The Great Transformation

C H A P T E R N I N E T E E N

When in the 1920s the international system failed, the almost forgotten issues of early capitalism reappeared. First and foremost among them stood that of popular government.

The fascist attack on popular democracy merely revived the issue of political interventionism which haunted the history of market economy, since that issue was hardly more than another name for the separation of the economic from the political sphere.

The interventionist issue was first brought to a head with regard to labor by Speenhamland and the New Poor Law on the one hand, Parliamentary Reform and the Chartist Movement on the other. In regard to land and money, the importance of interventionism was hardly smaller, even though clashes were less spectacular. On the Continent, similar difficulties in respect to labor, land, and money arose with a time lag which brought conflicts to bear on an industrially more modern but socially less unified environment. Everywhere the separation of the economic and the political sphere was the result of the same type of development. In England as on the Continent the starting points were the establishment of a competitive labor market and the democratization of the political state.

Speenhamland has been justly described as a preventive act of intervention, obstructing the creation of a labor market. The battle for an industrial England was first fought and, for the time being, lost on Speenhamland. In this struggle the slogan of interventionism was coined by the classical economists and Speenhamland branded an artificial interference with an actually nonexistent market order. Townsend, Malthus, and Ricardo erected upon the flimsy foundation of Poor Law conditions the edifice of classical economics, the most formidable conceptual instrument of destruction ever directed against an outworn order. Yet for another generation the allowance system protected the confines of the village against the attraction of high urban wages. By the middle 1820s Huskisson and Peel were broadening the avenues of foreign trade, export of machinery was permitted, the embargo on wool exports was raised, shipping restrictions were abolished, emigration was eased, while the formal revocation of the Statute of Artificers on apprenticeship and on wage assessments was followed by the repeal of the Anti-Combination Laws. And still the demoralizing Speenhamland Law was spreading from county to county, deterring the laborer from honest work, and making the very concept of an independent working man an incongruity. Though the time for a labor market had come, its birth was prevented by the squires’ “law.”

The Reform Parliament at once set out to abolish the allowance system. The New Poor Law which achieved this end has been called the most important act of social legislation ever carried by the House of Commons. Yet the core of the Bill was simply the repeal of Speenhamland. Nothing could prove more decisively that by this time the bare absence of intervention in the labor market was recognized as a fact of constitutive importance for the whole future structure of society. So much as to the economic source of the tension.

As to the political, the Parliamentary Reform of 1832 achieved a peaceful revolution. By the Poor Law Amendment of 1834 the social stratification of the country was altered, and some of the basic facts of English life were reinterpreted along radically new lines. The New Poor Law abolished the general category of the poor, the “honest poor,” or “laboring poor”—terms against which Burke had inveighed. The former poor were now divided into physically helpless paupers whose place was in the workhouse, and independent workers who earned their living by laboring for wages. This created an entirely new category of the poor, the unemployed, who made their appearance on the social scene. While the pauper, for the sake of humanity, should be relieved, the unemployed, for the sake of industry, should not be relieved. That the unemployed worker was innocent of his fate did not matter. The point was not whether he might or might not have found work had he only really tried, but that unless he was in danger of famishing with only the abhorred workhouse for an alternative, the wage system would break down, thus throwing society into misery and chaos. That this meant penalizing the innocent was recognized. The perversion of cruelty consisted precisely in emancipating the laborer for the avowed purpose of making the threat of destruction through hunger effective. This procedure makes intelligible that dismal feeling of desolation which speaks for us from the works of the classical economists. But to lock the doors safely upon the supernumeraries who were now caged in the confines of the labor market, government was put under a self-denying ordinance to the effect that—in Harriet Martineau’s words—to provide any relief to the innocent victims was on the part of the state a “violation of the rights of the people.”

When the Chartist Movement demanded entrance for the disinherited into the precincts of the state, the separation of economics and politics ceased to be an academic issue and became the irrefragable condition of the existing system of society. It would have been an act of lunacy to hand over the administration of the New Poor Law with its scientific methods of mental torture to the representatives of the selfsame people for whom that treatment was designed. Lord Macaulay was only consistent when he demanded in the House of Lords in one of the most eloquent speeches ever made by a great liberal the unconditional rejection of the Chartist petition in the name of the institution of property on which all civilization rested. Sir Robert Peel called the Charter an impeachment of the Constitution. But the more the labor market contorted the lives of the workers, the more insistently they clamoured for the vote. The demand for popular government was the political source of the tension.

