PDF version of Section C.
C.1 What is wrong with economics?
In a nutshell, a lot. While economists like to portray their discipline as “scientific” and “value free”, the reality is very different. It is, in fact, very far from a science and hardly “value free.” Instead it is, to a large degree, deeply ideological and its conclusions almost always (by a strange co-incidence) what the wealthy, landlords, bosses and managers of capital want to hear. The words of Kropotkin still ring true today:
“Political Economy has always confined itself to stating facts occurring in society, and justifying them in the interest of the dominant class . . . Having found [something] profitable to capitalists, it has set it up as a principle.“ [The Conquest of Bread, p. 181]
This is at its best, of course. At its worse economics does not even bother with the facts and simply makes the most appropriate assumptions necessary to justify the particular beliefs of the economists and, usually, the interests of the ruling class. This is the key problem with economics: it is not a science. It is not independent of the class nature of society, either in the theoretical models it builds or in the questions it raises and tries to answer. This is due, in part, to the pressures of the market, in part due to the assumptions and methodology of the dominant forms of economics. It is a mishmash of ideology and genuine science, with the former (unfortunately) being the bulk of it.
The argument that economics, in the main, is not a science it not one restricted to anarchists or other critics of capitalism. Some economists are well aware of the limitations of their profession. For example, Steve Keen lists many of the flaws of mainstream (neoclassical) economics in his excellent book Debunking Economics, noting that (for example) it is based on a “dynamically irrelevant and factually incorrect instantaneous static snap-shot” of the real capitalist economy. [Debunking Economics, p. 197] The late Joan Robinson argued forcefully that the neoclassical economist “sets up a ‘model’ on arbitrarily constructed assumptions, and then applies ‘results’ from it to current affairs, without even trying to pretend that the assumptions conform to reality.” [Collected Economic Papers, vol. 4, p. 25] More recently, economist Mark Blaug has summarised many of the problems he sees with the current state of economics:
“Economics has increasing become an intellectual games played for its own sake and not for its practical consequences. Economists have gradually converted the subject into a sort of social mathematics in which analytical rigor as understood in math departments is everything and empirical relevance (as understood in physics departments) is nothing . . . general equilibrium theory . . . using economic terms like ‘prices’, ‘quantities’, ‘factors of production,’ and so on, but that nevertheless is clearly and even scandalously unrepresentative of any recognisable economic system. . .
“Perfect competition never did exist and never could exist because, even when firms are small, they do not just take the price but strive to make the price. All the current textbooks say as much, but then immediately go on to say that the ‘cloud-cuckoo’ fantasyland of perfect competition is the benchmark against which we may say something significant about real-world competition . . . But how can an idealised state of perfection be a benchmark when we are never told how to measure the gap between it and real-world competition? It is implied that all real-world competition is ‘approximately’ like perfect competition, but the degree of the approximation is never specified, even vaguely . . .
“Think of the following typical assumptions: perfectly infallible, utterly omniscient, infinitely long-lived identical consumers; zero transaction costs; complete markets for all time-stated claims for all conceivable events, no trading of any kind at disequilibrium prices; infinitely rapid velocities of prices and quantities; no radical, incalculable uncertainty in real time but only probabilistically calculable risk in logical time; only linearly homogeneous production functions; no technical progress requiring embodied capital investment, and so on, and so on — all these are not just unrealistic but also unrobust assumptions. And yet they figure critically in leading economic theories.” [“Disturbing Currents in Modern Economics”, Challenge!, Vol. 41, No. 3, May-June, 1998]
So neoclassical ideology is based upon special, virtually ad hoc, assumptions. Many of the assumptions are impossible, such as the popular assertion that individuals can accurately predict the future (as required by “rational expectations” and general equilibrium theory), that there are a infinite number of small firms in every market or that time is an unimportant concept which can be abstracted from. Even when we ignore those assumptions which are obviously nonsense, the remaining ones are hardly much better. Here we have a collection of apparently valid positions which, in fact, rarely have any basis in reality. As we discuss in section C.1.2, an essential one, without which neoclassical economics simply disintegrates, has very little basis in the real world (in fact, it was invented simply to ensure the theory worked as desired). Similarly, markets often adjust in terms of quantities rather than price, a fact overlooked in general equilibrium theory. Some of the assumptions are mutually exclusive. For example, the neo-classical theory of the supply curve is based on the assumption that some factor of production cannot be changed in the short run. This is essential to get the concept of diminishing marginal productivity which, in turn, generates a rising marginal cost and so a rising supply curve. This means that firms within an industry cannot change their capital equipment. However, the theory of perfect competition requires that in the short period there are no barriers to entry, i.e. that anyone outside the industry can create capital equipment and move into the market. These two positions are logically inconsistent.
In other words, although the symbols used in mainstream may have economic sounding names, the theory has no point of contact with empirical reality (or, at times, basic logic):
“Nothing in these abstract economic models actually works in the real world. It doesn’t matter how many footnotes they put in, or how many ways they tinker around the edges. The whole enterprise is totally rotten at the core: it has no relation to reality.” [Noam Chomsky, Understanding Power, pp. 254-5]
As we will indicate, while its theoretical underpinnings are claimed to be universal, they are specific to capitalism and, ironically, they fail to even provide an accurate model of that system as it ignores most of the real features of an actual capitalist economy. So if an economist does not say that mainstream economics has no bearing to reality, you can be sure that what he or she tells you will be more likely ideology than anything else. “Economic reality” is not about facts; it’s about faith in capitalism. Even worse, it is about blind faith in what the economic ideologues say about capitalism. The key to understanding economists is that they believe that if it is in an economic textbook, then it must be true — particularly if it confirms any initial prejudices. The opposite is usually the case.
The obvious fact that the real world is not like that described by economic text books can have some funny results, particularly when events in the real world contradict the textbooks. For most economists, or those who consider themselves as such, the textbook is usually preferred. As such, much of capitalist apologetics is faith-driven. Reality has to be adjusted accordingly.
A classic example was the changing positions of pundits and “experts” on the East Asian economic miracle. As these economies grew spectacularly during the 1970s and 1980s, the experts universally applauded them as examples of the power of free markets. In 1995, for example, the right-wing Heritage Foundation’s index of economic freedom had four Asian countries in its top seven countries. The Economist explained at the start of 1990s that Taiwan and South Korea had among the least price-distorting regimes in the world. Both the Word Bank and IMF agreed, downplaying the presence of industrial policy in the region. This was unsurprising. After all, their ideology said that free markets would produce high growth and stability and so, logically, the presence of both in East Asia must be driven by the free market. This meant that, for the true believers, these nations were paradigms of the free market, reality not withstanding. The markets agreed, putting billions into Asian equity markets while foreign banks loaned similar vast amounts.
In 1997, however, all this changed when all the Asian countries previously qualified as “free” saw their economies collapse. Overnight the same experts who had praised these economies as paradigms of the free market found the cause of the problem — extensive state intervention. The free market paradise had become transformed into a state regulated hell! Why? Because of ideology — the free market is stable and produces high growth and, consequently, it was impossible for any economy facing crisis to be a free market one! Hence the need to disown what was previously praised, without (of course) mentioning the very obvious contradiction.
In reality, these economies had always been far from the free market. The role of the state in these “free market” miracles was extensive and well documented. So while East Asia “had not only grown faster and done better at reducing poverty than any other region of the world . . . it had also been more stable,” these countries “had been successful not only in spite of the fact that they had not followed most of the dictates of the Washington Consensus [i.e. neo-liberalism], but because they had not.” The government had played “important roles . . . far from the minimalist [ones] beloved” of neo-liberalism. During the 1990s, things had changed as the IMF had urged a “excessively rapid financial and capital market liberalisation” for these countries as sound economic policies. This “was probably the single most important cause of the  crisis” which saw these economies suffer meltdown, “the greatest economic crisis since the Great Depression” (a meltdown worsened by IMF aid and its underlying dogmas). Even worse for the believers in market fundamentalism, those nations (like Malaysia) that refused IMF suggestions and used state intervention has a “shorter and shallower” downturn than those who did not. [Joseph Stiglitz, Globalisation and its Discontents, p. 89, p. 90, p. 91 and p. 93] Even worse, the obvious conclusion from these events is more than just the ideological perspective of economists, it is that “the market” is not all-knowing as investors (like the experts) failed to see the statist policies so bemoaned by the ideologues of capitalism after 1997.
This is not to say that the models produced by neoclassical economists are not wonders of mathematics or logic. Few people would deny that a lot of very intelligent people have spent a lot of time producing some quite impressive mathematical models in economics. It is a shame that they are utterly irrelevant to reality. Ironically, for a theory claims to be so concerned about allocating scarce resources efficiently, economics has used a lot of time and energy refining the analyses of economies which have not, do not, and will not ever exist. In other words, scare resources have been inefficiently allocated to produce waste.
Why? Perhaps because there is a demand for such nonsense? Some economists are extremely keen to apply their methodology in all sorts of areas outside the economy. No matter how inappropriate, they seek to colonise every aspect of life. One area, however, seems immune to such analysis. This is the market for economic theory. If, as economists stress, every human activity can be analysed by economics then why not the demand and supply of economics itself? Perhaps because if that was done some uncomfortable truths would be discovered?
Basic supply and demand theory would indicate that those economic theories which have utility to others would be provided by economists. In a system with inequalities of wealth, effective demand is skewed in favour of the wealthy. Given these basic assumptions, we would predict that only these forms of economists which favour the requirements of the wealthy would gain dominance as these meet the (effective) demand. By a strange co-incidence, this is precisely what has happened. This did and does not stop economists complaining that dissidents and radicals were and are biased. As Edward Herman points out:
“Back in 1849, the British economist Nassau Senior chided those defending trade unions and minimum wage regulations for expounding an ‘economics of the poor.’ The idea that he and his establishment confreres were putting forth an ‘economics of the rich’ never occurred to him; he thought of himself as a scientist and spokesperson of true principles. This self-deception pervaded mainstream economics up to the time of the Keynesian Revolution of the 1930s. Keynesian economics, though quickly tamed into an instrument of service to the capitalist state, was disturbing in its stress on the inherent instability of capitalism, the tendency toward chronic unemployment, and the need for substantial government intervention to maintain viability. With the resurgent capitalism of the past 50 years, Keynesian ideas, and their implicit call for intervention, have been under incessant attack, and, in the intellectual counterrevolution led by the Chicago School, the traditional laissez-faire (‘let-the-fur-fly’) economics of the rich has been re-established as the core of mainstream economics.” [The Economics of the Rich ]
Herman goes on to ask “[w]hy do the economists serve the rich?” and argues that “[f]or one thing, the leading economists are among the rich, and others seek advancement to similar heights. Chicago School economist Gary Becker was on to something when he argued that economic motives explain a lot of actions frequently attributed to other forces. He of course never applied this idea to economics as a profession . . .” There are a great many well paying think tanks, research posts, consultancies and so on that create an “‘effective demand’ that should elicit an appropriate supply resource.”
Elsewhere, Herman notes the “class links of these professionals to the business community were strong and the ideological element was realised in the neoclassical competitive model . . . Spin-off negative effects on the lower classes were part of the ‘price of progress.’ It was the elite orientation of these questions [asked by economics], premises, and the central paradigm [of economic theory] that caused matters like unemployment, mass poverty, and work hazards to escape the net of mainstream economist interest until well into the twentieth century.” Moreover, “the economics profession in the years 1880-1930 was by and large strongly conservative, reflecting in its core paradigm its class links and sympathy with the dominant business community, fundamentally anti-union and suspicious of government, and tending to view competition as the true and durable state of nature.” [Edward S. Herman, “The Selling of Market Economics,” pp. 173-199, New Ways of Knowing, Marcus G. Raskin and Herbert J. Bernstein (eds.),p. 179-80 and p. 180]
Rather than scientific analysis, economics has always been driven by the demands of the wealthy (“How did [economics] get instituted? As a weapon of class warfare.” [Chomsky, Op. Cit., p. 252]). This works on numerous levels. The most obvious is that most economists take the current class system and wealth/income distribution as granted and generate general “laws” of economics from a specific historical society. As we discuss in the next section, this inevitably skews the “science” into ideology and apologetics. The analysis is also (almost inevitably) based on individualistic assumptions, ignoring or downplaying the key issues of groups, organisations, class and the economic and social power they generate. Then there are the assumptions used and questions raised. As Herman argues, this has hardly been a neutral process:
“the theorists explicating these systems, such as Carl Menger, Leon Walras, and Alfred Marshall, were knowingly assuming away formulations that raised disturbing questions (income distribution, class and market power, instability, and unemployment) and creating theoretical models compatible with their own policy biases of status quo or modest reformism . . . Given the choice of ‘problem,’ ideology and other sources of bias may still enter economic analysis if the answer is predetermined by the structure of the theory or premises, or if the facts are selected or bent to prove the desired answer.” [Op. Cit., p. 176]
Needless to say, economics is a “science” with deep ramifications within society. As a result, it comes under pressure from outside influences and vested interests far more than, say, anthropology or physics. This has meant that the wealthy have always taken a keen interest that the “science” teaches the appropriate lessons. This has resulted in a demand for a “science” which reflects the interests of the few, not the many. Is it really just a co-incidence that the lessons of economics are just what the bosses and the wealthy would like to hear? As non-neoclassical economist John Kenneth Galbraith noted in 1972:
“Economic instruction in the United States is about a hundred years old. In its first half century economists were subject to censorship by outsiders. Businessmen and their political and ideological acolytes kept watch on departments of economics and reacted promptly to heresy, the latter being anything that seemed to threaten the sanctity of property, profits, a proper tariff policy and a balanced budget, or that suggested sympathy for unions, public ownership, public regulation or, in any organised way, for the poor.” [The Essential Galbraith, p. 135]
It is really surprising that having the wealthy fund (and so control) the development of a “science” has produced a body of theory which so benefits their interests? Or that they would be keen to educate the masses in the lessons of said “science”, lessons which happen to conclude that the best thing workers should do is obey the dictates of the bosses, sorry, the market? It is really just a co-incidence that the repeated use of economics is to spread the message that strikes, unions, resistance and so forth are counter-productive and that the best thing worker can do is simply wait patiently for wealth to trickle down?
