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Economic theories and practices: Neoclassical and Keynesian projects in a critical perspective

I prefer to speak of theories and practices because there is no single “natural” or “material” reality of which economy could be the scientific theory. An economic system is just the way in which a group of people decide to organise work and exchanges. So there isn't one best economic theory. Each theory is actually the description of a specific project for society, and there are probably an unlimited number of projects that could work if people really identify with them. The neoliberal mind-control propaganda (“pensée unique”), basing itself on the collapse of state socialism, pretends that there is only one best way to run an economy (individualism, competition, privatisation, profit motive operating the “hidden hand” of the market, etc.), which implicitly corresponds to some genetically determined “human nature” of "economic man". This leads the extremist liberals (“libertarians”) to propose privatising the roads, the air and the seas, and to even interpreting marriage as a “profit-maximising” calculation. This is obviously hog-wash. An absolutely amazing diversity of economies have been tried by humans, nearly all of them much more stable and probably more satisfying to their populations, than neoliberal capitalism: societies where you never use the correct price in an exchange, because the rule is always to give more than what you received, totally centralised, planned empires like the ancient Egyptians or Incas (who even had social security for sick, orphans, etc.) which used no money at all... Someone proposed the other day to anull all debts every 30 years, like the early Jews. Well we could - even under capitalism - if there was a political consensus.

This applies importantly to neo-classic and Keynesian theories. Most economists, especially many Marxists, tend to describe the history of capitalism as a succession of quite different stages, quite rigidly determined by the objective development of production techniques, productivity, financial organisation, etc. The thirty post-war years of “Fordist” prosperity in which Keynesian theory, (government intervention to insure full employment, welfare, deficit spending, etc.) were dominant are seen as something very new and highly determined by a particular economic situation. This is a useful simplification to start with, but tends to make the economy seem to be a kind of independent reality determining political freedom, when fundamentally the opposite is at least just as true. In Keynesianism, Monetarism and the crisis of the State, Simon Clarke traces the history of English capitalism, showing first of all that similar economic and political options reoccur over two centuries. For instance, welfare versus forced labour (“workfare”); more or less government intervention in setting prices and salaries or controlling unions; free trade vs. protection; etc. At the end of the 19th century a balanced budget was considered by the right to be a constitutional guarantee against the “populist” and “inflationist” temptations (in fact sorts of proto-Keynesian policies). to which States might succumb during a period of economic crisis and unemployment. At the end of the 20th century the Swiss government just followed Reagan in the same direction! These options represent class interests, of course, and are backed up by economic “theories” that come in and out of fashion according to the balance of political forces. It should be no surprise that the “neo” liberal options resemble 19th century liberalism so much. After all, the description of globalisation in the Communist Manifesto still seems amazingly apt to us today!

(Note on North/South: economic theories are generally centered on the process of capitalist accumulation (in theNorth) and ignore the impact of imperialist pillage. This was of course the “nest egg” for capitalism and continues unabated. But it would be over-simplifying today to say that northern wealth is only based on present-day exploitation of the South. In fact, one of the problems of the South is that for many things they and their products are no longer really needed - even when totally over-exploited. (This of course weakens their position even more). Also, the era of Keynesian popular “prosperity” in particular pillaged the South less brutally than today's austerity.)

Neo-classic economics has different schools and aspects, but basically it is built around the idea that the ideal economy should function with a minimum of political, collective, “interference”. Money, untrammelled markets and private, self-interested initiatives more or less automatically establish the best possible self-regulating system of exchanges. At a limit, the State just has to insure respect to private property (since nowadays the neoliberals consider that private initiative could even do better taking care of health, education... even prisons!). This is obviously a convenient myth, since in power the most neoliberal capitalists have constantly used the State to increase their profits. The rational behind it is clear. If the “invisible hand” of the market does better when its not deformed by State interventions or social forces (collective bargaining), that leaves those who wield financial power all alone...

Just two examples of these "miraculous" self-regulating mecanisms will suffice.

