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Hobson on Underconsumption

Posted by Alex M Thomas on 28th December 2014

Although not in the same tradition, but raising a similar concern as Lauderdale, Malthus and Sismondi, J. A. Hobson (along with Mummery) develops what is known in the literature as the ‘underconsumption theory’. Mummery & Hobson present this in The Physiology of Industry: Being an Exposure of Certain Fallacies in Existing Theories in Economics (1889). These themes are also expressed in other works of Hobson such as The Social Problem (1901) and Problems of Poverty (1905). This blog post completely draws from M. Schneider’s 1996 book titled J. A. Hobson (Macmillan Press; especially chapter 4). A contraction of output can happen through two different routes in a closed economy: (1) underconsumption and (2) underinvestment. The logic of this argument can be explained in the following manner. If planned expenditure – consumption or investment, falls short of the planned output at the aggregate level, output levels will contract in the subsequent period of production. Planned expenditure may be less than planned output either due to planned consumption and/or planned investment falling short of the expenditure necessary to validate the planned output.

Mummery & Hobson take as their focus the first route. As Schneider writes:

‘In the underconsumption theory, a deficiency of consumption, and hence excessive saving, is seen as being accompanied by excessive investment. …underconsumption is simply a case of excess supply in the consumption goods market and excess demand in the investment goods market…’ (Schneider p. 59)

They conceptualize the economy as being made up of two sectors – consumption goods and investment goods sector. Aggregate income can be used for consumption or saving. What is not consumed is saved, and this is assumed to be translated into investment. Therefore, if consumption falls (i.e., there is underconsumption) then saving and investment increases (i.e., there is overinvestment).

Mummery & Hobson assume unchanging technology. A certain amount of ‘capital’ (circulating and fixed) is required to produce the output. [No substitution between labour and ‘capital’ as in marginalist economics.] Given this specification of technology, a decrease in consumption will reduce the quantity of ‘capital’ that can be usefully employed.

…since ‘the profits which form the money incomes of all capitalists concerned in production, the wages of all the labourers concerned…are in a regular condition of commerce, paid out of the prices paid by consumers’ (1889, p. 71), a decrease in consumption would lead to a ‘general reduction in the rate of incomes’ (1889, p. 96) or, in other words, to a ‘depression in trade’, with ‘requisites of production’, including labour, consequently becoming unemployed or only partially employed. (as in Schneider p. 62)

That is, a decrease in consumption ceteris paribus leads to a decrease in aggregate income, since expenditure falls short of output. This also leads to an increase in unemployed labour. This idea of underconsumption has to implicitly assume that investment is ultimately a function of consumption demand. Otherwise, the underconsumption does not pose a problem as it is matched by an equivalent overinvestment. This is why ‘underconsumption leads to the accumulation of excessive capital equipment’ (Schneider p. 71).

The link between aggregate consumption demand, aggregate income and saving is visible in the excerpt from Mummery & Hobson below.

‘it is precisely because they [people] are consuming more that they can save more.’ (1889, p. 126; as in Schneider p. 63).

This excerpt is also suggestive of activity levels being determined by aggregate demand, particularly, consumption demand. A higher income means that the funds to save from are higher. To put the same point differently, saving is a positive function of aggregate income.

Keynes underscored the fact that what is true for an individual need not be true for the aggregate. This is now known as the fallacy of composition.

Every ‘attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself.’ (Keynes 1936, p. 84; as in Schneider p. 63).

‘Hobson…called this (misleadingly) ‘the distributive fallacy’, which ‘consists in arguing that what is true of each must be true of all’ (1916, p 9; as in Schneider p. 63).

Hobson has made significant contributions to economics. The idea that saving should be favoured over consumption is shown to be false, and this principle is to be found in Kaleckian/Keynesian economics as well. Hobson demonstrated an implicit understanding of the accelerator principle – that investment is dependent of consumption (or that investment is a derived demand). Finally, underconsumption (or a deficiency of aggregate demand) leads to unemployment of labour and underutilized ‘capital’ stock.

