The A + B theorem

In January 1919, A Mechanical View of Economics by C.H. Douglas was the first article to appear in the New Age, edited by A.R. Orage, critiquing the methods by which economic activity is typically measured:

"It is not the purpose of this short article to depreciate the services of accountants; in fact, under the existing conditions probably no body of men has done more to crystallize the data on which we carry on the business of the world; but the utter confusion of thought which has undoubtedly arisen from the calm assumption of the book-keeper and the accountant that he and he alone was in a position to assign positive or negative values to the quantities represented by his figures is one of the outstanding curiosities of the industrial system; and the attempt to mold the activities of a great empire on such a basis is surely the final condemnation of an out-worn method."^[8]

In 1920, Douglas presented the A + B theorem in his book, Credit-Power and Democracy, in critique of accounting methodology pertinent to income and prices. In the fourth, Australian Edition of 1933 Douglas states:

"A factory or other productive organization has, besides its economic function as a producer of goods, a financial aspect—it may be regarded on the one hand as a device for the distribution of purchasing-power to individuals through the media of wages, salaries, and dividends; and on the other hand as a manufactory of prices – financial values. From this standpoint, its payments may be divided into two groups:

Group A - All payments made to individuals (wages, salaries, and dividends).

Group B - All payments made to other organizations (raw materials, bank charges, and other external costs).

Now the rate of flow of purchasing-power to individuals is represented by A, but since all payments go into prices, the rate of flow of prices cannot be less than A+B. The product of any factory may be considered as something which the public ought to be able to buy, although in many cases it is an intermediate product of no use to individuals but only to a subsequent manufacture; but since A will not purchase A+B; a proportion of the product at least equivalent to B must be distributed by a form of purchasing-power which is not comprised in the description grouped under A. It will be necessary at a later stage to show that this additional purchasing power is provided by loan credit (bank overdrafts) or export credit.”^[2]

Beyond empirical evidence, Douglas claims this deductive theorem demonstrates that total prices rise faster than total incomes when regarded as a flow.

In his pamphlet entitled, The New and the Old Economics, Douglas describes the cause of "B" payments:

“I think that a little consideration will make it clear that in this sense an overhead charge is any charge in respect of which the actual distributed purchasing power does not still exist, and that practically this means any charge created at a further distance in the past than the period of cyclic rate of circulation of money. There is no fundamental difference between tools and intermediate products, and the latter may therefore be included.”^[19]

In 1932, Douglas estimated the cyclic rate of circulation of money to be approximately three weeks. The cyclic rate of circulation of money measures the amount of time required for a loan to pass through the productive system and return to the bank. This can be calculated by determining the amount of clearings through the bank in a year divided by the average amount of deposits held at the banks (which varies very little). The result is the number of times money must turnover in order to produce these clearing house figures. In a testimony before the Alberta Agricultural Committee of the Alberta Legislature in 1934, Douglas said:

“Now we know there are an increasing number of charges which originated from a period much anterior to three weeks, and included in those charges, as a matter of fact, are most of the charges made in, respect of purchases from one organization to another, but all such charges as capital charges (for instance, on a railway which was constructed a year, two years, three years, five or ten years ago, where charges are still extant), cannot be liquidated by a stream of purchasing power which does not increase in volume and which has a period of three weeks. The consequence is, you have a piling up of debt, you have in many cases a diminution of purchasing power being equivalent to the price of the goods for sale."^[20]

According to Douglas, the major consequence of the problem is exponentially increasing debt. Further, society is forced to produce goods that consumers either do not want or cannot afford to purchase (i.e. economic sabotage). The latter represents a favorable balance of trade, meaning a country exports more than it imports. But not every country can pursue this objective at the same time, as one country must import more than it exports when another country exports more than it imports. The long-term consequence of this policy is a trade war, typically resulting in real war – hence, the Social Credit admonition, “He who calls for Full-Employment calls for War!”, expressed by the Social Credit Party of Great Britain and Northern Ireland, led by John Hargrave. The former represents excessive capital production and/or military build-up. Excessive capital production is only a temporary correction, as the cost of the capital appears in the cost of consumer goods or taxes, further exacerbating future gaps between income and prices. Military buildup necessitates either the violent use of weapons or a superfluous accumulation of them.

Labour displacement in the productive process implies that overhead charges (B) increase in relation to income (A), because "'B' is the financial representation of the lever of capital”.^[2] As Douglas stated in his first article, "The Delusion of Superproduction"^[21]:

"The factory cost--not the selling price--of any article under our present industrial and financial system is made up of three main divisions-direct labor cost, material cost and overhead charges, the ratio of which varies widely, with the "modernity" of the method of production. For instance, a sculptor producing a work of art with the aid of simple tools and a block of marble has next to no overhead charges, but a very low rate of production, while a modern screw-making plant using automatic machines may have very high overhead charges and very low direct labour cost, or high rates of production. Since increased industrial output per individual depends mainly on tools and method, it may almost be stated as a law that intensified production means a progressively higher ratio of overhead charges to direct labour cost, and, apart from artificial reasons, this is simply an indication of the extent to which machinery replaces manual labour, as it should.

Given that overhead charges (B) are constantly increasing relative to income (A), any attempt to stabilize or increase income is met with rising prices. If income (A) is constant or increasing, and overhead charges (B) are continuously increasing due to technological advancement, then prices (A+B) must also increase. Further, any attempt to stabilize or decrease prices (A+B) must be met by falling incomes. This is why deflation is regarded as a problem in orthodox economics. As the Phillips Curve suggests, inflation and unemployment are trade-offs, unless prices are reduced from monies derived from outside the productive system. As the A+B theorem suggests, the systemic problem of rising prices, or inflation, is not "too much money chasing too few goods", but is the increasing rate of overhead charges in production through the mechanization of industry. This is not to suggest that inflation cannot be caused by too much money chasing too few consumer goods, but it does demonstrate that this is not the only cause of inflation, and that inflation is systemic under the orthodox rules of cost accountancy, even if there is not enough purchasing power in existence to liquidate all the costs of production.