Under these conditions constitutionalism gained an utterly new meaning. Until then constitutional safeguards against unlawful interference with the rights of property were directed only against arbitrary acts from above. Locke’s vision did not transcend the limits of landed and commercial property, and aimed merely at excluding highhanded acts of the Crown such as the secularizations under Henry VIII, the robbing of the Mint under Charles I, or the “stop” of the Exchequer under Charles II. Separation of government from business, in John Locke’s sense, was achieved in an exemplary fashion in the charter of an independent Bank of England in 1694. Commercial capital had won its tilt against the Crown.

A hundred years later not commercial but industrial property was to be protected, and not against the Crown but against the people. Only by misconception could seventeenth-century meanings be applied to nineteenth-century situations. The separation of powers, which Montesquieu (1748) had meanwhile invented, was now used to separate the people from power over their own economic life. The American Constitution, shaped in a farmer-craftsman’s environment by a leadership forewarned by the English industrial scene, isolated the economic sphere entirely from the jurisdiction of the Constitution, put private property thereby under the highest conceivable protection, and created the only legally grounded market society in the world. In spite of universal suffrage, American voters were powerless against owners.^*

In England it became the unwritten law of the Constitution that the working class must be denied the vote. The Chartist leaders were jailed; their adherents, numbered in millions, were derided by a legislature representing a bare fraction of the population, and the mere demand for the ballot was often treated as a criminal act by the authorities. Of the spirit of compromise allegedly characteristic of the British system—a later invention—there was no sign. Not before the working class had passed through the Hungry Forties and a docile generation had emerged to reap the benefits of the Golden Age of capitalism; not before an upper layer of skilled workers had developed their unions and parted company with the dark mass of poverty-stricken laborers; not before the workers had acquiesced in the system which the New Poor Law was meant to enforce upon them was their better-paid stratum allowed to participate in the nation’s councils. The Chartists had fought for the right to stop the mill of the market which ground the lives of the people. But the people were granted rights only when the awful adjustment had been made. Inside and outside England, from Macaulay to Mises, from Spencer to Sumner, there was not a militant liberal who did not express his conviction that popular democracy was a danger to capitalism.

The experience of the labor issue was repeated on the currency issue. Here also the 1920s were foreshadowed by the 1790s. Bentham was the first to recognize that inflation and deflation were interventions with the right of property: the former a tax on, the latter an interference with, business.^† Ever since then labor and money, unemployment and inflation have been politically in the same category. Cobbett denounced the gold standard together with the New Poor Law; Ricardo fought for both, with very similar arguments, labor as well as money being commodities and the government having no right to interfere with either. Bankers who opposed the introduction of the gold standard, like Atwood of Birmingham, found themselves on the same side with socialists, like Owen. And a century later Mises was still reiterating that labor and money were no more a concern of the government than any other commodity on the market. In eighteenth-century pre-federation America cheap money was the equivalent of Speenhamland, that is, an economically demoralizing concession made by government to popular needs. The French Revolution and its assignats showed that the people might smash the currency, and the history of the American states did not help to dispel that suspicion. Burke identified American democracy with currency troubles and Hamilton feared not only factions but also inflation. But while in nineteenth-century America the bickerings of populists and greenback parties with Wall Street magnates were endemic, in Europe the charge of inflationism became an effective argument against democratic legislatures only in the 1920s, with far-reaching political consequences.

