Carroll Quigley - Tragedy and Hope - A History of the World in Our Time

9. A declining rate of economic expansion is the last important characteristic of the economic system of Europe in the present century up to 1950. This decline resulted almost inevitably from the other characteristics which we have already discussed. It varied from country to country, the countries of eastern Europe suffering less than those of western Europe on the whole, but chiefly because their previous rate of progress had been so much lower.

The causes of this decline are basically to be found in a relative increase in the power of the vested interests within the community to defend the status quo against the efforts of the progressive and enterprising members of the community to change it. This was revealed in the market (the central mechanism of the economic system) as a result of a relative increase in savings in respect to investment. Savings have continued or have increased for several reasons. In the first place, a tradition which placed a high social esteem on savings existed in western Europe from the Protestant Reformation until the 1930’s. In the second place, there had grown up established institutionalized savings organizations like insurance companies. In the third place, the rising standards of living increased savings even more rapidly. In the fourth place, the increasing disparity in the distribution of incomes increased savings. In the fifth place, the increase in size of enterprises and the separation of ownership from control acted to increase the amount of corporate savings (undistributed profits).

On the other hand, the inclination to invest did not rise so rapidly as savings, or even decreased. Here, again, the reasons are numerous. In the first place, the shift in advanced industrial countries from secondary to tertiary production reduces the demand for heavy capital investment. In the second place, declining rates of population increase, and geographic expansion may adversely affect the demand for investment. In the third place, the increasing disparity in the distribution of incomes, whether it is counteracted by government action or not, has a tendency to reduce the demand for investment capital. In the fourth place, the decrease in competition has served to reduce the amount of investment by making it possible for the controllers of existing capital to maintain its value by curtailing the investment of new capital which would make the existing capital less valuable. This last point may require additional explanation.

In the past, investment was not only capital-creating but also capital-destroying—that is, it made some existing capital worthless by making it obsolete. The creation by investment, for example, of shipyards for making iron-hull steam vessels not only created this new capital but at the same time destroyed the value of the existing yards equipped to make wooden-hull sailing ships. In the past, new investment was made in only one of two cases: (a) if an old investor believed that the new capital would yield sufficient profit to pay for itself and for the old investment now made obsolete, or (b) if the new investor was completely free of the old one, so that the latter could do nothing to prevent the destruction of his existing capital holdings by the new investor. Both of these two alternatives, in the twentieth century tended to become less likely (until 1950), the former by the decline in consumer purchasing power and the latter by the decrease in competition.

The way in which the relative decline of investment in respect to savings results in economic crisis is not difficult to see. In the modern economic community, the sum total of goods and services appearing in the market is at one and the same time the income of the community and the aggregate cost of producing the goods and services in question. The sums expended by the entrepreneur on wages, rents, salaries, raw materials, interest, lawyers’ fees, and so on, represent costs to him and income to those who receive them. His own profits also enter the picture, since they are his income and the cost of persuading him to produce the wealth in question. The goods are offered for sale at a price which is equal to the sum of all costs (including profits). In the community as a whole, aggregate costs, aggregate incomes, and aggregate prices are the same, since they are merely opposite sides of the identical expenditures.

The purchasing power available in the community is equal to income minus savings. If there are any savings, the available purchasing power will be less than the aggregate prices being asked for the products for sale and by the amount of the savings. Thus, all the goods and services produced cannot be sold as long as savings are held back. In order for all the goods to be sold, it is necessary for the savings to reappear in the market as purchasing power. The usual way in which this is done is by investment. When savings are invested, they are expended into the community and appear as purchasing power. Since the capital good made by the process of investment is not offered for sale to the community, the expenditures made by its creation appear completely as purchasing power. Thus, the disequilibrium between purchasing power and prices which was created by the act of saving is restored completely by the act of investment, and all the goods can be sold at the prices asked. But whenever investment is less than savings, the available supply of purchasing power is inadequate by the same amount to buy the goods being offered. This margin by which purchasing power is inadequate because of an excess of savings over investment may be called the “deflationary gap.” This “deflationary gap” is the key to the twentieth century economic crisis and one of the three central cores of the whole tragedy of the century.

The Results of Economic Depression

The deflationary gap arising from a failure of investment to reach the level of savings can be closed either by lowering the supply of goods to the level of the available purchasing power or by raising the supply of purchasing power to a level able to absorb the existing supply of goods, or by a combination of both. The first solution will give a stabilized economy on a low level of economic activity; the second will give a stabilized economy on a high level of economic activity. Left to itself, the economic system under modern conditions would adopt the former procedure. This would work roughly as follows: The existence of the deflationary gap (that is, available purchasing power less than aggregate prices of available goods and services) will result in falling prices, declining economic activity, and rising unemployment. All this will result in a fall in national income, and this in turn will result in an even more rapid decline in the volume of savings. This decline continues until the volume of savings reaches the level of investment, at which point the fall is arrested and the economy becomes stabilized at a low level.

As a matter of fact, this process did not work itself out in any industrial country during the great depression of 1929-1934, because the disparity in the distribution of the national income was so great that a considerable portion of the population would have been driven to zero incomes and absolute want before the savings of the richer segment of the population fell to the level of investment. Moreover, as the depression deepened, the level of investment declined even more rapidly than the level of savings. There can be little doubt that under such conditions the masses of the population would have been driven to revolution before the “automatic economic factors” were able to stabilize the economy, and the stabilization, if reached, would have been on a level so low that a considerable portion of the population would have been in absolute want. Because of this, in every industrial country, governments took steps to arrest the course of the depression before their citizens were driven to desperation.