Committee on Economic Security (CES)

Volume VI. Social Insurance

J. Economic Reform and Security Proposals

 

THE DOUGLAS THEORY

from
The Economics of Unemployment by J. A. Hobson (Chap. VIII)

The Economics of Unemployment by J. A. Hobson Ch. VIII pp. 119-127

THE DOUGLAS THEORY

It was inevitable that at a time like this, when the disturbances of financial machinery are so grave and so widespread, there should spring up schools of thought which find in the defects of out credit system a complete explanation of the industrial collapse. The most noteworthy of these schools is founded on the writings of Major Douglas. With a part of his diagnosis of the present trouble I find myself in cordial agreement. I agree with him in attributing trade depression to the failure of consumption, or effective demand, to keep pace with potential and actual production. The full product cannot be produced because, if produced, it could not be marketed at the price required under our actual system to make production profitable.

But Major Douglas and his followers give a different explanation of the failure of this effective demand from that which I should give. I trace this failure, not to any lack of the monetary power to purchase all the commodities that could be produced, but to the refusal of those in possession of this power of purchase to apply enough of it in buying consumables, because they prefer to apply it to buying non-consumables, in other words, to buying capital goods. According to the Douglas theory, however, as I understand it, it is economically impossible for all the commodities that could be produced to get sold, because the income to buy them all does not exist. Indeed, it goes still further, by insisting not merely that potential production is curbed by this deficiency of purchasing power, but that the market for part of the actual products is deficient for the same cause.

The least unintelligible summary of the doctrine in Major Douglas's own writings run as follows:

• Price cannot normally be less than cost plus profit.
• Cost includes all expenditure on product
• Therefore cost involves all expenditure on consumption (food, clothes, housing, etc.) Paid for out of the wages, salaries or dividends, as well as all expenditure on factory accounts, also representing previous consumption.
• Since it includes this expenditure, the portion of the cost represented by this expenditure has already been paid by the recipients of wages, salaries and dividends.
• These represent the community; therefore the only distribution of real purchasing power in respect of production over a unit period of time is the surplus wages. Salaries and dividends available after all subsistence, expenditure and cost of materials consumed has been deducted. The surplus production, however, includes all this expenditure in cost, and consequently in price.
• The only effective demand of the consumer, therefore, is a few percent of the price value of commodities, and is cash credit. The remainder of the home effective demand is loan credit, which is controlled by the banker, the financier, and the industrialist, in the interest of production with a financial objective, not in the interest of the ultimate consumer.

Now here the central charge is that only a small fraction of the money representing costs of production and gathered into sale-price is available for purchasing goods, and it is implied, though not explicitly stated, that no other sufficient power of purchase is available. Costs are, it appears, not available as purchase money for two widely different reasons. The money represented in wages, salaries and dividends, paid to the producers of these goods for producing them, have for the most part been spent already by their recipients in purchases for current consumption, before the goods, into whose costs they entered, had reached the retail stores. Only such small fraction of these 'costs,' as has been withheld from current expenditure, is available for purchase of these goods.

The other sort of 'costs.' viz. Expenditure on factory account, overhead charges, purchase of raw materials, etc., is not available for another reason. It represents bank credit, advances made by bankers to manufacturers and merchants out of a body of banking credit available only for this work of financing trade, and not for the ultimate purchase of the goods produced. Thus, Major Douglas reaches his conclusion that "the only effective demand of the consumer is a few percent of the price value of commodities."

Now the first most obvious comment on this analysis is that it proves too much. If it were true that only "a few percent" of the cost were available for purchases, the entire economic system must speedily be brought almost to a standstill. The recent 20 percent of industrial unemployment would be a trifle compared with the situation here envisaged.

But it is quite evident that the effective demand of consumers is not confined to the unspent portion of the money producers have received for producing these particular goods. In the very propositions setting out his case, Major Douglas exposes the nature of his error, for he gives as the reason why the bulk of wages, salaries and dividends are not available for purchasing the final goods that they have already been spent upon goods previously produced. And this, of course, is the habitual course of trade. The money available for bringing the commodities which each week flow into the retail stores, to replace those sold last week, is not the money paid for producing these commodities, but that paid for the various processes just performed for producing the commodities that will reach the retail stores next week or next month. Effective demand for commodities proceeds from the wages, salaries and dividends quite recently paid to the producers of these commodities for making their successors. Unless a slump in trade, prices and employment, has intervened (which is not Major Douglas' contention), there is therefore, no reason why the effective demand of consumers should be insufficient to purchase all the goods produced at a price covering all their costs of production.

But what about the costs which are incurred, not as wages salaries, and dividends, but "on factory account, overhead charges, purchase for raw materials, etc."? These elements in the final prices are not, it is contended, available as effective demand for those commodities or for any other! Why not? What is the difference between the availability for purchasing commodities of the wages paid to workers in a shoe factory and those paid in a factory for making shoe machinery, to replace the machines gradually worn out in the shoe factory? So with all the other money paid in overhead charges, raw material, etc. There is no difference in the availability of these costs and the other costs, as effective demand commodities.

