Chapter I. Introductory

Among the factors which determine any given business situation there are some which act from within and some which act from without the economic sphere. Economic consideration can fully account for the former only; the latter must be accepted as data and all we can do about them in economic analysis is to explain their effects on economic life. Hence we arrive at the very important concept of factors acting from without {let us call them External Factors), which it stands to reason we must try to abstract from when working out an explanation of the causation of economic fluctuations properly so called, that is, of those economic changes which are inherent in the working of the economic organism itself. [1]

The best examples of what we mean by an external factor are offered by such events as the great Tokyo earthquake, the virtue of which from our standpoint consists in the fact that no one has thought of attributing responsibility for them to our industrial system. Whenever a disturbance is the product of social processes, the difficult question arises whether it is not as much a consequence as a cause of economic events and situations and hence whether we are within our rights if we speak of it as "acting from without the economic sphere." In a deeper sense, the answer is undoubtedly in the negative. But for our purpose it is yet permissible to draw a line between the phenomena directly incident to the working of the economic system and the phenomena produced by other social agencies acting on the economic system, however obviously this action may be conditioned by economic situations or propelled by economic aim or class interest. In a sense, therefore, we may within the limited range of our investigation look upon wars, danger of war, revolutions, and social unrest as external factors. Changes in the tariff policy of a country or in its System of taxation, measures of social betterment, and government regulations of all kinds we include in the same class. After all, there is probably little that could be objected to in our recognition of the fact that it would not help us much, for instance in an analysis of the problems of foreign exchange, to deal indiscriminately with cases in which exchanges are determined by commercial factors alone and cases in which they are "pegged" as the French exchange was during the war. And this is all that our distinction amounts to so far. But for obvious reasons it is less easy to carry out the distinction in other cases, and great care—carried even to the extent of hairsplitting—is required in order to do justice to the endless variety of the social patterns we encounter.

Variations of crops due to natural causes, such as weather conditions or plagues, raise a problem only because of the difficulty of separating them from variations due to other causes. But for this, we could class them with the effects of earthquakes. Gold discoveries also could be listed in the same category as far as they may be considered, from the standpoint of the business organism, to be chance events. But it is a fact that variations in the total supply of gold often come about in response to business situations and in exactly the same way as variations in the supply of any other commodity. The variations in the monetary supply of gold are never conditioned by chance discoveries alone. Hence we have here a case of mixed character not always easy to interpret.

This, however, raises the question of discoveries of new coun­tries and of what is readily seen to be for our purposes similar in character and effect, inventions. Both create new possibilities and are no doubt among the most important causes of economic and social change. But are they external factors in our sense? Our answers will best be given by way of examples. If we scrutinize the motives and methods of Columbus's venture, we find that it would be by no means absurd to call it a business venture. In this case it would be just as much an element of the business situation as is any other enterprise. But if we refuse to do this, the discovery of America does not thereby become an external factor, for it was not directly relevant to the course of the economic process at all. It acquired relevance only as and when the new possibilities were turned into commercial and industrial reality, and then the individual acts of realization and not the possibilities themselves are what concern us. Those acts, the formation of companies for the exploitation of the new opportunities, the setting of the new countries, the exports into and the imports from them, are part of the economic process, as they are part of economic history, and not outside of it. Again, the invention of, say, the Montgolfier balloon was not an external factor of the business situation of its time; it was, indeed, no factor at all. The same is true of all inventions as such, witness the inventions of the antique world and the middle ages which for centuries failed to affect the current of life. As soon, however, as an invention is put into business practice, we have a process which arises from, and is an element of, the economic life of its time, and not something that acts on it from without. In no case, therefore, is in­vention an external factor.

We sometimes read that in the nineteenth century the opening up of new countries was the background on which economic evolution achieved what it did. In a sense this statement is true. But if the inference is that this circumstance was an external factor, that is, something distinct from that very economic evolution and independently acting upon it, then the statement ceases to be true: our vision of the evolution of capitalism must precisely include the opening up of new countries as one of its elements and as a result of the same process which also produced all the other economic features of that epoch. Among them is the mechanization of industry. Again, we read a statement made by a high authority in our field, to the effect that it is not "capitalistic enterprise" but technological progress (invention, machinery) which accounts for the rate of increase in total output during the nineteenth century. Obviously it is not a matter of indifference whether we accept the theory underlying that statement, namely that the mechanization of industry was a phenomenon distinct from "capitalistic enterprise" and independently influencing it—a phenomenon which could and would have come about in substantially the same way whatever the social organization—or whether we hold as we do (in this respect entirely agreeing with Marx) that technological progress was of the very essence of capitalistic enterprise and hence cannot be divorced from it.