The “law of supply and demand” is supposed to be capable of assuring full employment as long as minimum wage laws or unions don't artificially interfere with the market: If people don't find a job at a certain wage, it means that there's no demand at that price. They just have to reduce their price until it becomes worth some entrepreneurs while to hire them for something. Of course there's some truth in such a simplification. In Marx's time, salaries sometimes went so low that barges in England were pulled by women, because they cost less than horses. M. Hensch (of the Genevan bank of the same name) recently said that he would be glad when there were again people ready to shine shoes in the streets of Geneva for a frank! This “theory” is a realisable project as Thatcher and others have shown. However, Keynes also showed that the equilibrium between supply and demand of jobs could establish itself at many different levels. If salaries are really low, there will be very little demand for products or services, so very little demand for workers to produce them. Such an economic slump can continue indefinitely if no social forces intervene to increase buying power and get the economy going again, pushing the balance of supply and demand of jobs up to a higher point of equilibrium.

Another miraculous self-regulating mechanism, free trade. Capitalists have always claimed (when it was in their interest) that free trade was always good for both parties for two reasons.

First, free trade advocates say that it is self-regulating because it forces industries to be as productive and efficient as the foreign competition, while “protectionism” removes the incentive to increase productivity. This is no doubt true between two industries having roughly equivalent productivity. But if the gap is too large, the less advanced form of production is simply crushed. United States or European farmers are equipped to produce grain about 500 times more efficiently than the small farmers of many latin-american or african countries. In this case prices are forced down so low that the peasants go bankrupt (like in Mexico or Rwanda before the civil war). Those who survive, instead of improving their productivity, have so little income that they have to use even less efficient methods than before.

Ricardo's theory of comparative advantage pointed out that if a country produces less efficiently than another, it is better off specialising in what they do most efficiently and exchanging with other countries, rather than producing all products at higher cost. Like many economic theories, the reasoning is correct, but ignores many things. 1) It supposes that the capital of each country will stay in that country and specialise. But if a country is less efficient in producing everything, capital will simply go abroad and consumers will import everything.  2) It supposes that displaced workers can automatically find other jobs. Its not necessarily better for the country to have to pay massive unemployment benefits, or have thousands of bankrupt peasants living in shanty towns around the cities, when they could have been supporting themselves and avoiding importation of food - even if the imported food costs less.

In historical fact, free trade has always been to the advantage of, and advocated by, the most advanced competitive capitalists - the ones who stand to gain. All successful capitalist countries (from 18th century Great Britain and the USA through Japan, up to the oriental dragons) first passed by a period of protection (usually with heavy aid and planning by the State) which allowed their industry to become viable before affronting competition. Just as with the example of full employment and wages, we see that the theories justifying “laissez-faire” aim to avoid any political checks on the power of money. Their “invisible hand” prefers no interference!

The historical record shows that capitalism is in a sense self-regulating, but in an extremely crude and violent way: it has gone by "boom and bust" since its birth. The only exception being the 30 years of relative prosperity (for the North) of the "Fordist" or Keynesian era. Since then we have gone from stagflation to slump with periods of growth which have not stopped the growth of unemployment, debt, growing instablility (Debt crisis, Asian crisis, etc.) famine in the South and inequality in the North. So we can take the explanation of crises (and how to stop them) as the central question to compare theories.

The neo-classics, monetarists, etc., are pretty disqualified right away. They are always saying that crises are the fault of the State or unions and not of the system as such, but as they have been in power (usually pretty total power) for two centuries, they have had ample time to prove that they don't have a real explanation or solution, and are regularly choose, or are forced by reality, to not practice what they preach (e.g. monetarists in the '80ies). Bourgeois economics isn't inconsistent because they are stupid. As an ideology that justifies continual robbery and injustice, it has to reflect reality badly! (Myths as naive explanations of society.)

The more serious question concerns Keynesian economics. Did they really have a formula for making capitalism work smoothly? Or were they basically buying time and profiting from an exceptional situation (as the marxist economists claim)?

For K the problem is basically one of demand, of buying power. The classic crises of capitalism were of over-production. It was victim of its efficiency and constant growth. At the end of each cycle of production the capitalist normally recovers his capital plus a profit. At the next cycle, he therefor has to find an occasion to invest more, produce more and sell more.... and so on.

