Formative Process of John R. Commons’ Income Approach to Falling Prices

Abstract:

I illustrate the formative process of John R. Commons’ price movement theory. To characterize his theoretical development, I propose a framework, “income approach,” in which the change in collective expectation leads to a change in the amount of income, first as bank credit and then as price movement. Further, I illustrate his theoretical development as the framework's formation. Compared with his 1890s papers, his 1923 papers show significant theoretical progress. His reading of Ralph G. Hawtrey, the pioneer of the income approach, may have contributed to this progress. Subsequently, by elaborating on an explanation for the continuously falling prices during the Great Depression, Commons finally established his comprehensive income approachs.

Keywords::

• John R. Commons
• quantity approach
• income approach
• Ralph G. Hawtrey
• post-Keynesian institutionalism

JEL Classification Codes::

• B15
• B25
• B52

Notes

1 This is the foundation of the classical coordination mechanism of the balance of trade under the gold standard (Furukawa 2012, 59, 142). The quantity of money exogenously increases; then, prices increase, trade registers deficit, and gold registers outflows, that is, a decrease in the quantity of money. This is referred to as the “price effect” on the balance of trade. As a result, prices decrease and the balance of trade improves. The quantity of money, prices, and balance of trade returns to the equilibrium position.

2 Compared with the quantity approach, the income approach provides another explanation of the fluctuation of the balance of trade. When bank lending increases, income increases; then, the amount of imports increases and the available capacity to export decreases, leading to deterioration of the balance of trade. Compared to the price effect of the balance of trade under the quantity approach, this is instead an “income effect” to the balance of trade under the income approach (Furukawa 2012, 148).

3 Hawtrey (1927, 83) identified the determinants of the transition from this upward reinforcement to a downward reinforcement. When bank credit increases and the gold reserve decreases to a dangerous level, and if it is difficult for banks to voluntarily restrict their lending, the central bank should adhere to a tight credit policy that leads to the transition.

4 While the best-known scholar who presented the balance sheet path as “debt deflation” is Irving Fisher (1932), Hawtrey (1919) had already identified not only the basic path but also the balance sheet path of the income approach (Furukawa 2012, 97).

5 The gold standard in the United States was completely established in 1900.

6 If we only focus on a portion such as following, which shows his prospect if the “free silver coinage” plan proposed by farmers was adopted by the United States, we would inadvertently estimate that he adopted the quite typical quantity approach:

Free silver would also send all of our gold abroad and would raise Europe's gold prices about 20 per cent. [ … ] Free silver coinage [plan], with silver at its present value, would send prices in the United States up about 60 per cent, while in Europe they would rise only 20 per cent. (Commons 1894a, reel 19, frame 6)

7 Terakawa (2019) proposed that Commons (1893a, 1893b, 1894a, 1894b) implicitly expressed “the theory of endogenous money supply” and the “nominalism” view of monetary nature. While I advocate the proposition, this article only focuses on what was written in the papers and indicates that their descriptions of income approach to price fluctuation was rather inadequate.

8 Regarding a co-author, Harlan McCracken, who was Commons’ doctoral student at the time, see Steven Kates (2011).

9 The information in the memorandum was used in his manuscript “Inflation and Deflation” (Commons 1923a), the date mentioned being July 27, 1923.

10 Jürg Niehans (1992, 563) indicates that part of the explanation of the business cycle by Hawtrey (1919) is quite similar to Juglar's ideas.

11 As Commons (1923d, 646) clearly recognized, Foster and Catchings (1923, 12, 373) referred to Hawtrey (1922), which means there is a (small) possibility that Commons became familiar with the works of Hawtrey via Foster and Catchings (1923). I suppose that, since 1923, Commons had changed his reference on the issue of credit and business cycles from the works of Juglar to those of Hawtrey and that he maintained his high estimation of Hawtrey until the writing of his 1934 paper (Commons 1934).

12 An elaborated explanation of the income flow is subsequently provided in Commons (1934, 540–541).

13 It contains a section, titled “Creation of Debt” which is a shorter introduction to Hawtrey's (1919, 1923) discussion than the section “Hawtrey” in Commons (1928–1929a, 531–546) and the section “Creation of Debt” in Commons (1934, 472–483).

14 Commons (1928–1929a) was discovered by C. Whalen at the National Agricultural Library.

15 For more detailed comments regarding Commons’ perspective of the money as the institution, see Kota Kitagawa (2017b).

16 Among the myriad relevant or extant factors, the key factor for achieving the intended result of a certain going concern (e.g., the federal government, an association, a firm) is called the “limiting factor” (the other factors are called the “complementary factors”) by Commons. The same factors are not always the limiting factor or the complementary factors, and they are continuously changing (i.e., any given factor can shift from being a limiting factor to being a complementary factor). The role of the leader/leading body of the going concern is to inquire about and identify the current limiting factor in a “timely” way and to control it by “bargaining,” “managerial,” and “rationing” the transactions of the going concern (Commons 1934, 89–90, 305–306, 648). As we see below, Commons (1931a) identifies the currently operating limiting factor restricting the recovery of demand as the “expected margin for profit” of businesspersons.

