1. The Problem with "The Problem of Social Cost"

Tom Walker, draft, October 25, 2011

I. The Problem Examined and the Problem Not Examined

Ronald Coase's "The Problem of Social Cost"(1960) was "concerned with those actions of

business firms which have harmful effects on others." The economic analysis he

challenged and the standard examples he re-examined were taken from Pigou's treatment

in The Economics of Welfare (1920). It was Coase's contention that the suggested courses

of action in the Pigovian tradition – liability, taxation or regulation – were inappropriate

and often undesirable.

Coase didn't consider the full range of Pigou's examples and analysis, however. His focus

on so-called externalities – what Pigou referred to, in part II of Economics of Welfare, as

"incidental uncharged disservices" or "uncompensated services" – did relate to the version

of neoclassical welfare economics and the "Pigovian tradition" prevailing in the 1950s. But

that tradition was already enervated and emaciated by its inattention to part III of The

Economics of Welfare, which addressed labor issues, and the Institutionalist legacy of part

III in the analysis by John Maurice Clark of the social overhead costs of labor (1923a,

1923b).

This is not to say that Coase went too far in his critique of Pigou but that he didn't go far

enough. Instead of advancing Alfred Marshall's concept of external economies, which

raises fundamental methodological issues for economics, Pigou diminished diverted it onto

the dead-end dichotomy of government intervention vs. "the system of natural liberty."

II. The Supposed Reciprocal Nature of the Problem Reconsidered

Coase claimed that the traditional approach to the problem of social cost "tended to

obscure the nature of the choice to be made." He characterized the question posed by the

approach as "one in which A inflicts harm on B and what has to be decided is: how should

we restrain A?" But, Coase objected, the problem was really a reciprocal one and the real

question was "should A be allowed to harm B or should B be allowed to harm A? The

problem is to avoid the more serious harm." While such a restatement of the problem may

be appropriate with regard to the externality problems discussed by Pigou in part II, it

entirely overlooks the radically different problem encountered in part III, in which A

inflicts harm on both B and A and restraint of A may benefit both.

The determination of the hours of work provides a particularly intriguing example of a

circumstance in which mutual benefit could result from an imposed restraint. In part

III of Economics of Welfare, Pigou argued that "after a point, an addition to the hours

of labor normally worked in any industry would, by wearing out the work people,

ultimately lessen rather than increase the national dividend." Moreover, under

competitive conditions, employers would tend to prefer hours of work the exceeded

the optimum for output. If an individual employer and worker were able to negotiate

more optimal hours of work, it would involve a present investment by the employer in

the workers future productivity. Well-defined property rights to that future capacity

could not be transferred to the employer and thus the arrangement could be upset by a

future offer of higher wages from another employer.

The table below illustrates the dilemma confronting a "progressive" employer. Assume that

the current hours of work are ten a day, during which a worker produces an output of eight

units; that the optimal output of nine units could be achieved in eight hours a day but that it

would require four months for the improvement to achieve its full effect.

Month 1 2 3 4 (5…11) 12

Daily output (marginal

value) $96 $109 $122 $135 $135 $135

Daily pay $120 $120 $120 $131 $131 $131

Difference -$24.00 -$11.00 $2.00 $3.67 $3.67 $3.67

To retain workers, the employer would need to continue to pay the old daily rate, say $120

a day, even though initially total output would drop. In the first two months, the employer

would invest a total of $660 in anticipation of future productivity gains. After four months,

the employer could grant a wage increase but would want to retain a portion of the

increased output to recoup expenses from the first two months. However, a competing

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employer, who had not invested the $660 could offer the worker a wage premium of nearly

3%.

Pigou viewed market failure with respect to the hours of work as commonplace,

observing that, "the evidence is fairly conclusive that hours of labour in excess of what

the best interests of the national dividend require have often in fact been worked" (Part

III, Chapter VII, "The Hours of Labour" page 465). The chapter on the hours of labor

is one of two places in The Economics of Welfare where Pigou specifically called

attention to the divergence between the private net dividend and "the best interest of

the national dividend" and consequently where there is "a prima facie case for public

intervention." (p. 331)

III. Social Cost without Labor and Labor without Social Costs

Although Ronald Coase paid no heed to Part III of Pigou's Economics of Welfare in "The

Problem of Social Cost," it's not as though it simply disappeared. Donald Stabile (1993,

1995, 1996) has documented Pigou's influence on John Maurice Clark's analysis of the

social overhead cost of labor in Studies in the Economics of Overhead Costs and K.

