Today’s Economic History: Alfred and Mary Marshall on Debt Deflation

Alfred and Mary Marshall (1885): The Economics of Industry:

(5) The connexion between a fall of prices and a suspension of industry requires to be further worked out.

There is no reason why a depression of trade and a fall of prices should stop the work of those who can produce without having to pay money on account of any expenses of production. For instance a man who pays no wages, who works with his own hands, and produces what raw material he requires, cannot lose anything by continuing to work. It does not matter to him how low prices have fallen, provided that the prices of his goods have not fallen more in proportion than those of others. When prices are low, he will get few coins for his goods; but if he can buy as many things with them as he could with the greater number of coins he got when prices were high, he will not be injured by the fall of prices. He would be a little discouraged if be thought that the price of his goods would fall more than the prices of others; but even then be would not be very likely to stop work.

And in the same way a manufacturer, though he has to pay for raw material and wages would not check his production on account of a fall in prices, if the fall affected all things equally, and were not likely to go further. If the price which he got for his goods had fallen by a quarter, and the prices which he had to pay for labour and raw material had also fallen by a quarter, the trade would be as profitable to him as before the fall. Three sovereigns would now do the work of four, he would use fewer counters in measuring off his receipts against his outgoings; but his receipts would stand in the same relation to his outgoings as before. His net profits would be the same percentage of his total business. The counters by which they are reckoned would be less by one quarter, but they would purchase as much of the necessaries, comforts, and luxuries of life as they did before.

It however very seldom happens in fact that the expenses which a manufacturer has to pay out fall as much in proportion as the price which he gets for his goods. For when prices are rising, the rise in the price of the finished commodity is generally more rapid than that in the price of the raw material, always more rapid than that in the price of labour ; and when prices are falling, the fall in the price of the finished commodity is generally more rapid than that in the price of the raw material, always more rapid than that in the price of labour. And therefore when prices are falling the manufacturer’s receipts are sometimes scarcely sufficient even to repay him for his outlay on raw material, wages, and other forms of circulating capital; they seldom give him in addition enough to pay interest on his fixed capital and earnings of management for himself.

Even if the prices of labour and raw materials fall as rapidly as those of finished goods, the manufacturer may lose by continuing production if the fall has not come to an end. He may pay for raw material and labor at a time when prices generally have fallen by one-sixth; but if, by the time he comes to sell, prices have fallen by another sixth, his receipts may be less than is sufficient to cover his outlay.

We conclude then that manufacturing cannot be carried on except at a low rate of profit, or at a loss, when the prices of finished goods are low relative to those of labour and raw material; or when prices are falling, even if the prices of all things are falling equally.

(6) Thus a fall in prices lowers profits and impoverishes the manufacturer: while it increases the purchasing power of those who have fixed incomes. So again it enriches creditors at the expense of debtors. For if the money that is owing to them is repaid, this money gives them a great purchasing power; and if they have lent it at a fixed rate of interest, each payment is worth more to them than it would be if prices were high. But for the same reasons that it enriches creditors and those who receive fixed incomes, it impoverishes those men of business who have borrowed capital; and it impoverishes those who have to make, as most business men have, considerable fixed money payments for rents, salaries, and other matters. When prices are ascending, the improvement is thought to be greater than it really is ; because general opinion with regard to the prosperity of the country is much influenced by the authority of manufacturers and merchants. These judge by their own experience, and in time of ascending prices their fortunes are rapidly increased; in a time of descending prices their fortunes are stationary or dwindle. But statistics prove that the real income of the country is not very much less in the present time of low prices, than it was in the period of high prices that went before it. The average amount of the necessaries, comforts and luxuries which are enjoyed by Englishmen is probably greater now, in 1886, than it was in 1872.