Social protection and interference with the currency were not merely analogous but often identical issues. Since the establishment of the gold standard, the currency was just as much endangered by a rising wage level as by direct inflation—both might diminish exports and eventually depress exchanges. This simple connection between the two basic forms of intervention became the fulcrum of politics in the 1920s. Parties concerned for the safety of the currency protested as much against threatening budget deficits as against cheap money policies, thus opposing “treasury inflation” as much as “credit inflation,” or, in more practical terms, denouncing social burdens and high wages, trade unions and labor parties. Not the form, but the essence mattered, and who could doubt but that unrestricted unemployment benefits might be as effective in upsetting the balance of the budget as too low a rate of interest in inflating prices—and with the same nefarious consequences for the exchanges? Gladstone had made the budget the conscience of the British nation. With lesser peoples, a stable currency might take the place of the budget. But the result was closely similar. Whether wages or social services had to be cut, the consequences of not cutting them were inescapably set by the mechanism of the market. From the point of view of this analysis, the National Government of 1931 in Great Britain performed in a modest way the same function as the American New Deal. Both were moves of adjustment of single countries in the great transformation. But the British instance had the advantage of being free of complicating factors, such as civil strifes or ideological conversions, thus showing up the decisive features more clearly.

Since 1925 the position of Great Britain’s currency had been unsound. The return to gold was not accompanied by a corresponding adjustment of the price level, which was distinctly above world parity. Very few people were conscious of the absurdity of the course on which government and Bank, parties and trade unions had jointly embarked. Snowden, Chancellor of the Exchequer in Labour’s first government (1924), was a gold standard addict if ever there was one, yet he failed to realize that by undertaking to restore the pound he had committed his party either to shoulder a fall in wages or to go into the wilderness. Seven years later Labour was forced—by Snowden himself—to do both. By autumn 1931 the continuous drain of depression was telling on the pound. In vain had the collapse of the General Strike, in 1926, ensured against a further increase in the wage level—it did not prevent a rise in the financial burden of social services, especially through unconditional unemployment benefit. There was no need for a banker’s “ramp” (though ramp there was) to impress upon the nation the alternative of sound currency and sound budgets on the one hand, improved social services and a depreciated currency on the other—whether the depreciation was caused by high wages and falling exports or simply by deficit spending. In other words, there had to be either a cut in the social services or a fall in the exchanges. Since Labour was unable to decide for either—a cut was contrary to trade union policy and going off gold would have been deemed a sacrilege—Labour was shoved out of office, and the traditional parties cut the social services and, eventually, went off gold. Unconditional unemployment benefit was scrapped; a means test was introduced. At the same time the political traditions of the country underwent a significant change. The two-party system was suspended and no precipitation was shown to restore it. Twelve years later it was still in eclipse, with all signs against a real comeback. Without any tragic loss of welfare or of freedom the country, by suspending the gold standard, had taken a decisive step toward a transformation. During World War II this was accompanied by changes in the methods of liberal capitalism. However, these latter were not meant to be permanent and did not, therefore, remove the country from the danger zone.

In all important European countries a similar mechanism was active and with very much the same effect. In Austria in 1923, in Belgium and France in 1926, in Germany in 1931, Labour Parties were made to quit office “to save the currency.” Statesmen like Seipel, Francqui, Poincaré, or Brüning eliminated Labour from government, reduced social services, and tried to break the resistance of the unions to wage adjustments. Invariably the danger was to the currency, and with equal regularity the responsibility was fixed on inflated wages and unbalanced budgets. Such a simplification hardly does justice to the variety of problems involved which comprised almost every question of economic and financial policy, including those of foreign trade, agriculture, and industry. Yet the more closely we consider these questions the clearer it must become that eventually currency and budget focused the issues pending between employers and employees, with the rest of the population swinging in to the support of the one or the other of the leading groups.

The so-called Blum experiment (1936) offered another instance. Labour was in government, but on condition that no embargo on gold exports be imposed. The French New Deal never had a chance since the government was tied on the crucial question of currency. The case is conclusive since in France as in England, once labor had been made innocuous, the middle-class parties gave up the defense of the gold standard without further ado. These examples show how crippling the effect of the sound currency postulate was on popular policies.

The American experience taught the same lesson, in another way. The New Deal could not have been launched without going off gold, though foreign exchange actually mattered but little. Under the gold standard the leaders of the financial market are entrusted, in the nature of things, with the safeguarding of stable exchanges and sound internal credit on which government finance largely depends. The banking organization is thus in the position to obstruct any domestic move in the economic sphere which it happens to dislike, whether its reasons are good or bad. In terms of politics: On currency and credit governments must take the advice of the bankers, who alone can know whether a financial measure would or would not endanger the capital market and the exchanges. That social protectionism did not in this case result in a deadlock was due to the fact that the United States went off gold in time. For although the technical advantages of this move were slight (and the reasons given by the Administration were, as so often, very poor), the political dispossession of Wall Street was the result of this step. The financial market governs by panic. The eclipse of Wall Street in the 1930s saved the United States from a social catastrophe of the Continental type.

