The 1922 Study of The Trade Cycle

The contents of Lavingtons book on the trade cycle are now examined. Its subject matter is covered in nine short chapters, treating both the social and economic aspects of the cycle. Lavington’s (1922: 7) Preface acknowledges that:

Most of the leading ideas [for the book] have been drawn from the writings of Dr. Marshall, Professor Pigou, Mr. D.H. Robertson, and from the great work on Business Cycles by Professor W.C. Mitchell of California. The facts and the subsidiary argument have come from a wider range of sources, including the writings of Professor Mitchell and M. Aftalion, to whom inadequate acknowledgement is made in the text.

Lavington (ibid.) added indebtedness to Hubert Henderson and ‘other Cambridge friends’ for valuable criticism and suggestions, while his use of the records of the Board of Trade, Lavington’s former employer, was also acknowledged.

The introduction to the book also recognized that 1921 was a crisis year with much ‘unwilling unemployment’ and ‘ample resources vainly [seeking] employment’ (ibid.: 9). Price uncertainties, preventing reliable business forecasts, high protection costs limiting the ability of industry to successfully compete in foreign markets, and growing distrust in the labour market hampering appropriate wage settlements, are all parts of the crisis picture (ibid.: 10). The cycle, Lavington added, is a recurring phenomenon, as indicated by a century’s history of prosperity and depression, the major causes of which needed further investigation (ibid.: 11-12).

Chapter II evaluates the nature of the business cycle. It suggests growth occurs in waves, whose rhythmical character demands an explanation. From peak to peak, the average cycle is estimated to last eight years. It is marked by three stages: rising activity, the peak (followed by the crisis and panic), and then declining activity. Wholesale prices follow a similar pattern, as does the rate of change in capital goods production (ibid.: 14-16). The chapter ends with the claim that cycles are the leading cause of unemployment in modern industrial society, and with a rejection of the Jevonian sunspot theory as an implausible explanation for the cycle.

Chapter III elaborates on the contemporary business situation which generates cycles. Entrepreneurs make business decisions either in private firms, partnerships, or joint-stock companies engaged in manufacturing, in wholesale, or in the retail trade (ibid.: 18-19). Modern production takes time, resources have to be invested to meet future demands, hence expectations about the future have to be formulated. Given this pattern, investment goods production tends to fluctuate widely, but considerable interdependence among all types of producers nevertheless exists. Incomes generate production, indicate the prevalent volume of demand, thus in turn influencing output decisions. The pattern of the income-output cycle is also reflected in the price level, introducing monetary factors to the analysis of the cycle. Hence, the state of business confidence is a key factor.

Chapters IV and V examine business confidence in some detail. Lavington (ibid.: 29-30) suggests that business estimates of future market conditions are influenced by waves of optimism and pessimism. These have little influence in a planned and regulated economy. In a capitalist economy, however, they tend to exaggerate business reactions in both the upswing and the downswing, partly through their impact on purchasing power and money supply, which follow activity levels. As Lavington (ibid.: 36-37) put it at the end of Chapter IV:

When markets are rapidly expanding, and prices rising, the most inefficient entrepreneurs find business easy and profitable; rationally based confidence gives way to optimism—judgements are infected by a general error; many businesses are extravagantly managed, many ventures are undertaken with no reasonable prospects of success; and causes are set in motion whose effects, in the form of realised business error, destroy the confidence from which they arise and bring the period of prosperity to an end.

Chapter V considers in more detail the role that monetary factors play in the trade cycle by investigating price influences on business confidence. Increasing confidence during an upswing is reflected in rising market expectations, rising output, and eventually rising prices. Initially, output expansion tends to lower prices, but its impact also falls on money supply as bank deposits are more actively used as business improves. Monetary growth gradually outstrips output growth, putting pressure on prices (ibid.: 47-48). Rising prices benefit entrepreneurial incomes, lowering incomes for landlords, capitalists, and especially for labourers. Rising entrepreneurial incomes gradually induce errors in business forecasts from excessive optimism and bring the upswing eventually to an end. The effect of price rises on the availability of purchasing power assists this process.

