Increase of capital resources
What happens in this background about the much talked-of stagnation theory? Will each expansion in the stock of capital lower the marginal efficiency of capital while it raises the marginal productivity of labour? Does expansion itself contain seeds of stagnation? The answer is again to be sought in Rodan’s hypothesis. Capital saturation is a long way off for an under-developed economy with a strong pressure of population and a depressed standard of living.
For such an economy, an increase of capital resources, if it could be brought about, will make possible a simultaneous development of industries and will have, through the operation of ‘external’ economies,1 rather the effect of raising the marginal efficiency of capital. Indeed this points to a peculiar feature of an under-developed economy which distinguishes it fundamentally from a so-called mature economy. So economy of a country is essential. Keynes’s model is that of an economy in which the supply of labour is perfectly elastic at current money rate of wages; the model to which the economies of under-developed countries are a close approximation, is one in which the supply of labour is perfectly elastic at current real rate of wages. In Keynes’s model surplus labour is accompanied by excess capacity in capital equipment; in underdeveloped economies reserve capacities are deficient, if not nonexistent.
Further, in those mature economies which provide the model for Keynes’s analysis, since there exists a gap between current real rate of wages and the minimum standard of comfort and since, therefore, there is scope for a reduction of the real wage rate, a rise in prices at the diminishing return stage is (at least theoretically) consistent with constant money rate of wages. In under-developed economies, on the other hand, the current real rate of wages even in the urban sector, not to speak of the rural sector, is about the minimum necessary for physical existence. These economies cannot, therefore, allow prices to rise and yet expect the money rate of wages to remain constant. All this has an important bearing on policy. The need for public investment is urgent if the objective in the under-developed economies is to achieve a higher standard of living and increasing volume of employment. And, in the absence of an adequate flow of foreign capital and an adequate volume of public savings, deficit financing is also called for.
But whereas, in mature economies, deficit financing is more or less innocuous and can be depended on, with the aid of the multiplier, to achieve the desired level of employment without any substantial rise of prices and with a constant money rate of wages, in under-developed economies where structural resistances are strong, deficit financing leads to inflationary pressures and a tendency to a rise in money wage rate, except in so far as the pattern of investment is such as increases output within the time lag between the earning of additional rnoney income and its spending on consumption goods. In such economies, therefore, deficit financing has to be accompanied in the transition period (i.e. till the structure of capital equipment is matched with the extended structure of demand) by a system of controls very much on the lines of war-time controls. If money wage rates are to be kept constant, prices of wage-goods must not be allowed to rise.
And if resources are to be prevented from shifting to non-essential industries, price control must be accompanied by capital issue control. And so on. Public investment may perhaps proceed in the under-developed countries without curtailment of current consumption, though not along with increasing consumption, as it could in mature economies. But we would be deceiving ourselves if we thought that the process could function within the framework of a liberal economy, such as Keynes sought so anxiously to preserve. So economy of a country is essential.