Misunderstanding sometimes arises from the tendency to visualize productive efforts as directed to three ends, the production of commodities, work of repair and replacement of capital goods, production of more capital goods. How when production is properly realized, not as a single act or set of acts, but as a continuous process, the second of these ends (repair and replacement) simply disappears, i.e. is swallowed up in production of commodities, and the payments made on its behalf are available as effective demand for commodities, though not of the particular series of commodities into which they entered as costs.

Perhaps this is best realized by visualizing production as a constant rapid flow of raw materials from the extractive process of agriculture, mining, etc., though various stages of transport, manufacturers and distribution, assisted at the several stages by plant, fuel and other capital goods which flow as tributaries into the main stream, being worked up into the final commodities and forming costs of production on a par with the other costs, wages, salaries and interest, in the main slow of production. The net income of the commodity will consist of wages, salaries and interest paid in all these productive processes, whether conducted on the main stream or along the tributaries. All this income is available for effective demand of commodities. Sometimes it is so applied; but in that case no saving, or creation of new capital goods, takes place. Normally, however, some of the net income paid to producers for productive effort is not expended upon consumable commodities, but upon the purchase of new capital goods (i.e. it is saved and invested). But this does not in the least imply that some of the commodities produced cannot get purchased, because the money which might have bought them has been saved. So far as this saving is a normal, calculable process, it means that part of the productive process will be devoted, not to making consumable goods, but to making more capital goods that will be purchased and owned by the savers.

That income which is saved is spent in buying (i.e. paying people to make) a larger quantity of capital goods, materials, semi-manufactured goods, machines, fuel, etc., with a view to turning out an increased quantity of commodities at some future time.

I hold that the trouble comes from an under-consumption, or an over-saving, an attempt to save and utilized for future production a larger proportion of the aggregate income than can be saved and utilized. This disproportion between saving and spending I attribute to the unequal distribution of income, which leads to a large amount of automatic accumulation and investment of unearned excessive wealth. The futile attempt of these idle savings to find a remunerative use in the economic system clogs that system and congests it, causing those periodic gluts and stoppages which economists disguise or decorate under the title 'cyclical depressions.'

But this is a very different explanation from that adopted by Major Douglas.

But to treat the Douglas theory without any reference to bank credit would be to leave Hamlet out of the play. For it often appears as if the main source to trouble lay in the fact that bankers had to receive from the sale of goods the advances which they made to finance their production, and that, as these sums were not available for purchasing the goods, there was a huge deficiency of consuming power. Bank credits are advanced to business men at various stages of production and are used by them to pay wages, salaries, etc., and to purchase raw materials and machinery. Are not these payments costs of production? "If these have not gone into costs, where have they gone?" says Major Douglas.⁽¹⁾

My answer is that if by 'these' be meant the advances made by the banks for financing productive operations, they do not go into costs. Only the price paid by the manufacturer or merchant to the banker for these advances goes into costs, i.e. the interest on the bank advance. I grant that if a particular business transaction, a single bank advance, be artificially severed from the continuous process to which it belongs, it may be made to appear that, as the manufacturer must repay this loan out of the only available fund, viz. The money paid him by the merchant for the goods, this money must be got out of the sale price of the goods, so figuring as a cost of their production. But business is not conducted in this way. The manufacturer engaged in a line of business is not required to, and does not repay the banker the sum of his advance out of the money he receives for the goods. He only pays the interest. The banker makes a continuous advance of a certain amount, receiving periodically from his client the price of this advance. Out of this interest, the banker pays wages, salaries and dividend in the banking business. These incomes, distributed in the banking business, are precisely on a par with the other incomes which figure in the factory, warehouse or shop as costs of production, and are available precisely in the same way as purchasing power to buy the goods produced.

This represents the normal play of industry and of finance. If it were true that the body of the bank advance formed a cost of production, and had to be repaid out of the prices received for the goods, the whole trade would stop with a jerk. Something like this actually happens when bankers get frightened and call in their money, refusing further advances. Here is the element of truth in the criticism of trade financing by banks. They wield a dangerous power of stopping suddenly what has grown to be a normal and a necessary method of conduction business. The result of this abnormal action of banks in cally in and constricting credit is to stop trade and cause unemployment and under-production. Such a result may, if we like, be said to be due to the necessity under which traders are placed of repaying bank advances out of the proceeds of their sales, diverting to this purpose the money which normally they could and would have used to pay wages, salaries, etc., for producing more goods. Under such abnormal circumstances alone can it be represented that the body of a bank loan, not the interest, forms a cost of production. It is not true of the normal play of manufacture and commerce.

1. Socialist Review, March, 1922

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