be taken to mean cost of production of the equipment, earning-capacity of the concern, or market quotation of its securities. These unincumbered competitors are presumed to be making reasonable profits at current prices, and their presence in the competitive market therefore precludes an advance of prices to such a scale as would afford a reasonable profit to the other establishments after paying their interest charges on what is, in effect, over-capitalized property.
This tentative explanation of depression applies only so far as the period of depression is a time of relatively low rates of interest. But depression does not uniformly coincide with low interest rates; besides which, there are other facts in the case which limit the applicability of the explanation formulated above. To explain protracted depression, e.g., this line of argument would be convincing only on the supposition of a progressively falling rate of interest, - a condition not commonly met with in a protracted period of depression.
But this explanation, applicable within a limited range of the phenomena that make up a period of depression, points the way to another class of considerations that go far toward explaining the rest. It appears that the phase of the difficulty covered by this explanation is traceable to a discrepancy between the accepted capitalization, the interest charges, and the earning-capacity. And it appears equally plain that the only remedy applicable to the case (barring a speculative exaltation of business) is a recapitalization of the concerns affected on a lower basis, to fit the lowered cost of production of the equipment and its lowered earning-capacity. But under existing conditions of law such a remedy cannot be applied to the interest bearing securities, - except by process of insolvency, - and it is very reluctantly applied to other capitalized wealth; besides which it is, practically, very difficult to effect such an avowed recapitalization as applied to the stock of incorporated companies, particularly in the case of those whose stock is ostensibly the capitalized value of their plant.
Such a readjustment of nominal value to actual value as shown by the facts of earning-capacity is continually going on, in some measure; but it does not cover the entire range of facts involved, and it is nearly always of the nature of a reluctant concession, following only after the need of it has become somewhat pressing. It can, therefore, in the common run of cases, not catch up with the progressive difficulty which it is designed to meet, in so far as the difficulty is of a progressive character.
A discrepancy between accepted capitalization and current earning-capacity, similar to the discrepancy discussed above but of a progressive character, arises under modern conditions apart from a fall in the rate of interest. The discrepancy pointed out and provisionally disposed of above, due to a fall in interest rates, is a discrepancy between the nominal value (accepted capitalization) of the older establishments, computed on their earlier earning-capacity or on the original cost of their equipment, on the one hand, and their present actual value on the other hand, computed on their current earning-capacity in competition with rivals that have the advantage of a lower cost of equipment, or, in other words, a lower interest charge per unit of earning-capacity. Under the regime of the later, more fully developed machine production, a discrepancy having a similar effect arises out of a persistent divergence between the past cost of production of a given equipment and the current cost of a like or equivalent equipment at any subsequent date, - supposing that there intervenes no inflation of prices and no extraneous cause making for a speculative advance.130
Suppose prices of finished goods to be stable or to vary by inconsequential fluctuations, negligible for purposes of the argument, and suppose the rate of interest to be in a similarly negligible position. In other words, suppose such a condition as the business community would recognize as ordinary, normal, sound, without ground for pronounced hopes or fears. Under modern circumstances, dominated as the modern situation is by the machine industry, such a state of affairs is unstable, even apart from any disturbance of an extraneous kind. It is unstable by virtue of the forces at work in its own process, and these forces, on the whole, make for a progressive change in. the direction of depression.
It has appeared above that the depressing effect which a relatively low (declining) rate of interest has upon industrial business is due to its setting up a discrepancy between the accepted capitalization of older establishments and the cost of new establishments of an equivalent earning-capacity. Now, under the circumstances of the more fully developed machine industry, such as it has stood for a couple of decades past, a similar discrepancy results from the gradual but uninterrupted progressive improvements of industrial processes. "The state of the industrial arts," as the older economists are in the habit of calling it, is no longer to be conceived as stationary, even for the time being. No "statical" theory of the industrial arts or of business prosperity is tenable, even for the purposes of a "statical" theory of the industrial situation. Progressively increasing efficiency of the processes in use is a pervading trait of the industrial situation. No two successive years are now on the same, or virtually the same, plane in respect of the efficiency of the industrial arts; indeed, the "period of production" can no longer safely be construed to begin and end on the same level in this respect. At the same time the progressively wider and more close-knit articulation of the several industries in a comprehensive process is also going forward, and this also affects all branches of industrial business in some degree and in the same direction, as will appear presently.
The items of the equipment (plant, materials, and in a measure even good-will) in which any industrial enterprise invests, and by the use of which the business men in industry turn out their output of vendible goods, are themselves products of the machine industry. Machine processes, ever increasing in efficiency, turn out the mechanical appliances and materials with which the processes are carried on, at an ever decreasing cost; so that at each successive step the result is a process having a higher efficiency at a lower cost. This is now no longer a sporadic effect of ingenious contrivances having a local and limited application, to be handled as trade secrets and exploited as an enduring differential advantage.
The cost of production of "capital goods" is steadily and progressively lowered, as counted in terms of the processes involved in their production. In a competitive market this is reflected, with greater or less promptitude, in the prices of such capital goods to all buyers. But the buyers whose purposes this lower scale of prices particularly subserves are chiefly the new investors who go into business in the way of new industrial establishments or extensions of the old. Each new venture or extension goes into the competitive traffic of producing and selling any line of staple goods with a differential advantage, as against those that have gone before it, in the way of a lower scale of costs. A successively smaller aggregate value of new equipment will turn out a given volume of vendible product. In so far as there is no collusive control of the output or the prices, this means that the newcomers will cut under the scale of prices at which their predecessors have been content to supply the goods. The run of competitive prices is lowered; which means that at the new competitive prices, and with their output remaining on its old footing as regards expenses of production, the older establishments and processes will no longer yield returns commensurate with the old accepted capitalization. From the inherent character of the machine industry itself, therefore, it follows that the earning-capacity of any industrial enterprise enters on a decline from the outset, and that its capitalization, based on its initial putative earning-capacity, grows progressively antiquated from the start. The efficiency of the machine process in the "instrumental industries" sets up a discrepancy between cost and capitalization. So that a progressive readjustment of capitalization to correspond with the lowered earning-capacity is required by the nature of the case It is also, in the nature of the case, impracticable.
In so far as the process of investment and business management involves the use of credit, in the way of interest-bearing securities or loans equivalent to such securities, this element of credit retards the readjustment by force of the fixed charges which it involves. This retardation (aided as it is by the reluctance of business men to lower their capitalization) is of sufficient effect to hinder recapitalization, on the whole, from overtaking the progressive need of it, with the result that a fair or "ordinary" rate of profits on industrial investments is not permanently attainable in the field of open competition. In order that the rate of interest should effectually further
