Saul’s The Myth of the Great Depression, 1873–1896

Samuel B. Saul’s The Myth of the Great Depression, 1873–1896 (2nd edn. 1985) analyses the 1873 to 1896 deflationary period from the perspective of Great Britain. Saul raises many questions in this book, such as the question whether we are justified in considering 1873–1896 as a unified period of economic importance, and what causes produced the general deflationary trend.

Of course his major conclusion was that there was no actual continuous depression throughout the period, that real output at the end of the period was higher than at the beginning (Saul 1985: 54), and that the term “Great Depression” should not be used of the period (Saul 1985: 55). Furthermore, some of the trends visible in the 1873–1896 period continued afterwards and perhaps the downwards trend in prices was already underway in the 1860s and may, in some respects, have ended in the late 1880s (Saul 1985: 54). Overall the 1873–1896 period may not be a unified and historically significant era in the way previous economic historians thought (Saul 1985: 54–55).

Nevertheless, Saul also found that there were economic problems within the period (Saul 1985: 54), and a careful reading of the book shows that it presents problems for the advocates of price deflation.

I have summarised the main points and findings of Saul’s book below.

First, are we justified in seeing 1873 to 1896 as a unitary period?

Landes (1965), for example, argued that the whole period from 1815 to 1897 was essentially a unified period displaying a long-run downward trend in prices, with a plateau in prices in the middle, driven by technological advances and positive supply-side factors (Saul 1985: 13).

Nevertheless, to many historians and economists there is also something anomalous about the 1873 to 1896 deflation.

Saul (1985: 15) raises the possibility that there was an overall major factor driving the deflation until the late 1880s, but thereafter perhaps no general overall factor driving it. In fact, this was the view of Keynes in the Treatise on Money (1931), and Keynes saw monetary factors as the general cause of the deflation until the late 1880s, and then a different explanation for the 1890 to 1896 deflation (Saul 1985: 17).

Both at the time and continuing to this day, there have been two main explanations offered for the late 19th century deflation:

(1) falling prices owing to positive supply shocks and revolutionary technologies driving down prices, and

(2) a quantity theory of money explanation, either through (i) the modern neoclassical quantity theory or (ii) one stemming from the quantity tradition in Classical Economics, where the cost of production of gold was assumed to also influence changes in its “price”.

The second neoclassical quantity theory explanation has numerous supporters and certainly amongst monetarists, and it became popular by the 1980s (Saul 1985: 60). This explains the phenomenon as having been caused by the failure of the money supply to grow at a rate consistent with the growth in economic activity.

The second explanation sees the deflation as caused mainly by price falls in many goods from technological factors, innovative production techniques driving down costs and positive supply side factors. For example, freight rates on shipping from America to Britain and to the Continent fell sharply in the 1880s (Saul 1985: 22), as did overland freight rates too (Saul 1985: 23). Many agricultural goods saw price falls as production in the Americas, Australia, New Zealand, and South-East Asia increased markedly and transport costs fell.

In the end, Saul himself preferred an eclectic, not mono-causal, explanation of what caused the deflation that draws on many factors (Saul 1985: 26–28, 55).

But what about the economic problems that resulted from the deflation?

UK wages tell a very interesting story. Money wages fell from 1874 to 1879, but thereafter, despite long-run price deflation, were either stable or actually rose (apart from a brief and small fall from 1884 to 1886) (Saul 1985: 31). Real wages also rose virtually continuously from 1873 to 1896, apart from small falls from 1876–1878, 1879–1880, 1883–1884, and 1890–1892. It is clear that workers were able to maintain money wages even in the deflationary years and even during the recession of the early 1890s: in fact, in this period the share of income going to labour increased at the expense of profits (Saul 1985: 32–33, 63). This strongly confirms what contemporaries were saying: that the 1873–1896 period was marked by “proft deflation” or a profit squeeze that left business people highly pessimistic. While one cause of this for exporting industries is usually taken to be the slower growth of exports in the late 1880s (Saul 1985: 63), a fundamental cause must also have been price deflation and a significant degree of downwards nominal wage rigidity.

There emerges a further crucial point from the “profit deflation” phenomenon of these years. In Britain, it appears that a major source of business and industrial finance in the late 19th century was retained earnings out of profits (Saul 1985: 41). Saul adduces evidence that the share of profits out of industrial income fell as the deflation of 1873–1896 proceeded (Saul 1985: 42, citing Feinstein 1959), as can be seen in the following graph.

As we can see, the inflationary boom of the mid-Victorian age (1850–1873) saw rising levels of profits, but when the long-run deflation occurred, the percentage of profits of total industrial income fell significantly. It is possible too that what we would now call UK capacity utilisation rates fell in the late 19th century in this period (Saul 1985: 43, citing Ashworth 1966).

