, railroads, oil drills, and so on, were beginning to play a role. Still,
however important these developments and however great their quantita-
tive contribution to the Kondratieff, it was, nevertheless, one more case
of the great things having been done. The quantity of crude steel
consumed increased fully as much as we should expect it to do in a
Kondratieff prosperity, but the behavior of prices clearly does not
place steel production in the van of innovation. In the case of specialties
this behavior may enter into the class of prices of branded articles and
also veil an actual fall per efficiency unit. In other cases, for example
the standard one of the price of rails, which stood at ^8 from 1902 to
1915, it may be due to another type — akin to the cartel or NBA type —
of monopoloid situations,although rails had displayed a tendency to rise
before 1901. In other cases there was competition enough to enforce
a fall if conditions of production had warranted it. Yet none ensued,
except such as would occur in the course of Juglar situations.

Copper mining illustrates very well some of the ways of innovation.
In fact it would be interesting to go back to much earlier times in order
to show what role copper played in the evolution of capitalism, particu-
larly in Germany and in England, where it was associated with important
innovations in mining (for instance, with the use of gunpowder in blasting,
of steam for pumping, and others). Its American history begins in
Michigan (Keweenaw peninsula, 1854). Output increased rapidly —
there was plenty of demand in the fifties from the brass and copper
works in Connecticut (kitchen utensils; brass and copper tubing; both
not unimportant innovations), from producers of oil lamps and burners,
shipbuilders, and so on. By the sixties, a considerable industry had
developed, which profited greatly from the war, and the products of
which began to compete with iron — as iron, a century before, had almost
crowded out copper in Europe. Professor Taussig is presumably right
in his opinion (Some Aspects of the Tariff Question) that it owed but
little to the special bill of 1869, which gave it additional protection.
The Calumet and Hecla mines got into their stride in that year and figured
in the subsequent boom. The annual average price of copper in 1872

Histobical Outlines

423

almost reached the annual average of 1864, and then fell, with sharply
marked Juglar fluctuations, to 1894. This fall, which was greater than
that of the price level, was as much due to innovations of the downgrade
type (power drills, high-power explosives, all sorts of mechanizations)
that reduced costs so as to enforce a policy of ‘^nursing demand^’ in order
to extend old and create new uses, as it was to new competition from the
Arizona and Montana mines that were discovered in the seventies.
Output of the Montana mines (Butte, vein ores — expensive to win but of
high copper content — ^the basis of the position of the Anaconda concern)
outstripped that of the Michigan mines in 1887. These new sources of
supply were one of the by-products of railroad developments, both in the
sense that the railroads induced their discovery and in the sense that
they made exploitation possible, since there was no fuel for smelting and
refining in their neighborhood.

The great increase in output during our period, at the very beginning
of which there was a copper boom that culminated in 1899 and was
followed by another from 1904 to 1906, was induced, however, by the
developments of the electric industry and, later on, of the motorcar
industry. Already in the eighties the innovation of hard drawing of
copper wire had established that contact which then became the domi-
nant factor in the demand for copper. At the same time electricity had
contributed the new method of refining which in the course of the nineties
reduced costs to about half. New discoveries (porphyry ores) in Utah,
Nevada, New Mexico, Alaska (1900 to 1911), the great expansion in
Arizona which began in the middle nineties, and various improvements
in mining methods complete the list of innovations. Interpretation in
the light of our model is obvious; the competitive struggles with iron
(for example, early telegraph wires were made of iron) and aluminum are
particularly interesting. The foundation in 1899, and the success from
1899 to 1901 and again from 1905 to 1907 of a holding concern primarily
aiming at control of prices with a view to creating short-run monopoly
situations (Amalgamated Copper) deserves notice precisely because it
affords one of those rare instances to which the ordinary theory of
monopoly approximately applies. It also illustrates the conditions, the
limitations, and the essentially temporary character of all such cases and
the difference between them and the ordinary industrial combines.

The only other subject we can afford to touch is aluminum. Both its
commercially successful methods of production are branches of
electrical metallurgy (the brothers Cowles; Heroult-Hull). Their
invention in the eighties led to quick expansion in the last Juglar of the
second Kondratieff, and prices fell to one dollar per pound by about 1890.
The two firms in control of the industry (The Pittsburgh Reduction,
later American Aluminum Company and the Cowles Electric Smelting

424

Business Cycles

Company, Cleveland) afford as instructive a case study as the single
seller of later date does under similar conditions. Prices continued
to fall and in the middle nineties had reached the level at which mass
production for structural purposes became possible. The use for rail-
roads, motorcars, and electrical appliances, in the food industries, in
chemistry, and so on, begins in our period,

8. As usual, we cannot hope to explain every individual spurt and
breakdown by the factors which enter into our model. All the latter can
do for us, is to describe the industrial processes that underlie such spurts
and breakdowns and create conditions that favor their occurrence.
Enough facts have been presented to justify the statement that those
16 years were a period of rapid industrial evolution, tapering off at the
end, displaying all those characteristics that we imply when speaking
of a Kondratieff prosperity, and centering in the electrical innovation
with all that was induced by it. On referring to the sketches of industrial
histories that he has just perused, the reader will also have no difficulty
in satisfying himself that this Kondratieff prosperity naturally divides
up — ^within the developments associated with electricity, which went
on with hardly any break — into two periods each characterized by indus-
trial processes of its own, the first primarily by mergers, the second
primarily by the automobile industry, though both were also influenced
by other items, among them some that were merely ‘‘completing.’’
The processes of the second period are discernible by 1907, but do not
dominate the economic situation before 1909, though the processes of
the first period had clearly come to a provisional stop before. These
facts can be expressed in our language by saying that we have before us a
complete and an incomplete Juglar, the end of the latter being submerged
in the effects of the war.

But, worse than usual, the picture of general business situations
during several years completely fails tobear out the expectations which, on
the evidence from industrial history, we should form as to their complexion,
so much so as to make the dating of cyclical phases uncertain. The
nature of the difficulty is well brought out by the behavior of time series.
On the one hand, prices, output, pig-iron consumption, clearings, and so
on reflect very well, as will be seen in the following chapters, the general
features of a Kondratieff prosperity and also the division into two sub-
periods. If we eliminate trends, as the Harvard service does, the
Kondratieff effect is lost, but that division stands out quite strongly:
two sequences of well-marked Kitchins are separated by an abrupt trough
in 1907-1908. On the other hand, this trough is irregular from the stand-
point of our schema, as well as from the standpoint of industrial history.
For 1907 we should have expected the situation which we do not find before
the second half of 1909. Hence our schema does not explain that crisis —

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425

not, at all events, for tlie precise date at which it occurred and at which
either continued revival or prosperity ought to have commanded the scene.

The writer wished to put the case thus strongly in order to enable
his readers to record it against the three-cycle schema. He does not do
so himself, however, because those irregularities seem to him adequately
accounted for by a factor which in the preceding historical report has
repeatedly been stressed, viz.^ the course of events in the financial sphere,
which in the period under discussion acquired an abnormal importance.
We have seen that one class of the innovations that carried that Kondra-
tieff prosperity and in particular its first Juglar — ^mergers — ^tended more
than others to induce disturbances of a purely financial nature. We
have also seen that the banking system failed to function according to
design. The practices of the trust companies in fact revived, in a
modernized form, the wildcat banking of the thirties of the nineteenth
century. But recklessness in the handling of the most difficult part
of a bank’s business — ^that part which has to do with the financing of
innovation and of speculative transactions incident to innovation — was
not confined to them. Even the national banks maneuvered themselves
into positions of strain, almost from the start, and were repeatedly unable
to respond to current requirements, because they had lent on new securi-
ties that syndicates were unable to place. Both at the time and later,
responsibility for this state of things was attributed to the absence of a
central institution and to the legal framework within which the banking
system had to work, reserve requirements in particular. This, however,
was putting the cart before the horse. It is true that adequate machinery
did not exist for the handling of a crisis after the event. But this has
nothing to do with the way in which the conditions of strain arose. On
the contrary, the strain restrained what otherwise would have gone on
entirely unbridled.^ If any lesson can be drawn at all from the experience
of those days, it is exactly opposite to the one that recommended itself
both to the banking community and to the public mind. Blaming the
brake for the results of reckless driving is, however, part of the political
psychology of cycles.