Chapters VI, VII, and VIII present a discussion of the course of the business cycle. This starts with the downward phase of ‘dull business’. Gradually,

the minds of business men turn towards the future and its possibilities, armed with the knowledge that no depression is ever permanent. Confidence builds slowly, assisted by other promising features of the economic situation: lower wages, reduction in stocks to very low levels, rising bank reserves and low interest rates, while the fall in wholesale prices comes to an end. The sentiment takes hold that the end of the depression is near, making business confidence rise further. Repair work, generating growth in purchasing power and renewed consumer spending, reappears. The cycle goes into its upswing phase, marked by growth in capital investment, an expansion of employment and of credit, a great increase in business commitments based on a precarious extension of confidence and inducing a drain on bank reserves and ultimately an encroachment of costs on the margin of business profits (ibid.: 65).

These conditions are sufficient for Lavington to generate a downturn and declining trade, just as in the upswing, the necessary monetary expansion is ultimately limited while the rapid growth in investment outstrips the requisite savings levels pushing yields in a downward direction and putting upward pressure on the structure of interest rates. Expected yields are not realized as the boom progresses, eventually lowering the demand for new capital, lowering the rate of investment, and then the general level of demand for output. The fall in demand makes a depression inevitable (ibid.: 70-73, 78-79). The Lavington cycle rests on monetary factors including price levels, as well as real factors inherent in saving-investment analysis and the psychological factors of optimism and pessimism in business decision making.

In his final chapter, Lavington addresses the social consequences of the trade cycle. These are placed in a background deriving much from both free trade and free entry, in which real wages are growing considerably and where income distribution favours the middle classes and, to a lesser extent, the working class. This is not to say that business cycles have no harmful effects over the longer run. Their impact on unemployment, recognized by Lavington in his analysis, was considerable, as shown clearly in William Beveridge’s Unemployment: A Problem of Industry (1909). But, as Marshall (1890 [1920]: 687-688) had shown, medieval artisans had experienced ‘inconsistent employment’ so that the problem was an old one, not necessarily confined exclusively to contemporary developments (Lavington 1922: 94, 96-99, 101). Lavington also argued that social reorganization cannot really provide a cure. The banking system, however, had done much to mitigate the extent of the cycle, and in particular had reduced the incidence of panics. Moreover, the policy of public works, particularly that of spacing the impact of public works to fall into depressed periods, was spreading as a remedy for cyclical unemployment (ibid.: 109-110). Greater flexibility of wages and prices could assist the speedier revival from periods of depression and unemployment: ‘[C]hecking the excessive growth of business confidence’ by greater control over price changes, would likewise limit ‘the extravagance of the boom and the intensity of the following period of depression’ (ibid.: 113). Identifying remedies for the adverse consequences of the business cycle, in Lavington’s view, was closely related to grasping the fundamental causes of the cycle.

As Lavington himself came close to admitting, there was little originality in his treatment of the business cycle. Its essentials were very similar to the treatment of the subject by Alfred and Mary Marshall’s Economics of Industry (1879: Book III, Chapters 1 and 2). As mentioned previously, it also considerably resembled Pigou’s treatment of cyclical fluctuations in Part VI of The Economics ofWelfare, while the publication of Robertson’s A Study of Industrial Fluctuation in 1915 had greatly assisted Lavington, particularly because of its underlying saving-investment analysis. Lavington’s main contribution was his emphasis on financial markets and the uncertainty faced by businessmen when making financial and investment decisions. Furthermore, The Trade Cycle was a neat little volume, clearly setting out the role of business sentiments and fluctuating confidence levels, so popular in the 1920s. It was by no means Lavingtons major economic work, but an interesting contribution to the growing trade cycle literature nevertheless.