This co-incidence has been a feature of the “science” from the start. The French Second Empire in the 1850s and 60s saw “numerous private individuals and organisation, municipalities, and the central government encouraged and founded institutions to instruct workers in economic principles.” The aim was to “impress upon [workers] the salutary lessons of economics.” Significantly, the “weightiest motive” for so doing “was fear that the influence of socialist ideas upon the working class threatened the social order.” The revolution of 1848 “convinced many of the upper classes that the must prove to workers that attacks upon the economic order were both unjustified and futile.” Another reason was the recognition of the right to strike in 1864 and so workers “had to be warned against abuse of the new weapon.” The instruction “was always with the aim of refuting socialist doctrines and exposing popular misconceptions. As one economist stated, it was not the purpose of a certain course to initiate workers into the complexities of economic science, but to define principles useful for ‘our conduct in the social order.'” The interest in such classes was related to the level of “worker discontent and agitation.” The impact was less than desired: “The future Communard Lefrancais referred mockingly to the economists . . . and the ‘banality’ and ‘platitudes’ of the doctrine they taught. A newspaper account of the reception given to the economist Joseph Garnier states that Garnier was greeted with shouts of: ‘He is an economist’ . . . It took courage, said the article, to admit that one was an economist before a public meeting.” [David I. Kulstein, “Economics Instruction for Workers during the Second Empire,” pp. 225-234, French Historical Studies, vol. 1, no. 2, p. 225, p. 226, p. 227 and p. 233]
This process is still at work, with corporations and the wealthy funding university departments and posts as well as their own “think tanks” and paid PR economists. The control of funds for research and teaching plays it part in keeping economics the “economics of the rich.” Analysing the situation in the 1970s, Herman notes that the “enlarged private demand for the services of economists by the business community . . . met a warm supply response.” He stressed that “if the demand in the market is for specific policy conclusions and particular viewpoints that will serve such conclusions, the market will accommodate this demand.” Hence “blatantly ideological models . . . are being spewed forth on a large scale, approved and often funded by large vested interests” which helps “shift the balance between ideology and science even more firmly toward the former.” [Op. Cit., p. 184, p. 185 and p. 179] The idea that “experts” funded and approved by the wealthy would be objective scientists is hardly worth considering. Unfortunately, many people fail to exercise sufficient scepticism about economists and the economics they support. As with most experts, there are two obvious questions with which any analysis of economics should begin: “Who is funding it?” and “Who benefits from it?”
However, there are other factors as well, namely the hierarchical organisation of the university system. The heads of economics departments have the power to ensure the continuation of their ideological position due to the position as hirer and promoter of staff. As economics “has mixed its ideology into the subject so well that the ideologically unconventional usually appear to appointment committees to be scientifically incompetent.” [Benjamin Ward, What’s Wrong with Economics?, p. 250] Galbraith termed this “a new despotism,” which consisted of “defining scientific excellence in economics not as what is true but as whatever is closest to belief and method to the scholarly tendency of the people who already have tenure in the subject. This is a pervasive test, not the less oppress for being, in the frequent case, both self-righteous and unconscious. It helps ensure, needless to say, the perpetuation of the neoclassical orthodoxy.” [Op. Cit., p. 135] This plays a key role in keeping economics an ideology rather than a science:
“The power inherent in this system of quality control within the economics profession is obviously very great. The discipline’s censors occupy leading posts in economics departments at the major institutions . . . Any economist with serious hopes of obtaining a tenured position in one of these departments will soon be made aware of the criteria by which he is to be judged . . . the entire academic program . . . consists of indoctrination in the ideas and techniques of the science.” [Ward, Op. Cit., pp. 29-30]
All this has meant that the “science” of economics has hardly changed in its basics in over one hundred years. Even notions which have been debunked (and have been acknowledged as such) continue to be taught:
“The so-called mainline teaching of economic theory has a curious self-sealing capacity. Every breach that is made in it by criticism is somehow filled up by admitting the point but refusing to draw any consequence from it, so that the old doctrines can be repeated as before. Thus the Keynesian revolution was absorbed into the doctrine that, ‘in the long run,’ there is a natural tendency for a market economy to achieve full employment of available labour and full utilisation of equipment; that the rate of accumulation is determined by household saving; and that the rate of interest is identical with the rate of profit on capital. Similarly, Piero Sraffa’s demolition of the neoclassical production function in labour and ‘capital’ was admitted to be unanswerable, but it has not been allowed to affect the propagation of the ‘marginal productivity’ theory of wages and profits.
“The most sophisticated practitioners of orthodoxy maintain that the whole structure is an exercise in pure logic which has no application to real life at all. All the same they give their pupils the impression that they are being provided with an instrument which is valuable, indeed necessary, for the analysis of actual problems.” [Joan Robinson, Op. Cit., vol. 5, p. 222]
The social role of economics explains this process, for “orthodox traditional economics . . . was a plan for explaining to the privileged class that their position was morally right and was necessary for the welfare of society. Even the poor were better off under the existing system that they would be under any other . . . the doctrine [argued] that increased wealth of the propertied class brings about an automatic increase of income to the poor, so that, if the rich were made poorer, the poor would necessarily become poorer too.” [Robinson, Op. Cit., vol. 4, p. 242]
In such a situation, debunked theories would continue to be taught simply because what they say has a utility to certain sections of society:
“Few issues provide better examples of the negative impact of economic theory on society than the distribution of income. Economists are forever opposing ‘market interventions’ which might raise the wages of the poor, while defending astronomical salary levels for top executives on the basis that if the market is willing to pay them so much, they must be worth it. In fact, the inequality which is so much a characteristic of modern society reflects power rather than justice. This is one of the many instances where unsound economic theory makes economists the champions of policies which, is anything, undermine the economic foundations of modern society.” [Keen, Op. Cit., p. 126]
This argument is based on the notion that wages equal the marginal productivity of labour. This is supposed to mean that as the output of workers increase, their wages rise. However, as we note in section C.1.5, this law of economics has been violated for the last thirty-odd years in the US. Has this resulted in a change in the theory? Of course not. Not that the theory is actually correct. As we discuss in section C.2.5, marginal productivity theory has been exposed as nonsense (and acknowledged as flawed by leading neo-classical economists) since the early 1960s. However, its utility in defending inequality is such that its continued use does not really come as a surprise.
This is not to suggest that mainstream economics is monolithic. Far from it. It is riddled with argument and competing policy recommendations. Some theories rise to prominence, simply to disappear again (“See, the ‘science’ happens to be a very flexible one: you can change it to do whatever you feel like, it’s that kind of ‘science.'” [Chomsky, Op. Cit., p. 253]). Given our analysis that economics is a commodity and subject to demand, this comes as no surprise. Given that the capitalist class is always in competition within itself and different sections have different needs at different times, we would expect a diversity of economics beliefs within the “science” which rise and fall depending on the needs and relative strengths of different sections of capital. While, overall, the “science” will support basic things (such as profits, interest and rent are not the result of exploitation) but the actual policy recommendations will vary. This is not to say that certain individuals or schools will not have their own particular dogmas or that individuals rise above such influences and act as real scientists, of course, just that (in general) supply is not independent of demand or class influence.
Nor should we dismiss the role of popular dissent in shaping the “science.” The class struggle has resulted in a few changes to economics, if only in terms of the apologetics used to justify non-labour income. Popular struggles and organisation play their role as the success of, say, union organising to reduce the working day obviously refutes the claims made against such movements by economists. Similarly, the need for economics to justify reforms can become a pressing issue when the alternative (revolution) is a possibility. As Chomsky notes, during the 19th century (as today) popular struggle played as much of a role as the needs of the ruling class in the development of the “science”:
“[Economics] changed for a number of reasons. For one thing, these guys had won, so they didn’t need it so much as an ideological weapon anymore. For another, they recognised that they themselves needed a powerful interventionist state to defend industry form the hardships of competition in the open market — as they had always had in fact. And beyond that, eliminating people’s ‘right to live’ was starting to have some negative side-effects. First of all, it was causing riots all over the place . . . Then something even worse happened — the population started to organise: you got the beginning of an organised labour movement . . . then a socialist movement developed. And at that point, the elites . . . recognised that the game had to be called off, else they really would be in trouble . . . it wasn’t until recent years that laissez-faire ideology was revived again — and again, it was a weapon of class warfare . . . And it doesn’t have any more validity than it had in the early nineteenth century — in fact it has even less. At least in the early nineteenth century . . . [the] assumptions had some relation to reality. Today those assumptions have not relation to reality.” [Op. Cit., pp. 253-4]
Whether the “economics of the rich” or the “economics of the poor” win out in academia is driven far more by the state of the class war than by abstract debating about unreal models. Thus the rise of monetarism came about due to its utility to the dominant sections of the ruling class rather than it winning any intellectual battles (it was decisively refuted by leading Keynesians like Nicholas Kaldor who saw their predicted fears become true when it was applied — see section C.8). Hopefully by analysing the myths of capitalist economics we will aid those fighting for a better world by giving them the means of counteracting those who claim the mantle of “science” to foster the “economics of the rich” onto society.
To conclude, neo-classical economics shows the viability of an unreal system and this is translated into assertions about the world that we live in. Rather than analyse reality, economics evades it and asserts that the economy works “as if” it matched the unreal assumptions of neoclassical economics. No other science would take such an approach seriously. In biology, for example, the notion that the world can be analysed “as if” God created it is called Creationism and rightly dismissed. In economics, such people are generally awarded professorships or even the (so-called) Nobel prize in economics (Keen critiques the “as if” methodology of economics in chapter 7 of his Debunking Economics ). Moreover, and even worse, policy decisions will be enacted based on a model which has no bearing in reality — with disastrous results (for example, the rise and fall of Monetarism).
Its net effect to justify the current class system and diverts serious attention from critical questions facing working class people (for example, inequality and market power, what goes on in production, how authority relations impact on society and in the workplace). Rather than looking to how things are produced, the conflicts generated in the production process and the generation as well as division of products/surplus, economics takes what was produced as given, as well as the capitalist workplace, the division of labour and authority relations and so on. The individualistic neoclassical analysis by definition ignores such key issues as economic power, the possibility of a structural imbalance in the way economic growth is distributed, organisation structure, and so on.
Given its social role, it comes as no surprise that economics is not a genuine science. For most economists, the “scientific method (the inductive method of natural sciences) [is] utterly unknown to them.” [Kropotkin, Anarchism, p. 179] The argument that most economics is not a science is not limited to just anarchists or other critics of capitalism. Many dissident economics recognise this fact as well, arguing that the profession needs to get its act together if it is to be taken seriously. Whether it could retain its position as defender of capitalism if this happens is a moot point as many of the theorems developed were done so explicitly as part of this role (particularly to defend non-labour income — see section C.2). That economics can become much broader and more relevant is always a possibility, but to do so would mean to take into account an unpleasant reality marked by class, hierarchy and inequality rather than logic deductions derived from Robinson Crusoe. While the latter can produce mathematical models to reach the conclusions that the market is already doing a good job (or, at best, there are some imperfections which can be counterbalanced by the state), the former cannot.
Anarchists, unsurprisingly, take a different approach to economics. As Kropotkin put it, “we think that to become a science, Political Economy has to be built up in a different way. It must be treated as a natural science, and use the methods used in all exact, empirical sciences.” [Evolution and Environment, p. 93] This means that we must start with the world as it is, not as economics would like it to be. It must be placed in historical context and key facts of capitalism, like wage labour, not taken for granted. It must not abstract from such key facts of life as economic and social power. In a word, economics must reject those features which turn it into a sophisticated defence of the status quo. Given its social role within capitalism (and the history and evolution of economic thought), it is doubtful it will ever become a real science simply because it if did it would hardly be used to defend that system.
