Chapter 18
THE GENERAL THEORY OF EMPLOYMENT RE-STATED
I
We have now reached a point where we can gather together the
threads of our argument. To begin with, it may be useful to make
clear which elements in the economic system we usually take as
given, which are the independent variables of our system and
which are the dependent variables.
We take as given the existing skill and quantity of available
labour, the existing quality and quantity of available equipment,
the existing technique, the degree of competition, the tastes and
habits of the consumer, the disutility of different intensities
of labour and of the activities of supervision and organisation,
as well as the social structure including the forces, other than
our variables set forth below, which determine the distribution
of the national income. This does not mean that we assume these
factors to be constant; but merely that, in this place and
context, we are not considering or taking into account the
effects and consequences of changes in them.
Our independent variables are, in the first instance, the
propensity to consume, the schedule of the marginal efficiency of
capital and the rate of interest, though, as we have already
seen, these are capable of further analysis.
Our dependent variables are the volume of employment and the
national income (or national dividend) measured in wage-units.
The factors, which we have taken as given, influence our independent variables, but do not completely determine
them. For example, the schedule of the marginal efficiency of
capital depends partly on the existing quantity of equipment
which is one of the given factors, but partly on the state of
long-term expectation which cannot be inferred from the given
factors. But there are certain other elements which the given
factors determine so completely that we can treat these
derivatives as being themselves given. For example, the given
factors allow us to infer what level of national income measured
in terms of the wage-unit will correspond to any given level of
employment; so that, within the economic framework which we take
as given, the national income depends on the volume of
employment, i.e. on the quantity of effort currently devoted to
production, in the sense that there is a unique correlation
between the two.
Furthermore, they allow us to infer the shape of the aggregate
supply functions, which embody the physical conditions of
supply, for different types of products;¾that
is to say, the quantity of employment which will be devoted to
production corresponding to any given level of effective demand
measured in terms of wage-units. Finally, they furnish us with
the supply function of labour (or effort); so that they tell us inter
alia at what point the employment function
for labour as a whole will cease to be elastic.
The schedule of the marginal efficiency of capital depends,
however, partly on the given factors and partly on the
prospective yield of capital-assets of different kinds; whilst
the rate of interest depends partly on the state of
liquidity-preference (i.e. on the liquidity function) and partly
on the quantity of money measured in terms of wage-units. Thus we
can sometimes regard our ultimate independent variables as
consisting of (i) the three fundamental psychological factors, namely, the psychological propensity to consume, the
psychological attitude to liquidity and the psychological
expectation of future yield from capital-assets, (2) the
wage-unit as determined by the bargains reached between employers
and employed, and (3) the quantity of money as determined by the
action of the central bank; so that, if we take as given the
factors specified above, these variables determine the national
income (or dividend) and the quantity of employment. But these
again would be capable of being subjected to further analysis,
and are not, so to speak, our ultimate atomic independent
elements.
The division of the determinants of the economic system into
the two groups of given factors and independent variables is, of
course, quite arbitrary from any absolute standpoint. The
division must be made entirely on the basis of experience, so as
to correspond on the one hand to the factors in which the changes
seem to be so slow or so little relevant as to have only a small
and comparatively negligible short-term influence on our quaesitum;
and on the other hand to those factors in which the changes are
found in practice to exercise a dominant influence on our quaesitum.
Our present object is to discover what determines at any time the
national income of a given economic system and (which is almost
the same thing) the amount of its employment; which means in a
study so complex as economics, in which we cannot hope to make
completely accurate generalisations, the factors whose changes mainly
determine our quaesitum. Our final task might be to
select those variables which can be deliberately controlled or
managed by central authority in the kind of system in which we
actually live.
II
Let us now attempt to summarise the argument of the previous
chapters; taking the factors in the reverse order to that in
which we have introduced them.
There will be an inducement to push the rate of new investment
to the point which forces the supply-price of each type of
capital-asset to a figure which, taken in conjunction with its
prospective yield, brings the marginal efficiency of capital in
general to approximate equality with the rate of interest. That
is to say, the physical conditions of supply in the capital-goods
industries, the state of confidence concerning the prospective
yield, the psychological attitude to liquidity and the quantity
of money (preferably calculated in terms of wage-units)
determine, between them, the rate of new investment.
