Mill’s fourth proposition on capital

Mill’s fourth proposition about capital states that “the demand for commodities is not the demand for labor”. It was stated by English political economist John Stuart Mill in his famous 1848 book The principles of political economy as one of its four proposals on capital. Mill argued that, contrary to popular belief, the labor and other factors of production that go into making final goods and services are not really supported by consumer spending but by saving. Understanding Mill’s fourth proposition about capital, noted the English historian Leslie Stephen in 1876, is “the best test of a good economist”.

Derivative claim rebuttal

Mill’s fourth proposition is seen as a refutation of the idea of ​​”derived demand”, according to which demand for labor and other factors of production arises from consumer demand for final goods and services. The idea of ​​derived demand has been widely used by Keynesian economists to argue that consumer spending drives economic activity. According to this logic, the increase in consumption expenditure on finished goods and services would have the effect of causing an increase in the demand for labor and other factors of production. For example, the demand for shoes among consumers would increase the demand for the services of shoemakers and others involved in the production of shoes. Conversely, if consumer spending were to fall, there would be a drop in demand for the various factors of production. Savings, according to the same logic, would lead to a drop in consumer demand and would in turn affect the demand for the factors of production that go into the manufacture of final goods and services.

A sharp drop in consumer spending was considered the main reason for many major recessions in the past. Therefore, policy makers have discouraged saving in order to stimulate consumer spending, believing that things will not be produced unless people are willing to spend money to buy things. Most economists still believe that consumer spending is the key to prosperity and recommend monetary and fiscal stimulus that puts more money in the hands of consumers. After all, during recessions it’s easy to find a lot of unsold goods, and boosting consumer spending seems like the best solution.

Investments and savings

Unlike derived demand theory, Mill’s fourth proposition states that labor and other factors of production are not supported by consumer demand. Instead, he argues that the demand for labor and other factors of production comes from investments financed by savings. Without savings, it would not be possible to sustain the various factors of production over a long period of time until the final product is fully manufactured and ready to be sold to consumers. Thus, according to Mill, saving is what really sustains labor and other factors of production. It should be noted that since saving can only occur at the cost of immediate consumption expenditure, an increase in consumption expenditure will actually lead to a decrease in saving and investment. This would hinder capital formation and affect economic growth – Mill’s second proposition about capital actually states that capital is formed as a result of the investment of savings. This implies that, according to Mill, the Keynesian focus on consumer spending as the primary driver of economic activity will actually lead to slower economic growth. Proponents of Mill’s view of capital do not see economic downturns as the primary result of lower consumer spending. Instead, they view recessions, which are marked by unsold stock, as the result of entrepreneurial mistakes that led to the overproduction of some goods and services and the simultaneous underproduction of others.