Modern economists try and portray economics as a “value-free science.” Of course, it rarely dawns on them that they are usually just taking existing social structures for granted and building economic dogmas around them, so justifying them. At best, as Kropotkin pointed out:
“[A]ll the so-called laws and theories of political economy are in reality no more than statements of the following nature: ‘Granting that there are always in a country a considerable number of people who cannot subsist a month, or even a fortnight, without earning a salary and accepting for that purpose the conditions of work imposed upon them by the State, or offered to them by those whom the State recognises as owners of land, factories, railways, etc., then the results will be so and so.’
“So far academic political economy has been only an enumeration of what happens under these conditions — without distinctly stating the conditions themselves. And then, having described the facts which arise in our society under these conditions, they represent to us these facts as rigid, inevitable economic laws.“ [Anarchism, p. 179]
In other words, economists usually take the political and economic aspects of capitalist society (such as property rights, inequality and so on) as given and construct their theories around it. At best. At worse, economics is simply speculation based on the necessary assumptions required to prove the desired end. By some strange coincidence these ends usually bolster the power and profits of the few and show that the free market is the best of all possible worlds. Alfred Marshall, one of the founders of neoclassical economics, once noted the usefulness of economics to the elite:
“From Metaphysics I went to Ethics, and found that the justification of the existing conditions of society was not easy. A friend, who had read a great deal of what are called the Moral Sciences, constantly said: ‘Ah! if you understood Political Economy you would not say that'” [quoted by Joan Robinson, Collected Economic Papers, vol. 4, p. 129]
Joan Robinson added that “[n]owadays, of course, no one would put it so crudely. Nowadays, the hidden persuaders are concealed behind scientific objectivity, carefully avoiding value judgements; they are persuading all the better so.” [Op. Cit., p. 129] The way which economic theory systematically says what bosses and the wealthy want to hear is just one of those strange co-incidences of life, one which seems to befall economics with alarming regularity.
How does economics achieve this strange co-incidence, how does the “value free” “science” end up being wedded to producing apologetics for the current system? A key reason is the lack of concern about history, about how the current distribution of income and wealth was created. Instead, the current distribution of wealth and income is taken for granted.
This flows, in part, from the static nature of neoclassical economics. If your economic analysis starts and ends with a snapshot of time, with a given set of commodities, then how those commodities get into a specific set of hands can be considered irrelevant — particularly when you modify your theory to exclude the possibility of proving income redistribution will increase overall utility (see section C.1.3). It also flows from the social role of economics as defender of capitalism. By taking the current distribution of income and wealth as given, then many awkward questions can be automatically excluded from the “science.”
This can be seen from the rise of neoclassical economics in the 1870s and 1880s. The break between classical political economy and economics was marked by a change in the kind of questions being asked. In the former, the central focus was on distribution, growth, production and the relations between social classes. The exact determination of individual prices was of little concern, particularly in the short run. For the new economics, the focus became developing a rigorous theory of price determination. This meant abstracting from production and looking at the amount of goods available at any given moment of time. Thus economics avoided questions about class relations by asking questions about individual utility, so narrowing the field of analysis by asking politically harmless questions based on unrealistic models (for all its talk of rigour, the new economics did not provide an answer to how real prices were determined any more than classical economics had simply because its abstract models had no relation to reality).
It did, however, provide a naturalistic justification for capitalist social relations by arguing that profit, interest and rent are the result of individual decisions rather than the product of a specific social system. In other words, economics took the classes of capitalism, internalised them within itself, gave them universal application and, by taking for granted the existing distribution of wealth, justified the class structure and differences in market power this produces. It does not ask (or investigate) why some people own all the land and capital while the vast majority have to sell their labour on the market to survive. As such, it internalises the class structure of capitalism. Taking this class structure as a given, economics simply asks the question how much does each “factor” (labour, land, capital) contribute to the production of goods.
Alfred Marshall justified this perspective as follows:
“In the long run the earnings of each agent (of production) are, as a rule, sufficient only to recompense the sum total of the efforts and sacrifices required to produce them . . . with a partial exception in the case of land . . . especially much land in old countries, if we could trace its record back to their earliest origins. But the attempt would raise controversial questions in history and ethics as well as in economics; and the aims of our present inquiry are prospective rather than retrospective.” [Principles of Economics, p. 832]
Which is wonderfully handy for those who benefited from the theft of the common heritage of humanity. Particularly as Marshall himself notes the dire consequences for those without access to the means of life on the market:
“When a workman is in fear of hunger, his need of money is very great; and, if at starting he gets the worst of the bargaining, it remains great . . . That is all the more probably because, while the advantage in bargaining is likely to be pretty well distributed between the two sides of a market for commodities, it is more often on the side of the buyers than on that of the sellers in a market for labour.” [Op. Cit., pp. 335-6]
Given that market exchanges will benefit the stronger of the parties involved, this means that inequalities become stronger and more secure over time. Taking the current distribution of property as a given (and, moreover, something that must not be changed) then the market does not correct this sort of injustice. In fact, it perpetuates it and, moreover, it has no way of compensating the victims as there is no mechanism for ensuring reparations. So the impact of previous acts of aggression has an impact on how a specific society developed and the current state of the world. To dismiss “retrospective” analysis as it raises “controversial questions” and “ethics” is not value-free or objective science, it is pure ideology and skews any “prospective” enquiry into apologetics.
This can be seen when Marshall noted that labour “is often sold under special disadvantages, arising from the closely connected group of facts that labour power is ‘perishable,’ that the sellers of it are commonly poor and have no reserve fund, and that they cannot easily withhold it from the market.” Moreover, the “disadvantage, wherever it exists, is likely to be cumulative in its effects.” Yet, for some reason, he still maintains that “wages of every class of labour tend to be equal to the net product due to the additional labourer of this class.” [Op. Cit., p. 567, p. 569 and p. 518] Why should it, given the noted fact that workers are at a disadvantage in the market place? Hence Malatesta:
“Landlords, capitalists have robbed the people, with violence and dishonesty, of the land and all the means of production, and in consequence of this initial theft can each day take away from workers the product of their labour.” [Errico Malatesta: His Life and Ideas, p. 168]
As such, how could it possibly be considered “scientific” or “value-free” to ignore history? It is hardly “retrospective” to analyse the roots of the current disadvantage working class people have in the current and “prospective” labour market, particularly given that Marshall himself notes their results. This is a striking example of what Kropotkin deplored in economics, namely that in the rare situations when social conditions were “mentioned, they were forgotten immediately, to be spoken of no more.” Thus reality is mentioned, but any impact this may have on the distribution of income is forgotten for otherwise you would have to conclude, with the anarchists, that the “appropriation of the produce of human labour by the owners of capital [and land] exists only because millions of men [and women] have literally nothing to live upon, unless they sell their labour force and their intelligence at a price that will make the net profit of the capitalist and ‘surplus value’ possible.” [Evolution and Environment, p. 92 and p. 106]
This is important, for respecting property rights is easy to talk about but it only faintly holds some water if the existing property ownership distribution is legitimate. If it is illegitimate, if the current property titles were the result of theft, corruption, colonial conquest, state intervention, and other forms of coercion then things are obviously different. That is why economics rarely, if ever, discusses this. This does not, of course, stop economists arguing against current interventions in the market (particularly those associated with the welfare state). In effect, they are arguing that it is okay to reap the benefits of past initiations of force but it is wrong to try and rectify them. It is as if someone walks into a room of people, robs them at gun point and then asks that they should respect each others property rights from now on and only engage in voluntary exchanges with what they had left. Any attempt to establish a moral case for the “free market” in such circumstances would be unlikely to succeed. This is free market capitalist economics in a nutshell: never mind past injustices, let us all do the best we can given the current allocations of resources.
Many economists go one better. Not content in ignoring history, they create little fictional stories in order to justify their theories or the current distribution of wealth and income. Usually, they start from isolated individual or a community of approximately equal individuals (a community usually without any communal institutions). For example, the “waiting” theories of profit and interest (see section C.2.7) requires such a fiction to be remotely convincing. It needs to assume a community marked by basic equality of wealth and income yet divided into two groups of people, one of which was industrious and farsighted who abstained from directly consuming the products created by their own labour while the other was lazy and consumed their income without thought of the future. Over time, the descendants of the diligent came to own the means of life while the descendants of the lazy and the prodigal have, to quote Marx, “nothing to sell but themselves.” In that way, modern day profits and interest can be justified by appealing to such “insipid childishness.” [Capital, vol. 1, p. 873] The real history of the rise of capitalism is, as we discuss in section F.8, grim.
Of course, it may be argued that this is just a model and an abstraction and, consequently, valid to illustrate a point. Anarchists disagree. Yes, there is often the need for abstraction in studying an economy or any other complex system, but this is not an abstraction, it is propaganda and a historical invention used not to illustrate an abstract point but rather a specific system of power and class. That these little parables and stories have all the necessary assumptions and abstractions required to reach the desired conclusions is just one of those co-incidences which seem to regularly befall economics.
The strange thing about these fictional stories is that they are given much more credence than real history within economics. Almost always, fictional “history” will always top actual history in economics. If the actual history of capitalism is mentioned, then the defenders of capitalism will simply say that we should not penalise current holders of capital for actions in the dim and distant past (that current and future generations of workers are penalised goes unmentioned). However, the fictional “history” of capitalism suffers from no such dismissal, for invented actions in the dim and distant past justify the current owners holdings of wealth and the income that generates. In other words, heads I win, tails you loose.
Needless to say, this (selective) myopia is not restricted to just history. It is applied to current situations as well. Thus we find economists defending current economic systems as “free market” regimes in spite of obvious forms of state intervention. As Chomsky notes:
“when people talk about . . . free-market ‘trade forces’ inevitably kicking all these people out of work and driving the whole world towards a kind of a Third World-type polarisation of wealth . . . that’s true if you take a narrow enough perspective on it. But if you look into the factors that made things the way they are, it doesn’t even come close to being true, it’s not remotely in touch with reality. But when you’re studying economics in the ideological institutions, that’s all irrelevant and you’re not supposed to ask questions like these.” [Understanding Power, p. 260]
To ignore all that and simply take the current distribution of wealth and income as given and then argue that the “free market” produces the best allocation of resources is staggering. Particularly as the claim of “efficient allocation” does not address the obvious question: “efficient” for whose benefit? For the idealisation of freedom in and through the market ignores the fact that this freedom is very limited in scope to great numbers of people as well as the consequences to the individuals concerned by the distribution of purchasing power amongst them that the market throws up (rooted, of course in the original endowments). Which, of course, explains why, even if these parables of economics were true, anarchists would still oppose capitalism. We extend Thomas Jefferson’s comment that the “earth belongs always to the living generation” to economic institutions as well as political — the past should not dominate the present and the future (Jefferson: “Can one generation bind another and all others in succession forever? I think not. The Creator has made the earth for the living, not for the dead. Rights and powers can only belong to persons, not to things, not to mere matter unendowed with will”). For, as Malatesta argued, people should “not have the right . . . to subject people to their rule and even less of bequeathing to the countless successions of their descendants the right to dominate and exploit future generations.” [At the Cafe, p. 48]
Then there is the strange co-incidence that “value free” economics generally ends up blaming all the problems of capitalism on workers. Unemployment? Recession? Low growth? Wages are too high! Proudhon summed up capitalist economic theory well when he stated that “Political economy — that is, proprietary despotism — can never be in the wrong: it must be the proletariat.” [System of Economical Contradictions, p. 187] And little has changed since 1846 (or 1776!) when it comes to economics “explaining” capitalism’s problems (such as the business cycle or unemployment).
As such, it is hard to consider economics as “value free” when economists regularly attack unions while being silent or supportive of big business. According to neo-classical economic theory, both are meant to be equally bad for the economy but you would be hard pressed to find many economists who would urge the breaking up of corporations into a multitude of small firms as their theory demands, the number who will thunder against “monopolistic” labour is substantially higher (ironically, as we note in section C.1.4, their own theory shows that they must urge the break up of corporations or support unions for, otherwise, unorganised labour is exploited). Apparently arguing that high wages are always bad but high profits are always good is value free.
So while big business is generally ignored (in favour of arguments that the economy works “as if” it did not exist), unions are rarely given such favours. Unlike, say, transnational corporations, unions are considered monopolistic. Thus we see the strange situation of economists (or economics influenced ideologies like right-wing “libertarians”) enthusiastically defending companies that raise their prices in the wake of, say, a natural disaster and making windfall profits while, at the same time, attacking workers who decide to raise their wages by striking for being selfish. It is, of course, unlikely that they would let similar charges against bosses pass without comment. But what can you expect from an ideology which presents unemployment as a good thing (namely, increased leisure — see section C.1.5) and being rich as, essentially, a disutility (the pain of abstaining from present consumption falls heaviest on those with wealth — see section C.2.7).