If the market was not limited (at the beginning of an industry, during or after a good war, if there was an empire or the markets of a less efficient form of production to invade) this was not a problem. They just did more of the same. (This is called “extensive” accumulation). But when markets were limited, crises of over-production appeared, prices started falling, producing bankruptcies and cutbacks and thus unemployment and falling wages. This in turn reduced demand for products, which created more over-production and turned the spiral vicious. When enough capital had been devalued by bankruptcies, cheap buyouts, etc., it became very profitable to produce. The machine started rolling again, first slowly, then quicker as more people found jobs, etc., until ...

Keynes's solution

Distribute profits in such a way as to ensure a constant demand for the whole production. (higher wages, wage/productivity and wage/cost of living allowances, encourage unions ).

State intervention for a more stable, planified expansion (public works and military spending, unemployment insurance, retirement funds, etc., collective bargaining, mean more stable markets.

Increase credit in order to accompany the growth of real wealth and thus insure that there is a market for it.

If necessary anticipate or provoke the growth and full employment (a criterion for the central bank!) by easier credit or government deficit spending. If inflation became a problem, putting less money in circulation (by higher taxes and less borrowing to balance the government budget, for ex.) would slow down growth and price increases. ("Fine tuning")

But certain conditions had to be fulfilled for K to work:

  1. Political balance of forces in favor of redistribution.
  2. A not too open, globalized economy (or the same rules on a global scale)
  3. Enough productivity/profit gains to be able to give everyone a piece of pie.

In the South: era of relative independence (Cold War permits some “dragons” and unaligned movement), volontaristic state development planning, import substitution and even sometimes welfare.

The fall of K: fall of profits, stagflation

One could try to explain the fall of K essentially by 2): the development of globalisation making States incapable of efficient intervention, thereby letting things slip back into the hands of the greedier, stupider sorts of capitalists. But in fact when things started going wrong even people like Giscard d'Estaing, Johnson, labor and tories all tried K type growth stimulation policies, but these just produced inflation and thus balance of payments problems. The figures show that actually profits were really falling. Increasing demand just increased inflation. K wasn't working any more.

The marxist explanation: The Crisis of profits and overaccumulation. Since its beginning, capitalism has gone by boom and bust. Finally Kian policies only worked in certain conditions and only bought time before these returned.

The fall of profits 3) was the first problem (and is the basic problem of capitalist crises). That led capitalists to counterattack with increased globalisation 2) which changed the balance of forces 1).

So why a fall of profits? Political problems (proletarian insubordination)? or an economic cycle? They are inseparable. The political situation (Cold War) had led to some concessions by imperialists, popular struggles led to Keynesian policies conceding some popular power and revenue, encouraging new struggles and autonomy. But at the end of the cycle, things got tougher because the fall in profits (partly due to struggles) made these concessions unacceptable to capitalists, just at the time when the people were getting really impudent ('68, Italy, GM). Counter revolution and globalisation.

(where does value come from etc.?)

Over-accumulation of capital and crises.

Briefly: the dynamism, but also the crises of capitalism, stem from the contradiction between reality and the basic myth that money "works", earns a profit, all alone. All new values are created by new, living work, but in the capitalist system all capitals (not just that which hires labour power) must earn profits and at roughly the same rate (“normal” profit, abandoned industries). So huge parts of the new value created by work have to be channelled off, not just in the industrialist's profit, but also into rents, interest rates, commercial mark-ups of shops, etc. An industry doesn't just have to show some profit (and if possible be useful!). It has to make enough profit in each cycle to meet the rigid anticipations of the banker, the landowner, etc. And in the K era also enough to pay welfare, increase salaries according to collective contracts, etc.

Going back to the capitalist cycle: (x$ invested in labour and materials must pay costs plus this necessary profit. In the next cycle, the capitalist must then find a way to invest x$ + y$ of last year's profit, find a market for this enlarged production and make a “normal” profit on that, and so on...) If the market is relatively limited, the extra capital is often used to buy more efficient machines (“intensive” accumulation), thereby increasing the productivity of labour. This means extra profit, or a lower price (which increases sales to the detriment of the competition). If the increase in productivity is sufficient, there will be enough profit to pay everyone what they expect. Of course this kind of trick isn't always possible and generally gets more and more difficult, especially as the competition is doing the same thing. So when everyone has got the more efficient machines, prices tend to go down and the extra profit disappears. Of course, one can invest profits in another industry, but the same process is sometimes going on everywhere. A crisis of over-accumulation appears. In the crisis, weaker capitalists go broke or are bought out cheap, so the value of the capital invested in the industry falls. Probably unemployment will also force down wages. So, after considerable suffering and waste, the branch will be able to again make an “acceptable” rate of profit.