William Kapp's analysis in The Social Cost of Private Enterprise.

Coase's omission is regrettable but understandable considering the limited focus of his

paper on transaction costs. More puzzling is the almost total lack of attention to the

implications of that omission by subsequent scholars (with the notable exception of

Stabile) considering the prominence of Coase's article. Stabile (1996) laid the issue

squarely on the line when he asked:

If the costs of low wages are passed on to society, who represents it at the

bargaining table? If Coase had applied social costs to labour, rather than a theory

of the firm, he might have developed a theory of the union as a vehicle for

minimising the transaction costs of negotiating wages sufficient to cover social

costs.

Unfortunately, Stabile diluted the force of his critique by not highlighting it in the article's

abstract or even mentioning it at all until page six and by focusing on the specific question

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of Pigou's "Victorian attitude toward women" and the social costs of women participating

in the paid workforce rather than on the social costs of labour in general. Although the

relationship between social reproduction and workforce participation is indeed an

important one, a more straightforward case can be made regarding Pigou's observations on

the direct effects of low wages, unemployment and excessive hours of work.

The parallelism of the headings of two sections in Stabile's article appears to allude to a

corresponding parallelism in Coase's section headings in "The Problem of Social Cost."

Coase examined, respectively, "The Pricing System with Liability for Damage" and "The

Pricing System with No Liability for Damage." Stabile countered with "Social Costs

without Labour" and "Labour without Social Costs." In the latter section, Stabile observed

that "without a social cost perspective for labour issues, modern economists make efforts

to shift social costs back to business as 'a trade-off between equality and efficiency' (Okun

1975)." And "The idea that low wages led to inefficiency through non-payment of social

costs, as Pigou and Clark suggested, was not part of Okun's analysis."

Hovenkamp (2011) has called attention to the fact that Clark had developed his theory of

the firm fifteen years before Coase, wherein "contracting and coordination costs determine

when a firm will choose outside procurement or internal production." Hovenkamp offered

the following summary:

Clark's Overhead Costs, just as much as Coase's "Nature of the Firm," broke the

business firm apart and explored its inner decision making. For both, the premise

was that managers set out to maximize the firm's value. In that sense Clark's

Overhead Costs was firmly marginalist just as if was firmly institutionalist. While

Coase's "Nature of the Firm" is given considerable credit for producing

nonmonopolistic explanations for business decisions, Clark's Overhead Costs did

the same thing — pointing out, for example, that pricing above short run cost and

price discrimination are not unique attributes of monopoly, but can exist in any

market with fixed costs.

Of course all that was already manifest in Marshall's industrial economics, especially as it

was pursued by S.J. Chapman (1904) and then by Keynes (1981) in their examinations of

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"localization" and the evolution of the Lancashire cotton industry. Chapman (1909)

distilled his "realistic-impressionist study of human life" into a theory of the hours of labor,

which Pigou "borrowed" (with minimal acknowledgement) and which then became a key

consideration in the social overhead cost of labor, as analyzed by Clark.

The social overhead cost of labor is anything but "incidental" to the processes of

production and exchange. Instead it locates transaction costs and a uniquely non-

transferable property right at the very heart of the economic system and establishes not

only the opportunity or even the tendency for the shifting of costs onto society but, in the

absence of countervailing institutions, makes such cost shifting a competitive imperative

for the individual profit-maximizing firm.

IV. A Realistic Change in Approach?

Coase introduced the final section of "The Problem of Social Cost" with the following

observation:

It is my belief that the failure of economists to reach correct conclusions about the

treatment of harmful effects cannot be ascribed simply to a few slips in analysis.

It stems from basic defects in the current approach to problems of welfare

economics. What is needed is a change of approach.

One couldn't agree more. However, Coase then went on to advocate that economists use an

"opportunity cost approach… to compare the total product yielded by alternative social

arrangements." That is not a change in approach but hunkering down in the most basic

defects of same old approach. The opportunity cost doctrine reminded a puckish J. A.

Hobson of "the famous definition of sugar as 'the stuff which makes tea nasty when you

don’t put any in.'" It's basic defect is that it "perversely rules out all human considerations

related to the supply side of exchange, by substituting an indirect and strictly irrelevant test

for a direct and relevant one." The opportunity cost analysis is particularly suspect when it

comes to the hours of work because it overlooks the disutility of unemployment and the

possibility that a moderate amount of work can be intrinsically enjoyable.

