Originally Posted by The Great Depression
What triggered the crisis?
Fischer explained it was a combination of Marxian crisis theory and Keynesian under-consumption theory: "People who wanted to consume all did not have the means, and the people who had the means could not consume all. Hence our reduced purchasing power."
What needs to be done? "Divide and redivide profits," he said. "That is the way out." There should be "provision for a perfectly equal division of surplus value in years to come"; we should eliminate "the profit of the capital owner" and create "socialism."
Hazlitt responded by showing Fischer's figures on surplus value to be based on a "fallacy of selection." Fischer had picked base years (1899 and 1929) with a purpose in mind and then confused anomalies with a general trend. Two can play this game, and Hazlitt showed that labor's product can be said to have been increasing relative to output by picking other years (1869 and 1921).
Moreover, Hazlitt asked, why if labor's decreasing share of profits is the cause, how do we explain economic recoveries during the same period in question? How can we explain. using this reasoning, why the crisis did not come sooner?
As Hazlitt said, Marx's theory "makes it difficult to explain why we are not always in a crisis, and impossible to explain how we ever surmount one." On that basis, he dismissed the broader implication that the 1929 crash represented anything like a long-running trend in the structural basis of the economy.
But what if Fischer were right, that labor really was earning a smaller return relative to capital? Hazlitt noted this would not necessarily mean that people are being exploited. It could just mean the volume of capital in industry was increasing at a greater rate than that of labor, which indicates increasingly efficient technology. If so, that might lend weight to the expectations of the classical economists that labor would own more capital as productivity increased. For example, the number of stockholders increased dramatically during the 1920s.
Having dispensed with Fischer's sweeping Marxian theory, he argued that the best period to examine from an economic point of view was the time "between the last crisis and the present one—the period, say, from 1922 to 1929." In this period one notices that the prices and output of capital and labor in the industrial sector were growing out of proportion to the agricultural sector. That may not have any significance to the cause of the crisis, but it brings into question the idea of economy-wide exploitation of labor.
Having exploded Fischer's data and economic theory, he went on to speculate on an alternative. There was no visible free-market theory on why the U.S. was in crisis. But Hazlitt knew from his reading of history of the trouble that comes with an overactive and indebted government. He knew the secret to the crash resided with these problems.
A stable market order, he said, requires an atmosphere free of shocks, or at least a government that allows the economy to correct once those shocks had occurred. The war had artificially inflated the prices of commodities and they needed to correct downward to a more realistic level. He argued the crisis of 1929 was that downward correction.
"But the focus of this collapse," he wrote, "was aggravated enormously by the whole series of post-war policies." Among these he listed the "vicious Treaty of Versailles," the "disorganization caused by reparations and war debts," the "preposterous tariff barriers thrown up everywhere," the abandonment of the gold standard and the adoption of the "gold-exchange standard," and "reckless lending to foreign countries.
Most importantly, he blamed the "artificial cheap-money policy pursued both in England and America, leading here to a colossal real-estate and stock-market speculation under the benign encouragement of Messrs. Coolidge and Mellon." This malinvestment, caused by inflationary policies, created distortions in the capital stock which called for correction.
Later Hazlitt would conclude that malinvestment was the central problem, not only in the Great Depression, but in all business cycles. He did so under the influence of Ludwig von Mises, whom he met about a decade later. Together they advocated the gold standard as a policy, and the "Austrian" theory of the business cycle. The theory, developed by Mises, points to the way markets coordinate plans over time and the way central bank money and credit expansion disrupts those plans.
One such patently absurd recommendation in Fischer's essay, according to Hazlitt, was his call for high new taxes on capital. This measure "would violently aggravate the catastrophe," Hazlitt said, by causing business to take another downturn that would make the 1929 crash look trivial. An increase in wages would be undesirable as well, Hazlitt said, because that would cause their cost to business to increase and lead to even more unemployment. In order to make the economy recover, he said, we need more private capital, not less, and that means letting markets work.