17 Commons (1931a) is composed of eighteen pages (frames), each with approximately 300 words, and the date on the header of this manuscript is May 9. It was amended slightly and published as Commons (1931b) in a farming industry trade journal, Wisconsin Agriculturist and Farmer, in their June 20–July 11 issue.

18 In the time between 1929 and 1934, he clearly distinguished “risking” from “waiting” (Uni 2019). While waiting is businesspersons’ willingness to wait, and such action will be rewarded with interest, risking is businesspersons’ “willingness to run risks,” and such action has the possibility of being rewarded with profit (Commons 1934, 503).

19 While the income approach focuses mainly on the demand side of the economy, Commons (1928–1929a, partly missing, 375–495; 1928–1929b, reel 18, frame 390–475), written before the Great Depression, showed another approach to prices. It treats the income distribution as due to the increase in supply-side efficiency. Under the “efficiency” approach, Commons pointed out that deflation compels businesspersons and their employees to increase efficiency to reduce production costs. To prevent the exacerbation of deflation, he stressed that the value emerging from the increased efficiency should, at first, be distributed to producers (businesspersons and their employees) as profit and wages, the latter of which leads to stable employment and, after a lapse of time, is transferred to buyers as reduced commodity prices (Commons 1928–1929b, reel 18, frame 463, 475; Uni and Nakahara 2017, 150). To secure this development, he proposed institutional measures, for instance, “patent law,” a protection by law of “trade secrets,” “‘good-will’ and trade-marks of a business,” and the price stabilization of the Federal Reserve (Commons 1928–1929b, reel 18, frame 415, 467–475). The efficiency and income approaches thus became integrated into the “multiple causation” theory of Commons (1934).

20 Commons (1932a) is the draft of his speech to the Foreign Policy Association on April 22.

21 After he saw the interim success of the price management by the English and Swedish central banks in 1931–1932, Commons changed his mind from supporting the managed gold standard to questioning it and proposed the “Controlled Inflation and Stabilization” of prices by the Federal Reserve “on a paper money base” like in England and Sweden (Commons 1932a, reel 18, frame 754, 772; Chasse 2014, 205). He said that “the problems arising from experimental operations of stabilization of paper money prices by central banks or the Federal Reserve can hardly be worse than the alleged stability of the gold standard during the past 12 years, when gold has been monopolized under the control of 5 nations” (Commons 1932b, reel 18, frame 796). In June 1932, he strongly expressed that deflation is related to political volition:

[ … ] the issue at present is not that of abandoning the gold standard—it is, how soon will the gold standard be abandoned. The Federal Reserve System, by refusing to by securities or rising the discount rates can preserve the gold standard by forcing prices of commodities still lower. [ … ] This is a political question of how far the depression of prices shall be allowed to go. (Commons 1932b, reel 18, frame 795)

22 Before the Great Depression, Commons advocated transferring part of the “government expenditure from times of prosperity and busy seasons to times of depression and dull seasons,” as proposed by “Malthus, Foster and Catchings” (Commons 1928–1929b, reel 18, frame 470–471), while pointing out the practical limitations of this method. However, based on his profit-margin theory, Commons (1934, 589) denied the method because it transfers the income intertemporally, therefore not increasing demand.

23 Commons might have read the works of Hawtrey intensively in three periods. The first is when he had written the memorandum and manuscript (Commons n.d. 1923b). The second is when he had written the manuscripts (Commons 1928–1929a, 531–546; 1929, reel 18, frame 372–375). The third is when he had written Commons (1934, 600, 608).

24 During the Great Depression, when the government and the Federal Reserve sought to expand public spending and lending, there had been always the limitation of the reserve of “free gold” at the Federal Reserve and they had feared they would be compelled to abandon the essential institution of the managed gold standard (Commons 1932a, 1932b).

Additional information

Notes on contributors

Kota Kitagawa

Kota Kitagawa is an associate professor in the Faculty of Economics, Kansai University, Osaka, Japan. This work was supported by the JSPS KAKENHI grant numbers JP18K12753 and JP18K01530 and the Kansai University Fund for Supporting Young Scholars, 2018. In the JAFEE-AFEE Joint Session: Institutional Theory of Money and Business Cycle of John R. Commons, at the 23th JAFEE Annual Conference (Nagoya, March 16, 2019), where the draft of this article was presented, the author was provided helpful comments to improve the draft by Dr. Charles J. Whalen and Mr. Ryuichiro Terakawa. Disclosure statement: The author declares no financial interest or benefit and no conflict of interests.