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Coase came much closer to the mark 15 years later, when he commented on Marshall's

method and his objection to the unbridled use of mathematics,

What was it that Marshall found objectionable about the use of mathematics, at

any rate, when used extensively? He thought we lacked the data to support any

but relatively simple constructions. He feared that factors that could not easily be

dealt with in mathematical form would be neglected. But above all, he thought

that we would be tempted to engage in what he termed "mathematical diversions"

or, as Pigou put it (paraphrasing Marshall), we would be led to pursue

"intellectual toys, imaginary problems not conforming to the conditions of real

life." Marshall thought it would tend to divert our attention from the real world in

which poverty causes degradation and to the study of which he thought we should

devote our whole energies.

In these days, when the mathematical method rides triumphant in economics, one

may ask whether Marshall's fears were well-founded. Have we been tempted to

embark on "long chains of reasoning" without adequate supporting data? Do we

neglect factors difficult to put into mathematical form? Do we concern ourselves

not with the puzzles presented by the real economic world but with the puzzles

presented by other economists' analysis?... I very much doubt that what has

happened in recent years would have led him to change his mind.

But it wasn't simply the mathematics that Marshall objected to. It was the mechanical

analogy imposed by the deductive analytical method that postpones, as Keynes pointed

out, the "analysis of the actual facts." J. A. Hobson observed how mathematics and abstract

reasoning function as the modern substitute for laissez-faire, the "simple system of natural

liberty" – a substitute in which "economic harmony" is brought about by "a series of

minute adjustments at the margin."

The acceptance of this new method and instrument for economic service is due,

however, not merely to the craving of scientific men for exactitude. Its immanent

conservatism recommends it, not only to timid academic minds, but to the general

body of the possessing classes who, though they may be quite incapable of

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following its subtleties of reasoning, have sufficient intelligence to value its

general conclusions as popularized by the press.

For those who find Hobson's assignment of ideological motives hard to digest, it needs

to be repeated that Marshall, Keynes, Coase and Pigou himself, citing Marshall

substantially concur in their diagnosis of symptoms. Whether those symptoms result

from bad intentions or merely from neurosis is all that remains in question. They

certainly don't result from an absence or lack of clarity of the counter-statement.

Alfred Marshall's 1898 article, "Distribution and Exchange" is unsurpassed in explaining

precisely what the limits are to mathematical, abstract analysis. In that article he explained

why the mechanical analogy, which may be suitable for short period, ceteris paribus

analysis is entirely unsuitable for the long-period analysis in which the cumulative effects

of "external economies" predominate: "If we include in our account nearly all the

conditions of real life, the problem is too heavy to be handled; if we select a few, then

long-drawn-out and subtle reasonings with regard to them become scientific toys rather

than engines for practical work." In place of these mechanical analogies, Marshall

prescribed biological analogies for the investigation of long-period phenomena:

It has been well said that analogies may help one into the saddle, but are

encumbrances on a long journey. It is well to know when to introduce them, it is

even better to know when to stop them off. Two things may resemble one another

in their initial stages; and a comparison of the two may then be helpful: but after a

while they diverge; and then the comparison begins to confuse and warp the

judgment. There is a fairly close analogy between the earlier stages of economic

reasoning and the devices of physical statics. But is there an equally serviceable

analogy between the later stages of economic reasoning and the methods of

physical dynamics? I think not. I think that in the later stages of economics better

analogies are to be got from biology than from physics; and consequently, that

economic reasoning should start on methods analogous to those of physical

statics, and should gradually become more biological in tone.

Marshall's external economies, whose cumulative effect in the long period ruled out the

broader applicability of mechanical analogies, have somehow decomposed into incidental

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"externalities," nuisances that can be packaged into neat bundles of well-defined property

rights and traded on the futures market like any other commodity. The misconception is so

total and so egregious that one hardly knows where to begin to unpack it.

Marshall wrote "Distribution and Exchange" to clear up a misinterpretation of his

Principles of Economics. As he explained, it was only the first volume of his economic

treatise and its "successor" had not yet appeared. The intended successor volume never did

appear. Marshall's reaction to Pigou's Wealth and Welfare, published in 1912 indicated that

Pigou hadn't quite grasped Marshall's method and the significance of his distinction

between short-period and long-period factors, internal and external economies and

mechanical and biological analogies (Bharadwaj 1972, Raffaelli 2004).