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Posted in Economic Thought, Economics, History of Economic Thought, Keynes, Macroeconomics | No Comments »

Robert Torrens: An Introduction

Posted by Alex M Thomas on 30th September 2013

Robert Torrens’s An Essay on the Production of Wealth (1821) is an important contribution to economic theory, in particular, to classical economic theory. Torrens was involved in the founding of the London Political Economy Club along with James Mill, David Ricardo, Thomas Tooke and others. Torrens has written extensively on monetary issues, on colonisation and on price theory. He is also credited with having discovered the comparative costs principle independently of Ricardo. This blog post focuses on his contributions to the theory of value and the possibility of a general glut in his debate with Ricardo.

Torrens is one of the very few (to be precise, nine) economists mentioned by Piero Sraffa in his Production of Commodities by Means of Commodities; Sraffa approvingly cites him for his method of treating fixed capital. Fixed capital is conceptualised as a distinct commodity (a joint product) alongside new commodities which emerge from the production process. Torrens utilises a theory of value based on ‘capital’ as opposed to Ricardo’s labour theory of value. But, how is ‘capital’ to be measured without the knowledge of values/prices? Ricardo recognises that when labour-capital ratios are not uniform across sectors, value will not be proportional to the embodied labour. And, as Carlo Benetti writes in his entry on Torrens in The Elgar Companion to Classical Economics, when the rate of profit is zero, the labour theory of value holds; however, the existence of positive profits does not per se invalidate Ricardo’s labour theory of value. A satisfactory resolution of this problem in value theory is to be found in Sraffa’s simultaneous determination of profits and prices.

The macroeconomics of Torrens, built on his theory of value and distribution, suggests the possibility of a general glut in the economy. On general gluts, Torrens writes: ‘a glut of a particular commodity may occasion a general stagnation, and lead to a suspension of production, not merely of the commodity which first exists in excess, but of all other commodities brought to the market’ (Torrens 1821: 414; as quoted in the Benetti entry on page 473). The underlying reason for this is a disproportion between the different sectors of the economy. Owing to the structural interdependence prevalent in an economy, a disproportion can lead to a fall in ‘effectual demand’. This will lead to a glut in commodities in that particular sector and in other sectors as a consequence of a fall in sales and incomes in that sector. This, evidently, is in direct contrast with Say’s law, loosely understood as – supply creates its own demand.

Other notable commentators on Torrens include Giancarlo DeVivo and Lionel Robbins. The latter published his work in 1958 entitled Robert Torrens and the Evolution of Classical Economics. In 2000, DeVivo edited and put together the Collected Works of Robert Torrens. Studying Torrens will certainly prove invaluable in gaining a deeper understanding of classical economics, and especially his views on general gluts might have contemporary use in relation to the economics of Keynes and Kalecki.

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Posted in Classical Economics, Classical Political Economy, David Ricardo, Economic Thought, Economics, History of Economic Thought, Keynes, Macroeconomics, Michal Kalecki, Sraffa | No Comments »

Thomas Tooke: An Introduction

Posted by Alex M Thomas on 15th June 2013

Thomas Tooke (1774-1858) made important contributions to monetary history, theory and policy. His monetary economics has been viewed in a favourable light by economists such as Ricardo and Marx. Moreover, Tooke’s conception of the rate of interest as a variable determined independently (of the profit rate) bears significant similarities with Keynes’s idea of the rate of interest as a ‘monetary phenomenon’. This post presents Tooke’s monetary theory in brief through his role in the debates between the Currency School (to which Ricardo belonged) and the Banking School (Tooke being the prominent member) in the early 1840s. The reference for this post is mainly the recent research carried out by Matthew Smith.

During Tooke’s time, the dominant view was that the rate of interest is governed by the rate of profit (on capital employed in production) implying that the former is determined by ‘real’ forces. In Smith, it is the competition of capital and for Ricardo, it is the wage rate and production conditions taken together. Tooke argued that the rate of interest is determined by institutional factors in the financial market and is independent of the rate of profit. In his later writings, he stated that it is the rate of interest which regulates the rate of profit with the former entering as a component in the costs of production of commodities.