However, only in the United States, with its independence from world trade and its excessively strong currency position, was the gold standard chiefly a matter of domestic politics. In other countries, going off gold involved no less than dropping out of world economy. Perhaps the only exception was Great Britain, whose share in world trade was so large that she had been able to lay down the modalities under which the international monetary system should work, thus shifting the burden of the gold standard largely to other shoulders. In countries like Germany, France, Belgium, and Austria, none of these conditions existed. With them destruction of the currency meant cutting loose from the outer world and thereby sacrificing industries dependent upon imported raw materials, disorganizing foreign trade upon which employment rested, and all this without a chance of forcing a similar degree of depreciation on their purveyors and thus evading the internal consequences of a fall in the gold value of the currency, as Great Britain had done.

Exchanges were the highly effective arm of the lever that was pressing on the wage level. Before exchanges brought matters to a head, usually the wage issue was increasing the tension under the surface. But what the laws of the market often could not force upon reluctant wage-earners, the foreign exchange mechanism most effectively performed. The currency indicator made visible to all the unfavorable effects that interventionist trade union policies had on the market mechanism (the inherent weaknesses of which, including the trade cycle, were taken for granted).

Indeed, the utopian nature of a market society cannot be better illustrated than by the absurdities in which the commodity fiction in regard to labor must involve the community. The strike, this normal bargaining weapon of industrial action, was more and more frequently felt to be a wanton interruption of socially useful work, which, at the same time, diminished the social dividend out of which, ultimately, wages must come. Sympathy strikes were resented, general strikes were regarded as a threat to the existence of the community. Actually, strikes in vital services and public utilities held the citizens to ransom while involving them in the labyrinthine problem of the true functions of a labor market. Labor is supposed to find its price on the market, any other price than that so established being uneconomical. As long as labor lives up to this responsibility, it will behave as an element in the supply of that which it is, the commodity “labor,” and will refuse to sell below the price which the buyer can still afford to pay. Consistently followed up, this means that the chief obligation of labor is to be almost continually on strike. The proposition could not be outbidden for sheer absurdity, yet it is only the logical inference from the commodity theory of labor. The source of the incongruity of theory and practice is, of course that labor is not really a commodity, and that if labor was withheld merely in order to ascertain its exact price ( just as an increase in supply of all other commodities is withheld in similar circumstances) society would very soon dissolve for lack of sustenance. It is remarkable that this consideration is very rarely, if ever, mentioned in the discussion of the strike issue on the part of liberal economists.

Returning to reality: the strike method of fixing wages would be disastrous in any type of society, not to mention our own, which prides itself on its utilitarian rationality. Actually, the worker has no security in his job under a system of private enterprise, a circumstance which involves a grave deterioration in his status. Add to this the threat of mass unemployment, and the function of trade unions becomes morally and culturally vital to the maintenance of minimum standards for the majority of the people. Yet clearly any method of intervention that offers protection to the workers must obstruct the mechanism of the self-regulating market, and eventually diminish the very fund of consumers’ goods that provides them with wages.

By inherent necessity the root problems of market society reappeared: interventionism and currency. They became the center of politics in the 1920s. Economic liberalism and socialist interventionism turned upon the different answers given to them.

Economic liberalism made a supreme bid to restore the self-regulation of the system by eliminating interventionist policies which obstructed the freedom of markets for land, labor, and money. It undertook no less than to solve, in an emergency, the secular problem involved in the three fundamental principles of free trade, a free labor market, and a freely functioning gold standard. It became, in effect, the spearhead of a heroic attempt to restore world trade, remove all avoidable hindrances to the mobility of labor, and reconstruct stable exchanges. This last aim had precedence over the rest. For unless confidence in the currencies was restored, the mechanism of the market could not function, in which case it was illusory to expect governments to refrain from protecting the lives of their people by all the means at their disposal. In the nature of things, these means were, primarily, tariffs and social laws designed to secure food and employment, that is, precisely the type of intervention which made a self-regulating system unworkable.