The closest thing to the non-existent volume of Marshall's Principles was Chapman's The

Lancashire Cotton Industry, published in 1904. Chapman's theory of the hours of labor,

published in 1909, was distilled from his "realistic-impressionist" study of the Lancashire

cotton industry. Marshall's 1898 article, Chapman's realistic-impressionist study of the

cotton industry and his 1909 theory of the hours of labor and John Maurice Clark's 1923

Studies in the Economics of Overhead Costs point in the direction of a realistic change in

approach to the problem of social cost. In the sequel to this paper, "The solution to 'The

Problem of Social Cost'", I examine the relationship between Chapman's work, Marshall's

method and Pigou's chapter on the "Hours of Labour" in The Economics of Welfare.

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2. The Solution to "The Problem with Social Cost"

Ronald Coase's "The Problem with Social Cost" managed to avoid mentioning the elephant

in the room – labor – and most of the subsequent discussion of the Coase Theorem

dutifully follows suit. The omission is beyond bizarre. Classical political economy adhered

to a labor theory of value. Both A. C. Pigou's and J. M. Clark's previous forays into the

problem of social costs addressed the issue of labor as central. It would usually be

incumbent on a scholar to either address the salient issue or at least indicate why such

attention isn't necessary.

In Coase's defense, much of the Pigovian tradition also evaded the thorny question of work

and unemployment. Perhaps that was because it was felt those question had become the

rightful jurisdiction of Keynesianism. But post-War political Keynesianism (as distinct

from Keynes himself) was concerned primarily with short-run responses to cyclical

fluctuations in aggregate demand and not with evolutionary change in the economic

structure. In the long run, we were all dead.

The work of another of Marshall's favorite pupils, Sydney J. Chapman, offers a suggestive

counter-example of what really might be done within the scope of Marshall's economic

paradigm. This paper argues that Chapman's analysis, along with Clark's discussion of

overhead costs mentioned in the companion paper, provides greater insight into the

problem of social cost and of so-called externalities than does either Pigou's or Coase's.

I. Pigou's "Hours of Labour" and Chapman's

Although he provided only a perfunctory footnote to Chapman's work, Pigou's analysis of

the hours of labor in The Economics of Welfare closely followed five main points of the

theory Chapman had presented in 1909 in his presidential address to the Economics and

Statistics section of the British Association for the Advancement of Science and

subsequently published in the Economic Journal as "Hours of Labour."

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In his article, Chapman referred to a mass of evidence from the 19th century indicating that

reductions in the hours of work had not led to proportionate declines in output and, instead,

had often led to increases. The reduction of hours allowed better rested workers to produce

as much or more in shorter hours. Pigou inferred from the same evidence "that hours of

labour in excess of what the best interests of the national dividend require have often in

fact been worked. The reason for this is that "after a point, an addition to the hours of

labour normally worked in any industry would, by wearing out the workpeople, ultimately

lessen, rather than increase, the national dividend."

Both economists referred to the several complicating factors but arrived at the same

conclusion regarding a hypothetical optimal length of working day. For Pigou, the

"essential point" was that "in each several industry, for each class of workers there is some

length of working day the overstepping of which will be disadvantageous to the national

dividend." Similarly, Chapman had concluded that beyond a certain point, each additional

hour of work would contribute to the output of the current day's total output but at the

expense of the following (and subsequent) day's capacity for effort. The intensity of the

work involved would dictate the point at which cumulative output would begin to decline

and thus the length of the optimal working day.

The historical evidence disappoints the expectation that self-interest would lead employers

and employees to pursue an optimal working day, from each of their perspectives and to

negotiate a compromise. Chapman's analysis explained why competition would tend to

produce excessively long days. Workers would choose a day longer than was prudent for

their welfare because the prospect of unemployment would cause them to give higher

consideration to immediate earnings than to their long-term earning capacity. Similarly,

because well-rested workers could be lured away by an offer of higher wages from another

firm, an employer could never be certain of benefiting from the short-term restraint that

maintaining an optimal workweek would require.