This factor did more than disturb the surface. It is understandable
that, in an atmosphere in which everyone lived on, and worked with,
what as yet were future possibilities, the industrial process also should be
profoundly affected. Remembering this, we shall now venture upon an
interpretation of events year by year.

^ A contemporary observer (R. W. Lawson, The New York Banks and the Treasury,
Bankers' Magazine for November 1902) seems to have made the same point, when he wrote
that the real question was not whether banks remained or did not remain within the 25 per
cent requirement, but ‘‘what they did with the other 75 per cent,’’ although this evidently
was not the most felicitous way of putting it.

426

Business Cycles

Eighteen ninety-eight makes a very normal first year of a Kondratieff
prosperity. But a significant reaction to a pace, particularly in the
financial sphere, which was clearly abnormal and very strongly displayed
the features that we subsume under the heading Secondary Wave,
occurred as early as February 1899, and liquidation, not quite confined
to the financial sphere, lasted to the end of May (death of Flower, May
12).^ Another setback came in December — call money at 186 per cent
on the eighteenth of that month actually had a sobering effect for a year,
although caused by English troubles; it threw much light on the situa-
tion — but industry did not slacken until the middle of 1900. This
completes the prosperity of the first Juglar, the recession of which should,
according to our schema, display much the same symptoms, because
of the location of that Juglar in the Kondratieff. So it does through
1902, witness the "‘steel famine.’’ The wheat harvests of 1901 and
1902 were favorable external factors. But the way was studded with
financial vicissitudes of which that outbreak of speculative frenzy that
has already been noticed (centering in the Northern Pacific corner)
and the reaction thereto were the most important. However, while
upsetting the international money market and the normal functioning of
the domestic banking system, they did not blot out the industrial rhythm.
What can be interpreted as a regular Juglar depression, mitigated by the
underlying Kondratieff swell, set in at the beginning of 1903 and lasted
till nearly the end of 1904, the so-called “rich men’s panic” being its
complement in the financial sphere. Recovery followed, and under the
circumstances there is no reason to wonder at its violence, which may
be held to account for a short reaction. The latter or the recovery from
it would then complete that Juglar’s third Kitchin. This carries us to
about the middle of 1906.

Then followed indeed a strong upswing in the second half of 1906,
sustained though on a stationary level until the autumn 1907; but
it does not link up with any new processes in industry and suddenly
gave way to what looks like deep depression for the rest of the year,
followed by an only less sudden recovery in 1908. The year 1909 dis-

^ Also, notes of warning were sounded, coming perhaps from what the writer has an
unscientific propensity to call serious banking quarters. It is a question of some interest
•why these, or their exponents in the press, were not more outspoken and why, when they
spoke, they talked about the Philippines and other irrelevant elements of the situation,
instead of those that were relevant. The answer — of some importance for the mechanism
of crises — ^is that they could not speak frankly. If we visualize in a practical spirit the net-
work of duties and interests in which any businessman finds himself enmeshed, we shall
imderstand that plain speech would have implied stricture on groups who were able to
make their resentment felt, and would have given offense to a public bent on speculating,
which would have blamed the warning banker for any untoward event that might have
followed.

Historical Outlines

427

plays all the features of a regular prosperity milder in character than
that of the first Juglar, which we should expect from its location in the
Kondratieff, although we should not have expected, and must trace to
aftereffects of preceding irregularities, the early relapse in 1910 and 1911.
191£ was a year of good business and is true to form, and in 1913 and
1914 the system was sliding into what bears interpretation as a regular
Juglar depression.^ Although not wholly, irregularity is, therefore,
mainly confined to 1907 and 1908, i,e,y to the crisis of 1907 and its after-
math. This crisis is an intermezzo, which falls outside of our schema.
It should be added that, once we accept that explanation of it which is
offered here, it becomes as understandable that the setting in of the
industrial processes that carried the second Juglar should have been
deferred by it, as the same effect would have been understandable if,
instead of the crisis, a natural catastrophe or a social disturbance of
sufficient magnitude had occurred. For the crisis would, not less than
events of the latter type, interfere with entrepreneurial activity by
destroying the neighborhood of equilibrium from which alone it starts.
Also, it would follow that we should not accept at face value what looks
like an overgrown Kitchin — extending, if we count from trough to trough,
from 1904 to 1908 — ^but rather allow the dent in 1906 to split it so that
the first Juglar ends in (the middle of) that year.

We will not go into the details of the crisis of 1907 or into the tech-
nique, such as it was, by which that crisis was handled. But, since our
diagnosis attributes its violence and its location in time entirely to the
doings in the financial sector, both defense and explanation seem to be
called for. As to the first, a survey of events since 1898, the elements
of which have been presented above, clearly yields supporting evidence.
In particular, it should be observed that the manner in which the financial
engine was from the start handled by the groups and individuals at or near
the steering wheel, while perfectly adequate to produce breakdowns, at
the same time produced, for those groups and individuals, results which
offered ample enticement to repeat abuses on an ever-enlarging scale.
That a major breakdown, when it eventually occurred, did not remain
confined to the stock exchange and to the banks, but also paralyzed the
economic process, is not surprising. But the short duration of this
"‘depression,” as well as the fact, repeatedly pointed out by Mr. Carl
Snyder, that it was not nearly so deep as we might infer from indices
that heavily weight the output in the most affected sectors, and as we
might expect from the violence of the financial catastrophe, lend support

^ Our sketcli sliould be compared to Mr. Thorp’s description of the individual years.
From 1898 until 1908, both included, the grading “prosperity” occurs five times, and four
more times with qualifications; from 1909 to 1914, three times and in no case without
qualification. This expresses well the difference between the two subperiods.

428

Business Cycles

to our view that it was not a depression in our sense at all. Nor can
it be urged, as an argument against the above analysis, that the crisis
was international. For Germany and a few other countries, such as
Egypt, a very similar state of things can be shown to have existed and
to have produced, largely autonomously, similar results, synchronization
of which is easily accounted for by existing financial relations. As
regards the rest of the world, which was much less affected, these rela-
tions — and infection by the speculative excesses in America — are sufficient
to account for such crises as occurred. In fact, foreign capital played
a considerable role in the American stock exchange and money market
at the critical time.

If, then, this diagnosis seem acceptable, it follows that, barring those
surface phenomena that characterize any crisis, there is no analogy
between 1907 and either 1873 or 1929. This is indeed obvious from the
character and duration of the depressions that ensued in the two latter
cases. There is more similarity between 1907 and 1857. We should
not attach much importance to such details as that each of these cases
centered around a conspicuous failure (in 1907 that of the Knickerbocker
Trust on Oct. 22). But it is more relevant that both occurred in the
first half of the Kondratieff. The reader should observe how many
of the actual facts of both cases are covered by this formula, and how
well the similarities between them and the differences between these
two and other cases are expressed by it. The analogy should not,
however, be pressed too far. The location of both crises in their Kondra-
tieffs is not exactly the same. That of 1857 occurred at a later stage
and hence it can, to a much greater extent, be explained by the under-
lying phase of the evolutionary process. But the ever-forgotten lesson
about what causes such spectacular breakdowns of the capitalist engine
and how they could be prevented or mitigated is the same in both, and
in fact all, cases.

1 The writer does not intend to suggest that the Knickerbocker failure started anything.
On the contrary, it made astonishingly little impression and no panic ensued even on the
stock exchange. This was due not only to the support which was forthcoming in the stock
market and to the action taken by the Treasury and by a leading banker, but also to the
whole previous course of events in the stock market. There was a bear position — even a
bear market — from the very beginning of 1906. When the strong fall had run its course
to March 1907, the market rallied again until the second week of April. After that there
was, it is true, a practically uninterrupted decline to Nov. %% but with decreasing sales.
A short-lived rally followed, then a small relapse, then again a rally, followed by a still
smaller relapse — all in December. Stock prices increased in the first half of January 1908,
then fell, to about the middle of February, after which a vigorous recovery set in — a very
pretty example for what we have called Hesitations and for the truth that stock exchange
vicissitudes cannot by their own momentum and in the absence of deeper causes develop
into catastrophes.