Ultimately, only economists would argue, with a straight face, that the billionaire owner of a transnational corporation is exploited when the workers in his sweatshops successfully form a union (usually in the face of the economic and political power wielded by their boss). Yet that is what many economists argue: the transnational corporation is not a monopoly but the union is and monopolies exploit others! Of course, they rarely state it as bluntly as that. Instead they suggest that unions get higher wages for their members be forcing other workers to take less pay (i.e. by exploiting them). So when bosses break unions they are doing this not to defend their profits and power but really to raise the standard of other, less fortunate, workers? Hardly. In reality, of course, the reason why unions are so disliked by economics is that bosses, in general, hate them. Under capitalism, labour is a cost and higher wages means less profits (all things being equal). Hence the need to demonise unions, for one of the less understood facts is that while unions increase wages for members, they also increase wages for non-union workers. This should not be surprising as non-union companies have to raise wages stop their workers unionising and to compete for the best workers who will be drawn to the better pay and conditions of union shops (as we discuss in section C.9, the neoclassical model of the labour market is seriously flawed).
Which brings us to another key problem with the claim that economics is “value free,” namely the fact that it takes the current class system of capitalism and its distribution of wealth as not only a fact but as an ideal. This is because economics is based on the need to be able to differentiate between each factor of production in order to determine if it is being used optimally. In other words, the given class structure of capitalism is required to show that an economy uses the available resources efficiently or not. It claims to be “value free” simply because it embeds the economic relationships of capitalist society into its assumptions about nature.
Yet it is impossible to define profit, rent and interest independently of the class structure of any given society. Therefore, this “type of distribution is the peculiarity of capitalism. Under feudalism the surplus was extracted as land rent. In an artisan economy each commodity is produced by a men with his own tools; the distinction between wages and profits has no meaning there.” This means that “the very essence of the theory is bound up with a particular institution — wage labour. The central doctrine is that ‘wages tend to equal marginal product of labour.’ Obviously this has no meaning for a peasant household where all share the work and the income of their holding according to the rules of family life; nor does it apply in a [co-operative] where, the workers’ council has to decide what part of net proceeds to allot to investment, what part to a welfare found and what part to distribute as wage.” [Joan Robinson, Collected Economic Papers, p. 26 and p. 130]
This means that the “universal” principles of economics end up by making any economy which does not share the core social relations of capitalism inherently “inefficient.” If, for example, workers own all three “factors of production” (labour, land and capital) then the “value-free” laws of economics concludes that this will be inefficient. As there is only “income”, it is impossible to say which part of it is attributable to labour, land or machinery and, consequently, if these factors are being efficiently used. This means that the “science” of economics is bound up with the current system and its specific class structure and, therefore, as a “ruling class paradigm, the competitive model” has the “substantial” merit that “it can be used to rule off the agenda any proposals for substantial reform or intervention detrimental to large economic interests . . . as the model allows (on its assumptions) a formal demonstration that these would reduce efficiency.” [Edward S. Herman, “The Selling of Market Economics,” pp. 173-199, New Ways of Knowing, Marcus G. Raskin and Herbert J. Bernstein (eds.), p. 178]
Then there are the methodological assumptions based on individualism. By concentrating on individual choices, economics abstracts from the social system within which such choices are made and what influences them. Thus, for example, the analysis of the causes of poverty is turned towards the failings of individuals rather than the system as a whole (to be poor becomes a personal stigma). That the reality on the ground bears little resemblance to the myth matters little — when people with two jobs still fail to earn enough to feed their families, it seems ridiculous to call them lazy or selfish. It suggests a failure in the system, not in the poor themselves. An individualistic analysis is guaranteed to exclude, by definition, the impact of class, inequality, social hierarchies and economic/social power and any analysis of any inherent biases in a given economic system, its distribution of wealth and, consequently, its distribution of income between classes.
This abstracting of individuals from their social surroundings results in the generating economic “laws” which are applicable for all individuals, in all societies, for all times. This results in all concrete instances, no matter how historically different, being treated as expressions of the same universal concept. In this way the uniqueness of contemporary society, namely its basis in wage labour, is ignored (“The period through which we are passing . . . is distinguished by a special characteristic — WAGES.” [Proudhon, Op. Cit., p. 199]). Such a perspective cannot help being ideological rather than scientific. By trying to create a theory applicable for all time (and so, apparently, value free) they just hide the fact their theory assumes and justifies the inequalities of capitalism (for example, the assumption of given needs and distribution of wealth and income secretly introduces the social relations of the current society back into the model, something which the model had supposedly abstracted from). By stressing individualism, scarcity and competition, in reality economic analysis reflects nothing more than the dominant ideological conceptions found in capitalist society. Every few economic systems or societies in the history of humanity have actually reflected these aspects of capitalism (indeed, a lot of state violence has been used to create these conditions by breaking up traditional forms of society, property rights and customs in favour of those desired by the current ruling elite).
The very general nature of the various theories of profit, interest and rent should send alarm bells ringing. Their authors construct these theories based on the deductive method and stress how they are applicable in every social and economic system. In other words, the theories are just that, theories derived independently of the facts of the society they are in. It seems somewhat strange, to say the least, to develop a theory of, say, interest independently of the class system within which it is charged but this is precisely what these “scientists” do. It is understandable why. By ignoring the current system and its classes and hierarchies, the economic aspects of this system can be justified in terms of appeals to universal human existence. This will raise less objections than saying, for example, that interest exists because the rich will only part with their money if they get more in return and the poor will pay for this because they have little choice due to their socio-economic situation. Far better to talk about “time preference” rather than the reality of class society (see section C.2.6).
Neoclassical economics, in effect, took the “political” out of “political economy” by taking capitalist society for granted along with its class system, its hierarchies and its inequalities. This is reflected in the terminology used. These days even the term capitalism has gone out of fashion, replaced with the approved terms “market system,” the “free market” or “free enterprise.” Yet, as Chomsky noted, terms such as “free enterprise” are used “to designate a system of autocratic governance of the economy in which neither the community nor the workforce has any role (a system we would call ‘fascist’ if translated to the political sphere).” [Language and Politics, p. 175] As such, it seems hardly “value-free” to proclaim a system free when, in reality, most people are distinctly not free for most of their waking hours and whose choices outside production are influenced by the inequality of wealth and power which that system of production create.
This shift in terminology reflects a political necessity. It effectively removes the role of wealth (capital) from the economy. Instead of the owners and manager of capital being in control or, at the very least, having significant impact on social events, we have the impersonal activity of “the markets” or “market forces.” That such a change in terminology is the interest of those whose money accords them power and influence goes without saying. By focusing on the market, economics helps hide the real sources of power in an economy and attention is drawn away from such a key questions of how money (wealth) produces power and how it skews the “free market” in its favour. All in all, as dissident economist John Kenneth Galbraith once put it, “[w]hat economists believe and teach is rarely hostile to the institutions that reflect the dominant economic power. Not to notice this takes effort, although many succeed.” [The Essential Galbraith, p. 180]
This becomes obvious when we look at how the advice economics gives to working class people. In theory, economics is based on individualism and competition yet when it comes to what workers should do, the “laws” of economics suddenly switch. The economist will now deny that competition is a good idea and instead urge that the workers co-operate (i.e. obey) their boss rather than compete (i.e. struggle over the division of output and authority in the workplace). They will argue that there is “harmony of interests” between worker and boss, that it is in the self-interest of workers not to be selfish but rather to do whatever the boss asks to further the bosses interests (i.e. profits).
That this perspective implicitly recognises the dependent position of workers, goes without saying. So while the sale of labour is portrayed as a market exchange between equals, it is in fact an authority relation between servant and master. The conclusions of economics is simply implicitly acknowledging that authoritarian relationship by identifying with the authority figure in the relationship and urging obedience to them. It simply suggests workers make the best of it by refusing to be independent individuals who need freedom to flourish (at least during working hours, outside they can express their individuality by shopping).
This should come as no surprise, for, as Chomsky notes, economics is rooted in the notion that “you only harm the poor by making them believe that they have rights other than what they can win on the market, like a basic right to live, because that kind of right interferes with the market, and with efficiency, and with growth and so on — so ultimately people will just be worse off if you try to recognise them.” [Op. Cit., p. 251] Economics teaches that you must accept change without regard to whether it is appropriate it not. It teaches that you must not struggle, you must not fight. You must simply accept whatever change happens. Worse, it teaches that resisting and fighting back are utterly counter-productive. In other words, it teaches a servile mentality to those subject to authority. For business, economics is ideal for getting their employees to change their attitudes rather than collectively change how their bosses treat them, structure their jobs or how they are paid — or, of course, change the system.
Of course, the economist who says that they are conducting “value free” analysis are indifferent to the kinds of relationships within society is being less than honest. Capitalist economic theory is rooted in very specific assumptions and concepts such as “economic man” and “perfect competition.” It claims to be “value-free” yet its preferred terminology is riddled with value connotations. For example, the behaviour of “economic man” (i.e., people who are self-interested utility maximisation machines) is described as “rational.” By implication, then, the behaviour of real people is “irrational” whenever they depart from this severely truncated account of human nature and society. Our lives consist of much more than buying and selling. We have goals and concerns which cannot be bought or sold in markets. In other words, humanity and liberty transcend the limits of property and, as a result, economics. This, unsurprisingly, affects those who study the “science” as well:
“Studying economics also seems to make you a nastier person. Psychological studies have shown that economics graduate students are more likely to ‘free ride’ — shirk contributions to an experimental ‘public goods’ account in the pursuit of higher private returns — than the general public. Economists also are less generous that other academics in charitable giving. Undergraduate economics majors are more likely to defect in the classic prisoner’s dilemma game that are other majors. And on other tests, students grow less honest — expressing less of a tendency, for example, to return found money — after studying economics, but not studying a control subject like astronomy.
“This is no surprise, really. Mainstream economics is built entirely on a notion of self-interested individuals, rational self-maximisers who can order their wants and spend accordingly. There’s little room for sentiment, uncertainty, selflessness, and social institutions. Whether this is an accurate picture of the average human is open to question, but there’s no question that capitalism as a system and economics as a discipline both reward people who conform to the model.” [Doug Henwood, Wall Street, p, 143]
So is economics “value free”? Far from it. Given its social role, it would be surprising that it were. That it tends to produce policy recommendations that benefit the capitalist class is not an accident. It is rooted in the fibre of the “science” as it reflects the assumptions of capitalist society and its class structure. Not only does it take the power and class structures of capitalism for granted, it also makes them the ideal for any and every economy. Given this, it should come as no surprise that economists will tend to support policies which will make the real world conform more closely to the standard (usually neoclassical) economic model. Thus the models of economics become more than a set of abstract assumptions, used simply as a tool in theoretical analysis of the casual relations of facts. Rather they become political goals, an ideal towards which reality should be forced to travel.
This means that economics has a dual character. On the one hand, it attempts to prove that certain things (for example, that free market capitalism produces an optimum allocation of resources or that, given free competition, price formation will ensure that each person’s income corresponds to their productive contribution). On the other, economists stress that economic “science” has nothing to do with the question of the justice of existing institutions, class structures or the current economic system. And some people seem surprised that this results in policy recommendations which consistently and systematically favour the ruling class.
In a word, no. If by “scientific” it is meant in the usual sense of being based on empirical observation and on developing an analysis that was consistent with and made sense of the data, then most forms of economics are not a science.
Rather than base itself on a study of reality and the generalisation of theory based on the data gathered, economics has almost always been based on generating theories rooted on whatever assumptions were required to make the theory work. Empirical confirmation, if it happens at all, is usually done decades later and if the facts contradict the economics, so much the worse for the facts.
A classic example of this is the neo-classical theory of production. As noted previously, neoclassical economics is focused on individual evaluations of existing products and, unsurprisingly, economics is indelibly marked by “the dominance of a theoretical vision that treats the inner workings of the production process as a ‘black box.'” This means that the “neoclassical theory of the ‘capitalist’ economy makes no qualitative distinction between the corporate enterprise that employs tens of thousands of people and the small family undertaking that does no employ any wage labour at all. As far as theory is concerned, it is technology and market forces, not structures of social power, that govern the activities of corporate capitalists and petty proprietors alike.” [William Lazonick, Competitive Advantage on the Shop Floor, p. 34 and pp. 33-4] Production in this schema just happens — inputs go in, outputs go out — and what happens inside is considered irrelevant, a technical issue independent of the social relationships those who do the actual production form between themselves — and the conflicts that ensure.