Pigou explained the market failure as follows: "workpeople, in considering for what hours

per day they will consent to work, often fail to take account of the damage unduly long

hours may do to their efficiency." In the case of employers, they "also often fail to realise

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that shorter hours would promote efficiency among their workpeople, and so would

redound to their own interest." Furthermore, "except in firms which possess a practical

monopoly in some department of industry, and so expect to retain the same hands

permanently, the lack of durable connection between individual employers and their

workpeople makes it to the employers' interest to work longer hours than are in the long

run to the interest of production as a whole."

In 1932 J. R. Hicks posited a condition for sidestepping, in practice if not in theory, the

type of market failure indicated in Chapman's theory and reiterated in part III of Pigou's

Economics of Welfare. Hicks conjectured that a "very modest degree of rationality on the

part of employers will thus lead them to reduce hours to the output optimum as soon as

Trade Unionism has to be reckoned with at all seriously…"

Insofar as Chapman's analysis of the hours of work was regarded as both novel and

canonical (Hicks 1932, Marshall 1920, Robbins 1929), Pigou's presentation can best be

understood as an unacknowledged paraphrase of that theory. The distinction is more than a

quibble over footnotes because Chapman's hours of labor theory evolved out of what

Marshall called his "realistic-impressionist" scholarship on the Lancashire cotton industry

– a method of inquiry that Marshall upheld as more suitable to the subject matter than the

abstract, "statical" method employed by Pigou.

II. The Prince and the Pauper: The succession of Pigou to Marshall's chair at

Cambridge

When Alfred Marshall retired from his chair at Cambridge University in 1908, he was

succeeded by his "favorite pupil," as Keynes described him, A. C. Pigou. The main

candidates to succeed Marshall were Pigou and Herbert S. Foxwell but there was another

candidate, whom Marshall had urged to apply for the position but who subsequently

withdrew: Sydney Chapman. Chapman, at the time was chairman of the economics

department at Manchester University and went on to a distinguished civil service career.

In the 1970s, Ronald Coase participated in a debate in the Journal of Law and Economics

on the circumstances surrounding the Pigou's appointment to Marshall's chair. Curiously,

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Chapman's name was scarcely mentioned in the debate and his abandoned candidacy was

not mentioned at all. Chapman's own shyness and reticence may offer a plausible

explanation for such oversight. It was a characteristic distinctive enough to be stressed by

his son, Stephen, in a 1971 letter conveying his father's memoirs to an archivist:

I should, I think, stress that he was always a rather shy and reticent man. He was

obsessed with the idea that someone might write a "Life" or "Study" of him or his

period or his friends or connections, and he made it a point of principle to destroy

ruthlessly all correspondence as soon as he and my mother had read it.

In his memoir, Chapman also made no mention of his candidacy for the Cambridge chair

or of his withdrawal. Marshall, however, recalled the circumstance in a letter to Walter

Layton in which he revealed, rather cryptically, that while urging Chapman to apply he

"did not give him to understand that I should support him against Pigou." Was Marshall

just being polite? Did he hint to Chapman that he would support Pigou? Regardless of

Marshall's preference at the time of the succession, subsequent evidence suggest that he

became quietly disillusioned with Pigou's overly abstract theoretical approach.

One clue comes in the letter to Layton mentioned above, in which Marshall also confided

that, "[in 1908] I should have been very anxious as to the provision of lectures on

'Structure and Problems of Modern Industry', if you had not been at hand." Raffaelli (2004)

observed that "These statements are remarkable, the more so if one considers that in the

period 1914 – 19 the subject had been taught by Pigou himself."

A second clue can be found in the critical annotations Marshall left in his copy of Pigou's

Wealth and Welfare (1912). (See Bharadwaj 1972, "Marshall on Pigou's Wealth and

Welfare"). On the end paper of his copy, Marshall wrote the general comment,

I incline to think that the marginal supply curve Part II Ch. VIII has no reality; I

think he overrates the possibilities of the statical method, and so far I agree with

Hobson's criticism of marginalism… In this I may be wrong. For I can't follow all

that A. C. P[igou] says: and it is possible that he has some recondite meaning.

Anyhow I incline not to controvert him, even under 4 eyes, for the present. When

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he translates his W[ealth] & W[elfare] into realism, then I may perhaps raise a

question, if I still cannot follow him.