The Currency School maintained that prices can be controlled by adjusting the quantity of money, as espoused by the quantity theory of money. That is, by altering the bank notes in circulation, it was believed that fluctuations in nominal income could be suppressed. This assumes that there are no time lags and that the velocity of circulation is constant. Tooke contested this policy and stressed the role for a discretionary monetary policy flexible enough to deal with different economic situations. The central principles of the Banking School are as follows: (i) the quantity of money in circulation is endogenously determined by the level of nominal income; (ii) ‘the rate of interest has no systematic influence on the inducement to spend’; and (iii) the rate of interest, being a component of commodity prices, exerts a ‘positive causal influence on the price level’ (Smith 1996: xliv-xlv). Such principles imply that the velocity of circulation is, in fact, a summary measure of the institutional setting of the financial market which can change when activity levels and prices vary.

Tooke’s contributions place a greater responsibility on the central banks. The principles of the Banking School imply that the interest policy of the monetary authorities can have lasting impact on real variables (such as income and employment) by influencing prices and the rate of profit. There is no long-run neutrality of money – monetary variables impact real variables. Moreover, attempts to control the quantity of money solely based on the rate of interest need not be successful since it is endogenously determined. Finally, the causation runs from prices to the quantity of money and not vice versa.


SMITH, M. (1996), ‘Introduction’, in Variorum of the First and Second Editions of Thomas Tooke’s Considerations on the State of the Currency (1826), edited in collaboration with P. D. GROENEWEGEN, Reprints of Economic Classics, Series 2, Number 8, Sydney, Centre for the History of Economic Thought, The University of Sydney, pp. vi–xlvi.

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Posted in Classical Political Economy, Economic Thought, Economics, History of Economic Thought, Inflation, Macroeconomics, Monetary Economics | 1 Comment »

Reflections on Chayanov’s The Theory of Peasant Economy

Posted by Alex M Thomas on 17th February 2013

Alexander Vasilevich Chayanov, the Russian agricultural economist published the essay ‘On the Theory of Non-Capitalist Economic Systems’ in 1924 and Peasant Farm Organization in 1925, both in Russian. This blog post presents a selective summary of the English translations of these two works, one of the aims being to comment on Chayanov’s method of doing economics. He wrote around 60 books and essays during his lifetime. This blog post, it must be noted, is not an exhaustive survey of the essay and the book.


Chayanov’s essay on non-capitalist economic systems questioned the dominant approach of economic theorising which is conducted in the framework of capitalism. One of the characteristic features of the capitalist system is the presence of wage labour. So, how does such a theoretical framework understand peasant economies, where wage labour is non-existent? This is Chayanov’s question. Since labour is entirely provided by the peasant family, there exists no labour market and therefore no concept of wage labour. Moreover, the peasant family undertakes agricultural production (and engages in simple manufacturing) with the family labour and the surplus (or net product) arising from production cannot be resolved into wages and profits. The notions of profitability present in a family run enterprise, according to Chayanov, is very different from a capitalist enterprise. Chayanov terms the returns from the enterprise as the net product.

The required consumption of each family member is set by custom and habit. Chayanov computes an ‘internal equilibrium for the well-being of the family’ which is given by the intersection of their well-being and drudgery functions (p. 5). The gross product can be increased if more land is cultivated and/or an increase in labour intensity; remember, that the number of workers are given for any peasant farm organization. (This can change, perhaps in the very long-run, if the birth rate of the family is greater than its death rate.) The net product is arrived at by deducting the necessary consumption of the family and necessary consumption of the capital equipment from the gross product. The increase in labour intensity has definite physical limits; according to Chayanov, the family as a farm unit will increase labour intensity (drudgery) until the point when the net product is sufficient to meet the consumption needs of the workers and their dependants (children, parents and grandparents). The family’s access to land will depend on the land price and their ability to buy/lease more land will be constrained by their net product.

After laying out the basic relationships prevalent in a peasant farm, Chayanov concludes the essay by listing the various economic systems (p. 25). The extreme forms are capitalism and communism. In between, he introduces the family economy, slave economy and the feudal system (comprising landlord economy and peasant economy). Chayanow wishes for multiple economic theories catering to the needs of different economic-systems, as his last sentence in the essay shows:

…we have no doubt that the future of economic theory lies not in constructing a single universal theory of economic life but in conceiving a number of theoretical systems that would be adequate to the range of present or past economic orders and would disclose the forms of their coexistence and evolution. (p. 28)


In Chayanov’s 1925 work entitled Peasant Farm Organization, his team carries out a detailed analysis of the agricultural situation in various districts of Russia based on zemstvo statistics, state statistics, independent research and budget studies (p. 38). At the outset, Chayanov points out the ‘coexistence and evolution’ of the capitalist and non-capitalist forms. When the peasant as worker-entrepreneur is unable to make sufficient earnings (owing to a bad harvest, increased input cost or some other factor), he temporarily abandons his undertaking and becomes a wage-labour in order to avoid being unemployed (p. 40). A peasant farm, to reiterate, does not make use of hired labourers.