Of course, lowering wages or increasing hours or speed of production (increasing the exploitation of labour), means abandoning the K deal, because workers will have less buying power for some capitalist's products. And that is basically what Thatcher, Reagan, etc., did.

This explanation seems to fit the facts best. One can verify that:

- Profits really did go down

- Investments in machines were not increasing productivity as much as before.

- K policies first tried to guarantee a demand for all the products (and thus enough profits for everyone) as usual, by increasing the supply of money. But since in reality the new investments weren't productive enough, weren't really producing that much more riches, that many new products, the result was inflation (= more money competing for the same amount of products mean higher prices.) “Stagflation” (inflation and stagnation, unemployment) defeated "fine tuning".

Back to monetarism

Inflation the only enemy, high interest rates the cure: Another blatant example of biased neo-classical theory.

Nowadays it goes almost without saying that inflation is controlled by increasing interest rates. (the reasoning: If interests are high it will make funding many projects too expensive, so people will borrow less, so there will be less demand for things, so prices will stop rising.) And of course wage increases are refused as obviously inflationary. But what does this really mean? Wages are the revenue of workers, and interest the revenue of capitalists. So what they are really saying (and doing!) is: “There's too much money in circulation, but if we increase the percent that we grab enough, it will slow things down.” Well why not slow things down by increasing salaries? Of course that's considered to be sabotaging the efficiency of the economy! (High interest = the banker's cost of living adjustment. But nobody else gets one!)

In fact, increasing interest rates is an incredibly inefficient way of fighting inflation especially nowadays when indebtedness is very high. The increase in interest rates also applies to much of the debts already contracted, so businesses have to raise their prices (inflation) in order to pay increased interest, supposedly imposed in order to decrease inflation! Also, high interest rates pull up other "normal" profit rates.

(Third World debt: after the Mcnamara Keynesian easy credit, the Reagan hold-up).

Anyhow, either businesses borrow anyhow (in which case it increases inflation), or they don't (in which case there is less money around, but also less products!)

Many useful, necessary and viable activities can no longer get credit (peasants, pme, cooperatives, etc.)

In fact there is no correlation (or even a negative one) between high interest rates and low inflation!(study covering 1946 to 1989)

High interest is a way of increasing the capitalists share of wealth produced. Its a marching order for all bosses to attack salaries.

Other attacks: lower taxes for the rich ("supply side" fiasco), less social wage, unions attacked as causing inflation, tampering with market, etc. (note that interest rates are not fixed by market!). Capital flights (Rust belt, Italy) and globalisation (abandon of K and social "partnership" to seize larger global markets and cut wage costs.)

Crisis of profits solved.... but crisis of demand comes back

Neo-fordism or post-fordism?

Neo-fordism has lost out to globalisation (can't be that much more efficient if they can't protect their markets)

The new wave of globalisation buys some time for capitalism, but when they have destroyed the last small farmers and businesses, bought themselves out to the point of creating global monopolies on everything, over-accumulation will menace again.

...and now capitalism's problems are worse than ever, because investment, which used to create jobs, now rhymes with layoffs. Because instead of expanding its social role, obeying the capitalist rules of the money game is throwing more and more people, whole regions and countries of the South out of the game (Marcos's “pockets of oblivion”). So how could K (or neo-fordism) and “growth” (even if that were still ecologically acceptable!) bring back full employment, adequate demand for goods? A new (final?) kind of crisis for capitalism. Capitalism has never been weaker as a social project. Can't even offer “a job”, let alone a future.

Alternatives to growing monopolisation and misery

Reduction of work time (also a way of reducing the North's comparative advantage)?

Guaranteed revenue (a rather planned economy)?/or Workfare?

Or total breakdown, fascism, war, dark ages... (return of slavery in the USA)

Or something quite else... local money, local economies?

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Materials: Economic Theory — Neoclassic and Keynesian / Olivier de Marcellus Last modified: 98-11-20 / comments to: agpweb (AT)