Herewith the first part of as lecture I gave at Williams College a quarter of century ago. Although much has happened since, the central thesis is, I believe, even more pertinent now than it was then. This is the first of three parts.
A Critique of Keynes
It is my purpose this afternoon to urge upon you the virtues of
socialism. I shall argue that at the present time, the proper way to manage our
economic life is through social planning founded upon collective management of
the means of production. I shall not advance this proposition in the customary
way, however, by telling you affecting tales of human suffering or by
thundering at the injustices of the capitalist system. Human suffering we have
aplenty in our society, and there is more than enough injustice to support a
multitude of tirades. But I have charted a quieter course for myself this
afternoon. I shall review with you something of the history and development of
economic theory during the past two centuries; in order to show you why even
the most sophisticated elaborations of modern neo-classical econometric
model-building no longer serve to keep us from disastrous economic trouble. My
argument will be quite simple and rather abstract, as benefits a philosopher,
and there will be very little in it to puzzle or put off those among you who
have not yet undertaken the study of economics. The heroes of my story are an
Anglo-Jewish stock broker, an émigré from Soviet Russia, the son of an Italian
jurist, and a left-Hegelian romantic philosopher -- which is to say, David
Ricardo, Wassily Leontief, Piero Sraffa, and Karl Marx.
I begin by voicing what is, I hope, our shared agreement that the
American economy is in a godawful mess. We will also agree, I hope, that the
establishment of professional economists is no longer able to speak with solid,
collective scientific confidence about the causes of our present disaster and
the alternative possible cures. The present disarray of the economics
profession is manifest in the self-doubts expressed in technical journals and
presidential addresses to associations of economists, in the absence of
consensus among those middle-of-the-road economists who are routinely looked to
by both major parties for guidance and counsel, and in the bizarre emergence
into respectability and even hegemony of such pseudo-science -- Voodoo
economics, our vice-president once called it -- as supply-side theory.
The profession of economics – or political economy, as it was once
called – has gone through a succession of stages of confidence and self-doubt
during the past two centuries. The triumphant reception of the elegant and
powerful theories of David Ricardo in the first quarter of the nineteenth
century gave way to increasing doubt and confusion as the century wore on, both
because of the internal theoretical inadequacies of Ricardo’s principles and
because of a succession of increasingly violent business cycles of boom and
bust which threatened both social peace and the continued growth of capitalist
enterprise. The new marginalist theories of the last third of the nineteenth
century laid the theoretical foundations for a moral justification of
capitalism, as set forth most famously in the work of J.B.Clark, and also for
the scientific conclusion that in a properly functioning free market, there
could be no sizeable long-term involuntary unemployment. The great depression
after the first world war strained belief in this bit of economic science to
the breaking point, for as the depression grew deeper and unemployment in the
United States, for example, exceeded a quarter of the work force, it became
more and more difficult to maintain that this violent deviation from rational,
efficient full-employment was simply a short term frictional imperfection or a perverse
consequence of sub-optional collective bargaining.
With the macro-economic theories of John Maynard Keynes, the economics
profession entered a new era. If Keynes was right, then it ought to be possible
to salvage capitalism by managing the swings from boom to bust with
counter-cyclical actions by the central government. The state, it seemed, was
not to be confined under capitalism to the role of night-watchman. Instead, it
had a much more important task to perform, as the regulator of effective demand
in the service of full employment growth.
The great test of Keynesian theory came with the end of the second world
war. In the United States and Western Europe, the experiment was made of
capitalism with the state as a macro-economic governor. For a quarter of a
century, the theory seemed to work with brilliant success. Unemployment was
low, growth was steady and rapid, inflation was kept to an acceptable level and
the inevitable business contractions were softened so as to be nothing more
than pauses on the way to ever greater growth. It was during this period – the
golden age of the profession of economics – that Nobel prizes began to be
distributed to these physicians of the body politic. Clearly, ideology and
politics had given way to science.
Alas, the reputation of economics, like the housing and automobile
markets, has soared to ever greater heights, only to plunge to new depths. As
unemployment creeps toward ten percent and the United States, once proud leader
in per capita gross national product, dips to tenth place behind even Italy,
once the weakest partner in the Atlantic Alliance, it is perhaps time to stand
back and reflect a bit on what has gone wrong.