We need not stay to explain why, for any country, business fluctuations in another country should be looked upon as external factors. But to treat in this way variations in the number and age distribution of populations is less easy to justify. Migrations in particular are so obviously conditioned by business fluctuations that no description of the mechanism of cycles can claim to be complete without including them, and including them—at least some of them—as internal factors. However, as we shall not deal with this group of problems in this volume— although the writer is alive to the seriousness of this breach in our wall—it will be convenient to consider migration over the frontiers of the territories to which our statistics refer, provisionally, as an external factor, while migration within those territories, which it would be impossible so to consider, will be no­ticed but incidentally. Changes in numbers and age distributions due to other causes than migration sometimes are in fact external factors or consequences of external factors, such as wars. [2]

Finally, we have had examples (changes in tariff policy, taxation, and so on) of what we may term changes in the institutional framework. They range from fundamental social reconstruction, such as occurred in Russia after 1917, down to changes of detail in social behavior or habits, such as keeping one's liquid resources in the form of a demand deposit rather than in the form of cash at home or contracting collectively rather than individually. It is entirely immaterial whether or not such changes are embodied in, or recognized by, legislation. In any case they alter the rules of the economic game and hence the significance of indices and the systematic relations of the elements which form the economic world. In some cases, however, they so directly act by means of business behavior that it may become difficult to recognize them as external factors. Change of practice by the Federal Reserve System or by any Central Bank in Europe may be itself an act of business behavior and an element of the mechanism of cycles, as well as an external factor; and so may collective measures taken by the business world itself. Every such case must be treated on its merits, and decision may be difficult indeed. Our distinction must be kept in mind even in such cases, but it works with increasing difficulty the more frequent they become. This is but a consequence of the fact that our economic system is not a pure one but in full transition toward something else, and, therefore, not always describable in terms of a logically consistent analytic model.

Now, it is obvious that the external factors of economic change arc so numerous and important that if we beheld a complete list of them we might be set wondering whether there was anything left in business fluctuations to be accounted for in other ways. This impression is much intensified by the fact that the impact of external factors would of itself account for wavelike alternation of states of prosperity and of depression, both because some disturbances occur at almost regular intervals and because most of them induce a process of adaptation in the system which will produce the picture of a wavelike oscillation in every individual case.

In fact, it would be possible to write, without any glaring absurdity, a history of business fluctuations exclusively in terms of external factors, and such a history would probably miss a smaller amount of relevant fact than one which attempts to do without them. Consequently, a theory of business fluctuations to the effect that they are caused by external factors would not lack verifying evidence; indeed, it might be the first to suggest itself to an unprejudiced mind.

There are instances covering considerable stretches of our material, in which effects of external factors entirely overshadow everything else, cither in the behavior of individual elements of business situations or in the behavior of business situations as a whole. The fall of greenback prices during the greenback "deflation" after 1866, which even the prosperity of 1872 was powerless to reverse (although it did arrest it) is an instance of the first class. The whole course of economic events from 1914 to about 1920 may be cited as an instance of the second. There is no perfectly satisfactory remedy for this. We shall, indeed, exclude from the facts on which we are to base fundamental conclusions, material which is obviously vitiated by such things as the World War, "wild" inflations, and so on. This is the reason why we shall deal with postwar cycles separately and try, as far as possible, to work out fundamentals from prewar material, although sources of facts and figures flow much more freely since 1919 than they did before 1914. We cannot, however, go very far in this direction without losing too much of our material. But the influence of external factors is never absent. And never are they of such a nature that we could dispose of them according to the schema of, say, a pendulum continually exposed to numerous small and independent shocks. The power of the economic machine is great enough to hold its own to an astonishing degree, even as it shows its working in the worst material and the most faultily constructed indices. But it never works entirely true to design, although at some times more so than at others. Seven conclusions of great, if sinister, importance follow from this.

In the first place, it is absurd to think that we can derive the contour lines of our phenomena from statistical material only. All that we could ever prove from it is that no regular contour lines exist. We must put our trust in bold and unsafe mental experiments or else give up all hope. Here also we strike one of the fundamental difficulties about economic forecasting—one which goes far to explain and even to excuse some of the failures of predictions to come true. At almost any point of time statistical contour lines bear uncomfortable resemblance to the skyline of a city after an earthquake. Hence it is as unreasonable to expect the economist to forecast correctly what will actually happen as it would be to expect a doctor to prognosticate when his patient will be the victim of a railroad accident and how this will affect his state of health.

Second, it is important to keep in mind that what we know from experience is not the working of capitalism as such, but of a distorted capitalism which is covered with the scars of past injuries inflicted on its organism. This is true not only of the way in which our business organism functions but also of its structure. The very fundaments of the industrial organisms of all nations have been politically shaped. Everywhere we find industries which would not exist at all but for protection, subsidies, and other political stimuli, and others which are overgrown or otherwise in an unhealthy state because of them, such as the beet-sugar industry in Europe and shipbuilding all over the world. Such industries are assets of doubtful value, in any case a source of weakness and often the immediate cause of breakdowns or depressive symptoms. This type of economic waste and maladjustment may well be more important than any other.

Third, in some cases we may gather enough information about the nature, range and duration of a big disturbance to know more or less precisely which of our figures are vitiated by it. Then we can either drop these items or try to correct them —as we sometimes do, for instance, in the case of prices during an inflation. But whether we do this or something else or nothing at all, it is always of the utmost importance for us to be thoroughly masters of the economic history of the time, the country or the industry, sometimes even of the individual firm in question, before we draw any inference at all from the behavior of time series. We cannot stress this point sufficiently. General history (social, political, and cultural), economic history, and more particularly industrial history are not only indispensable but really the most important contributors to the understanding of our problem. All other materials and methods, statistical and theoretical, are only subservient to them and worse than useless without them.