The theory does have a few key assumptions associated with it, however. First, there are diminishing returns. This plays a central role. In mainstream diminishing returns are required to produce a downward sloping demand curve for a given factor. Second, there is a rising supply curve based on rising marginal costs produced by diminishing returns. The average variable cost curve for a firm is assumed to be U-shaped, the result of first increasing and then diminishing returns. These are logically necessary for the neo-classical theory to work.
Non-economists would, of course, think that these assumptions are generalisations based on empirical evidence. However, they are not. Take the U-shaped average cost curve. This was simply invented by A. C. Pigou, “a loyal disciple of [leading neo-classical Alfred] Marshall and quite innocent of any knowledge of industry. He therefore constructed a U-shaped average cost curve for a firm, showing economies of scale up to a certain size and rising costs beyond it.” [Joan Robinson, Collected Economic Papers, vol. 5, p. 11] The invention was driven by need of the theory, not the facts. With increasing returns to scale, then large firms would have cost advantages against small ones and would drive them out of business in competition. This would destroy the concept of perfect competition. However, the invention of the average cost curve allowed the theory to work as “proved” that a competitive market could not become dominated by a few large firms, as feared.
The model, in other words, was adjusted to ensure that it produced the desired result rather than reflect reality. The theory was required to prove that markets remained competitive and the existence of diminishing marginal returns to scale of production did tend by itself to limit the size of individual firms. That markets did become dominated by a few large firms was neither here nor there. It did not happen in theory and, consequently, that was the important thing and so “when the great concentrations of power in the multinational corporations are bringing the age of national employment policy to an end, the text books are still illustrated by U-shaped curves showing the limitation on the size of firms in a perfectly competitive market.” [Joan Robinson, Contributions to Modern Economics, p. 5]
To be good, a theory must have two attributes: They accurately describe the phenomena in question and they make accurate predictions. Neither holds for Pigou’s invention: reality keeps getting in the way. Not only did the rise of a few large firms dominating markets indirectly show that the theory was nonsense, when empirical testing was finally done decades after the theory was proposed it showed that in most cases the opposite is the case: that there were constant or even falling costs in production. Just as the theories of marginality and diminishing marginal returns taking over economics, the real world was showing how wrong it was with the rise of corporations across the world.
So the reason why the market become dominated by a few firms should be obvious enough: actual corporate price is utterly different from the economic theory. This was discovered when researchers did what the original theorists did not think was relevant: they actually asked firms what they did and the researchers consistently found that, for the vast majority of manufacturing firms their average costs of production declined as output rose, their marginal costs were always well below their average costs, and substantially smaller than ‘marginal revenue’, and the concept of a ‘demand curve’ (and therefore its derivative ‘marginal revenue’) was simply irrelevant.
Unsurprisingly, real firms set their prices prior to sales, based on a mark-up on costs at a target rate of output. In other words, they did not passively react to the market. These prices are an essential feature of capitalism as prices are set to maintain the long-term viability of the firm. This, and the underlying reality that per-unit costs fell as output levels rose, resulted in far more stable prices than were predicted by traditional economic theory. One researcher concluded that administered prices “differ so sharply from the behaviour to be expected from” the theory “as to challenge the basic conclusions” of it. He warned that until such time as “economic theory can explain and take into account the implications” of this empirical data, “it provides a poor basis for public policy.” Needless to say, this did not disturb neo-classical economists or stop them providing public policy recommendations. [Gardiner C. Means, “The Administered-Price Thesis Reconfirmed”, The American Economic Review, pp. 292-306, Vol. 62, No. 3, p. 304]
One study in 1952 showed firms a range of hypothetical cost curves, and asked firms which ones most closely approximated their own costs. Over 90% of firms chose a graph with a declining average cost rather than one showing the conventional economic theory of rising marginal costs. These firms faced declining average cost, and their marginal revenues were much greater than marginal cost at all levels of output. Unsurprisingly, the study’s authors concluded if this sample was typical then it was “obvious that short-run marginal price theory should be revised in the light of reality.” We are still waiting. [Eiteman and Guthrie, “The Shape of the Average Cost Curve”, The American Economic Review, pp. 832-8, Vol. 42, No. 5, p. 838]
A more recent study of the empirical data came to the same conclusions, arguing that it is “overwhelming bad news . . . for economic theory.” While economists treat rising marginal cost as the rule, 89% of firms in the study reported marginal costs which were either constant or declined with output. As for price elasticity, it is not a vital operational concept for corporations. In other words, the “firms that sell 40 percent of GDP believe their demand is totally insensitive to price” while “only about one-sixth of GDP is sold under conditions of elastic demand.” [A.S. Blinder, E. Cabetti, D. Lebow and J. Rudd, Asking About Prices, p. 102 and p. 101]
Thus empirical research has concluded that actual price setting has nothing to do with clearing the market by equating market supply to market demand (i.e. what economic theory sees as the role of prices). Rather, prices are set to enable the firm to continue as a going concern and equating supply and demand in any arbitrary period of time is irrelevant to a firm which hopes to exist for the indefinite future. As Lee put it, basing himself on extensive use of empirical research, “market prices are not market-clearing or profit-maximising prices, but rather are enterprise-, and hence transaction-reproducing prices.” Rather than a non-existent equilibrium or profit maximisation at a given moment determining prices, the market price is “set and the market managed for the purpose of ensuring continual transactions for those enterprises in the market, that is for the benefit of the business leaders and their enterprises.” A significant proportion of goods have prices based on mark-up, normal cost and target rate of return pricing procedures and are relatively stable over time. Thus “the existence of stable, administered market prices implies that the markets in which they exist are not organised like auction markets or like the early retail markets and oriental bazaars” as imagined in mainstream economic ideology. [Frederic S. Lee, Post Keynesian Price Theory, p. 228 and p. 212]
Unsurprisingly, most of these researchers were highly critical the conventional economic theory of markets and price setting. One viewed the economists’ concepts of perfect competition and monopoly as virtual nonsense and “the product of the itching imaginations of uninformed and inexperienced armchair theorisers.” [Tucker, quoted by Lee, Op. Cit., p. 73f] Which was exactly how it was produced.
No other science would think it appropriate to develop theory utterly independently of phenomenon under analysis. No other science would wait decades before testing a theory against reality. No other science would then simply ignore the facts which utterly contradicted the theory and continue to teach that theory as if it were a valid generalisation of the facts. But, then, economics is not a science.
This strange perspective makes sense once it is realised how key the notion of diminishing costs is to economics. In fact, if the assumption of increasing marginal costs is abandoned then so is perfect competition and “the basis of which economic laws can be constructed . . . is shorn away,” causing the “wreckage of the greater part of general equilibrium theory.” This will have “a very destructive consequence for economic theory,” in the words of one leading neo-classical economist. [John Hicks, Value and Capital, pp. 83-4] As Steve Keen notes, this is extremely significant:
“Strange as it may seem . . . this is a very big deal. If marginal returns are constant rather than falling, then the neo-classical explanation of everything collapses. Not only can economic theory no longer explain how much a firm produces, it can explain nothing else.
“Take, for example, the economic theory of employment and wage determination . . . The theory asserts that the real wage is equivalent to the marginal product of labour . . . An employer will employ an additional worker if the amount the worker adds to output — the worker’s marginal product — exceeds the real wage . . . [This] explains the economic predilection for blaming everything on wages being too high — neo-classical economics can be summed up, as [John Kenneth] Galbraith once remarked, in the twin propositions that the poor don’t work hard enough because they’re paid too much, and the rich don’t work hard enough because they’re not paid enough . . .
“If in fact the output to employment relationship is relatively constant, then the neo-classical explanation for employment and output determination collapses. With a flat production function, the marginal product of labour will be constant, and it will never intersect the real wage. The output of the form then can’t be explained by the cost of employing labour. . . [This means that] neo-classical economics simply cannot explain anything: neither the level of employment, nor output, nor, ultimately, what determines the real wage . . .the entire edifice of economics collapses.” [Debunking Economics, pp. 76-7]
It should be noted that the empirical research simply confirmed an earlier critique of neo-classical economics presented by Piero Sraffa in 1926. He argued that while the neo-classical model of production works in theory only if we accept its assumptions. If those assumptions do not apply in practice, then it is irrelevant. He therefore “focussed upon the economic assumptions that there were ‘factors of production’ which were fixed in the short run, and that supply and demand were independent of each other. He argued that these two assumptions could be fulfilled simultaneously. In circumstances where it was valid to say some factor of production was fixed in the short term, supply and demand could not independent, so that every point on the supply curve would be associated with a different demand curve. On the other hand, in circumstances where supply and demand could justifiably be treated as independent, then it would be impossible for any factor of production to be fixed. Hence the marginal costs of production would be constant.” He stressed firms would have to be irrational to act otherwise, foregoing the chance to make profits simply to allow economists to build their models of how they should act. [Keen, Op. Cit., pp. 66-72]
Another key problem in economics is that of time. This has been known, and admitted, by economists for some time. Marshall, for example, stated that “the element of time“ was “the source of many of the greatest difficulties of economics.” [Principles of Economics, p. 109] The founder of general equilibrium theory, Walras, recognised that the passage of time wrecked his whole model and stated that we “shall resolve the . . . difficulty purely and simply by ignoring the time element at this point.” This was due, in part, because production “requires a certain lapse of time.” [Elements of Pure Economics, p. 242] This was generalised by Gerard Debreu (in his Nobel Prize for economics winning Theory of Value ) who postulated that everyone makes their sales and purchases for all time in one instant.
Thus the cutting edge of neo-classical economics, general equilibrium ignores both time and production. It is based on making time stop, looking at finished goods, getting individuals to bid for them and, once all goods are at equilibrium, allowing the transactions to take place. For Walras, this was for a certain moment of time and was repeated, for his followers it happened once for all eternity. This is obviously not the way markets work in the real world and, consequently, the dominant branch of economics is hardly scientific. Sadly, the notion of individuals having full knowledge of both now and the future crops up with alarming regularly in the “science” of economics.
Even if we ignore such minor issues as empirical evidence and time, economics has problems even with its favoured tool, mathematics. As Steve Keen has indicated, economists have “obscured reality using mathematics because they have practised mathematics badly, and because they have not realised the limits of mathematics.” indeed, there are “numerous theorems in economics that reply upon mathematically fallacious propositions.” [Op. Cit., p. 258 and p. 259] For a theory born from the desire to apply calculus to economics, this is deeply ironic. As an example, Keen points to the theory of perfect competition which assumes that while the demand curve for the market as a whole is downward sloping, an individual firm in perfect competition is so small that it cannot affect the market price and, consequently, faces a horizontal demand curve. Which is utterly impossible. In other words, economics breaks the laws of mathematics.
These are just two examples, there are many, many more. However, these two are pretty fundamental to the whole edifice of modern economic theory. Much, if not most, of mainstream economics is based upon theories which have little or no relation to reality. Kropotkin’s dismissal of “the metaphysical definitions of the academical economists” is as applicable today. [Evolution and Environment, p. 92] Little wonder dissident economist Nicholas Kaldor argued that:
“The Walrasian [i.e. general] equilibrium theory is a highly developed intellectual system, much refined and elaborated by mathematical economists since World War II — an intellectual experiment . . . But it does not constitute a scientific hypothesis, like Einstein’s theory of relativity or Newton’s law of gravitation, in that its basic assumptions are axiomatic and not empirical, and no specific methods have been put forward by which the validity or relevance of its results could be tested. The assumptions make assertions about reality in their implications, but these are not founded on direct observation, and, in the opinion of practitioners of the theory at any rate, they cannot be contradicted by observation or experiment.” [The Essential Kaldor, p. 416]
In a word, no. No economic system is simply the sum of its parts. The idea that capitalism is based on the subjective evaluations of individuals for goods flies in the face of both logic and the way capitalism works. In other words, modern economists is based on a fallacy. While it would be expected for critics of capitalism to conclude this, the ironic thing is that economists themselves have proven this to be the case.
Neoclassical theory argues that marginal utility determines demand and price, i.e. the price of a good is dependent on the intensity of demand for the marginal unit consumed. This was in contrast to classic economics, which argued that price (exchange value) was regulated by the cost of production, ultimately the amount of labour used to create it. While realistic, this had the political drawback of implying that profit, rent and interest were the product of unpaid labour and so capitalism was exploitative. This conclusion was quickly seized upon by numerous critics of capitalism, including Proudhon and Marx. The rise of marginal utility theory meant that such critiques could be ignored.
However, this change was not unproblematic. The most obvious problem with it is that it leads to circular reasoning. Prices are supposed to measure the “marginal utility” of the commodity, yet consumers need to know the price first in order to evaluate how best to maximise their satisfaction. Hence it “obviously rest[s] on circular reasoning. Although it tries to explain prices, prices [are] necessary to explain marginal utility.” [Paul Mattick, Economics, Politics and the Age of Inflation, p.58] In the end, as Jevons (one of the founders of the new economics) acknowledged, the price of a commodity is the only test we have of the utility of the commodity to the producer. Given that marginality utility was meant to explain those prices, the failure of the theory could not be more striking.