My message today is scarcely original, but it is, I believe, true. I
shall argue that it is fundamentally irrational to permit the direction and
shape of our economic life to emerge as the unplanned consequence of a myriad
of private decisions. For reasons which are simple but theoretically quite
fundamental, an industrial economy in which there is both population growth and
technological innovation cannot be relied upon to grow in a crisis-free manner.
What is more, efforts to shape or direct an essentially private economy by
fiscal or monetary policies of the central government are doomed to fail. The
only rational solution, I shall suggest at the end of my talk, is a thoroughly
socialised economy in which the course of capital accumulation and allocation,
as well as the pattern of distribution of the social product, is made the
object of collective social choice.
Let me begin my story almost two centuries ago, with the classical
vision of a capitalist economy as a free market system in which the pattern of
prices, of capital accumulation, of distribution, and of growth emerges as the
unintended consequence of the interactions of rationally self-interested
workers, consumers, and entrepreneurs. This vision, first adumbrated by Adam Smith and brought to rigorous
fulfillment in David Ricardo’s PRINCIPLES OF POLITICAL ECONOMY AND TAXATION,
rested upon a number of simplifying assumptions, each of which in a different
way made it possible for Ricardo and his followers to draw powerful theoretical
conclusions from the premises of perfect competition, rational self-interested,
and a free market.
The assumptions fall into three categories: behavioral assumptions about
the criteria or guidelines followed by the several classes of agents in their
economic decisions; knowledge assumptions about the kind, degree, and accuracy
of the information available to economic agents; and a rather special
assumption about the nature of money.
The behavioral assumptions are these: capitalists were assumed to be
motivated entirely by a rationally self-interested pursuit of profit, which
they measured in monetary terms. Confronted by a choice among several
alternatives, capitalists could by and large be counted on to choose the most
profitable. Furthermore, capitalists were conceived as perfect accumulators, so
to speak. “Accumulate! Accumulate! That is Moses and the Prophets!” said Marx
of the capitalist class. In effect, what this meant was that the total private
consumption of the capitalist class was so small, in comparison with the
aggregate output of the economy as a whole, that it could, for purposes of
economic calculation, be treated as effectively zero. In part, of course, this
assumption was justified by the relative smallness of the capitalist class as a
group. Even a high standard of living per capitalist does not add up to much in
the way of aggregate consumption. But more important was the behavioral
assumption that capitalists, for whatever reasons, were driven by a desire to
accumulate capital as rapidly as possible. To this end, they reinvested almost
their entire profits in an expanded scale of operations. The classicals and
Marx viewed this process of reinvestment as the primary engine of economic
growth.
The landlords – who loom larger in the writings of Smith and Ricardo
than in those of Marx – are by contrast conceived as grasshoppers, as perfect
consumers. They save nothing, and support a large population of unproductive
servants. As a consequence, of course, the portion of profits diverted to them
as rentals drops out of the economy and plays no role in the process of growth.
Finally, the workers are presumed to live at or near the subsistence
level, with the consequences that as a class they do not save. In the short
run, to be sure, individual workers may succeed in saving enough to rise into
the class of small entrepreneurs, and during the transitional periods of labour
shortage wages may rise significantly above subsistence for large numbers of
workers; but both Ricardo and Marx thought that over the long run, external
pressures of population or unemployment would hold wages at a level at which
worker saving could not regularly take place.
The effect of these behavioral assumptions, you will immediately
realize, is to make certain theoretical calculations extremely simple. The
quantity of capital directed toward investment will be exactly equal to aggregate
profits. Effective final demand for consumer goods will simply equal rents plus
wages. And so forth. To an extent that is not always recognized, particularly
by those outside the profession of economics, the distinctive a priori
character of the reasoning of classical economic theory derives directly from
these behavioral assumptions.
In addition to the behavioral assumption, classical theory makes a
number of powerful simplifying knowledge assumptions. Consumers and sellers are
presumed to have effectively a perfect knowledge of the market – what is being
sold, where, and at what price. Entrepreneurs have perfect knowledge of the
available production techniques, of the prices in factor markets, of the risks
and constraints of different modes of production. Entrepreneurs know also how
other entrepreneurs are doing, so that superprofits anywhere in the economy
will fairly quickly draw interested investors to the favored sector. The result
of these assumptions is to consign to the margins of the theory any
consideration of market imperfections.
