by Utsa Patnaik
The Return to the Gold Standard
The loss of colonial markets also explains the balance of payments problems of Britain in the interwar period. The most significant event of the period, of course, was Britain’s return to the gold standard in 1925 at prewar parity. But even the discussion of this event has invariably made no reference to the loss of colonial markets, to the fact that the unsustainability of Britain’s return to the gold standard at prewar parity arose precisely because the colonial arrangement was no longer working in the interwar period.
This is hardly surprising.5 Indeed, the colonial arrangement does not even figure in discussions of the sustainability of the prewar gold standard. But in view of our extensive discussion of the role of the colonial arrangement in sustaining the gold standard, based on the work of S. B. Saul, the breakdown of that arrangement has to be accorded a centrality in any explanation of Britain’s balance of payments problems in the interwar period.
Discussion on the unsustainability of the prewar parity when Britain returned to the gold standard has focused mainly upon the relative price levels in the United States and Britain. Since the United States had maintained its prewar parity on the gold standard, and since British prices at prewar parity were nearly 6 percent higher than the corresponding prices in the United States (some opponents of return at prewar parity claimed that they were 10 percent higher, while several proponents of return at prewar parity thought they were 2.5 percent higher), return at prewar parity would have entailed an overvaluation of the pound sterling. Keynes, who was opposed to a return to the gold standard, wanted the floating exchange rate to continue.
We argue, however, that while the exhaustion of Britain’s colonial markets and their growing penetration by Japan manifested themselves through the unsustainability of the prewar parity at which Britain returned to the gold standard, they would have manifested themselves anyway, nullifying whatever policy Britain followed for improving its balance of payments.
Floating the exchange rate would not have overcome Britain’s difficulties. The loss of markets to Japan could not have been negated this way, since the Japanese would have retaliated. And if Britain’s loss of markets to Japan was compensated by a capture of markets from other competitors, then they too would have retaliated. Hence, there was no equilibrium exchange rate of the pound sterling at which the British balance of payments could have stabilized. Even if the current balance could, in principle, have improved with exchange rate depreciation in the absence of retaliation, there were limits to which competitors would have allowed Britain to encroach on their markets.
The fear expressed by A. C. Pigou that with the system of floating exchange rates, there would be a continuous depreciation of this rate, or “debasement of the currency,” which would be damaging to the financial health of the British economy, was an implicit recognition of this fact. Because of this apprehension Pigou wanted a return to the gold standard, which would at least fix the exchange rate. But even a fixed exchange rate, no matter what the parity, would have scarcely helped.
Let us briefly see what a fixed exchange rate would have implied. Introducing such fixity through a return to the gold standard, no matter what the parity, would necessarily have immediately required, at given money wages and prices, an adequate amount of capital inflows to manage the balance of payments, for which the interest rate had to be raised.
But if the balance of payments was to be sustained through a better current balance rather than through capital inflows, then the current balance had to be improved. If the parity at which Britain returned to the gold standard had been low enough to bring about an improvement in the current balance without any lowering of the domestic price level, then this would have required a lowering of money wages, and hence real wages. This is because the higher sterling value of imported inputs at the new exchange rate would have had to be accommodated at the given price level only through a money wage (and hence real wage) cut. Besides, if the current balance did improve, then a competitor like Japan would have retaliated by going off the gold standard and depreciating its currency, as indeed it did later.
On the other hand, if the parity had been high, as it actually was when Britain returned to the gold standard, then the domestic price level had to be brought down through a lowering of money wages. This too would have entailed a real wage cut;6 and if successful in improving the current balance, it would also have invited retaliation. In other words, whether Britain adopted a floating rate as Keynes had suggested or a fixed rate as Pigou had suggested, along with a lowering of money wages and prices, there would necessarily have been a real wage cut. And it would have been ineffective to boot, as Britain’s competitors would have retaliated if it showed signs of improving Britain’s current balance.
Indeed, both the proponents and opponents of a return to the gold standard wanted a reduction in dollar terms of the British wage rate, which meant, in effect, a reduction in the real wage rate. However, while the proponents wanted it through a reduction in the money wage rate (their estimates of the requisite cut were small), the opponents wanted it through a reduction in the British exchange rate rather than through a reduction in British money wage rate. Among their arguments for doing so could be a belief in the “money illusion” on the part of the workers, that is, they would react sharply to a cut in money wages (which in fact they did), but not to a cut in real wages due to an exchange rate depreciation. Indeed, we have no means of knowing how they would have reacted to such a cut.
In short, how a cut in British real wages could be effected was the point of the debate, but a cut in real wages was not being opposed by any side. And a cut had become necessary because the British balance of payments were no longer sustainable, owing, inter alia, to the loss of colonial markets.
But whether Britain went back to the gold standard at the prewar parity, or at some other parity, or continued with a floating exchange rate, as suggested by Keynes, its balance of payments could not have been stabilized. Any improvement in its current balance, no matter how it was achieved, even if through a reduction in the domestic level of activity caused by the fall in real wages, would have meant a deterioration in the current balance of one or the other of its competitors. Such a deterioration in their current balance would necessarily have meant a fall in the level of activity in their economy, since government expenditure to sustain the level of activity had not yet come to be in vogue. In response to this, the competitors would have retaliated, either by lowering their own exchange rate if it had been floating earlier or by moving to a floating rate if they had been on the gold standard.
