Harrod [Notes on The Trade Cycle]

 

See accompanying letter

Chapter I

Page 42. Greater plasticity of wage-rates is equivalent, as is implied in the argument, to a nearer approach to the conditions in which the primary stabilizers operated. [2] Doubt expressed as to whether it would operate as a stabilizer is, therefore, paradoxical. The doubt is presumably due to further complications to be introduced later. None the less, this paragraph (first of the page) might better be omitted here, as unnecessarily puzzling to the reader, the point being taken up later on.

Page 47. [3] I do not agree. Coalmining is a capitalist form of production. But, until quota arrangements etc. were introduced, the pressure of competitive market conditions forced coalowners in periods of depression to sell at heavy losses, i.e. to cut prices much more than, say, an engineer quoting for a specific control would have done. It was for this reason indeed that the quota arrangements were introduced. It is of the essence of "perfect competition" (vide p. 17 [4] ) that the changes in the output of the individual firm make a negligible difference to the price he gets, so that conditions of depression give no inducement to the individual producer to reduce his output, & <output> may come therefore to exceed demand by a large proportion. On the other hand, where producers work only in response to order, the curtailment of output as demand falls off is automatic. e.g. the curtailment of the output of a non-capitalist retail shopkeeper is automatic. I don't dispute that the non-capitalist nature of agriculture also falls in the same direction, though I should regard this as a minor factor. [5] But your negative assertion seems to me to fly in the face of palpable facts. And what is meant by the competitive capitalist restricting until he has reduced his marginal cost to the new price? A restriction of output is surely more likely to increase his marginal cost; & he doesn't think in these terms anyway. [6]

P. 64. Your empirical proposition is not comprehensive enough (in so far as warranted by experience) to justify this claim for your stabilizers. It may well be that falling prices will diminish trade activity for some time, but that after a bit they will give rise to corrective tendencies (more abundant bank-money, lower rates of interest etc.). On p. 70 you yourself give an explanation, in which the influence of falling prices does not continue indefinitely, &, without endowing it, you describe it as "attractive & convincing". But this would destroy your claim on p. 64, reiterated on p. 74 as one of the main conclusions of the chapter. [7]

Chapter II.

p. 81 (bottom) [8] While in full sympathy with your general argument here, I'm not sure that I follow it in detail. Surely so long as "slack" exists in the shape of surplus capacity in the consumption good industries you don't need as much constructional activity to increase output of consumable goods, as you do after the slack has been taken up. You appear to be saying the opposite. This has a bearing on your remarks about the inevitability of the cycle at the end of the chapter. [9]

pp. 93-105. [10]

In this section you give, I think, an admirably clear criticism of J.M.K.'s earlier doctrines & exposition of the relation between them & the latest version. I like your "Relation", greatly preferring it to the "Multiplier" (which I dislike because in so far as it is [b] valid it adds nothing to the old proposition that the forces that make for trade activity & depression are cumulative in character, & in so far as it goes further & asserts a limit (on the lines of a convergent series) & to this influence, it is invalid; the limits that there are being of a different sort than those indicated.) I think you bring off quite successfully the attempt to show how large changes in investment will in fact be associated with large changes of savings. My only quarrel with this section is my quarrel with J.M.K.'s new doctrines, which you appear to endorse, at points where I dislike them. I dislike this insistence on the identity of savings & investment, because it suggests false causal implications: e.g. I am convinced that if we all decided to spend all our incomes, the rate of interest would certainly rise. I am prepared at length to show how & why. The key to the muddle is, of course, the part played by unsold stocks of goods in net investment, as defined. This makes nonsense of some of the causal propositions enunciated, e.g. expository sentence on p. 101 [c] : [11] "the general level of economic activity is determined by the amount of investment taking place". Very well then. We all decide to spend only half as much on current consumption, next week as last. It follows that next week, net investment (as defined) will increase enormously. According to the doctrine, economic activity should be stimulated. We know that in fact the opposite would occur. For this proposition, the nature of the investment is obviously crucial; & so I claim it is for others. Instead of all the talk about "voluntary & involuntary savings" [d] , I wish there had been some about "voluntary & involuntary investment"! But all this is not fair regarded as a criticism of a very well-argued & well-sustained section.

Pages 105-122. [12]

I'm afraid that I'm fundamentally unsympathetic to the analysis of this section. It seeks to establish certain conclusions e.g. that the influence of your law of diminishing elasticities of demand is of practical importance [13]   1 by means of reasoning based on the assumption that even in a short period each entrepreneur is endeavouring to maximise his "monopoly net income". [14] As a statement of an (in a theoretical sense) ideal position, this assumption has no doubt a legitimate place in long-term theory, tho' I don't believe in elaborating it much there. But as an instrument of trade cycle analysis, it is too unreal to be legitimate. Entrepreneurs don't think in these terms & can't. It's [e] not only that they can't measure the elasticities of demand which are an integral part of the conception. The notion of elasticity itself, as applied to the individual firm, really presents a misleading picture of the facts. There is no even theoretically determinate proportion between an increase of output by an individual firm in imperfect competition & the price reduction to which he'd have to submit to sell his whole output. 2 (But I must leave this for verbal argument.) The essential point is that you found certain conclusions on the assumption that employers in fact pursue a certain objective. But they don't pursue it; so that your conclusions fall to the ground as unproved.

I add, however, certain comments on points of detail.

P. 112. Your paradox. [15] True enough, I think, but the connection is not of course causal. The "rise of marginal cost" doesn't raise the profit per unit. It's [g] the higher price, implied in the assumption stated, that does that; & the rise in marginal cost follows consequentially.

