Friday, June 14, 2013

S. B. Saul on the Profit Deflation of the 1873–1896 Period

S. B. Saul’s book The Myth of the Great Depression, 1873–1896 (London 1985) is frequently cited by defenders of price deflation. Though it is indeed an important book, the deflation advocates ought to read it more carefully, for I contend that it does not really support their case.

Saul comments on the UK economy during the long period of price deflation from 1873 to 1896:
“one major source of finance for industry was industrial profits and variations in their level were of high importance in determining the trends in industrial investment. Evidence for the years after 1870 suggests that such investment varied more than proportionately with changes in profits. When profits fell, for instance, industrial investment declined to a greater extent. Probably at those times entrepreneurs used such profits as they made to buy foreign securities or to maintain dividends. Now, as we have already seen, a major feature of the British economy after 1876 was the low level of such profits.” (Saul 1985: 41).
Even more interesting is Saul’s conclusion about the
“Lower prices squeezed profits to the benefit of wages and probably this led to lower industrial investment.” (Saul 1985: 53).
So here price deflation’s effects may have been good for real wages of labour at certain times, but bad for business, which in the end only decreased aggregate investment and employment.

So much for the great claims made for this period of late 19th century deflation! Business seems to have hated it and the deflation depressed their expectations and investment levels.


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


  1. '“Lower prices squeezed profits to the benefit of wages and probably this led to lower industrial investment.” (Saul 1985: 53)."'

    So what was the reason for lowering prices if that led to lower profits ? Why didn't they just raise them again ?

    There has to be something else going on.

  2. That doesn't make any sense. How would lower prices squeeze profits and increase wages? A decrease in nominal profits due to lower prices leads to, cet par, the same real profits. Wages will only increase if nominal wages remain sticky.

    Deflation has its distributional effects through the credit system -- it favours creditors. And it has its effects on investment mainly through animal spirits, but also due to aggregate demand falling for the reasons Keynes laid out in Chapter 19 which are as follows (my summary):

    1. If wages falls the marginal propensity to consume will also fall. Even if prices adjust downwards, workers will save more relative to their income. If investment is not increased to make up the gap – and there is no reason to assume that it will – aggregate demand will fall by the same amount.
    2. As wages and prices fall, total real indebtedness rises. This may result in bankruptcies and otherwise put strains on companies’ balance-sheets.
    3. Expectations are important and if wages/prices are expected to fall further entrepreneurs will postpone investing in new capital goods.
    4. Likewise, price instability will make it very difficult for entrepreneurs to make business calculations going forward which may induce them to invest less.
    5. If wages and prices fall, those in society with more savings – i.e. the wealthier members of society – will hold more of the wealth. Since these people probably have a lower propensity to consume, total aggregate demand will likely fall.