A third indication appears in Marshall's Industry and Trade, cited by Keynes as illustrating

an argument of Marshall's Keynes considered to be "of great philosophical importance":

his "proof that laissez-faire breaks down in certain conditions theoretically, and not merely

practically, regarded as a principle of maximum social advantage…" In his memoir of

Marshall in the Economic Journal, Keynes identified Pigou as the successor to whom

"further exploration of that field has been left." That assessment would seem to have

become canonical in the history of economic thought (see Medema 56). But in Industry

and Trade, Marshall cited Pigou only twice, only to point out that the mathematical

analysis undertaken by Pigou was not applicable to the real world conditions Marshall

sought to address:

The brilliant work of Edgeworth and Pigou has special claims on English readers.

But their route is not followed here: for mathematical analysis cannot easily be

applied to conditional monopoly: it is almost constrained to start with the

hypothesis of pure monopoly, and gradually to introduce successive limitations,

corresponding to the various limitations and restrictions…

Marshall's polite dismissal of the route followed by Edgeworth and Pigou can best be

interpreted in the context of his strong 1898 rejection of mechanical analogies for "the later

stages of economic reasoning." By contrast, Marshall cited Chapman's The Lancashire

Cotton Industry with approval three times in Industry and Trade, along with two other

works by Chapman. Fifteen years earlier, Marshall had written to Chapman, praising his

book as "the best monograph of the kind that has ever been published. It is both a realistic-

impressionist study of human life and an economic treatise." The reference to "realism" is

significant. Compare to Marshall's comments on Pigou's Wealth and Welfare, noted above,

in which he indicated the necessity of "translating" it into realism.

II. The Marshallian Realism of Chapman's Lancashire Cotton Industry

For Marshall, "realism" was not merely a matter of relaxing the constraints of simplifying

assumptions that had been imposed on an abstract hypothesis. He viewed economics as an

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organic process not a mechanical one, more akin to biology than physics. In Marshall's

view, according to Chapman, theory and realism were "two lines of investigation" that

converged. The evolution of actual economic practices was not something that could be

deduced from abstract principles. It needed to be documented through historical

investigation and the amassment of facts. Chapman's study of the Lancashire cotton

industry converged toward a more comprehensive theoretical understanding whereas

Pigou's Wealth and Welfare veered away from realism in its privileging of theoretical

abstraction.

Although Pigou succeeded Marshall in his chair at Cambridge, Chapman may be still

regarded as the superior candidate for heir to his method. According to Raffaelli (2004),

Chapman's history of the Lancashire cotton industry was one of two "promising steps

towards the establishment of a Marshallian school of industrial economics." The other was

a theoretical study by David H. Macgregor of the growth and combination of firms into

giant industrial units.

In his book's preface, Chapman explained that, "much is said of the opinions held by those

who share in the earnings of the Cotton industry." He called the "different guiding notions"

of employers and employed a "striking feature in the history of the Cotton industry". Some

of those guiding notions were with regard to the hours of work and the agitation for shorter

hours. Instead of relying on an abstract analysis of the economics, Chapman scrupulously

investigated the workers' own view of the question. It is reasonable to surmise that his

1909 theory of the hours of labor was an outgrowth of this investigation.

Chapman made no mention in his unpublished autobiography of his 1909 presidential

address on the hours of work to the Economics and Statistics section of the British

Association for the Advancement of Science. The closest he came was toward the end of

the manuscript, he reminisced for a paragraph about his delight in traveling to Canada and

making an extended tour of some months where he was much impressed with the

"unlimited economic scope" of the prairies and thrilled by the Rockies. The omission

would be inexplicable were it not for Chapman's previously mentioned shyness and

reticence.

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There is, however, an anecdote about his student days at Cambridge that offers another

clue regarding how Chapman's historical study of the ideas of workers and employers in

the cotton industry informed his theory of the hours of labour. Besides, "the Colossus,"

Marshall, Chapman vividly remembered two courses given by Professor Foxwell, one of

which was on the early English socialist writers, "several of whom he had rescued from

oblivion." The latter phrase is evocative of a remark by Engels in the preface to Volume II

of Marx's Capital, in which he refers to an anonymous pamphlet by one of those early

socialist writers, The Source and Remedy of the National Difficulties as Deduced from

Principles of Political Economy, as having been "saved from falling into oblivion" by

Marx.

In his memoir, Chapman had alluded to a "volume by another writer" to which Foxwell

had contributed a lengthy introduction and bibliography. The book was The Right to the

Whole Produce of Labor by Anton Menger, who referred in a footnote to the claim by

Engels, albeit with skepticism about the plausibility of Marx's theory of surplus value

being much influenced by the pamphlet. That, of course, was long before the publication of

Marx's Grundrisse and the Economic Manuscripts of 1861 and 1863, the evidence of

which adds credence to Engels's claim. One phrase in particular from the pamphlet caught

Marx's attention: "Truly wealthy a nation, when the working day is 6 rather than 12 hours.