Saul blames institutional factors, the negative legacy of Britain’s “early start” in industrialisation, and the decline in Britain’s overseas export markets in the late 19th century for its failure to innovate and its lower levels of investment (Saul 1985: 51).

But he also points to another important explanation: it can be argued that, given that UK investment was financed out of retained earnings to an important degree, the price deflation led to a falling profit rate given relatively inflexible wages so that this probably adversely affected aggregate investment and expectations (Saul 1985: 53–54). This actually stands out as one of Saul’s most important conclusions (Saul 1985: 53–54).

So the effects of the “profit deflation” on business expectations were significantly negative, which probably caused increasing pessimism and unwillingness to invest. Saul, however, does not address the issue of debt deflation as a cause of business pessimism, but it may have been an important factor, and there seem to be hints from contemporaries like Alfred Marshall that it was a factor.

Finally, recent estimates of UK unemployment in the late 1800s show that significant unemployment did exist for much of this period, as can be seen in the graph below (with data from Boyer and Hatton 2002).

Further Reading
“Robert Giffen on the Deflation of 1873–1896,” December 7, 2014.

“Alfred Marshall on Business Confidence,” December 3, 2014.

“Alfred Marshall on Wage Stickiness and Debt Deflation,” November 30, 2014.

“The Profit Deflation of the 1890s,” June 13, 2013.

“Alfred Marshall’s Judgement on the “Depression” of 1873–1896,” June 13, 2013.

“S. B. Saul on the Profit Deflation of the 1873–1896 Period,” June 14, 2013.

“Alfred Marshall on the Deflation of 1873–1896,” October 14, 2014.

“Alfred Marshall’s Interest Rate Theory,” November 3, 2014.

BIBLIOGRAPHY
Ashworth, W. 1966. “The Late Victorian Economy,” Economica n.s. 33.129: 17–33.

Beckworth, David. 2007. “The Postbellum Deflation and its Lessons for Today,” The North American Journal of Economics and Finance 18.2: 195–214.

Boyer, George R. and Timothy J. Hatton. 2002. “New Estimates of British Unemployment, 1870–1913,” The Journal of Economic History 62.3: 643–667.

Capie, F. H. and G. E. Wood, 1997. “Great Depression of 1873–1896,” in D. Glasner and T. F. Cooley (eds). Business Cycles and Depressions: An Encyclopedia. Garland Pub., New York. 287–288.

Feinstein, Charles H. 1959. “Home and Foreign Investment: Some Aspects of Capital Formation, Finance and Income in the United Kingdom, 1870–1913,” Ph.D. dissert., University of Cambridge.

Hanes, C. 1998. “Consistent Wholesale Price Series for the United States, 1860–1990,” in Trevor J. O. Dick (ed.), Business Cycles since 1820: New International Perspectives from Historical Evidence. E. Elgar, Cheltenham, UK and Northampton, MA.

Landes, D. S. 1965. “Technological Change and Development in Western Europe, 1750–1914,” in H. J. Habakkuk and M. Postan (eds.) The Cambridge Economic History of Europe (vol. 6). Cambridge University Press, Cambridge. 274–601.

Saul, Samuel Berrick. 1985. The Myth of the Great Depression, 1873–1896 (2nd edn.), Macmillan, London.

The Profit Deflation of the 1890s

The phenomenon of “profit deflation” in the 1890s is described in this fascinating analysis by H. Clark Johnson:

“The international deflation of 1891–96 directly compressed profits. The extent of actual price decline was less than for the two income deflations considered above. From 1890 through 1896, Sauerbeck’s British wholesale price index declined by 18 percent and The Economist’s index dropped by 14 percent. British money wages, however, actually rose by several percentage points, so the rise in real wages was striking. The rate of investment dropped sharply; new capital issues averaged £102 million during 1880–89 and £154 million during 1889-90 but fell to an average level of £70 million during 1891–96. (These data depict a trend; investment need not be financed through new issues.) The rate of saving was high and increased from perhaps £150 million annually in 1880 to £200 million annually in 1896. Aggregate savings deposits grew greatly during the 1890s, both at the Post Office and at private banks. As investment declined despite the increase in savings, the second term of the price equation turned negative, while the first term increased slightly but steadily — reflecting the rigidity of input costs.

The pattern in the United States was similar. During 1893–96, the wholesale price index declined by 2.4 percent annually, compared to a decline of 1.1 percent annually during 1879–92. Unlike wages during the deflation of the 1870s, hourly wages were steady in nominal terms and hence rose in real terms. (Evidence on British and American wage levels during the 1890s undermines frequent assertions that wages were flexible during the period of the prewar gold standard.) Whereas the (nominal) volume of New York City bank clearings was steady during the deflation of the 1870s, it decreased abruptly during 1892–94. Tobin’s q declined moderately from 1892 through 1896, which was significant in part because it followed a full decade of stagnation in real stock prices. The annualized stock index level of 1881 was not exceeded until 1899.