There was also another, more immediate, reason to put the restoration of the international monetary system first: in the face of disorganized markets and unstable exchanges international credit was playing an increasingly vital part. Before the Great War international capital movements (other than those connected with long-term investments) merely helped to keep the balance of payment liquid, but were strictly limited even in this function by economic considerations. Credit was given only to such as seemed deserving of confidence on business grounds. Now the position was reversed: debts had been created on political grounds such as reparations, and loans were given on semipolitical grounds, in order to make reparation payments possible. But loans were also given for reasons of economic policy, in order to stabilize world prices or to restore the gold standard. The credit mechanism was being used by the relatively sound part of world economy to bridge the gaps in the relatively disorganized parts of that economy, irrespective of the conditions of production and trade. Balances of payment, budgets, exchanges were made to balance artificially in a number of countries with the help of a supposedly all-powerful international credit mechanism. But this mechanism itself was based on the expectation of a return to stable exchanges, which again was synonymous with a return to gold. An elastic band of amazing strength helped to maintain the semblance of unity in a dissolving economic system; but whether the band would stand the strain depended upon a timely return to gold.

The achievement of Geneva was remarkable in its way. Had the aim not been intrinsically impossible, it would have been surely attained, so able, sustained, and single-minded was the attempt. As matters stood, no intervention was probably more disastrous in its results than that of Geneva. Just because it always appeared to be almost successful, it aggravated enormously the effects of the ultimate failure. Between 1923, when the German mark was pulverized within a few months, and the beginning of 1930, when all the important currencies of the world were back to gold, Geneva used the international credit mechanism to shift the burden of the incompletely stabilized economies of Eastern Europe, first, to the shoulders of the Western victors, second, from there to the even broader shoulders of the United States of America.^* The collapse came in America in the course of the usual business cycle, but by the time it came, the financial web created by Geneva and Anglo-Saxon banking entangled the economy of the planet in that awful capsize.

But even more was involved. During the 1920s, according to Geneva, questions of social organization had to be wholly subordinated to the needs of the restoration of the currency. Deflation was the primary need; domestic institutions had to adjust as best they might. For the time being, even the restoration of free internal markets and of the liberal state had to be postponed. For in the words of the Gold Delegation, deflation had failed “to affect certain classes of goods and services, and failed, therefore, to bring about a stable new equilibrium.” Governments had to intervene in order to reduce prices of monopoly articles, to reduce agreed wage schedules, and to cut rents. The deflationist’s ideal came to be a “free economy under a strong government”; but while the phrase on government meant what it said, namely, emergency powers and suspension of public liberties, “free economy” meant in practice the opposite of what it said, namely, governmentally adjusted prices and wages (though the adjustment was made with the express purpose of restoring the freedom of the exchanges and free internal markets). Primacy of exchanges involved no less a sacrifice than that of free markets and free governments—the two pillars of liberal capitalism. Geneva thus represented a change in aim, but no change in method: while the inflationary governments condemned by Geneva subordinated the stability of the currency to stability of incomes and employment, the deflationary governments put in power by Geneva used no fewer interventions in order to subordinate the stability of incomes and employment to the stability of the currency. In 1932 the Report of the Gold Delegation of the League of Nations declared that with the return of the exchange uncertainty the main monetary achievement of the past decade had been eliminated. What the report did not say was that in the course of these vain deflationary efforts free markets had not been restored though free governments had been sacrificed. Though opposed in theory to interventionism and inflation alike, economic liberals had chosen between the two and set the sound-currency ideal above that of nonintervention. In so doing they followed the logic inherent in a self-regulating economy. Yet such a course of action tended to spread the crisis, it burdened finance with the unbearable strain of massive economic dislocation, and it heaped up the deficits of the various national economies to the point where a disruption of the remnants of international division of labor became inevitable. The stubbornness with which economic liberals, for a critical decade, had, in the service of deflationary policies, supported authoritarian interventionism, merely resulted in a decisive weakening of the democratic forces which might otherwise have averted the fascist catastrophe. Great Britain and the United States—masters not servants of the currency—went off gold in time to escape this peril.