The crucial advantage of the colonial markets had been that the colonies could not retaliate. The colonies provided a sanctuary to which Britain could export as much as it liked to avoid any balance of payments difficulties, which in turn helped the entire capitalist world to run account surpluses vis-à-vis Britain. The loss of this sanctuary necessarily meant difficulties for Britain no matter what exchange rate regime it adopted, and no matter what parity it adopted in the event of returning to the gold standard.
Hence, the structural problems facing Britain owing to the collapse of the colonial arrangement that had sustained it earlier should not be reduced to a question of what the appropriate gold-pound-sterling parity was. Whatever the parity, Britain faced a problem.
This unsustainability of the prewar parity led to an attempt at wage deflation to make the exchange rate stick, which in turn resulted in the 1926 General Strike in Britain. The return to gold at prewar parity was the demand of the City, which wanted London to remain the financial center of the capitalist world. Crucial to its ambition was the need to ensure that the pound sterling was “as good as gold,” namely that wealth-holders who put their trust in sterling would never have any cause to rue their decision, since sterling would never depreciate in value vis-à-vis gold (or other currencies under a gold standard arrangement). The unsustainability of the prewar parity owing to the unraveling of the coloni
al arrangement, which sharpened the conflict between British finance capital and the British working class, must not, however, mislead us into thinking that some other parity would have been sustainable.
The gold standard became unsustainable because the exhaustion of the colonial and semi-colonial markets meant that no “outside” space was available to which British goods could retreat. Now the different capitalist powers were locked in a zero-sum game where none of them could improve its current balance without someone else’s current balance worsening.
The implications of capitalist powers getting locked in a zero-sum game were mentioned in passing by Keynes in The General Theory. Referring to the “economic causes of war, namely the pressure of population, and the competitive struggle for markets,” he writes:
It is the second factor that probably played a predominant part in the nineteenth century, and might again, that is germane to this discussion.… Under the system of domestic laissez-faire and international gold standard such as was orthodox in the latter half of the nineteenth century there was no means open to a government whereby to mitigate economic distress at home except through the competitive struggle for markets. For all measures helpful to a state of chronic or intermittent underemployment were ruled out, except measures to improve the balance of trade on income account.7
Keynes was wrong on his facts. There were no major wars in Europe between the Crimean War and the First World War, other than the wars for German and Italian unification, and this was precisely because there were no competitive struggles for markets as the colonial and semi-colonial markets were available and “on tap.” But with the exhaustion of colonial and semi-colonial markets, we get into the situation described by Keynes, and a competitive struggle for markets comes on the agenda. Britain was caught in this struggle in the interwar period and, no matter what instruments it used, it would have faced retaliation and been unsuccessful in overcoming its balance of payments difficulties.8
The unraveling of the colonial arrangement that sharpened the contradiction between British finance capital and the British working class has important theoretical implications. Colonialism, or more generally imperialism, has been widely seen as blunting the intensity of class conflict in advanced capitalist countries. This has always been explained, following Lenin, through the fact that the super-profits earned by monopoly capital are used to “bribe” a “labor aristocracy,” a thin upper stratum of the working class (which includes trade union leaders).
Michal Kalecki’s theory of distribution made possible a widening of the discussion from mere monopoly super-profits, which appear to be confined to only a certain segment of the capitalists, to the entire issue of the terms of trade between manufacturing and primary commodities. Since the manufacturing sector as a whole follows “markup” pricing, a rise in money wages can be “passed on” without any reduction in the capitalists’ profit margins; it can cause a rise in real wages through the terms of trade between manufacturing and primary commodities being tilted against the latter. The functioning of the price system, in short, was such that a rise in workers’ share in the gross value of output could be accommodated without a decline in capitalists’ share through a squeeze on the share of the primary commodity producers. It is not some category of “super-profits” but the very modus operandi of the system that accommodates workers at the expense of primary commodity producers, and imperialism is the entire arrangement that makes this possible.
But whether we take the Leninist conception of “super-profits” being used to “bribe” a “labor aristocracy” or the notion derived from Kalecki of an arrangement where a rise in money wages gives rise to a higher wage share by turning the terms of trade against primary commodity producers, the role of imperialism in stabilizing capitalism through accommodating workers has been seen entirely in terms of its distributive implications. But as our discussion of the colonial arrangement shows, the role of imperialism in stabilizing the system by placating the working class has to be seen not in merely distributive terms but in more comprehensive terms, namely its implications for employment, growth, exchange rate, confidence in the leading currency, and so on. The return to gold at prewar parity did not per se mean any increase in capitalists’ share or primary producers’ share; nonetheless, it led to an attempt to reduce the workers’ share. The colonial prop that contributes toward blunting working-class resistance consists, in other words, in much more than merely providing super-profits or enabling higher wages.