But an increase (or decrease) in the rate of investment will
have to carry with it an increase (or decrease) in the rate of
consumption; because the behaviour of the public is, in general,
of such a character that they are only willing to widen (or
narrow) the gap between their income and their consumption if
their income is being increased (or diminished). That is to say,
changes in the rate of consumption are, in general, in the
same direction (though smaller in amount) as changes in the
rate of income. The relation between the increment of consumption
which has to accompany a given increment of saving is given by
the marginal propensity to consume. The ratio, thus determined,
between an increment of investment and the corresponding
increment of aggregate income, both measured in wage-units, is
given by the investment multiplier.
Finally, if we assume (as a first approximation) that the
employment multiplier is equal to the investment multiplier, we
can, by applying the multiplier to the increment (or decrement)
in the rate of investment brought about by the factors first
described, infer the increment of employment.
An increment (or decrement) of employment is liable, however,
to raise (or lower) the schedule of liquidity-preference; there
being three ways in which it will tend to increase the demand for
money, inasmuch as the value of output will rise when employment increases
even if the wage-unit and prices (in terms of the wage-unit) are
unchanged, but, in addition, the wage-unit itself will tend to
rise as employment improves, and the increase in output will be
accompanied by a rise of prices (in terms of the wage-unit) owing
to increasing cost in the short period.
Thus the position of equilibrium will be influenced by these
repercussions; and there are other repercussions also. Moreover,
there is not one of the above factors which is not liable to
change without much warning, and sometimes substantially. Hence
the extreme complexity of the actual course of events.
Nevertheless, these seem to be the factors which it is useful and
convenient to isolate. If we examine any actual problem along the
lines of the above schematism, we shall find it more manageable;
and our practical intuition (which can take account of a more
detailed complex of facts than can be treated on general
principles) will be offered a less intractable material upon
which to work.
III
The above is a summary of the General Theory. But the actual
phenomena of the economic system are also coloured by certain
special characteristics of the propensity to consume, the
schedule of the marginal efficiency of capital and the rate of
interest, about which we can safely generalise from experience,
but which are not logically necessary.
In particular, it is an outstanding characteristic of the
economic system in which we live that, whilst it is subject to
severe fluctuations in respect of output and employment, it is
not violently unstable. Indeed it seems capable of remaining in a
chronic condition of subnormal activity for a considerable period
without any marked tendency either towards recovery or towards
complete collapse. Moreover, the evidence indicates that full, or even approximately full, employment is of rare
and short-lived occurrence. Fluctuations may start briskly but
seem to wear themselves out before they have proceeded to great
extremes, and an intermediate situation which is neither
desperate nor satisfactory is our normal lot. It is upon the fact
that fluctuations tend to wear themselves out before proceeding
to extremes and eventually to reverse themselves, that the theory
of business cycles having a regular phase has been
founded. The same thing is true of prices, which; in response to
an initiating cause of disturbance, seem to be able to find a
level at which they can remain, for the time being, moderately
stable.
Now, since these facts of experience do not follow of logical
necessity, one must suppose that the environment and the
psychological propensities of the modern world must be of such a
character as to produce these results. It is, therefore, useful
to consider what hypothetical psychological propensities would
lead to a stable system; and, then, whether these propensities
can be plausibly ascribed, on our general knowledge of
contemporary human nature, to the world in which we live.
The conditions of stability which the foregoing analysis
suggests to us as capable of explaining the observed results are
the following:
(i) The marginal propensity to consume is such
that, when the output of a given community increases (or
decreases) because more (or less) employment is being applied to
its capital equipment, the multiplier relating the two is greater
than unity but not very large.
(ii) When there is a change in the prospective
yield of capital or in the rate of interest, the schedule of the
marginal efficiency of capital will be such that the change in
new investment will not be in great disproportion to the change
in the former; i.e. moderate changes in the prospective yield of
capital or in the rate of interest will not be associated with
very great changes in the rate of investment.
(iii) When there is a change in employment,
money-wages tend to change in the same direction as, but not in
great disproportion to, the change in employment; i.e. moderate
changes in employment are not associated with very great changes
in money-wages. This is a condition of the stability of prices
rather than of employment.
(iv) We may add a fourth condition, which provides
not so much for the stability of the system as for the tendency
of a fluctuation in one direction to reverse itself in due
course; namely, that a rate of investment, higher (or lower) than
prevailed formerly, begins to react unfavourably (or favourably)
on the marginal efficiency of capital if it is continued for a
period which, measured in years, is not very large.