However, this is the least of its problems. At first, the neoclassical economists used cardinal utility as their analysis tool. Cardinal utility meant that it was measurable between individuals, i.e. that the utility of a given good was the same for all. While this allowed prices to be determined, it caused obvious political problems as it obviously justified the taxation of the wealthy. As cardinal utility implied that the “utility” of an extra dollar to a poor person was clearly greater than the loss of one dollar to a rich man, it was appropriated by reformists precisely to justify social reforms and taxation.
Capitalist economists had, yet again, created a theory that could be used to attack capitalism and the income and wealth hierarchy it produces. As with classical economics, socialists and other social reformists used the new theories to do precisely that, appropriating it to justify the redistribution of income and wealth downward (i.e. back into the hands of the class who had created it in the first place). Combine this with the high levels of class conflict at the time and it should come as no surprise that the “science” of economics was suitably revised.
There was, of course, a suitable “scientific” rationale for this revision. It was noted that as individual evaluations are inherently subjective, it is obvious that cardinal utility was impossible in practice. Of course, cardinality was not totally rejected. Neoclassical economics retained the idea that capitalists maximise profits, which is a cardinal quantity. However for demand utility became “ordinal,” that is utility was considered an individual thing and so could not be measured. This resulted in the conclusion that there was no way of making interpersonal comparisons between individuals and, consequently, no basis for saying a pound in the hands of a poor person had more utility than if it had remained in the pocket of a billionaire. The economic case for taxation was now, apparently, closed. While you may think that income redistribution was a good idea, it was now proven by “science” that this little more than a belief as all interpersonal comparisons were now impossible. That this was music to the ears of the wealthy was, of course, just one of those strange co-incidences which always seems to plague economic “science.”
The next stage of the process was to abandon then ordinal utility in favour of “indifference curves” (the continued discussion of “utility” in economics textbooks is primarily heuristic). In this theory consumers are supposed to maximise their utility by working out which bundle of goods gives them the highest level of satisfaction based on the twin constraints of income and given prices (let us forget, for the moment, that marginal utility was meant to determines prices in the first place). To do this, it is assumed that incomes and tastes are independent and that consumers have pre-existing preferences for all possible bundles.
This produces a graph that shows different quantities of two different goods, with the “indifference curves” showing the combinations of goods which give the consumer the same level of satisfaction (hence the name, as the consumer is “indifferent” to any combination along the curve). There is also a straight line representing relative prices and the consumer’s income and this budget line shows the uppermost curve the consumer can afford to reach. That these indifference curves could not be observed was not an issue although leading neo-classical economist Paul Samuelson provided an apparent means see these curves by his concept of “revealed preference” (a basic tautology). There is a reason why “indifference curves” cannot be observed. They are literally impossible for human beings to calculate once you move beyond a trivially small set of alternatives and it is impossible for actual people to act as economists argue they do. Ignoring this slight problem, the “indifference curve” approach to demand can be faulted for another, even more basic, reason. It does not prove what it seeks to show:
“Though mainstream economics began by assuming that this hedonistic, individualist approach to analysing consumer demand was intellectually sound, it ended up proving that it was not. The critics were right: society is more than the sum of its individual members.” [Steve Keen, Debunking Economics, p. 23]
As noted above, to fight the conclusion that redistributing wealth would result in a different level of social well-being, economists had to show that “altering the distribution of income did not alter social welfare. They worked out that two conditions were necessary for this to be true: (a) that all people have the same tastes; (b) that each person’s tastes remain the same as her income changes, so that every additional dollar of income was spent exactly the same way as all previous dollars.” The former assumption “in fact amounts to assuming that there is only one person in society” or that “society consists of a multitude of identical drones” or clones. The latter assumption “amounts to assuming that there is only one commodity — since otherwise spending patterns would necessary change as income rose.” [Keen, Op. Cit., p. 24] This is the real meaning of the assumption that all goods and consumers can be considered “representative.” Sadly, such individuals and goods do not exist. Thus:
“Economics can prove that ‘the demand curve slows downward in price’ for a single individual and a single commodity. But in a society consisting of many different individuals with many different commodities, the ‘market demand curve’ is more probably jagged, and slopes every which way. One essential building block of the economic analysis of markets, the demand curve, therefore does not have the characteristics needed for economic theory to be internally consistent . . . most mainstream academic economists are aware of this problem, but they pretend that the failure can be managed with a couple of assumptions. Yet the assumptions themselves are so absurd that only someone with a grossly distorted sense of logic could accept them. That grossly distorted sense of logic is acquired in the course of a standard education in economics.” [Op. Cit., pp. 25-7]
Rather than produce a “social indifference map which had the same properties as the individual indifference maps” by adding up all the individual maps, economics “proved that this consistent summation from individual to society could not be achieved.” Any sane person would have rejected the theory at this stage, but not economists. Keen states the obvious: “That economists, in general, failed to draw this inference speaks volumes for the unscientific nature of economic theory.” They simply invented “some fudge to disguise the gapping hole they have uncovered in the theory.” [Op. Cit., p. 40 and p. 48] Ironically, it took over one hundred years and advanced mathematical logic to reach the same conclusion that the classical economists took for granted, namely that individual utility could not be measured and compared. However, instead of seeking exchange value (price) in the process of production, neoclassical economists simply that made a few absurd assumptions and continued on its way as if nothing was wrong.
This is important because “economists are trying to prove that a market economy necessarily maximises social welfare. If they can’t prove that the market demand curve falls smoothly as price rises, they can’t prove that the market maximises social welfare.” In addition, “the concept of a social indifference curve is crucial to many of the key notions of economics: the argument that free trade is necessarily superior to regulated trade, for example, is first constructed using a social indifference curve. Therefore, if the concept of a social indifference curve itself is invalid, then so too are many of the most treasured notions of economics.” [Keen, Op. Cit., p. 50] This means much of economic theory is invalidated and with it the policy recommendations based on it.
This elimination of individual differences in favour of a society of clones by marginalism is not restricted to demand. Take the concept of the “representative firm” used to explain supply. Rather than a theoretical device to deal with variety, it ignores diversity. It is a heuristic concept which deals with a varied collection of firms by identifying a single set of distinct characteristics which are deemed to represent the essential qualities of the industry as a whole. It is not a single firm or even a typical or average firm. It is an imaginary firm which exhibits the “representative” features of the entire industry, i.e. it treats an industry as if it were just one firm. Moreover, it should be stressed that this concept is driven by the needs to prove the model, not by any concern over reality. The “real weakness” of the “representative firm” in neo-classical economics is that it is “no more than a firm which answers the requirements expected from it by the supply curve” and because it is “nothing more than a small-scale replica of the industry’s supply curve that it is unsuitable for the purpose it has been called into being.” [Kaldor, The Essential Kaldor, p. 50]
Then there is neoclassical analysis of the finance market. According to the Efficient Market Hypothesis, information is disseminated equally among all market participants, they all hold similar interpretations of that information and all can get access to all the credit they need at any time at the same rate. In other words, everyone is considered to be identical in terms of what they know, what they can get and what they do with that knowledge and cash. This results in a theory which argues that stock markets accurately price stocks on the basis of their unknown future earnings, i.e. that these identical expectations by identical investors are correct. In other words, investors are able to correctly predict the future and act in the same way to the same information. Yet if everyone held identical opinions then there would be no trading of shares as trading obviously implies different opinions on how a stock will perform. Similarly, in reality investors are credit rationed, the rate of borrowing tends to rise as the amount borrowed increases and the borrowing rate normally exceeds the leading rate. The developer of the theory was honest enough to state that the “consequence of accommodating such aspects of reality are likely to be disastrous in terms of the usefulness of the resulting theory . . . The theory is in a shambles.” [W.F Sharpe, quoted by Keen, Op. Cit., p. 233]
Thus the world was turned into a single person simply to provide a theory which showed that stock markets were “efficient” (i.e. accurately reflect unknown future earnings). In spite of these slight problems, the theory was accepted in the mainstream as an accurate reflection of finance markets. Why? Well, the implications of this theory are deeply political as it suggests that finance markets will never experience bubbles and deep slumps. That this contradicts the well-known history of the stock market was considered unimportant. Unsurprisingly, “as time went on, more and more data turned up which was not consistent with” the theory. This is because the model’s world “is clearly not our world.” The theory “cannot apply in a world in which investors differ in their expectations, in which the future is uncertain, and in which borrowing is rationed.” It “should never have been given any credibility — yet instead it became an article of faith for academics in finance, and a common belief in the commercial world of finance.” [Keen, Op. Cit., p. 246 and p. 234]
This theory is at the root of the argument that finance markets should be deregulated and as many funds as possible invested in them. While the theory may benefit the minority of share holders who own the bulk of shares and help them pressurise government policy, it is hard to see how it benefits the rest of society. Alternative, more realistic theories, argue that finance markets show endogenous instability, result in bad investment as well as reducing the overall level of investment as investors will not fund investments which are not predicted to have a sufficiently high rate of return. All of which has a large and negative impact on the real economy. Instead, the economic profession embraced a highly unreal economic theory which has encouraged the world to indulge in stock market speculation as it argues that they do not have bubbles, booms or bursts (that the 1990s stock market bubble finally burst like many previous ones is unlikely to stop this). Perhaps this has to do the implications for economic theory for this farcical analysis of the stock market? As two mainstream economists put it:
“To reject the Efficient Market Hypothesis for the whole stock market . . . implies broadly that production decisions based on stock prices will lead to inefficient capital allocations. More generally, if the application of rational expectations theory to the virtually ‘idea’ conditions provided by the stock market fails, then what confidence can economists have in its application to other areas of economics . . . ?” [Marsh and Merton, quoted by Doug Henwood, Wall Street, p. 161]
Ultimately, neoclassical economics, by means of the concept of “representative” agent, has proved that subjective evaluations could not be aggregated and, as a result, a market supply and demand curves cannot be produced. In other words, neoclassical economics has shown that if society were comprised of one individual, buying one good produced by one factory then it could accurately reflect what happened in it. “It is stating the obvious,” states Keen, “to call the representative agent an ‘ad hoc’ assumption, made simply so that economists can pretend to have a sound basis for their analysis, when in reality they have no grounding whatsoever.” [Op. Cit., p. 188]
There is a certain irony about the change from cardinal to ordinal utility and finally the rise of the impossible nonsense which are “indifference curves.” While these changes were driven by the need to deny the advocates of redistributive taxation policies the mantel of economic science to justify their schemes, the fact is by rejecting cardinal utility, it becomes impossible to say whether state action like taxes decreases utility at all. With ordinal utility and its related concepts, you cannot actually show that government intervention actually harms “social utility.” All you can say is that they are indeterminate. While the rich may lose income and the poor gain, it is impossible to say anything about social utility without making an interpersonal (cardinal) utility comparison. Thus, ironically, ordinal utility based economics provides a much weaker defence of free market capitalism by removing the economist of the ability to call any act of government “inefficient” and they would have to be evaluated in, horror of horrors, non-economic terms. As Keen notes, it is “ironic that this ancient defence of inequality ultimately backfires on economics, by making its impossible to construct a market demand curve which is independent on the distribution of income . . . economics cannot defend any one distribution of income over any other. A redistribution of income that favours the poor over the rich cannot be formally opposed by economic theory.” [Op. Cit., p. 51]
Neoclassical economics has also confirmed that the classical perspective of analysing society in terms of classes is also more valid than the individualistic approach it values. As one leading neo-classical economist has noted, if economics is “to progress further we may well be forced to theorise in terms of groups who have collectively coherent behaviour.” Moreover, the classical economists would not be surprised by the admission that “the addition of production can help” economic analysis nor the conclusion that the “idea that we should start at the level of the isolated individual is one which we may well have to abandon . . . If we aggregate over several individuals, such a model is unjustified.” [Alan Kirman, “The Intrinsic Limits of Modern Economy Theory”, pp. 126-139, The Economic Journal, Vol. 99, No. 395, p. 138, p. 136 and p. 138]
So why all the bother? Why spend over 100 years driving economics into a dead-end? Simply because of political reasons. The advantage of the neoclassical approach was that it abstracted away from production (where power relations are clear) and concentrated on exchange (where power works indirectly). As libertarian Marxist Paul Mattick notes, the “problems of bourgeois economics seemed to disappear as soon as one ignored production and attended only to the market . . . Viewed apart from production, the price problem can be dealt with purely in terms of the market.” [Economic Crisis and Crisis Theory, p. 9] By ignoring production, the obvious inequalities of power produced by the dominant social relations within capitalism could be ignored in favour of looking at abstract individuals as buyers and sellers. That this meant ignoring such key concepts as time by forcing economics into a static, freeze frame, model of the economy was a price worth paying as it allowed capitalism to be justified as the best of all possible worlds:
“On the one hand, it was thought essential to represent the winning of profit, interest, and rent as participation in the creation of wealth. On the other, it was thought desirable to found the authority of economics on the procedures of natural science. This second desire prompted a search for general economic laws independent of time and circumstances. If such laws could be proven, the existing society would thereby be legitimated and every idea of changing it refuted. Subjective value theory promised to accomplish both tasks at once. Disregarding the exchange relationship peculiar to capitalism — that between the sellers and buyers of labour power — it could explain the division of the social product, under whatever forms, as resulting from the needs of the exchangers themselves.” [Mattick, Op. Cit., p. 11]
The attempt to ignore production implied in capitalist economics comes from a desire to hide the exploitative and class nature of capitalism. By concentrating upon the “subjective” evaluations of individuals, those individuals are abstracted away from real economic activity (i.e. production) so the source of profits and power in the economy can be ignored (section C.2 indicates why exploitation of labour in production is the source of profit, interest and rent and not exchanges in the market).