Historical Outlines

429

Explanation is due because our diagnosis explains the occurrence of
the crisis of 1907 by a disturbance of the normal working of the cyclical
process of evolution, which was not attributable to an external factor
but to the systematic abuse of the financial apparatus. Speaking of a
disturbance of the capitalist process by a factor that arises out of that
process itself obviously raises a methodological question. It has,
however, been pointed out in our discussion on mergers in what sense
it seems justifiable to do so. Any economic or social system has its
logic and the standards inherent to that logic. Effects due to action
conforming to this logic and those standards are one thing, effects of
deviations from them another thing. In matters of human behavior,
both conforming and deviating action must be separately taken into
account, for both are equally real. This should also explain why we
can speak of abuse as distinguished from use of institutions without
thereby committing ourselves to a moral — or any other — ^value judgment.
The former term is intended merely to indicate the fact that the behavior
deviates from standards which follow from the structure of an economic
system. Of course, if features, which as a matter of fact are morally
disapproved, are being called ‘‘deviations from the logic of system,’*
this may imply apologetics as regards that system itself. Neither
defenders of capitalism nor defenders of socialism are ever free from tempta-
tions of this kind. But for us the only question that matters is whether
or not that distinction is supported by the facts and in turn serves to
elucidate them. If this be answered in the affirmative, “faulty” han-
dling of institutions may induce breakdowns exactly as an external
factor, and disturbance of this nature can autonomously arise in the
financial as in any other sphere of economic activity.

9. In both England and Germany, all the facts that we have in
mind when speaking of a Kondratieff prosperity and of a beginning
Kondratieff recession were clearly present during these 16 years. The
shorter fluctuations in those countries roughly coincide with the American
fluctuations. The fundamental similarity, or rather sameness, of the
underlying industrial process is beyond the possibility of doubt. We shall
use our sketch of American evolution as a background and confine
ourselves to noticing briefly the more important features.

The English case presents the striking contrast pointed out in the
introduction to this section. Whatever the deeper cause or causes,
the nature of the difference stands out when we glance at the curves of
percentage changes in pig-iron or steel production, which rise but weakly
in 1898 and display much less vitality throughout. The strong increase
of capital export (according to Mr. C. K. Hobson’s figures) complements
this. Foreign, in particular colonial, enterprise and lending was in
fact the dominant feature of the period. Rubber, oil, South African

430

Business Cycles

gold and diamonds, Egyptian cotton, sugar, irrigation. South American
(Argentinian) land developments, the financing of Japan and of colonial
communities (municipalities, especially Canadian) afford examples for
the way in which England, more than through domestic development,
took part in the industrial processes which carried that Kondratieff
prosperity. The London money market concerned itself in fact mainly
with foreign and colonial issues to an extent never equaled in England
or in any other country. The great issuing houses in particular almost
exclusively cultivated this business, managing, sometimes rigging, the
market for it, and practically abstained from the issues of domestic indus-
tries. The railways, nevertheless, kept their contact with, and old
established industries resorted to, the London money market, but new
industrial companies account even in years of great activity, such as
1897, 1898, 1907, 1911, and 191^, only for a minor part of the total of
capital applications. 2

It is true that the impression we thus get is somewhat misleading.
Industrial concerns found their supply of capital primarily in provincial
centers, to some extent on the provincial stock exchanges, but to a much
larger extent in the inherited accumulations of wealthy families that
preferred the private company or even partnerships. Induced expansion
was financed largely from profits: the Colwyn report mentions, for
instance, that, ex income tax, 96 million pounds were reserved by com-
panies out of profits (in the income tax sense), amounting to S12 million
poxmds in 1912. Some financing of industrial concerns was done also
by the trust and investment companies, which considerably grew in
importance. But however much may thus be explained by English
conditions and habits, it still remains true that the main reason why
we find so little public financing of domestic innovation is that there
was not much to finance.

We will recall a few familiar facts about rubber.® The great innova-
tion in this field was rubber planting (the manufacture of rubber products,

^ The Trustee acts of 1889 and 1893, and the Colonial Stock Act (1900) extended the
powers of trustees to invest trustee funds in the stocks of English municipalities and colonial
governments. Owing to the importance of trtistee funds in a country of old wealth, these
measures were highly significant.

* See Lavington, English Money Market, Powell, Evolution of the Money Market.
The familiar picture stands out well in the pages of the Economist or the Financial News.

®The author acknowledges indebtedness to Akers, C. E., The Rubber Industry in
Brazil and the Orient (London, 1914); Figart, David M., America and Rubber Restriction,
pamphlet (New York, 19ii6) and The Plantation Rubber Industry in the Middle East
(Bureau of Foreign and Domestic Commerce, Trade Proinotion Series, No. 2, Washington,
1925); Fraser, C. E., and G. F. Doriot, Analyzing Our Industries (New York, 1932);
Lawrence, J. C., The World's Struggle with Rubber (New York, 1931); National Bank of
Commerce, New York, India Rubber (mimeographed, 1919); Orton, William, Rubber — A

Historical Outlines

431

as has been pointed out before, was by then an old-established English
industry, which indeed went on developing during that period but does
not call for comment). In 1876 seeds of the hevea tree were smuggled to
England from Brazil, which then was, and to the end of the first decade
of the twentieth century remained, the chief producer of crude rubber.
Nothing came from it for a quarter of a century, although the superiority
of the plantation product in cost (also cost of transportation) and quality
(purity) must have been obvious and although the price fluctuated about
a rising trend, a good example for the ways of innovation. The chief
difficulty to overcome was the considerable investment required and the
long period of gestation: the interval between planting and the first crop
of latex is between 4 and 7 years, full yield is not reached until the tree
is 10, and maximum yield not until it is over 20 years old. Enterprise
started in the last years of the century, but as late as 1905 all plantations
in existence produced only 150 long tons, as compared with Brazil’s
more than 30,000. Then came the new demand from motorcars and
the plantation boom which centered in 1910. It was a purely English
achievement, all plantations being British-owned until 1912, when Dutch
planting began. But by 1910 already a considerable percentage of that
British ownership was Asiatic (native and Chinese) and these non-
English Britishers behaved in exactly the same way as Brazilian coffee
planters. Since the area available was practically unlimited, we can
discern the roots of the postwar situation already at that time. Prices
fell abruptly after 1910 (in consequence of acreage planted long before
the plantation boom, which also broke the Brazilian rubber corner of
1909) in the course of a competitive process which was, on the one hand,
practically to crowd out wild rubber and, on the other, to eliminate
profits : within our period profits and dividends fell from their maximum
in 1910 until war demand temporarily pulled them up a little.

In many respects, this history is typical and extremely easy to inter-
pret in the sense of our model, the nature, emergence, and disappearance
of profits, in particular, being illustrated to perfection. The small
contribution to the first Juglar and the considerable contribution to the
second Juglar of the English Kondratieff and its financial complement
are as clear as the relation to one of the ‘‘carrying” innovations of
the period, motorcars. But three remarks suggest themselves. First,

Case Study, American Economic Review, December 1927, pp. 617 ff.; Rowe, J. W. F.,
Studies in tbe Artificial Control of Raw Material Supplies — No. 2, Rubber, London and
Cambridge Economic Service, Special Memorandum 34, March 1931; XJ. S. Bureau of
Foreign and Domestic Commerce, Trade Information Bulletins, 27, 180; Whittlesey,
Charles R., Governmental Control of Crude Rubber (Princeton thesis, 1931); Wilhelm,
Donald, The Story of Rubber, World's Work, January 1927; House Hearings, 68th Con-
gress, Jant 1926.