P. 116. (middle paragraph). [16] Why should a rise of wages not affect unfavourably the relation between marginal revenue & price 3 , which is mentioned (p. 108. [17] ) as also relevant to profits? To say, as you do, "Of course--my paradox doesn't hold there of the individual firm or industry" seems to me very unsatisfactory. The greater part of your analysis in this section is related to the individual firm. Your previous paradox was true of it; & so should this one be if it were valid. But, taking it as limited to industry as a whole, the proposition is only true if you assume that prices move in accordance with wages in a rather complex relationship. I can't see that you've any right to make this assumption about prices, or indeed any other, without having said yet virtually anything about money. Incidentally in the earlier paragraph on this page, you make statements about "the secular trend" of prices, [18] which are very much exposed to this objection. The phrase about "no words of mine" should in any case be omitted, in the event of publication. [19] You mustn't pick a quarrel with your readers; & this smacks to me very much like the abuse of the attorney with the bad case!

P. 119 (footnote) [20] I follow the differential equation; & note that if h (the elasticity of demand) were less than unity, the marginal cost would be negative. Doesn't this make nonsense? (By the way on this page, I'd never omit to put in "per unit" after profit & underline it--e.g. last line but one [21] --I thought at first your argument meant that M r Ford's profits must fall, if he finds he increases his sales greatly by a moderate lowering of price. Your argument appears at first sight to have no necessary connection with whether demand is moving up or down; & I think it well to bring out more clearly that it has.)

  1. 1. Harrod, The Trade Cycle ( 1936:8 ).

    2. The stabilizing force exerted by the "Plasticity of Prime Costs" is discussed in Harrod, The Trade Cycle ( 1936:8 ), pp. 28-29.

    3. The distinction between the reactions of "capitalist" and "non-capitalist" producers in the face of a reduction in their demand is discussed on pp. 32-33 of The Trade Cycle. "Capitalism" is defined as "the system in which the ownership of means of production is divorced from the function of actually using them" ( 1936:8 , p. 24).

    4. Harrod, The Trade Cycle ( 1936:8 ), p. 12.

    5. The destabilizing effect of the falling importance of agriculture in modern conditions was already discussed by Harrod and Henderson in October 1933, in the debate following Harrod's presentation of the memorandum on "Continuity of Values and the Long-Term International Problem" before the Royal Institute of International Affairs' Group on International Monetary Problems: see essay 13 , [jump to page] and note 11 .

    6. Henderson is probably referring to the revelations of the first entrepreneur interviewed by the Oxford Economists' Research Group, from which it resulted that he followed a pricing policy based on total rather than marginal cost, thus differing from the "rational entrepreneur" postulated by economic theory: see Harrod, minutes of the "Visit of Mr. H. F. Scott-Stokes on 31.i.36", in HCN 5/1/7 (Harrod later extensively discussed the problems relating with the assumption of rational behavior in a memorandum titled "Notes on Interviews with Entrepreneurs", here as essay 17 : see in particular [jump to page] - [jump to page] ).

    7. Harrod, The Trade Cycle ( 1936:8 ), pp. 43-44, 49 and 52. Harrod considered the proposition that "prices rise when goods are turned out in greater abundance and fall in the opposite situation" as "one of the very few generalizations vouchsafed by empirical observation" and as an "hypothesis strongly suggested by observation" (p. 41); its de-stabilizing effect is examined on p. 42.

    8. Harrod, The Trade Cycle ( 1936:8 ), p. 57.

    9. Harrod, The Trade Cycle ( 1936:8 ), pp. 102-06.

    10. Harrod, The Trade Cycle ( 1936:8 ), pp. 65-75.

    11. Harrod, The Trade Cycle ( 1936:8 ), p. 70 middle.

    12. Harrod, The Trade Cycle ( 1936:8 ), pp. 75-88.

    13. Harrod, The Trade Cycle ( 1936:8 ), pp. 85-86.

    14. Harrod, The Trade Cycle ( 1936:8 ), p. 75.

    15. Harrod, The Trade Cycle ( 1936:8 ), pp. 81-82. Harrod argues that the plasticity of prime costs determines price fluctuations to accompany output fluctuations, but does not determine a shift to profit.

    16. Harrod, The Trade Cycle ( 1936:8 ), pp. 84-85.

    17. Harrod, The Trade Cycle ( 1936:8 ), p. 78.

    18. Harrod, The Trade Cycle ( 1936:8 ), p. 84 bottom.

    19. The passage was eventually omitted from the published version.

    20. Harrod, The Trade Cycle ( 1936:8 ), p. 86 n.

    21. The suggested specification was added (p. 86), though not emphasized.

    1. a. ALS, two pages on one leaf, in HP, IV-480-484. The annexe autograph note, seven pages on seven notebook leaves, is in the same folder. A leaf with two pages of calculations in Harrod's handwriting is also attached, which do not seem to be related neither to Henderson's note or with one another.

      b. Ms: «as valid».

      c. Ms: «.».

      d. The inverted commas were not closed in the Ms.

      e. Ms: «Its».

      f. Possibly more than one illegible words.

      g. Ms: «Its».


1. therefore rising prices important to sustain trade activity [Henderson's note in the margin].

2. i.e., the elasticities don't really exist, even as unascertainable reality: the continuity <+> [f] implied, & which is essential for the use of the differential calculus to be legitimate do not exist [Henderson's note in the margin].

3. Marginal cost = marginal revenue; & marginal cost has increased [Henderson's note in the margin].


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