The familiar model of a self-correcting economy in dynamic equilibrium,
efficiently allocating available resources in response to consumer demand,
rests upon these twin pillars of simplifying behavioral assumptions and the
assumption of perfect knowledge. The theorems of the classical model, and also
those of the neo-classical model as well, can be proved only because the
knowledge and behavior of economic actors is conceived in this manner.
One final theoretical assumption underpins the classical theories, an
assumption concerning the nature of money. It is an odd fact – odd, I might
say, to the point of absurdity – that there is no place for real money as we
know it either in the economic theories of the classicals or in the marginalist
theories of modern economics. Ricardo conceived of money as simply one
commodity among others – gold, of course, in the world he was looking at –
whose value was determined, as was the value of every commodity, by the conditions
of its production. An ounce of gold exchanged for so much linen, coal, or corn,
he thought, because the conditions under which it was mined and refined bore a
certain relation to the conditions under which linen was woven, coal dug, and
corn grown. Just as a change in the techniques for growing corn would affect
its value relative to other commodities, although in ways more complex than
Ricardo had originally thought, so too a change in the techniques for mining
and refining gold would alter the rate at which gold exchanged with other
goods.
The assumption of commodity-money, as it was called, an assumption which
Marx shared, makes even modern capitalist economic transactions essentially
sophisticated acts of barter. The grounding of the economic system in a
physical base of commodity production is thereby rendered transparent, with the
consequence that such phenomena is inflation, credit squeezes, the so-called
money-illusion, and so forth can play no theoretical role in the analysis of
the economy.
The classicals concluded from their simplified model that in the absence
of distorting interventions from the central government, a capitalist economy
would function efficiently in long-run equilibrium. Marx sought to demonstrate
that capitalism, even in this extremely simple conception of it, is internally
unstable and prone to operational breakdowns. But Marx shared with the
classicals all of the behavioral and knowledge assumptions I have just
sketched.
One of the first major departures from this simple model appears in John
Stuart Mill’s PRINCIPLES OF POLITICAL ECONOMY, a book which, in many editions,
was the leading economics textbook of the nineteenth century. In a little
chapter entitled “Of Competition and Custom,” Mill introduces a new element
into political economy which, I shall argue, destroys classical theory and
eventually leads to an entirely different understanding of capitalism. It is
completely typical of Mill that at one and the same time he understands the
theoretical significance of what he is doing, and yet treats it as a mere
adjustment to a theory which he is otherwise prepared to continue supporting. This
paragraph, from the opening page of Mill's little chapter "Of Competition
and Custom," is worth quoting:
"So far as rents, profits, wages, prices, are determined by
competition, laws may be assigned for them.
Assume competition to be their exclusive regulator, and principles of
broad generality and scientific precision may be laid down, according to which
they will be regulated. The political
economist justly deems this his proper business: and as an abstract or hypothetical science,
political economy cannot be required to do, and indeed cannot do, anything
more. But it would be a great
misconception of the actual course of human affairs, to suppose that
competition exercises in fact this unlimited sway. I am not speaking of monopolies, either
natural or artificial, or of any interferences of authority with the liberty of
production or exchange. Such disturbing
causes have always been allowed for by political economists. I speak of cases in which there is nothing to
restrain competition; no hindrance to it
either in the nature of the case or in artificial obstacles; yet in which the result is not determined by
competition, but by custom or usage;
competition either not taking place at all, or producing its effect in
quite a different manner from that which is ordinarily assumed to be natural to
it."
In his development of this idea, Mill emphasizes the customary character
of groundrent, and also to a lesser degree of market prices for consumer goods.
Now, I wish to suggest that once custom has been acknowledged as a determinant
of any of the central economic variables, the entire edifice of classical
economic theory must surely crumble. Before turning to the way in which Mill’s
little point about custom has been expanded into a full-scale theoretical
transformation of the classical theory, let me explore for a bit the
significance of the elementary example Mill offers.
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