The 1890s saw intense agitation for inflationary policies, and a central plank of William Jennings Bryan’s Democratic party platform of 1896 was that the gold standard should be abandoned in favor of bimetallism. When the Republicans won the election, the gold standard was again perceived as being secure. This conclusion was soon reinforced by rising world gold output and the beginning of a mild international inflation, which weakened the political attraction of bimetallism.” (Johnson 1997: 20).

There are two issues here, although the second is more important for my purposes:

(1) the idea that the 19th century was a period of relatively flexible wages, and

(2) the effects of the price deflation from 1873 to 1896, and in particular on profits and the level of investment.

First, it appears wages were not as flexible in the 1890s, during this later era of the gold standard, as some economists think.

Secondly, it appears that profit deflation, from the price deflation, with relative wage rigidity, induced a fall in investment. That was part of the economic crisis in the 1890s.

Now some neoclassical Marshallian economists at Cambridge University had their own pre-Keynesian theory about the causes of the late 19th century economic problems in the 1880s.

John Neville Keynes, John Maynard Keynes’s father, gave his own evidence to the UK “Royal Commission on the Depression of Trade and Industry” (whose final report was published in 1886).

He saw price deflation as having the following undesirable effects, as described by Skidelsky:

“These linkages were brought out by Neville Keynes in his evidence to the Royal Commission on the Depression of Trade and Industry (1886). The depression in trade was ‘partly but not wholly due’ to the rise in the value of gold relative to other commodities. This discouraged enterprise for five reasons:

(a) because a fall in price between the start and the completion of a transaction involved the trader in loss;

(b) because the trader tended to exaggerate his own loss by not taking sufficient account of the general fall in prices,

(c) because the profits of enterprise were temporarily diminished on account of increased depreciation of fixed capital;

(d) because the ratio of profits to wages fell as a result of the fall in money wages lagging behind the fall in prices, and

(e) because the fall in prices increased the burden of debt, transferring wealth from borrowers to lenders.

Such evidence was not intended to challenge the now orthodox quantity theory, merely to point to the difficulties of adjusting from one price level to another. Its implication was that monetary policy should be used to raise prices, and thereafter stabilise the price level. Out of such considerations developed the movement for bimetallism, which was an attempt to increase the amount of legal tender money by obliging the central bank to mint both gold and silver on demand at a fixed ratio.” (Skidelsky 1983: 231).

So John Neville Keynes anticipated modern concerns about debt deflation and also identified profit deflation as one of the causes of decreased private investment during this period of deflation.


BIBLIOGRAPHY
Johnson, H. Clark. 1997. Gold, France, and the Great Depression, 1919–1932. Yale University Press, New Haven and London.

Skidelsky, R. J. A. 1983. John Maynard Keynes: Hopes Betrayed 1883–1920 (vol. 1). Macmillan, London.

Reply to “Unemployment, Deflation and Growth During the Period of 1873–1896”

A commentator on Mises.org called “Rodolphe Topffer” attempts a critique of my views on US GNP growth in the late 19th century:

“Unemployment, Deflation and Growth During the Period of 1873–1896,” 4 September, 2012.

My response:

(1) The whole post suffers from the use of a straw man argument.

Curiously, the author cites Bordo and Filardo for the view that it is “abundantly clear that deflation need not be associated with recessions, depressions, and other unpleasant conditions” – but this very view is, as far as I can see, already accepted by Keynesians. Certainly, I accept it.

The idea that there is “a common belief among Keynesians that a situation of a falling prices will result in a recession” is simply not true, if by that we mean that academic Keynesian economists think that price deflation always results in recession. On the contrary, any Keynesian with a decent knowledge of economic history knows about the long period of deflation in the Western world from 1873–1896, during which there was in fact real output growth. In one of the first posts on my blog, I in fact noted this myself.

Now what Keynesians would say is that deflation can be a consequence of economic crisis when the money supply collapses, or that, in an environment of heavy private debt, steep deflation is likely to induce debt deflationary effects. This is quite different from thinking price deflation is always bad or results in real output collapse.

(2) Rodolphe Topffer states:

“The periods running from 1873 to 1879 and 1879 to 1896 show a huge increase in GNP per capita, see Rothbard (2002) ‘A History of Money and Banking in the United States’ (see pages 360–361, 400–403, 154–155, 159–161, 164).”

