Keynes, the Classicals, and Capital
There’s been a fairly acrimonious conversation going on at the Society for the History of Economics listserv, revolving around what Keynes had to say about “classical” economics, whether what he said was fair or accurate, and what this means for how we should interpret Keynesian economics. [Some of the participants suggest (a) Keynes’ interpretation of classical economics was almost wholly wrong and (b) as a result Keynesian economics should be almost wholly rejected. Others reach pretty much the opposite conclusion.] One specific area of contention is the meaning of Say’s Law within classical economics and resulting interpretation of Keynes’ theories of capital and of the rate of interest. While I don’t expect to settle any part of this debate, I have a long-standing interest in classical economics (my understanding of it has been shaped mostly by Samuel Hollander’s Classical Economics and Thomas Sowell’s Classical Economics Reconsidered and in Say’s Law. My conclusion is that the parties to this discussion have been talking past each other, for one primary reason: The world changed from one in which one conception of capital (and therefore of interest) was more-or-less valid to one in which it was not.
Consider the classical conception of production. It’s a world in which there is a discrete period of production, in which resources are combined to produce an output. During that period of production, entrepreneurs have to pay for the resources they use. At the end of that period the output is sold. Then, entrepreneurs have to decide whether to undertake a subsequent period of production. And periods of production are not overlapping. The implication of this is that the entrepreneur must have on hand at the beginning of the period of production the means of paying for the resources used during production. As a consequence, the classical conception of capital includes whatever it is that serves as a means of compensation for the resources used during production. One way this shows up is in the concept of the wages-fund, which is a form of capital used to pay labor during the production period. (It also shows up in the concept of circulating capital.) Where in the world is this conception of the production process (and the cycle of production) valid? In agriculture, and particular in the cultivation of annual crops, like wheat or oats or corn. And in the late 17th and early 18th century, one could argue that this was a reasonable way to think about production. According to this study, for example, agriculture accounted for more than 70% of total employment in the US in 1800 and a similar share of employment in England. So we have, in both countries, a production period that is (1) long—specifically, longer than the pay period for labor—and (2) sequential and non-overlapping. Producers need to know how they will pay for (for example) labor (and other variable resources) before undertaking production. Or, in other words, production is not a flow; it occurs at the end of the production period as a stock of output. Meanwhile, variable resources are a flow and must be paid during their period of use.
Now let us fast-forward to the 1920s. By 1930, agriculture accounted for less than 25% of US employment and less than 20% in England. How does this change things? First of all, we now have a situation in which periods of production are short—shorter than the pay period for labor. Secondly, we have overlapping periods of production. In automobile manufacturing, for example, a producer need not finish one production run of vehicles before beginning another. So the cycle for producers has changed. Payments for labor (and other variable resources) need not be funded in advance; rather, these payments can be made from an ongoing flow of revenue from the sales of the firm’s product. In short, production does not, in the “modern” world, result in a stock of product at the end of a production period that is then sold. Production is now a flow of product (the production period, again, is shorter than the pay period for variable resources) the sale of which can be used to pay for those variable resources. Firms will tend to hold stocks (inventories) of finished goods in order to be able to make sales at any time; firms will also tend to hold stocks (inventories) of intermediate goods in order to facilitate the ongoing flow of production. So inventories (and inventory finance) can—and is—still considered to be a part of capital, which labor is not. The concept of a pre-existing fund used to pay labor during an extended production period is, in fact, no longer useful, or valid.
Keynes wrote in this later period. And while he may well have mistakenly applied the (relevant) modern concept of capital to the period in which classical economists wrote, I don’t think he was wrong to introduce a new concept of capital, which required a new concept of interest, and a new concept of the position of labor in the production process.