The peasant farm is an organization that makes use of family labour and receives a single labour income. And, the trade-off between physical effort and material results (already noted in the previous section) is re-emphasised (p. 41). Responding against criticisms against their employing the method of marginalist economics, Chayanov maintains that the trade-off between family member as consumer and as labourer (labour-consumer balance) determines the volume of family economic activity but he does ‘not at all consider it possible to deduce from this a whole system of the national economy’ (p. 46). His objective is not, in modern terms, macroeconomics. The concept of a family has its basis in ‘the purely biological concept of the married couple, living together with their descendants and the aged representatives of the older generation’ (p. 54). Moreover, the gross product of the labour farm includes income from ‘agriculture’ as well as ‘crafts and trades’ (p. 70).

Given the trade-off between manual work and well-being, ‘the annual intensity of labor declines under the influence of better pay, because to remain the same it is absolutely essential that the productivity of the year’s labor (and equally the standard of well-being) should grow in proportion to the increase in the pay of a unit of labour’ (p. 80). In conclusion, as Chayanov states:

Thus, any labor farm has a natural limit to its output, determined by the proportions between intensity of annual family labor and degree of satisfaction of its demands. (p. 82)

One of the problems of such a principle is the exclusion of the relationship between labour intensity and consumption needs of the labourers. For instance, when income increases, there might arise a heightened demand to consume more of luxury products. The consumption needs certainly have a lower limit or a floor, but it is not bounded from above. In other words, labour intensity and consumption needs are interrelated factors.

One final observation before we move to conclusions. Chayanov, with a view to aiding practical policy, was interested in finding the ‘optimal farm size’ because ‘the optimal combination gives the highest income, and any deviation from it gives the proprietor a reduced profit rate’ (p. 91). In part, and by large, the combination is based on the technical relations between inputs and outputs. Therefore, ‘[a]ny excess of production means available to labor or of land above the technically optimal level will be an excessive burden on the undertaking’ (p. 92). It is also on account of the technological relationship that  the ‘volume of agricultural activity is not a simple arithmetic derivative of the size of area used’ (p. 94). Some of these technological relationships can be better grasped by taking recourse to ‘the basic laws of contemporary agricultural science’ (see especially pp. 138-47 for a rich account of crop rotation, manuring, etc).


First, Chayanov is dissatisfied with economic theory studying capitalist systems alone. But, (neoclassical) microeconomics can perhaps explain certain features of the peasant farm, especially the trade-off between drudgery and well-being (the backward bending labour supply curve is a good example). Also, the search for the optimal farm size can also be conducted by certain microeconomic procedures. One does not need to accept the marginal productivity theory of distribution which is a central feature of microeconomics. To put it differently, the ‘science of choice’ can explain the trade-offs which Chayanov is talking about by making appropriate changes in the parameters.

Secondly, treating the farm output as being ‘determined by the proportions between intensity of annual family labor and degree of satisfaction of its demands,’ as noted earlier, assumes them to be independent of each other which need not be the case. But in his credit, Chayanov undertakes a very detailed analysis of the farm households which provides content to the maximization problem. Also, the tabular and visual representation of the data is remarkable.

Finally, the co-existence of different economic organizations like capitalist and peasant farms is characteristic of economies like India. Often, they are called a dual economy. Self-employment, as opposed to wage employment is a significant feature of the Indian labour force; so is informal versus formal employment. Understanding their innate dynamics as well as their interrelationships is of much use. They require a combination of good theory, data collection methods, statistical analysis and an understanding of the socio-economic history of the particular locality.

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Posted in Agricultural sector, Communism, Development Economics, Economic Thought, Economics, History of Economic Thought, India, Informal Sector, Marginalist economics, Neoclassical Economics | 1 Comment »