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Business Cycles

the element of antirational behavior was present to an abnormal degree,
not only with native planters — ^this element of the case came into still
greater prominence after the war, when all the native planting in the
Dutch Indies asserted itseh^ — ^but also with English promoters and
capitalists. That the rubber boom should have been staged — on Mar.
16, 1910, over 11£ million pounds were cleared on rubber shares (see
Orton, Of, eit, p. 6£3) — ^when it was ‘^evident that the 1910 acreage in
full bearing was capable of giving double the total world supply of that
year’’ {ibid,, p. 6^7) and that capital issues should have reached a maxi-
mum in 1911, cannot be brought within rationality by however great a
stretch of the imagination as to the elasticity and the prospective upward
shifts of the demand curve or as to possible reductions in cost. Second,
the case, involving export of capital into noncapitalistic areas, might
easily be misused as a verificatory instance of the Neo-Marxian theory
of Imperialism: capital in flight from shrinking rates of surplus value
prevailing in an old capitalist country, seeking new opportunities for the
exploitation of labor in semicivilized or uncivilized countries. Of course,
there is nothing in this. Capital in this case went to Malaya, not because
of any such economico-sociological mechanism, but because the hevea
tree grows there and not in Norway. Third, the English producers’
and consumers’ goods that were directly required in order to carry out
this innovation were inconsiderable. With the exception of the increase
of rubber imports at falling prices, the process touched England only
through the financial sphere. Both the rise of the New and the decline
of the Old (Brazil) occurred abroad. Hence many of the phenomena
that normally accompany innovation were absent in England, while
others asserted themselves in a different way. This does not affect
the explanatory schema, but must be taken into account in applying it.

Several other examples of enterprise of this type that could be adduced
were not wanting in boldness and success. But at home entrepreneurial
activity in the fundamental lines distinctly stayed behind America and
Germany, The motorcar industry lacks anything that could be com-
pared to the Ford achievement, chemistry — in spite of developments
in the old-established inorganic field and with an exception to be men-
tioned presently — anything that would bear comparison with German
progress. Electricity affords one of the few cases in which performance
of the private entrepreneur was so inadequate as to invite, on the obvious
^ It has been stated that capital requirements were considerable. But this is true only
for large-scale plantations. SmaU-scale planting by, say, the Javanese natives requires
hardly any capital at all, and is done without any rational regard to labor cost. More-
over, the writer’s personal impression was (1980) that any attempt at regulation of output
would have been misunderstood and resisted by the natives and that the compulsion by
which alone it could have been made effective, might have made unmanageable what, in
that year at least, seemed to be a delicate political situation.

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433

merits of the case acknowledged by all parties, government initiative
and public planning. In the eighties there had been a considerable
development in electrical lighting, which went on in our period, as did
the business in maritime cables. There was not much innovation about
this. Production of current by public supply systems, the great new
thing, developed slowly and in 1913 reached only £3^ billion kilowatt-
hours, the capital invested being about 60 million pounds. The iron
and steel, paper, and chemical industries allowed themselves to be
electrified, however. There was, also, a considerable production by
industrial consumers, in many cases extremely wasteful of coal. Produc-
tion and export of electrotechnical commodities was not very important,
but the electric tram and the underground, in part by municipal enter-
prise, made their main stride during the period. The result of dis-
appointing experiences during the war was the Electricity Supply Act
of 1919. Relatively more important — ^by comparison with this country
and Germany — ^were developments in old industries. Breweries and
bicycle concerns continued their expansion, which was noticed in the
preceding section. The beginning of the century witnessed great
activity in store and trading companies, and there was a building boom.
But these and other items come much more within the categories of
growth and of induced expansion than within that of innovation.

Here it is convenient to assemble the comments to be made on the
production of rayon, that branch of the chemical industry which illus-
trates so well the manner in which chemical — ^like electrical or railroad —
innovation revolutionizes large sectors of the economic organism that
seem to be past innovation stage. We will throw our three countries
into one unit for the purpose and discard, for brevity’s sake, the short-
staple fiber (which is chemically the same thing as rayon but differs
from it in that threads are cut to the length of cotton and wool fibers
and then made into yarn on the usual textile machinery) and special
products, such as artificial horsehair. Development of the technology
goes back to Reaumur (1734), and to the discovery, by Schonbein, of
nitrocellulose and collodium (1845). A practicable nitrate process, then
worked out by the Swiss Audemars and perfected by Swan, is to this day
the basis of all the methods of production. The products were used, on
a very small scale, in gas lighting. The entrepreneur — and a very
characteristic type of entrepreneur — ^who solved the commercial and
organizational as well as some additional technological problems and
made the product a success was Count Chardonnet. By definitively
establishing the nitrocellulose process and setting up factories in France
and Switzerland, he became the founder of the industry — ^the New Man
in whose wake the host was soon to follow — in a fuller sense of the word
than almost any other.

434

Btjsiness Cycles

Induced improvement and alternative methods came in due course:
the cuproammonium process (M. Fremery, Urban, Bronnert, 1899; the
German variant called Glanzstoff, produced by the Vereinigte Glanz-
stoff Fabriken A. G., Elberfeld, a subvariant being theThiele-Bemberg
process, J. P. Bemberg A. G., Barmen) the raw material of which is
however, the same as that of the nitro-cellulose process and of the most
recent, the acetate, process — ^namely, cotton and cotton waste. The
English variant, the viscose process (Bevan, Beadle, and Steam), works
with cellulose as a raw material and, owing to its cost advantage, is the
method most widely used in all countries. The fundamental entre-
preneurial idea was at first simply to produce cheap ‘"silk"^ for the
masses. Hosiery and plush-goods, accordingly, account for S5 per cent
of the consumption in 1913 (as compared with £5 per cent in 19£4!),
when total world production was estimated by the United States Tariff
Commission at about £9 million pounds, and prices moved in strict
covariation with those of silk. This was the case until 19£4. By that
time, however, rayon had emerged from the modest role of a cheap sub-
stitute for silk and conquered a wide field in its own right.

The innovation under discussion is only in a technological, but not in
an economic sense, correctly described as the introduction of a new raw
material. For it was primarily finished or semifinished consumers*
goods that were offered to the public, not a raw material that was offered
to the existing textile industries, although the cotton, silk," and woolen
industries all availed themselves of it to some extent (£5 per cent of
the rayon production was in 1913 taken by silk and cotton weavers and
manufacturers of woolen goods, 34 per cent in 1 9£4) . The process of com-
petition with the Old and of absorption into the system must be viewed
in the light of the fact that rayon producers were primarily textile manu-
facturers of a new type. But their new products not only met a demand
schedule for textiles that was constantly shifting upwards but also con-
quered ground that was no man’s land before and a net addition to the
textile field. Quite apart from the fact that the decisive improvement in
quality and the grant quantitative expansion were downgrade develop-
ments, the impact of the innovation on the existing industrial structure
was, therefore, mild and would have been so even if possible depressive
effects had not been lost in the war boom. The course of prices calls for
an additional remark. Up to the war — ^which raised them to an all-
time peak, from which they fell almost uninterruptedly, though with
cyclical fluctuations, toward the trough of the world crisis, passing the
prewar level about 19£4 — ^they reflect the oligopolistic situation char-
acteristic of a new industry. On the one hand, the really successful
concerns were few and, patents and experience giving them a decisive
advantage over would-be and actual competitors, felt secure, for the

Historical Outlines

435

time being, in the possession of the field. On the other hand, that field
had to be developed, and the product, as stated above, was looked upon
as a substitute.

These circumstances — and others, such as the absence of major
fluctuations in the raw materials — ^were responsible for the orderly
advance we observe, which lost nothing in vigor by being cautious.
Tiere was, for those concerns, little motive to fight each other and to
spoil each other’s markets and there were, hence, no dramatic spurts
aud breakdowns. Though exceptional, the case thus affords a good
instance of the essentials of innovation free from extraneous or acci-
dental distortions. Entrepreneurial profits in the successful cases were
high and quickly supplied the bases for very sound financial positions,
wtile in the long run the interest of consumers was possibly better served
than it would have been by either perfect competition — ^which would have
issued in a disorganized market — or by planning of the cartel type. We
will add at once that postwar developments display substantially the
same characteristics. In this country, for instance, the profits of the
American Viscose attracted scores of rayon-producing enterprises, but
only three, all of which were affiliated with and backed by European con-
cerns, attained commercial success, and two of them (Celanese and Indus-
trial Rayon), accounted, together with American Viscose, for about 90 per
cent of the total American production, which by 19£9 was more than twice
as great as the Italian. With the typical downgrade expansion of out-
put went a no less typical fall in profits which, however, still remained
abnormally high to 1930.