Agricultural Crisis
Apart from the loss of Britain’s Asian markets, another factor that undermined the colonial arrangement was the agricultural crisis that set in during the 1920s. The war years had raised agricultural prices; in the postwar period these prices kept declining, so that fixing a precise date for the onset of the agricultural crisis becomes difficult. But whatever the precise date, the agricultural crisis added further to Britain’s balance of payments problems.
Britain, we have seen, had managed its balance of payments by using the export surplus of the colonies, which it appropriated gratis against arbitrarily-imposed items of expenditure that figured both in the colonial government’s budget and on the debit side of the current account of the balance of payments of the colony (since they had to be spent abroad). But the export items of the colonies that yielded this surplus consisted mainly of primary commodities, especially agricultural goods. With the fall in agricultural prices, there was a fall in the export surplus of colonies, which was now not enough to meet Britain’s balance of payments requirements.
This, to be sure, meant that the colonies had to borrow more in order to defray their drain-related expenditure, which in turn added to their future payment obligations. But this was of little assistance to the British balance of payments. Let us say that India has to pay 100 pounds to Britain on account of drain-related payments but has no export surplus with which to pay it. Then, India borrows 100 pounds and pays Britain. But if Britain has to settle its deficit with the United States, then it will ideally need either dollars or gold for this purpose. If it has neither, then there will be an excess supply of pounds and an excess demand for gold or dollars, which would threaten the pound sterling’s exchange rate. Being on the gold standard where the currency is supposed to be convertible into gold, Britain will then have to adopt domestic recessionary policies to maintain its exchange rate.
Thus, both the loss of colonial markets and the world agricultural crisis made the earlier colonial arrangement untenable. Britain could no longer play its customary role as the leader of world capitalism. Its level of activity could not be sustained in the face of the growing balance of payments difficulties it faced. And this, in turn, affected the entire capitalist world. The Great Depression of the 1930s had its roots in this unraveling of the colonial arrangement.
One implication of the agricultural crisis, as we have just seen, was the inability of the colonies to meet their drain-related expenditures, and hence they got into debt. Soon, however, Britain demanded that they should repay their debt through gold. As a result, colonies like India had to ship gold to Britain. Put differently, the form of the drain, which could no longer be agricultural goods (exported to the newly-industrializing world but used to settle Britain’s deficits with that world), now became gold, because of the sharp drop in the prices of such goods. This may have brought some relief to the British balance of payments, but it accentuated greatly the impact of the Great Depression on the colonial economies.
As we have seen, meeting the drain-related expenditures meant having a budget surplus that corresponded to the export surplus on the balance of payments of the colony. During the Great Depression, when there was a deficiency of aggregate demand, the need was to boost aggregate demand through a fiscal deficit. In the colonies, however, loan repayment at this very juncture meant an increase in the size of the fiscal surplus. This had the opposite effect to what was required, namely a contractionary effect on the colonial economy caught in the throes of t
he Great Depression.
This effect was over and above the effect of the price crash of agricultural goods. Since the drain-related expenditure was fixed in pounds sterling, it was also fixed in nominal terms in local currency at any given exchange rate. To meet this expenditure, adequate tax revenue had to be raised, which in the context of a fall in agricultural prices meant a larger effective tax burden on the peasantry. The large-scale indebtedness of the peasantry all over the third world during the Depression years was not just because of the shift in the terms of trade between manufacturing and primary products in favor of the former, but also because the cash payment obligations of the peasantry, including for tax payments, remained unchanged even as their money incomes fell because of the decline in agricultural prices. Loan repayment by government added to this.
The unraveling of the colonial arrangement, in short, had a destabilizing effect on world capitalism, which not only brought the long Victorian and Edwardian booms to an end but plunged the world economy into the Great Depression. We shall discuss this in the next chapter.
CHAPTER 12
A Perspective on the Great Depression
The Great Depression of the 1930s has been variously explained. But curiously, among these explanations the role of the unraveling of the colonial arrangement that had sustained the long boom of “the long nineteenth century” does not even figure. This is a lacuna we attempt to overcome in the present chapter.
Alternative Explanations of the Depression
The number of explanations advanced for the Great Depression underscores as much the importance of the event in the history of capitalism as the richness of the theoretical attempts to capture its dynamics. Joseph Schumpeter had explained the Great Depression in terms of the fact that the troughs of all the three business cycles, the Kondratieff, the Juglar, and the Kitchin, had coincided. Alvin Hansen, a prominent economist in the Keynesian tradition, had seen it as the consequence of the “closing of the frontier.” Nicholas Kaldor, another Keynesian, who had sought to theorize technological progress, had seen it as arising from a shift in the “technological progress function,” that is, a drying up of the stream of innovations. Baran and Sweezy attributed the Great Depression to the emergence of monopoly capitalism, which brought with it a stagnationist tendency. And Charles Kindleberger saw in it a period of transition where Britain had lost its capacity to exercise the leadership role over the capitalist world, while the United States, which was to succeed Britain as the leader, was not yet ready to take on this role.
