359. Harrod to H. D. Henderson , 17 June 1934 [a]
17 June 1934
I think our muddle  was due to the failure to keep absolutely distinct the question of replacements and new capital. It is required to find how much new capital, i.e. how much employment in the constructional trades, is required to finance the provision of additional services under the 2 plans.
Take the case of a taxi-cab comp[any] which can either (a) have £2000 taxis lasting 20 years or (b) £400 taxis lasting 4.
The replacement expenditure under (a) or (b) is the same, viz under (a) 1/20 of existing taxis at £2000 each and under (b) 1/4 of existing taxis at £400 each.
Now in addition to this it is required to provide one new taxi every year. Under (a) this gives rise to £2000 fresh capital expenditure each year, while under (b) it only gives rise to £400 fresh capital expenditure each year.
I know that there is a temptation to say, ah--but under (b) there will be extra [b] capital expenditure at the end of 4 years. But this, I submit, involves a fallacious confusion of fresh capital & replacement expenditure. Under either system there will be the same value of orders given to car makers for replacement in the 5th year, in one case 1/20 of outstanding cars at £2000 each, in the other 1/4 of outstanding cars at £400 each. Under (b) there will be more cars to replace, but each will be less expensive than under (a).
The extra new capital required under (a) is net and not offset by any diminished expenditure on replacement. This is reflected in the fact that under (a) the total value of outstanding taxis rises at £2000 a year and under (b) at only £400 a year.
This means that there is more <work> for the engineering trade under (a), and, unless investors find some other investment for a sum accumulating at £1600 p.a. less demand for labour.
Now I think this fact is masked by another tendency, namely that the machines as well as being shorter-lived are more 1 labour saving. This would account for activity in the engineering trades, but might not be sufficient to offset the diminished output for savings.
Instead of taxis in the above ex[ample] read machines. Now let us suppose that instead of a £2000 machine lasting for 20 years we have a machine lasting only 4 years which costs not £400 but £500 and that the use of the flimsy but more complicated machine saves labour in the use of it worth £25 p.a. = £100 during the life of the machine. The value of replacement has now clearly gone up. Replacement instead of costing £ , costs £ (= £ ). There is more work for the engineering trades. But there is a corresponding amount of labour displaced from the trade using the machines. The increased activity in the engineering trades on replacement is exactly offset by diminished employment of labour in the trade using the machines. So that squares out.
But on the side of new machines, the value of output is now less, viz £500 p.a. instead of £2000 p.a. This will probably nothing like offset the greater activity on replacement in the engineering trades. So we shall have the engineering trades busy and making larger new issues to cope with the rising tide of replacements. But these new issues are exactly offset by a diminution in the new issues of the trade using the machines. 2 But on top of that you have the fact that new issues required to finance [c] the making of extra machines have shrunk from £2000 to £500 and this is not offset by anything.
So tho' the engineering trades may have become more active as a result of the change, there will be less new issues to absorb savings as a consequence of it.
Would you send this on to James Meade,  Hertford College, in case he is worrying about it.
2. The note was actually forwarded to Meade, and is now preserved among Meade's papers (see source note a to this letter). It is accompanied by a note in which Henderson commented as follows: "I enclose a note from Harrod which clears up, quite satisfactorily to me, the point about which we got confused this morning" (Henderson to Meade, 17 June 1934, is in MP 2/4 (43)).
- a. ALI, three pages (numbered from the second) on three leaves, in MP 2/4(9-11); photocopy in HP (NC). The last two pages are written on the back of two crossed-out pages (numbered 25 and 23, respectively) of a manuscript on the remedies to depression in gold standard conditions.
b. Ms: «will extra».
c. Ms: «Finance».
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