Socialism is, essentially, the tendency inherent in an industrial civilization to transcend the self-regulating market by consciously subordinating it to a democratic society. It is the solution natural to industrial workers who see no reason why production should not be regulated directly and why markets should be more than a useful but subordinate trait in a free society. From the point of view of the community as a whole, socialism is merely the continuation of that endeavor to make society a distinctively human relationship of persons which in Western Europe was always associated with Christian traditions. From the point of view of the economic system, it is, on the contrary, a radical departure from the immediate past, insofar as it breaks with the attempt to make private money gains the general incentive to productive activities, and does not acknowledge the right of private individuals to dispose of the main instruments of production. This is, ultimately, why the reform of capitalist economy by socialist parties is difficult even when they are determined not to interfere with the property system. For the mere possibility that they might decide to do so undermines that type of confidence which in liberal economy is vital, namely, absolute confidence in the continuity of titles to property. While the actual content of property rights might undergo redefinition at the hands of legislation, assurance of formal continuity is essential to the functioning of the market system.

Since the Great War two changes have taken place which affect the position of socialism. First, the market system proved unreliable to the point of almost total collapse, a deficiency that had not been expected even by its critics; second, a socialist economy was established in Russia, representing an altogether new departure. Though the conditions under which this venture took place made it inapplicable to Western countries, the very existence of Soviet Russia proved an incisive influence. True, she had turned to socialism in the absence of developed industries, general literacy, and democratic traditions—all three of which according to Western ideas, were preconditions of socialism. This made her special methods and solutions inapplicable elsewhere, but did not prevent socialism from becoming an inspiration. On the Continent workers’ parties had always been socialist in outlook and any reform they wished to achieve was, as a matter of course, suspect of serving socialist aims. In quiet times such a suspicion would have been unjustified; socialist working-class parties were, on the whole, committed to the reform of capitalism, not to its revolutionary overthrow. But the position was different in an emergency. If normal methods were insufficient, abnormal ones would then be tried, and with a workers’ party such methods might involve a disregard of property rights. Under the stress of imminent danger workers’ parties might strike out for measures which were socialistic or at least appeared as such to the militant adherents of private enterprise. And the very hint would suffice to throw markets into confusion and start a universal panic.

Under conditions such as these the routine conflict of interest between employers and employees took on an ominous character. While a divergence of economic interests would normally end in compromise, the separation of the economic and the political spheres in society tended to invest such clashes with grave consequences to the community. The employers were the owners of the factories and mines and thus directly responsible for carrying on production in society (quite apart from their personal interest in profits). In principle, they would have the backing of all in their endeavor to keep industry going. On the other hand the employees represented a large section of society; their interests also were to an important degree coincident with those of the community as a whole. They were the only available class for the protection of the interests of the consumers, of the citizens, of human beings as such, and, under universal suffrage, their numbers would give them a preponderance in the political sphere. However, the legislature, like industry, had its formal functions to perform in society. Its members were entrusted with the forming of the communal will, the direction of public policy, the enactment of long-term programs at home and abroad. No complex society could do without functioning legislative and executive bodies of a political kind. A clash of group interests that resulted in paralysing the organs of industry or state—either of them, or both—formed an immediate peril to society.

Yet precisely this was the case in the 1920s. Labor entrenched itself in parliament where its numbers gave it weight, capitalists built industry into a fortress from which to lord the country. Popular bodies answered by ruthlessly intervening in business, disregarding the needs of the given form of industry. The captains of industry were subverting the population from allegiance to their own freely elected rulers, while democratic bodies carried on warfare against the industrial system on which everybody’s livelihood depended. Eventually, the moment would come when both the economic and the political systems were threatened by complete paralysis. Fear would grip the people, and leadership would be thrust upon those who offered an easy way out at whatever ultimate price. The time was ripe for the fascist solution.

* Hadley, A. T., Economics: An Account of the Relations between Private Property and Public Welfare, 1896.

† Bentham, J., Manual of Political Economy, p. 44, on inflation as “forced frugality”; p. 45 (footnote) as “indirect taxation.” Cf. also Principles of Civil Code, Ch. 15.

* Polanyi, K., “Der Mechanismus der Weltwirtschaftskrise,” Der Österreichische Volkswirt, 1933 (Supplement).