Let us look at US per capita GDP in the late 19th century from the figures in Angus Maddison (2006), which appear to be calculated from the estimates in Balke and Gordon (1989):

US per capita GDP 1870–1900
(in 1990 international Geary-Khamis dollars)
Year | GDP | Growth rate
1870 | 2445 |
1871 | 2489 | 1.79%
1872 | 2524 | 1.40%
1873 | 2562 | 1.50%
1874 | 2601 | 1.50%
1875 | 2643 | 1.61%
1876 | 2686 | 1.62%
1877 | 2732 | 1.71%
1878 | 2780 | 1.75%
1879 | 2829 | 1.76%
1880 | 2880 | 1.80%
1881 | 2921 | 1.42%
1882 | 2963 | 1.43%
1883 | 3008 | 1.51%
1884 | 3056 | 1.59%
1885 | 3106 | 1.63%
1886 | 3158 | 1.67%
1887 | 3213 | 1.74%
1888 | 3270 | 1.77%
1889 | 3330 | 1.83%
1890 | 3392 | 1.86%
1891 | 3467 | 2.21%
1892 | 3728 | 7.52%
1893 | 3478 | -6.70%
1894 | 3314 | -4.71%
1895 | 3644 | 9.95
1896 | 3504 | -3.84%
1897 | 3769 | 7.56
1898 | 3780 | 0.29
1899 | 4051 | 7.16
1900 | 4091 | 0.98
Average Growth Rate 1871–1900: 1.78%
Average Growth Rate 1873–1879: 1.64%
Average Growth Rate 1879 to 1896: 1.36%
Average Growth Rate 1871–1880: 1.64%
Average Growth Rate 1881–1890: 1.65%
Average Growth Rate 1891–1900: 2.04%
(Maddison 2006: 465–466).

The average per capita GDP rate from 1873 to 1879 was 1.64%.

The average per capita GDP rate from 1879 to 1896 was 1.36%. This was not especially high historically.

As always, the data is only an estimate and might be challenged. For example, Joseph H. Davis’s (2006) list of recessions in the 19th century, on the basis of his annual dataset of US industrial production from 1796 to 1915, shows that the US had a recession from 1873 to 1875 lasting about 3 years, a recession which is absent from Balke and Gordon (1989).

If Davis is right, the mid-1870s was hardly a prosperous period.

The most telling data is unemployment, which we can see here from the estimates is that of J. R. Vernon (1994):

Year | Unemployment Rate
1869 | 3.97%
1870 | 3.52%
1871 | 3.66%
1872 | 4.00%
1873 | 3.99%
1874 | 5.53%
1875 | 5.83%
1876 | 7.00%
1877 | 7.77%
1878 | 8.25%
1879 | 6.59%
1880 | 4.48%
1881 | 4.12%
1882 | 3.29%
1883 | 3.48%
1884 | 4.01%
1885 | 4.62%
1886 | 4.72%
1887 | 4.30%
1888 | 5.08%
1889 | 4.27%
1890 | 3.97%
1891 | 4.34%
1892 | 4.33%
1893 | 5.51%
1894 | 7.73%
1895 | 6.46%
1896 | 8.19%
1897 | 7.54%
1898 | 8.01%
1899 | 6.20%
(Vernon 1994: 710).

The 1873–1896 era saw two periods of rising unemployment: (1) 1875–1878 and (2) 1893–1896.

Thus the period from 1873–1896 in the US had two periods of economic crisis: the mid/late 1870s and 1893–1896. During both these periods unemployment rose sharply. A financial crisis also appears to have begun the crisis periods. It is quite likely that the economy in both 1870s and 1890s experienced some degree of debt deflation, so that the deflation was the cause of economic malaise.

(3) The author objects to a comparison of per capita GDP between 1946–1973 and 1873–1896, but the major objection is simply absurd:

“2) Theoretically, we can say that economic growth is much easier when the economy has to recover from the damages caused by the war. The comparison therefore does not hold.”

Why is this absurd? The US was not invaded or damaged during the war in the way the European economics were. Thus there was no “war reconstruction” in the US as there was in Europe. Instead, what occurred was the reconversion of the US economy from its wartime command structure to a peacetime consumer economy. That was certainly accomplished by 1950. So even if we were to subtract the 1946–1949 period, it is obvious that a comparison of 1950–1973 with an equivalent period in the late 19th century (say, 1873–1896) should be perfectly justifiable.



BIBLIOGRAPHY

Balke, N. S., and R. J. Gordon, 1989. “The Estimation of Prewar Gross National Product: Methodology and New Evidence,” Journal of Political Economy 97.1: 38–92.

Davis, J. H. 2006. “An Improved Annual Chronology of U.S. Business Cycles since the 1790s,” Journal of Economic History 66.1: 103–121.

Maddison, Angus. 2006. The World Economy: Volume 1: A Millennial Perspective and Volume 2: Historical Statistics. OECD Publishing, Paris.