Wealth is not command over surplus labour time' (real wealth), 'but rather, disposable time

outside that needed in direct production, for every individual and the whole society." That

phrase is central to a section in the Grundrisse known as the "Fragment on Machines" that

addresses what Marx considered the most profound internal contradiction of capital: on the

one hand the aggregate valuation of commodities – and thus also of capital accumulated –

in terms of the amount of labor time embodied in their manufacture; on the other hand, the

drive of each individual capitalist to reduce the quantity of labor time used per unit of

output.

In The Lancashire Cotton Industry, Chapman demonstrated his astute knowledge of the

early socialist writers as well as of their opponents. In a brief review of Marx's Value,

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Price and Profit, Chapman also demonstrated some familiarity with Marx's work with a

mixture of admiration for Marx's prescient critical insights into the wage-fund theory of

classical political economy and condescension for his "characteristic fallacies" about value

and profit. It is conceivable that Chapman may have absorbed some of the insights from

the early English socialist writers about the relationship between value, leisure and

working time without quite recognizing the extent of their (parallel?) influence on Marx's

thought.

IV. Keynes and the collapse of the Lancashire cotton industry in the 1920s

As it happens, in the late 1920s Keynes became interested in the decline of the Lancashire

cotton industry. Keynes's involvement in trying to engineer a solution to the industry's

crisis has been described by Roberto Marchionatti (1995) as suggestive of the

"microfoundations" for the subsequent macroeconomic General Theory of Employment,

Interest and Money. It's beyond the scope of this essay to delve into the links between

Keynes's writing on the Lancashire cotton industry and his general theory or to elaborate

on similarities and differences between Chapman's discussion of the Lancashire cotton

industry and Keynes's. What interests me here is the key role played by "external

economies" in both analyses of the industry.

In Marshall's view – faithfully represented by Chapman – localization enabled small and

medium-sized firms to take advantage of proximity and evolve a mixture of competition

and co-operation that was sometimes explicit and sometimes tacit. By contrast, Keynes

viewed the unorganized collection of firms as preventing rationalization in the face of a

profound change in international competitiveness. He termed the situation "a cumulative

progress towards perdition only limited by the rate at which other countries can erect new

spindles." The problem Keynes identified was the irreversibility of processes in time:

The method of building up a growing industry by individuals adding spindle to

spindle and mill to mill when they see profitable opportunities to do so, works

perfectly well. But... this system includes no provision whatever for reversing the

process, except the slow and dragging cure which time brings at last by decay and

obsolescence.

16

Keynes's prescribed remedy for the stultifying disorganization of the industry was

cartelization, enforced by pressure from the banks. It transpired that the industry was

indeed cartelized but continued its historical decline anyway. In both Keynes and

Chapman, time is of the essence, with regard, first, to the evolution of the particular

institutional forms that come to prevail and, second, to the absence of symmetry between

how firms enter and exit from the market.

V. Realism and Method

A conclusion is hardly the place to launch into an arcane methodological discussion. I must

confess that these two brief articles were originally a single one and that when I got to the

end of this one I was surprised to find that I had already used the one conclusion in the

other half. The easy way out would be to say "read the conclusion to the other paper

again." But more importantly, read the articles in the bibliography, especially the ones with

the stars. Especially the ones by me, "Missing, the strange disappearance of S. J.

Chapman's theory of the hours of labour" and "Time on the ledger: social accounting for

the good society."

The problem with, and the solution to, the problem of social cost started out as a response

to a reviewer's comment on "Time on the ledger." The reviewer asked for "an alternative

within conventional economic theory" of policy to deal with "negative externalities." I

knew the standard policy prescriptions were Pigovian taxes and cap and trade schemes but

I also realized that those two standard options were not the whole story – that Pigou

himself had addressed the social costs of excessive hours of work as establishing "a prima

facie case for intervention. I knew that my proposals were not "new" or eccentric but were

an integral part of the original conventional policy array that had been mysteriously

deleted. "Time on the Ledger" is thus the implementation of the realistic methodology and

these historical account above is the vindication of its methodological legitimacy.

17

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20