Mill’s Fourth Proposition on Capital states that “the demand for goods is not the demand for labour.” This was stated by the English political economist John Stuart Mill in his famous 1848 book principles of political economy as one of his four proposals on capital. Mill argued that, contrary to popular belief, the labor and other factors of production that go into the creation of final goods and services are actually supported not by consumer spending but by savings. An understanding of Mill’s fourth proposition on capital, noted by the English historian Leslie Stephen in 1876, “is the best test of a sound economist.”
denial of derived demand
Mill’s fourth proposition is seen as a refutation of the idea of ”derived demand”, which states that the demand for labor and other factors of production comes from consumer demand for final goods and services. The idea of derived demand has been widely argued by Keynesian economists that consumer spending is the driving force behind economic activity. According to this logic, an increase in consumer spending on finished goods and services would have a chain effect of increasing demand for labor and other factors of production. For example, the demand for shoes among consumers will increase the demand for the services of cobblers and others involved in the production of shoes. Conversely, if consumer spending falls, the demand for the various factors of production will fall. Saving, by the same logic, causes a fall in consumer demand and in turn affects the demand for the factors of production that go into manufacturing final goods and services.
The sharp decline in consumer spending was thought to be the primary reason behind many of the great recessions of the past. Therefore, policy makers discourage saving to promote consumer spending, believing that things will not be produced unless people are willing to spend money to buy things. Most economists still believe consumer spending is the key to prosperity and recommend monetary and fiscal stimulus that put more cash in the hands of consumers. After all, during a recession it’s easy to find many goods that go unsold, and boosting consumer spending seems like the best solution.
investment and savings
In contrast to the theory of derived demand, Mill’s fourth proposition states that labor and other factors of production are not supported by consumer demand. Instead, it argues that demand for labor and other factors of production comes from investment funded by savings. Without savings, it would not be possible to support the various factors of production over an extended period of time until the final product is fully produced and ready to be sold to consumers. So saving, according to Mill, is actually labor and other factors of production. It should be noted that since savings can only come at the cost of spending on immediate consumption, higher consumer spending will actually lead to lower savings and lower investments. It hinders capital formation and affects economic growth – Mill’s second proposition on capital actually says that capital is formed as a result of investment of savings. This implies that, in Mill’s view, the Keynesian emphasis on consumer spending as the primary driver of economic activity would actually lead to slower economic growth. Supporters of Mill’s outlook on capital do not see the economic slowdown as primarily the result of declining consumer spending. Instead, they view recessions, marked by unsold supplies, as a result of entrepreneurial errors that led to overproduction of some goods and services as well as underproduction of others.