(i) Our first condition of stability, namely, that
the multiplier, whilst greater than unity, is not very great, is
highly plausible as a psychological characteristic of human
nature. As real income increases, both the pressure of present
needs diminishes and the margin over the established standard of
life is increased; and as real income diminishes the opposite is
true. Thus it is natural¾at any rate
on the average of the community¾that
current consumption should be expanded when employment increases,
but by less than the full increment of real income; and that it
should be diminished when employment diminishes, but by less than
the full decrement of real income. Moreover, what is true of the
average of individuals is likely to be also true of governments,
especially in an age when a progressive increase of unemployment
will usually force the State to provide relief out of borrowed
funds.
But whether or not this psychological law strikes the reader
as plausible a priori, it is certain that experience would
be extremely different from what it is if the law did not hold.
For in that case an increase of investment, however small, would
set moving a cumulative increase of effective demand until a
position of full employment had been reached; while a decrease of investment
would set moving a cumulative decrease of effective demand until
no one at all was employed. Yet experience shows that we are
generally in an intermediate position. It is not impossible that
there may be a range within which instability does in fact
prevail. But, if so, it is probably a narrow one, outside of
which in either direction our psychological law must
unquestionably hold good. Furthermore, it is also evident that
the multiplier, though exceeding unity, is not, in normal
circumstances, enormously large. For, if it were, a given change
in the rate of investment would involve a great change (limited
only by full or zero employment) in the rate of consumption.
(ii) Whilst our first condition provides that a
moderate change in the rate of investment will not involve an
indefinitely great change in the demand for consumption-goods our
second condition provides that a moderate change in the
prospective yield of capital-assets or in the rate of interest
will not involve an indefinitely great change in the rate of
investment. This is likely to be the case owing to the increasing
cost of producing a greatly enlarged Output from the existing
equipment. If, indeed, we start from a position where there are
very large surplus resources for the production of
capital-assets, there may be considerable instability within a
certain range; but this will cease to hold good as soon as the
surplus is being largely utilised. Moreover, this condition sets
a limit to the instability resulting from rapid changes in the
prospective yield of capital-assets due to sharp fluctuations in
business psychology or to epoch-making inventions¾though more, perhaps, in the upward than
in the downward direction.
(iii) Our third condition accords with our
experience of human nature. For although the struggle for
money-wages is, as we have pointed out above, essentially a
struggle to maintain a high relative wage, this struggle is likely, as employment increases, to be
intensified in each individual case both because the bargaining
position of the worker is improved and because the diminished
marginal utility of his wage and his improved financial margin
make him readier to run risks. Yet, all the same, these motives
will operate within limits, and workers will not seek a much
greater money-wage when employment improves or allow a very great
reduction rather than suffer any unemployment at all.
But here again, whether or not this conclusion is plausible a
priori, experience shows that some such psychological law
must actually hold. For if competition between unemployed workers
always led to a very great reduction of the money-wage, there
would be a violent instability in the price-level. Moreover,
there might be no position of stable equilibrium except in
conditions consistent with full employment; since the wage-unit
might have to fall without limit until it reached a point where
the effect of the abundance of money in terms of the wage-unit on
the rate of interest was sufficient to restore a level of full
employment. At no other point could there be a
resting-place.
(iv) Our fourth condition, which is a condition not
so much of stability as of alternate recession and recovery, is
merely based on the presumption that capital-assets are of
various ages, wear out with time and are not all very long-lived;
so that if the rate of investment falls below a certain minimum
level, it is merely a question of time (failing large
fluctuations in other factors) before the marginal efficiency of
capital rises sufficiently to bring about a recovery of
investment above this minimum. And similarly, of course, if
investment rises to a higher figure than formerly, it is only a
question of time before the marginal efficiency of capital falls
sufficiently to bring about a recession unless there are compensating changes in other
factors.
For this reason, even those degrees of recovery and recession,
which can occur within the limitations set by our other
conditions of stability, will be likely, if they persist for a
sufficient length of time and are not interfered with by changes
in the other factors, to cause a reverse movement in the opposite
direction, until the same forces as before again reverse the
direction.
Thus our four conditions together are adequate to explain the
outstanding features of our actual experience;¾namely,
that we oscillate, avoiding the gravest extremes of fluctuation
in employment and in prices in both directions, round an
intermediate position appreciably below full employment and
appreciably above the minimum employment a decline below which
would endanger life.
But we must not conclude that the mean position thus
determined by 'natural' tendencies, namely, by those tendencies
which are likely to persist, failing measures expressly designed
to correct them, is, therefore, established by laws of necessity.
The unimpeded rule of the above conditions is a fact of
observation concerning the world as it is or has been, and not a
necessary principle which cannot be changed.