Our sketch suffices to show that England’s economic history from
1S97 to 1913 cannot, owing to the comparative weakness of the evolution
(in our sense) of her domestic industries, be written in terms of our model
— the only case of this kind within the epoch covered by our material.
Instead, we have a picture of induced developments and growth — ^which,
let us note once more, may reasonably be held responsible for some con-
ceptions formed by English economists both of the economic process
and its monetary complement — ^financed by the returns to accumulated
wealth partly invested abroad and, because the feeders of the system
were spread over the whole world, particularly sensitive to foreign booms
and slumps, which, during those years tended to become the dominant
factor in the English business situations. Other disturbances, such as the
Boer War or labor difficulties, assert themselves much more strongly
tkan they would have done in the presence of vigorous evolution of
domestic industries. Recovery from the depression of the last Juglar
of the second Kondratieff was strong and displayed, as we have seen,
some of the features that were to be prominent for some time after
(milling boom, brewery boom, building boom). It is therefore doubtful

436

Business Cycles

whether we are within our rights in describing 1897 as the last year of
recovery rather than as the first year of the new Kondratieff.^ If, how-
ever, we put our trust in pig-iron production, prices of consols, and the
like, and decide in favor of the former alternative, we then get two years
and a half of a prosperity, from the beginning of 1898 to the end of the
second quarter of 1900.

Another prolonged spell of prosperous business starts in the autumn
of 1909 and continues to the autumn of 1913. But both were periods
of all-round activity in domestic industries — ^those which lagged behind
doing so for ‘‘external” reasons, such as strikes, crop failures in the
countries to which they exported, hostile tariffs, and so on — ^largely
conditioned by foreign progress and almost wholly unconnected with
major innovations at home. And the crash of 1907, as well as the spurt
which preceded and the depression which followed it, with its unemploy-
ment peak in the third quarter of 1908 and the rapid recovery therefrom,
obviously was the response of the world’s greatest banker, investor,
trader, shipper, and so on to events which did not originate with him.
In this sense only, we may speak of two Juglars also in the English case:
a complete one, from 1898 to the middle of 1906 — ^with a prosperity phase
lasting to the middle of 1900, a recession lasting through 190^, a depres-
sion covering 1903 and 1904, and a somewhat dubious “third Kitchin” —
and an incomplete one, rising in the middle of 1909 — ^with a prosperity
phase lasting to the summer of 1911, a recession phase covering the rest
of that year and 1912 and 1913, depression setting in at the beginning
of 1914,^ while, here again, 1907 and 1908 constitute an intermezzo.

10. As striking as the contrast between the United States and England
is the similarity between the former country and Germany. It becomes
still more impressive if viewed in connection with the differences in the
national situations, the social frameworks, and the attitudes of both
nations. Several symptoms of these differences have been mentioned
before, such as armaments, measures of social betterment (Sozialpolitik),
and fiscal policies. We will mention one more, the Stock and Produce
Exchange Act (Boersengesetz) of June 22, 1896. It prohibited not only
forward trading in grain but also the analogous forms of speculation
{T erminhandel) in shares of mining and manufacturing companies,
and beyond that it imposed various restrictions on those speculative
activities which remained legal, with a view to discouraging stock

1 Mr. Thorp designates 1897 as a year of prosperity without qualification.

^ Cf. Professor Spiethoff’s comments, oy. ciL, pp. 56-59, and Mr. Thorp’s Annals. The
latter author notices the “slackening of the rate of progress” in 1911. That neither of the
two years that at the time were hailed as record years, 1906 and 1912, was a year of “pros-
perity” in our sense is, if we bear our terminology in mind, no reason for objection, although
our dating may be open to all sorts of doubts on other grounds.

Historical Outlines

437

exchange speculation in general. This legislation may not have attained
its objects — all of them, at least — ^but the official expression of moral
disapproval of gambling conveyed in it is, nevertheless, highly significant^
and may have done something to restrain excesses, which never went
to the same Ipngths as in this country. Absolutely, however, they were
important enough to count as a major factor in the sequence of business
situations. A public that had both the means and the inclination to
speculate was led on by a haute finance, that chronically was under the
compulsion of unloading securities, much in the same way as in the
United States. Even individual stimuli bear some resemblance. For
instance, although the foundation of the Stahlwerksverband (March
1904) did not, like that of the United States Steel Corporation, entail
a great financial transaction, and although it did not mean the same
thing industrially, it yet gave a speculative impulse. Although there
was no Harriman campaign, yet phenomena not unlike some of the
incidents of that campaign were produced by the offer of the Prussian
Ministry of Commerce (July 1904) to buy out the shareholders of the
Hibernia mining company (payment to be made in Prussian consols),
the various implications of which — ^possibility of a struggle for control
and others — induced a violent boom in the shares of coal and iron con-
cerns. Nor does the analogy stop at individual instances. The under-
lying industrial processes also were similar and there was, moreover,
both a tendency toward the formation of giant concerns and a larger
merger movement, although the former shows less conspicuously owing
to the fact that its work in the railroad field had already been (practically)
completed by government enterprise, and although the latter did not
pervade the whole of the industrial organism.

Pinancial practice differed — more on the surface than fundamentally
— ^because of the dominant position of the great ‘^industrial” banks of
the type previously described. Long before the beginning of our period,
they had established that position and their methods. They directly
participated in, and “patronized,” enterprise, floated and promoted,
frequently taking the initiative, developing the technique of harnessing
acceptance credit to the purpose of financing long-time investment.
But the only major bank failure that resulted was that of the Leipziger
Bank (1901). No other big bank ever got into serious straits, or
even showed the scars of occasional wounds. This was due not only

^ The attempt to put a stigma on private speculators is particularly obvious from the
registration clause. Of course, it was not diiG&cult to thwart the legislative intention by
cash transactions and also by resorting to foreign centers. The clauses concerning specu-
lation in grain (and products of milling) were, moreover, based on popular views about the
role of speculation in the pricing process that were palpably wrong. These and other
aspects do not interest us here. All that matters is the* spirit of that legislation.

438

Business Cycles

to their size and standing, but also to the fact that their business, however
much at variance with English principles, was, or during our period
became, substantially sound in our sense : as a rule they financed reason-
able propositions, which they carefully studied and which they were
able to see through. As far as this goes, German banking in the latter
part of that period perhaps affords the best illustration of the role of
banks in the process of evolution and, incidentally, an answer to the
argument that this role must always be associated with abuses neces-
sarily productive of breakdowns.^ It was different outside the sphere
of the leading banks. Mortgage banks were a particularly weak spot.
In 1900 the Preussische Hypothekenbank and the Deutsche Grund-
schuld Bank failed and so did others in 1901 — illustrating the con-
sequences of lending on mortgage without paying attention to purpose.
Before breaking down, however, the speculative builders and their
financial sponsors who lent on the anticipated increments of values,
achieved a great stride on the road to modern housing conditions.

As clearly as in the United States, electricity stands out as the
dominant factor in the industrial processes of that epoch. Both directly
and by what they induced all over the industrial field, the power plants
and the electrical industry shaped the fundamental conditions and the
pulse of general business. In fact, the behavior of symptomatic quanti-
ties was linked up with them by the banking opinion of the time — ^the
behavior of the rate of interest, for instance, with the capital require-
ments of electricity and electrification. The latter — definitive penetra-
tion of industry (much less of agriculture) by electricity — got under way
after 1909; during the first Juglar, lighting and electric trams were as
yet the most important items. It must be remembered that, although
technologically the stage had been fully set before, a number of problems
solution of which was essential to large-scale success were as yet unsolved:
at the beginning of the period, long-distance transmission (O. Miller,
1891) was still confined to modest tensions; electrochemistry was in its
infancy; electrical steel production (1899) was not yet invented; the

1 The point would merit elaboration. Eor business at large, if not for the stock exchange,
those banks after 1902 proved a source of strength in diflBicult situations and a moderating
influence in prosperity. To some extent at least, they were also successful in discouraging
fraudulent or reckless promotion. And they could not have done this if they had kept
aloof in the manner of English banks of deposit. Although a respectable list of mistakes
and of cases of doubtful practice could, nevertheless, be drawn up, revision of much of the
criticism leveled against those institutions and their unique method of combining regular’'
banking with the financing of long-period investment seems in order. It is, perhaps, not
too hazardous to say that the war interrupted a development that might have led to as
efficient a ** control” of business fluctuations as can be hoped for from any banking system.
Some, although not all, aspects of this link up with mere size of the individual banking unit
and with branch banking.