Hence the flight from classical economics to the static, timeless world of individuals exchanging pre-existing goods on the market. The evolution of capitalist economics has always been towards removing any theory which could be used to attack capitalism. Thus classical economics was rejected in favour of utility theory once socialists and anarchists used it to show that capitalism was exploitative. Then this utility theory was modified over time in order to purge it of undesirable political consequences. In so doing, they ended up not only proving that an economics based on individualism was impossible but also that it cannot be used to oppose redistribution policies after all.
The dominant form of economic analysis since the 1880s has been equilibrium analysis. While equilibrium had been used by classical economics to explain what regulated market prices, it did not consider it as reflecting any real economy. This was because classical economics analysed capitalism as a mode of production rather than as a mode of exchange, as a mode of circulation, as neo-classical economics does. It looked at the process of creating products while neo-classical economics looked at the price ratios between already existing goods (this explains why neo-classical economists have such a hard time understanding classical or Marxist economics, the schools are talking about different things and why they tend to call any market system “capitalism” regardless of whether wage labour predominates of not). The classical school is based on an analysis of markets based on production of commodities through time. The neo-classical school is based on an analysis of markets based on the exchange of the goods which exist at any moment of time.
This indicates what is wrong with equilibrium analysis, it is essentially a static tool used to analyse a dynamic system. It assumes stability where none exists. Capitalism is always unstable, always out of equilibrium, since “growing out of capitalist competition, to heighten exploitation, . . . the relations of production . . . [are] in a state of perpetual transformation, which manifests itself in changing relative prices of goods on the market. Therefore the market is continuously in disequilibrium, although with different degrees of severity, thus giving rise, by its occasional approach to an equilibrium state, to the illusion of a tendency toward equilibrium.” [Mattick, Op. Cit., p. 51] Given this obvious fact of the real economy, it comes as no surprise that dissident economists consider equilibrium analysis as “a major obstacle to the development of economics as a science — meaning by the term ‘science’ a body of theorems based on assumptions that are empirically derived (from observations) and which embody hypotheses that are capable of verification both in regard to the assumptions and the predictions.” [Kaldor, The Essential Kaldor, p. 373]
Thus the whole concept is an unreal rather than valid abstraction of reality. Sadly, the notions of “perfect competition” and (Walrasian) “general equilibrium” are part and parcel of neoclassical economics. It attempts to show, in the words of Paul Ormerod, “that under certain assumptions the free market system would lead to an allocation of a given set of resources which was in a very particular and restricted sense optimal from the point of view of every individual and company in the economy.” [The Death of Economics, p. 45] This was what Walrasian general equilibrium proved. However, the assumptions required prove to be somewhat unrealistic (to understate the point). As Ormerod points out:
“[i]t cannot be emphasised too strongly that . . . the competitive model is far removed from being a reasonable representation of Western economies in practice. . . [It is] a travesty of reality. The world does not consist, for example, of an enormous number of small firms, none of which has any degree of control over the market . . . The theory introduced by the marginal revolution was based upon a series of postulates about human behaviour and the workings of the economy. It was very much an experiment in pure thought, with little empirical rationalisation of the assumptions.” [Op. Cit., p. 48]
Indeed, “the weight of evidence” is “against the validity of the model of competitive general equilibrium as a plausible representation of reality.” [Op. Cit., p. 62] For example, to this day, economists still start with the assumption of a multitude of firms, even worse, a “continuum” of them exist in every market. How many markets are there in which there is an infinite number of traders? This means that from the start the issues and problems associated with oligopoly and imperfect competition have been abstracted from. This means the theory does not allow one to answer interesting questions which turn on the asymmetry of information and bargaining power among economic agents, whether due to size, or organisation, or social stigmas, or whatever else. In the real world, oligopoly is common place and asymmetry of information and bargaining power the norm. To abstract from these means to present an economic vision at odds with the reality people face and, therefore, can only propose solutions which harm those with weaker bargaining positions and without information.
General equilibrium is an entirely static concept, a market marked by perfect knowledge and so inhabited by people who are under no inducement or need to act. It is also timeless, a world without a future and so with no uncertainty (any attempt to include time, and so uncertainty, ensures that the model ceases to be of value). At best, economists include “time” by means of comparing one static state to another, i.e. “the features of one non-existent equilibrium were compared with those of a later non-existent equilibrium.” [Mattick, Op. Cit., p. 22] How the economy actually changed from one stable state to another is left to the imagination. Indeed, the idea of any long-run equilibrium is rendered irrelevant by the movement towards it as the equilibrium also moves. Unsurprisingly, therefore, to construct an equilibrium path through time requires all prices for all periods to be determined at the start and that everyone foresees future prices correctly for eternity — including for goods not invented yet. Thus the model cannot easily or usefully account for the reality that economic agents do not actually know such things as future prices, future availability of goods, changes in production techniques or in markets to occur in the future, etc. Instead, to achieve its results — proofs about equilibrium conditions — the model assumes that actors have perfect knowledge at least of the probabilities of all possible outcomes for the economy. The opposite is obviously the case in reality:
“Yet the main lessons of these increasingly abstract and unreal theoretical constructions are also increasingly taken on trust . . . It is generally taken for granted by the great majority of academic economists that the economy always approaches, or is near to, a state of ‘equilibrium’ . . . all propositions which the pure mathematical economist has shown to be valid only on assumptions that are manifestly unreal — that is to say, directly contrary to experience and not just ‘abstract.’ In fact, equilibrium theory has reached the stage where the pure theorist has successfully (though perhaps inadvertently) demonstrated that the main implications of this theory cannot possibly hold in reality, but has not yet managed to pass his message down the line to the textbook writer and to the classroom.” [Kaldor, Op. Cit., pp. 376-7]
In this timeless, perfect world, “free market” capitalism will prove itself an efficient method of allocating resources and all markets will clear. In part at least, General Equilibrium Theory is an abstract answer to an abstract and important question: Can an economy relying only on price signals for market information be orderly? The answer of general equilibrium is clear and definitive — one can describe such an economy with these properties. However, no actual economy has been described and, given the assumptions involved, none could ever exist. A theoretical question has been answered involving some amount of intellectual achievement, but it is a answer which has no bearing to reality. And this is often termed the “high theory” of equilibrium. Obviously most economists must treat the real world as a special case.
Little wonder, then, that Kaldor argued that his “basic objection to the theory of general equilibrium is not that it is abstract — all theory is abstract and must necessarily be so since there can be no analysis without abstraction — but that it starts from the wrong kind of abstraction, and therefore gives a misleading ‘paradigm’ . . . of the world as it is; it gives a misleading impression of the nature and the manner of operation of economic forces.” Moreover, belief that equilibrium theory is the only starting point for economic analysis has survived “despite the increasing (not diminishing) arbitrariness of its based assumptions — which was forced upon its practitioners by the ever more precise cognition of the needs of logical consistency. In terms of gradually converting an ‘intellectual experiment’ . . . into a scientific theory — in other words, a set of theorems directly related to observable phenomena — the development of theoretical economics was one of continual degress, not progress . . . The process . . . of relaxing the unreal basis assumptions . . . has not yet started. Indeed, [they get] . . . thicker and more impenetrable with every successive reformation of the theory.” [Op. Cit., p. 399 and pp. 375-6]
Thus General Equilibrium theory analyses an economic state which there is no reason to suppose will ever, or has ever, come about. It is, therefore, an abstraction which has no discernible applicability or relevance to the world as it is. To argue that it can give insights into the real world is ridiculous. While it is true that there are certain imaginary intellectual problems for which the general equilibrium model is well designed to provide precise answers (if anything really could), in practice this means the same as saying that if one insists on analysing a problem which has no real world equivalent or solution, it may be appropriate to use a model which has no real-world application. Models derived to provide answers to imaginary problems will be unsuitable for resolving practical, real-world economic problems or even providing a useful insight into how capitalism works and develops.
This can have devastating real world impact, as can be seen from the results of neoclassical advice to Eastern Europe and other countries in their transition from state capitalism (Stalinism) to private capitalism. As Joseph Stiglitz documents it was a disaster for all but the elite due to the “market fundamentalism preached” by economists It resulted in “a marked deterioration” in most peoples “basic standard of living, reflected in a host of social indicators” and well as large drops in GDP. [Globalisation and its discontents, p. 138 and p. 152] Thus real people can be harmed by unreal theory. That the advice of neoclassical economists has made millions of people look back at Stalinism as “the good old days” should be enough to show its intellectual and moral bankruptcy.
What can you expect? Mainstream economic theory begins with axioms and assumptions and uses a deductive methodology to arrive at conclusions, its usefulness in discovering how the world works is limited. The deductive method is pre-scientific in nature. The axioms and assumptions can be considered fictitious (as they have negligible empirical relevance) and the conclusions of deductive models can only really have relevance to the structure of those models as the models themselves bear no relation to economic reality:
“Some theorists, even among those who reject general equilibrium as useless, praise its logical elegance and completeness . . . But if any proposition drawn from it is applied to an economy inhabited by human beings, it immediately becomes self-contradictory. Human life does not exist outside history and no one had correct foresight of his own future behaviour, let alone of the behaviour of all the other individuals which will impinge upon his. I do not think that it is right to praise the logical elegance of a system which becomes self-contradictory when it is applied to the question that it was designed to answer.” [Joan Robinson, Contributions to Modern Economics, pp. 127-8]
Not that this deductive model is internally sound. For example, the assumptions required for perfect competition are mutually exclusive. In order for the market reach equilibrium, economic actors need to able to affect it. So, for example, if there is an excess supply some companies must lower their prices. However, such acts contradict the basic assumption of “perfect competition,” namely that the number of buyers and sellers is so huge that no one individual actor (a firm or a consumer) can determine the market price by their actions. In other words, economists assume that the impact of each firm is zero but yet when these zeroes are summed up over the whole market the total is greater than zero. This is impossible. Moreover, the “requirements of equilibrium are carefully examined in the Walrasian argument but there is no way of demonstrating that a market which starts in an out-of-equilibrium position will tend to get into equilibrium, except by putting further very severe restrictions on the already highly abstract argument.” [Joan Robinson, Collected Economic Papers, vol. 5, p. 154] Nor does the stable unique equilibrium actually exist for, ironically, “mathematicians have shown that, under fairly general conditions, general equilibrium is unstable.” [Keen, Debunking Economics, p. 173]
Another major problem with equilibrium theory is the fact that it does not, in fact, describe a capitalist economy. It should go without saying that models which focus purely on exchange cannot, by definition, offer a realistic analysis, never mind description, of the capitalism or the generation of income in an industrialised economy. As Joan Robinson summarises:
“The neo-classical theory . . . pretends to derive a system of prices from the relative scarcity of commodities in relation to the demand for them. I say pretend because this system cannot be applied to capitalist production.
“The Walrasian conception of equilibrium arrived at by higgling and haggling in a market illuminates the account of prisoners of war swapping the contents of their Red Cross parcels.
“It makes sense also, with some modifications, in an economy of artisans and small traders . . .
“Two essential characteristics of industrial capitalism are absent in these economic systems — the distinction between income from work and income from property and the nature of investments made in the light of uncertain expectations about a long future.” [Collected Economic Papers, vol. 5, p. 34]
Even such basic things as profits and money have a hard time fitting into general equilibrium theory. In a perfectly competitive equilibrium, super-normal profit is zero so profit fails to appear. Normal profit is assumed to be the contribution capital makes to output and is treated as a cost of production and notionally set as the zero mark. A capitalism without profit? Or growth, “since there is no profit or any other sort of surplus in the neoclassical equilibrium, there can be no expanded reproduction of the system.” [Mattick, Op. Cit., p. 22] It also treats capitalism as little more than a barter economy. The concept of general equilibrium is incompatible with the actual role of money in a capitalist economy. The assumption of “perfect knowledge” makes the keeping of cash reserves as a precaution against unexpected developments would not be necessary as the future is already known. In a world where there was absolute certainty about the present and future there would be no need for a medium of exchange like money at all. In the real world, money has a real effect on production an economic stability. It is, in other words, not neutral (although, conveniently, in a fictional world with neutral money “crises do not occur“ and it “assumed away the very matter under investigation,” namely depressions. [Keynes, quoted by Doug Henwood, Wall Street, p. 199]).