Historical Outlines

439

relative merit of different kinds of current was under researck; water
power (wkich in Germany came later than in this country) was undevel-
oped; the competitive position to steam was unfavorable; cost as yet
was so high that only those sources of demand could be tapped which
were comparatively insensitive to price.

The first Juglar largely removed these obstacles and also witnessed
initial vicissitudes. Enterprise centered in electrical manufacture and
it was by manufacturing concerns and their banking associates that the
development of the supply of current was promoted and financed. A
first outburst of activity, much like some of the American railroad
booms, went beyond the immediately possible and landed the industry
in a critical situation as early as 1900. Bankruptcies and mergers
(A. E. G. — Union; Siemens and Halske — Schuckert and Co.) cleared the
ground and advance was speedily resumed. The merger movement
went on, however {e.g., Felten and Guilleaume — Elektrizitats-Gesellschaft
vormals Lahmeyer 1905; this combination entered the A. E. G. concern
in 1910), and the new giants then continued to conquer, in some cases
beyond the electrical field — ^the A. E. G., for instance, acquiring interests
not only in trolleys, supply concerns, and so on, but also in banks and
nonelectrical industries. The contours of postwar concentration and
postwar communities of interests (Interessengemeinschaften) thus
became visible, particularly among the heavy industries, which were
to develop into such entities as the Stinnes concern (Siemens — ^Rheinelbe
— Schuckert — Union; Elektro-Montan Trust). Though some concerns
(Bergmann Elektrizitatswerke, A. G.; Brown-Boveri, A. G.) and hun-
dreds of electrotechnical firms remained independent, the electrical
industry may be said to have been dominated, at the end of our period,
by A. E. G. and Siemens. These two evolved a modus vivendi by division
of labor (heavy current — flight current industry; but also territorially)
and cooperation and, jointly and individually, also established new
relations with foreign concerns. A comprehensive international electro-
cartel seemed a possibility in 1914.

The crux of electrical enterprise was power finance.’’ Only the
largest concerns were up to the task of developing the production of
current, and even those knew no more urgent problem than that of
making it financially self-supporting and independent. Together with
their banks, manufacturing interests controlled about 40 per cent of total
"‘public” supply as late as 1914. They created finance and holding
companies and issued bonds or debentures secured on the works built
or to be Ibuilt. One of those companies, intended for international
business from the outset, was the “bank” for Electrical Enterprises
in Zurich; another, the A. E. G. affiliate, the “bank” for Electrical
Securities (Bank fiir elektrische Werte) in Berlin; a third, the Siemens

440

Business Cycles

affliate, the Continental Company for Electrical Enterprises in Nurem-
berg. But unlike America, Germany resorted to public enterprise, as
well, at a comparatively early stage. Occasionally this led to conflicts
but in general this form of ^"municipal socialism’’ (and also action by
provincial bodies and states) was welcomed by the manufacturing
industry. Publicly owned or ‘^mixed” power concerns thus emerged,
harnessing the credit of public bodies into the service. Local power
stations and, with the development of long-distance transmissions,
interlocal ones then rapidly displaced the isolated plants that dominated
the picture up to the threshold of our period, and by 1900 most of the
bigger and many small towns were served by stations that at least
covered their areas. The number of works, nevertheless, increased
from 265 in 1897 to over 4,000 in 191S, most of which were still small.
The large-scale stations (Grosskraftwerke) did not emerge in our
period; but the way was prepared for them, so much so that capacity
installed in public supply stations, which was about 13 ^ million
kilowatts in 191S, doubled in the subsequent decade, in spite of the war
and its aftermath, while kilowatt-hours produced in the same time
increased from 2.2 to 7.2 billions. Water power was developed to the
extent of 700,000 kilowatts (in 1930, 1,200,000).

On this basis, production and export of electrical appliances embarked
upon that triumphant career which is too well known to call for descrip-
tion. We know that by virtue of her tradition and environmental
conditions Germany was particularly well prepared for that task. Elec-
trical technology had, at the beginning of our period, become an applied
science which it was possible to learn and to develop in laboratories
and schools. A considerable part of the men who currently rose to fill
the, very roughly, 40,000 to 50,000 leading or semileading positions in the
industrial organism of Germany had that sort of training, at least to the
extent of being able to understand and apply readily what was suggested
by the scientific engineer, many being scientific engineers themselves.
Many so easily found avenues to wealth and advancement within the
existing big concerns that to try to set up new ones would have
been mere waste of energy for them. Vigorous and varied enterprise
thus went on under the almost immediate impulse of the technical depart-
ments of those concerns, the entrepreneurs being largely employees and
monopoly positions of individual gadgets being incessantly won or lost in
the course of a race which, though never displaying the formal properties
of perfect competition, yet produced all the results usually attributed to
perfect competition. At the beginning, cables, bulbs, and the like
predominated; but the field broadened to practically all branches of
industry within the period, at the end of which Germany accounted
for about one-third of the value of the world’s production of electrical

Histoeical Outlines

441

products (1918). There is no official estimate, but several private
estimates agree on a figure between 1,^00 and 1,800 millions of marks.

The immediate influence of this development on metallurgy and
chemistry was less important than was its influence on the machine
industry, for which dynamos, electromotors, transformers, and the
fact that use of electric power required new types of machines in general
meant a new epoch. But there were independent developments, also.
The gas motor (Otto and Langen), well established before, extended
its field of application, and the Diesel engine and the steam turbine came
more slowly into their own. There were, besides, many innovations
in the field of machine tools and of apparatus of aU sorts. Enterprise
retained many of the characteristics it had displayed of old. The small
and medium-sized family firm, often rising (sometimes with the help,
all too readily proffered, of ambitious managers of the big banks^ branch
offices) from an artisan’s shop, still was its most common form, although
there was a number of largest sized concerns even without the sphere of
the big vertical combinations in the heavy industry. Value of output
doubled within the first Juglar and value of exports of machinery (boilers
and accessories included) was 1.145 billion, including electrical machinery
1.231 billion, marks in 1918. But the German automobile industry
cannot by itself be listed as one of the major ‘‘carriers” of that Kondra-
tieff upswing. Although one of the earliest in its field and technologically,
at that time, in the van of progress, it did not, owing to the economic
structure of its environment, reach the stage of mass production. Only
20,000 units (trucks included) were produced in 1918.

The success in the electrical field was matched by an analogous success
in the chemical field — and by no means wholly in that part of it which
experienced an access of new possibilities from electricity; on the con-
trary, the decisive achievements of electrochemistry in that period
became, outside of the metallurgical field, quantitatively important
only in the downgrade of the Kondratieff. The great new thing which,
although foreshadowed in the preceding period, now broke into rapid
development was dyes and pharmacological products. As in the
industry of electrical appliances, it was the efficient “school” (Liebig,
Hofmann, Kekule, and others) that helped to shape a semiscientific
type of entrepreneur, and again it was the attitude of this type rather
than the capital required which facilitated the emergence of great con-
cerns, in particular of the J. G. Farben (“Dye Trust”), which was to
grow far beyond the chemical industry proper and to acquire mining,
textile, and other interests. With the host of minor innovations
or those innovations which for the time being remained of minor impor-
tance or in the incubating stage — ^it is impossible to deal here. We will
confine ourselves to stating the obvious fact that the chemical industry,

442

Business Cycles

both, by its capital requirements — ^its role as an employer of labor was
small, though growing — and by its output, substantially contributed to
the ignition of that Kondratieff prosperity. Neglecting everything
else, we will add a remark on mining and the heavy industries.

Their impressive expansion, which was the subject of so much con-
temporary comment — ^pig-iron consumption per head rose from 133.3
kilograms in 1897 to 276.6 kilograms in 1913 — ^was in part the reflex
of mere growth, as may be inferred from the building activity of the
period, the demand for railroad equipment, and similar indicators, which
are, though not wholly dominated, yet strongly influenced, by that
component. Several external factors helped, also. But the main
impulse came from electricity and other innovations. Mining, iron-
and steelmaking, and their technological neighbors thus primarily
experienced an induced development, as they did in other countries.
Oil production in Alsace and Hannover — almost entirely controlled by
the Deutsche Erdol Gesellschaft — ^was new, however, and it was in our
period that the potash industry grew to full stature. Among the innova-
tions in the iron and steel industry we will notice the progress in the
utilization of coal, which reduced its consumption per ton of ore to about
half. The importance of coal as a factor of location being thus lowered,
the industry began to migrate, new works being erected, on the one
hand, in the ore districts and, on the other hand, on the seacoast. But
the principal innovation, to which many technological and commercial
ones were subsidiary, was organization and concentration. This move-
ment, led by a number of entrepreneurs of exceptional force, differed
from, yet paralleled, the American. One difference was caused by the
prevalence of family positions in the industry — ^practically all those
entrepreneurs came from old iron and coal families — ^which made it
unnecessary to appeal to banks and the public to anything like the same
extent as in America. Another was due to the absence of any strong
public or official opposition to cartels or simple price conventions, which
hence could be resorted to in cases that in America would have necessi-
tated the setting up of holding companies, even if nothing but ‘^regula-
tion” of markets was intended.

The difficulties of 1900, therefore, at first only resulted in the forma-
tion of syndicates for the control of output and prices. In 1903 the
Rheinisch-Westphalische Kohlensyndikat was renewed and much
extended in scope as well as membership, and so, in the same year, was
the Rheinisch-Westphalische Roheisensyndikat. Even the Deutsche
Stahlwerksverband, mentioned above, in 1904 was not much more than a
selling agency for 27 big steel works, which accounted for over 80 per
cent of the Western steel production and were soon joined by the leading
outsiders. A similar organization of the steelworks of Upper Silesia

HisTOBiCAii Outlines

443

followed in 1905. Many other examples, among them international
organizations such as the International Rail Manufacturers Association
(1904) or the zinc convention (1909), could be quoted. AU of them
differed from the American Trust not only as to efficiency in attaining
their objects, but in these objects themselves. They did not directly
create giant units of control, but contributed, by their quota systems
and, in the case of the iron and steel industry, by the exclusion from their
control of that part of the output of coal and intermediate products
that the works themselves consumed, an additional motive for amal-
gamations. They increased price rigidities more than giant units would
have done, but dislocated subsequent stages of production probably
less than they stabilized’^ their own. An example, also interesting
for other reasons, will illustrate the latter effect.

Lignite (“brown coar’)^ mining in the Rhineland was puUed out
of the depression of the seventies by an innovation, briquettes, which
remained throughout the prewar time, first for domestic and from about
1900 for industrial fueling also, the main product of the industry — ^the
role of lignite as a raw material of the chemical industry was still confined
to the laboratory — and the success of which, reflected in the spectacular
increase of German “brown-coal” production, was among the major
features of the period under discussion. Total German production
increased from ^9.4 million tons in 1897 to 87.1 million tons in 1918,
total production of briquettes from 3.9 to 21.4 million tons. Owing
to the accessibility and favorable location of lignite and to the resistance
offered by consumers, what may be called the briquette boom of the
last Juglar of the preceding Kondratieff issued into a depressed condition
that lasted throughout the general recovery but cannot be said to have
produced price wars or disorganization of markets. ^ This is the kind of
thing which it is important to see in the setting of an industry’s particular
circumstances and not to mistake for an instance of a general tendency
toward a permanent state of overproduction. Consumers’ demand
catching up and trolleys (Kleinbahnen) providing both another source of
demand and cheaper transport facilities, we observe another boom and
fully utilized capacity, but no appreciable rise in prices of briquettes, from
1897 to the end of 1899.

This perfectly healthy and, for a comparatively “new” industry,
typical state of things was somewhat veiled by the complaints about over-

^ In German, Lignit designates only one of several kinds of the Tertiary Coal tliat we
mean by lignite here.

* Tbe export to the Low Countries and Switzerland, which kept up well, gave a support
to what was typically an oligopolistic situation (four briquette factories existed in the
Rhineland in 1890), threatened by invaders. A cartel, only in part effective, was founded
in 1893.

444

Business Cycles

production and unfair competition tkat were the prelude to the formation
of a pool (Verkaufsverein), which, therefore, did not arise from any break-
down of competition but could at the most be called a preventive measure.
It put up prices immediately, then somewhat receded under pressure
from outsiders and, having absorbed them in 1902, kept prices steady —
although not inflexible; wholesale prices were between 8 and 9 marks per
ton from 1902 to 1906, 10 marks from 1907 to 1912, and a little over 8 in
1913 and 1914 — at a level which on the whole and considering the fall in
costs due to mechanization and electrification of operations — output per
workman increased about 33 per cent in the course of the first Juglar —
must have been very remunerative, but naturally drew fresh capital into
the field. New firms emerged even in the difficulties of 1901-1902 and
then again in 1910. That excess capacity and ‘‘overproduction” ensued
which is a characteristic feature of such attempts at organization, or, as
they were euphemistically called, at “adaptation of production to con-
sumption.” Now the pool had from the first undertaken to buy the
output of the constituent firms and, since the larger works had a strong
interest to prevent a breakdown, they had occasionally, for instance in
1904, no choice but to render fulfillment of that obligation possible by
reducing their own output in favor of the smaller ones.

The various aspects of such a policy need not detain us.^ They are
no less obvious in the case of the potash industry, in which the outcome
was cartelization by law and price fixing by public authority (Zwangs-
syndikat, 1910), and which illustrates with particular clearness why and
how cartelization helps to induce amalgamation. Neither this com-
pulsory organization nor the voluntary one that preceded it is adequately
described by the term monopoly. Neither output nor price behaved as
the theory of monopoly would suggest. It is by no means obvious that
in the long run they differed from what we could have expected them to
be under conditions of perfect competition working in an orderly way.
What those organizations aimed at was rather to bring about such orderly
advance in an industry which was rapidly conquering new outlets and at
the same time — ^like the American oil industry — exploiting a temporarily
inexhaustible “natural agent.” But while thus there was, owing to the
particular conditions of the industry, a special case for organization
for the purpose of avoiding breakdowns and waste and of preserving
financial health, the premium that it put on concentration, i.e., on
vertical and horizontal extension of the unit of control, exerted its effect.
Although there had been mergers before — ^the Westeregeln concern had

1 Eor the facts of the case see PlSnes, Die XJehererzeugung im Eheinischen Kohlenberghau,
19S5; Beisert, Die Entwicklung des Deiitschen Braunkohlenbergbaus, 1910; Hotop and
Wiesenthal, Deutschlands Braunkohle; Klein, Handbuch fiir den Deutschen Braun-
kohlenbergbau, 1914,

Historical Outlines

445

started on its campaign of conquest as early as 1900, also vertically by
acquiring lignite interests — ^the movement got into full swing only after
the potash act of 1910, and it was then that the big concerns emerged —
those of the Deutsche Kaliwerke, of Wintershall, of Burbach, of Aschers-
leben, and others. That is what entrepreneurial activity mainly con-
sisted of in this field. Consumption by German agriculture increased to
more than five times from 1898 to 1913, while industrial consumption did
not quite double.

The most obvious parallel to American development, however, is
afforded by the heavy industry which also coupled its cartelization with
concentration. Legal forms mainly consisted in purchase, fusion, and
community of interests. Starting points are to be located not techno-
logically or commercially but personally. Vertical concentration did not,
for instance, proceed from some definite stage of the production process
the particular conditions of which made it imperative or financially
desirable, but indiscriminately and as the chance of personality deter-
mined, from the raw material, or from steel, or from the finished product.
To quote a few examples: the Thyssen concern started from coal and
acquired first ore interests in Lorraine, then steel- and ironworks; the
Stinnes concern (Deutsch-Luxemburg) expanded, vertically and hori-
zontally, from what also was primarily a coal basis; the Phoenix concern
worked back to coal and later into the field of semifinished products; the
Hoesch iron and steel concern acquired, among other things, a machine
factory; Krupp bought additional ore and coal mines and, at the other
end, the Germania Shipping Yard, as well as other manufacturing con-
cerns; and so on. The positions thus created were mostly sectional.
The Rheinisch- Westphalian and the Upper Silesian sectors, for instance,
developed very few structural relations between each other. In almost
all cases substantial gain in productive efficiency ensued, owing less to
what we might call automatic savings incident to combination than to
the replacement of less able by more able managers, who knew better how
to ‘‘rationalize’^ production and carried out an indefinite number of
improvements more quickly.

The history of most of the big concerns that emerged at that time
displays — ^because of the particular type of entrepreneur that commanded
the stage — ^the will to 'performance very much more obviously than does
the history of parallel phenomena in countries or cases in which it is
financial maneuvering that strikes the eye first. This once more teaches
the lesson of the emptiness of the word control^ as such, and the impossi-
bility of analyzing concentration in terms of impersonal capital agglom-
erations and of the mechanical effects on output, prices, and social
conditions it might have ceteris paribus. The new leadership made all
the difference, even in cases in which amalgamation was not economical

446

Business Cycles

on paper, i.e,, did not in itself imply any great economies of scale. Tte
course of wages, more favorable than in England, does not indicate any
monopolistic pressure. Output increased at a rate which makes it
impossible to consider quasi-monopolistic restriction as the essence of the
efectSy whatever may have been the motivation. Those oligopolies, on
the contrary, existed for expansion. They were driven along not so
much by potential competition as by the possibilities of their own crea-
tion, and forced to adapt their price policy accordingly. At every step,
save in high prosperity, this meant no doubt excess capacity, but it seems
more realistic to look for explanation to the theory of the process of
innovation rather than to either the static theory of monopoly or the
popular theories of overinvestment. Prices of individual products were
rigid in many cases. But prices in general were not. Those of ingots and
steel billets, moving under the opposing influences (most of the time) of
buoyant demand and falling unit costs, follow business fluctuations on a
level far below that of the late seventies and early eighties. They moved
upward in the vehement upswing of the late nineties to a peak in 1900
(107.^ marks per ton), down to 1904 (78.8), up to 1907 (96.7), down in
1908 and 1909, and then up again. These are the yearly figures of the
official statistics. They suffice, however, to show that there was, in that
case, no lack of fiexibility. Dislocating effects from rigidity cannot, at all
events, have been very great, contemporaneous complaints notwithstand-
ing. Some stabilizing effects on the general business situation may per-
haps — ^but this is very doubtful — ^be discerned in the comparative mild-
ness of the crisis of 1907. Let us recall, however, that this sketch is
merely intended to illustrate an analytic schema and does not pretend to
offer the material for a general appraisal of the merger movement in the
German heavy industries.

Dating of cyclical phases is not easier than we found it to be in the two
other countries. It should, however, be observed ‘from the outset that
German participation in foreign enterprise and German enterprise abroad
had by then sufficiently grown to make foreign booms and vicissitudes a
nonnegligible factor in German business situations. Taking 1898 for the
first year of the new Kondratieff can also be defended on time-series
evidence, price level turning upward, for instance, in that year, and the
price of consols having turned in 1897 — although it would not be con-
clusive by itself. The state of activity in the capital market, in particular,
could be justifiably pointed to in favor of an earlier date: companies with
a capital of nearly 900 millions of marks were founded in the three years
from 1895 through 1897.^ There is, however, no doubt about the strong

1 Professor Spiethoff, in fact, dates the Aufschwungsspanne from 1895. It must be
remembered, however, that, according to his schema, part of our Juglar recoveries would
come within his prosperities in any case, Mr. Thorp diagnoses 1895 as revival, 1896 as

Historicai. Outlines

447

tide of prosperity that lasted until the summer of 1900, or about its
nature. Everyone, at the time, commented on electricity and Klein-
bahnen. The picture loses nothing of its normality by the fact that in
important lines, such as textiles, household consumption fell off, a
phenomenon again observable in and after 1910. But the sharp reaction
that followed and that lent the colors of depression to what, according to
our schema, should be labeled as recession, requires explanation,^

Signs of an approaching turning point had shown themselves in 1899
when employment and building activity began to decrease, though
commodity prices continued to rise to the third quarter of 1900, after
which the general situation became steadily worse till toward the end of
190£ — ^while, as will be recalled, it continued to be favorable in America.
The pace of innovation and the dimensions of the Secondary Wave — ^the
building boom, in particular — mainly account for this; but there were,
also, troubles with finance and on the stock exchange of the purely
speculative type. Business measurements do not quite bear out con-
temporary reports about unheard-of calamities. Price level declined but
moderately, pig-iron consumption fell sharply but only during 1001,
employment improved before the end of 1902, and the large number of
failures again points toward reckless financing. Apart from building, the
machine and iron industries were the chief sufferers; textiles displayed
increasing activity as early as December 1901. But on the stock exchange
there was undoubtedly a severe crisis. Speculative excesses of the public
had already produced a crash in 1895. A vehement boom set in after it,
which under the conditions of the time is not dijEcult to understand and
which provided the basis for the plethora of new industrial capital issues
noticed above; another billion followed in 1898 and 1899, and about 340
millions more in 1900. The Reichsbank’s control over the money market
was as yet very defective, and its position was rendered more diflScult
by the course of events in England. Its rate was 6 per cent from Oct. 3,
1899 to Dec. 18, 1899, and then went to 7 per cent, but returned to the
former figure on Jan. 12, 1900, and to on Jan. 27. Stock prices which
had — ^perfectly normally — weakened in the summer of 1899, then
recovered until April 1900, when a serious breakdown occurred. With
fluctuations that are partly accounted for by impulses from America,
stock exchange business moved on a very low level until the autumn of
1902, thus bearing witness to the severity of the chastisement.

This diagnosis, which stresses the role of the consequences of stock
exchange speculation, speculative building, and careless financing in the

mild prosperity, 1897 as prosperity without qualification. Effects of favorable external
factors, such as the commercial treaties of the early nineties, also asserted themselves.

^ Adherents of the harvest theory will stress the good harvest of 1898 and the bad one
of 1901.

448

Business Cycles

events of 1901 and 1902, derives additional support from the fact that
later setbacks, which were much less associated with those factors, proved
less difficult to overcome. But still those events constitute a deviation
from our schema in that we find depressive conditions in a period that
should have displayed the feature of a Juglar recession and, correspond-
ingly, what seems a very normal recovery, starting without any new
impulses, from an indefinite number of points, in reaction to the sub-
normal activity in 1903. Recession and depression were telescoped into
one phase, and revival was prolonged accordingly. It gathered momen-
tum in 1904 and went on with hardly any break during 1905 and 1906,
general business activity simply feeding upon itself.

In the spring of 1907 the building and iron industries, at first without
decrease of output, ran into losses. Later on came failures and a marked
decrease in employment, but no spiral developed and important sectors
were very little affected. Nothing really serious happened in the finan-
cial sector; as mentioned above, the strength of the great banks stood out
well and there was not much to liquidate. Moreover, the stock exchange
had undergone a purifying process at the beginning of 1904. In the
autumn of 1907 it suffered a severe shock from America. But owing to
the absence of previous excesses, readjustments did not amount to a
slump. Professor Spiethoff is perhaps right in denying that there
was any ‘"crisis’’ at all. Everything straightened itself out within a
year and a half.

A new stride in electrification and mergers carried the upswing which
set in at the end of 1909. The four years following present all the features
of a Juglar prosperity, slowly turning through recession toward depres-
sion. But diagnosis is made uncertain, owing to the presence of many
disturbances, particularly of an international character, the precise
importance of which is difficult to appraise. We should, for instance,
expect a relatively small setback in 1911. As a matter of fact, however,
there was a major slump, almost amounting to a crash, on the stock
exchange in September of that year, and all sorts of irregularities — market
rate above bank rate for instance — ^in the money market. This, of course,
links up with the Morocco difficulties and with withdrawals of French
funds. The influence of the Balkan War of 1912 was less obvious. By
the autumn of 1914 the war boom was in full swing.

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