Given that general equilibrium theory does not satisfactorily encompass such things as profit, money, growth, instability or even firms, how it can be considered as even an adequate representation of any real capitalist economy is hard to understand. Yet, sadly, this perspective has dominated economics for over 100 years. There is almost no discussion of how scarce means are organised to yield outputs, the whole emphasis is on exchanges of ready made goods. This is unsurprising, as this allows economics to abstract from such key concepts as power, class and hierarchy. It shows the “the bankruptcy of academic economic teaching. The structure of thought which it expounds was long ago proven to be hollow. It consisted of a set of propositions which bore hardly any relation to the structure and evolution of the economy that they were supposed to depict.” [Joan Robinson, Op. Cit., p. 90]
Ultimately, equilibrium analysis simply presents an unreal picture of the real world. Economics treat a dynamic system as a static one, building models rooted in the concept of equilibrium when a non-equilibrium analysis makes obvious sense. As Steven Keen notes, it is not only the real world that has suffered, so has economics:
“This obsession with equilibrium has imposed enormous costs on economics . . . unreal assumptions are needed to maintain conditions under which there will be a unique, ‘optimal’ equilibrium . . . If you believe you can use unreality to model reality, then eventually your grip on reality itself can become tenuous.” [Op. Cit., p. 177]
Ironically, given economists usual role in society as defenders of big business and the elite in general, there is one conclusion of general equilibrium theory which does have some relevance to the real world. In 1956, two economists “demonstrated that serious problems exist for the model of competitive equilibrium if any of its assumptions are breached.” They were “not dealing with the fundamental problem of whether a competitive equilibrium exists,” rather they wanted to know what happens if the assumptions of the model were violated. Assuming that two violations existed, they worked out what would happen if only one of them were removed. The answer was a shock for economists — “If just one of many, or even just one of two [violations] is removed, it is not possible to prejudge the outcome. The economy as a whole can theoretically be worse off it just one violation exists than it is when two such violations exist.” In other words, any single move towards the economists’ ideal market may make the world worse off. [Ormerod, Op. Cit., pp. 82-4]
What Kelvin Lancaster and Richard Lipsey had shown in their paper “The General Theory of the Second Best” [Review of Economic Studies, December 1956] has one obvious implication, namely that neoclassical economics itself has shown that trade unions were essential to stop workers being exploited under capitalism. This is because the neoclassical model requires there to be a multitude of small firms and no unions. In the real world, most markets are dominated by a few big firms. Getting rid of unions in such a less than competitive market would result in the wage being less than the price for which the marginal worker’s output can be sold, i.e. workers are exploited by capital. In other words, economics has itself disproved the neoclassical case against trade unions. Not that you would know that from neoclassical economists, of course. In spite of knowing that, in their own terms, breaking union power while retaining big business would result, in the exploitation of labour, neoclassical economists lead the attack on “union power” in the 1970s and 1980s. The subsequent explosion in inequality as wealth flooded upwards provided empirical confirmation of this analysis.
Strangely, though, most neoclassical economists are still as anti-union as ever — in spite of both their own ideology and the empirical evidence. That the anti-union message is just what the bosses want to hear can just be marked up as yet another one of those strange co-incidences which the value-free science of economics is so prone to. Suffice to say, if the economics profession ever questions general equilibrium theory it will be due to conclusions like this becoming better known in the general population.
As we discussed in section C.1.2, mainstream economics is rooted in capitalism and capitalist social relations. It takes the current division of society into classes as both given as well as producing the highest form of efficiency. In other words, mainstream economics is rooted in capitalist assumptions and, unsurprisingly, its conclusions are, almost always, beneficial to capitalists, managers, landlords, lenders and the rich rather than workers, tenants, borrowers and the poor.
However, on another level mainstream capitalist economics simply does not reflect capitalism at all. While this may seem paradoxical, it is not. Neoclassical economics has always been marked by apologetics. Consequently, it must abstract or ignore from the more unpleasant and awkward aspects of capitalism in order to present it in the best possible light.
Take, for example, the labour market. Anarchists, like other socialists, have always stressed that under capitalism workers have the choice between selling their liberty/labour to a boss or starving to death (or extreme poverty, assuming some kind of welfare state). This is because they do not have access to the means of life (land and workplaces) unless they sell their labour to those who own them. In such circumstances, it makes little sense to talk of liberty as the only real liberty working people have is, if they are lucky, agreeing to be exploited by one boss rather than another. How much an person works, like their wages, will be based on the relative balance of power between the working and capitalist classes in a given situation.
Unsurprisingly, neoclassical economics does not portray the choice facing working class people in such a realistic light. Rather, it argues that the amount of hours an individual works is based on their preference for income and leisure time. Thus the standard model of the labour market is somewhat paradoxical in that there is no actual labour in it. There is only income, leisure and the preference of the individual for more of one or the other. It is leisure that is assumed to be a “normal good” and labour is just what is left over after the individual “consumes” all the leisure they want. This means that working resolves itself into the vacuous double negative of not-not-working and the notion that all unemployment is voluntary.
That this is nonsense should be obvious. How much “leisure” can someone indulge in without an income? How can an economic theory be considered remotely valid when it presents unemployment (i.e. no income) as the ultimate utility in an economy where everything is (or should be) subject to a price? Income, then, has an overwhelming impact upon the marginal utility of leisure time. Equally, this perspective cannot explain why the prospect of job loss is seen with such fear by most workers. If the neoclassical (non-)analysis of the labour market were true, workers would be happy to be made unemployed. In reality, fear of the sack is a major disciplining tool within capitalism. That free market capitalist economists have succeeded in making unemployment appear as a desirable situation suggests that its grip on the reality of capitalism is slim to say the least (here, as in many other areas, Keynes is more realistic although most of his followers have capitulated faced with neoclassical criticism that standard Keynesian theory had bad micro-economic foundations rather than admit that later was nonsense and the former “an emasculated version of Keynes” inflicted on the world by J.R. Hicks. [Keen, Op. Cit., p. 211]).
However, this picture of the “labour” market does hide the reality of working class dependency and, consequently, the power of the capitalist class. To admit that workers do not exercise any free choice over whether they work or not and, once in work, have to accept the work hours set by their employers makes capitalism seem less wonderful than its supporters claim. Ultimately, this fiction of the labour market being driven by the workers’ desire for “leisure” and that all unemployment is “voluntary” is rooted in the need to obscure the fact that unemployment is an essential feature of capitalism and, consequently, is endemic to it. This is because it is the fundamental disciplinary mechanism of the system (“it is a whip in [the bosses’] hands, constantly held over you, so you will slave hard for him and ‘behave’ yourself,” to quote Alexander Berkman). As we argued in section B.4.3, capitalism must have unemployment in order to ensure that workers will obey their bosses and not demand better pay and conditions (or, even worse, question why they have bosses in the first place). It is, in other words, “inherent in the wage system” and “the fundamental condition of successful capitalist production.” While it is “dangerous and degrading” to the worker, it is “very advantageous to the boss” and so capitalism “can’t exist without it.” [Berkman, What is Anarchism?, p. 26] The experience of state managed full employment between (approximately) 1950 and 1970 confirms this analysis, as does the subsequent period (see section C.7.1).
For the choice of leisure and labour to be a reality, then workers need an independent source of income. The model, in other words, assumes that workers need to be enticed by the given wage and this is only the case when workers have the option of working for themselves, i.e. that they own their own means of production. If this were the case, then it would not be capitalism. In other words, the vision of the labour market in capitalist economics assumes a non-capitalist economy of artisans and peasant farmers — precisely the kind of economy capitalism destroyed (with the help of the state). An additional irony of this neoclassical analysis is that those who subscribe to it most are also those who attack the notion of a generous welfare state (or oppose the idea of welfare state in all forms). Their compliant is that with a welfare state, the labour market becomes “inefficient” as people can claim benefits and so need not seek work. Yet, logically, they should support a generous welfare state as it gives working people a genuine choice between labour and leisure. That bosses find it hard to hire people should be seen as a good thing as work is obviously being evaluated as a “disutility” rather than as a necessity. As an added irony, as we discuss in section C.9, the capitalist analysis of the labour market is not based on any firm empirical evidence nor does it have any real logical basis (it is just an assumption). In fact, the evidence we do have points against it and in favour of the socialist analysis of unemployment and the labour market.
One of the reasons why neoclassical economics is so blasé about unemployment is because it argues that it should never happen. That capitalism has always been marked by unemployment and that this rises and falls as part of the business cycle is a inconvenient fact which neoclassical economics avoided seriously analysing until the 1930s. This flows from Say’s law, the argument that supply creates its own demand. This theory, and its more formally put Walras’ Law, is the basis on which the idea that capitalism could never face a general economic crisis is rooted in. That capitalism has always been marked by boom and bust has never put Say’s Law into question except during the 1930s and even then it was quickly put back into the centre of economic ideology.
For Say, “every producer asks for money in exchange for his products only for the purpose of employing that money again immediately in the purchase of another product.” However, this is not the case in a capitalist economy as capitalists seek to accumulate wealth and this involves creating a difference between the value of commodities someone desired to sell and buy on the market. While Say asserts that people simply want to consume commodities, capitalism is marked by the desire (the need) to accumulate. The ultimate aim is not consumption, as Say asserted (and today’s economists repeat), but rather to make as much profit as possible. To ignore this is to ignore the essence of capitalism and while it may allow the economist to reason away the contradictions of that system, the reality of the business cycle cannot be ignored.
Say’s law, in other words, assumes a world without capital:
“what is a given stock of capital? In this context, clearly, it is the actual equipment and stocks of commodities that happen to be in existence today, the result of recent or remote past history, together with the know-how, skill of labour, etc., that makes up the state of technology. Equipment . . . is designed for a particular range of uses, to be operated by a particular labour force. There is not a great deal of play in it. The description of the stock of equipment in existence at any moment as ‘scare means with alternative uses’ is rather exaggerated. The uses in fact are fairly specific, though they may be changed over time. But they can be utilised, at any moment, by offering less or more employment to labour. This is a characteristic of the wage economy. In an artisan economy, where each producer owns his own equipment, each produces what he can and sells it for what it will fetch. Say’s law, that goods are the demand for goods, was ceasing to be true at the time he formulated it.” [Joan Robinson, Collected Economic Papers, vol. 4, p. 133]
As Keen notes, Say’s law “evisage[s] an exchange-only economy: an economy in which goods exist at the outset, but where no production takes place. The market simply enables the exchange of pre-existing goods.” However, once we had capital to the economy, things change as capitalists wish “to supply more than they demand, and to accumulate the difference as profit which adds to their wealth.” This results in an excess demand and, consequently, the possibility of a crisis. Thus mainstream capitalist economics “is best suited to the economic irrelevance of an exchange-only economy, or a production economy in which growth does not occur. If production and growth do occur, then they take place outside the market, when ironically the market is the main intellectual focus of neoclassical economics. Conventional economics is this a theory which suits a static economy . . . when what is needed are theories to analyse dynamic economies.” [Debunking Economics, p. 194, p. 195 and p. 197]
Ultimately, capital assets are not produced for their own stake but in expectation of profits. This obvious fact is ignored by Say’s law, but was recognised by Marx (and subsequently acknowledged by Keynes as being correct). As Keen notes, unlike Say and his followers, “Marx’s perspective thus integrates production, exchange and credit as holistic aspects of a capitalist economy, and therefore as essential elements of any theory of capitalism. Conventional economics, in contrast, can only analyse an exchange economy in which money is simply a means to make barter easier.” [Op. Cit., pp. 195-6]
Rejecting Say’s Law as being applicable to capitalism means recognising that the capitalist economy is not stable, that it can experience booms and slumps. That this reflects the reality of that economy should go without saying. It also involves recognising that it can take time for unemployed workers to find new employment, that unemployment can by involuntary and that bosses can gain advantages from the fear of unemployment by workers.
That last fact, the fear of unemployment is used by bosses to get workers to accept reductions in wages, hours and benefits, is key factor facing workers in any real economy. Yet, according to the economic textbooks, workers should have been falling over themselves to maximise the utility of leisure and minimise the disutility of work. Similarly, workers should not fear being made unemployed by globalisation as the export of any jobs would simply have generated more economic activity and so the displaced workers would immediately be re-employed (albeit at a lower wage, perhaps). Again, according to the economic textbooks, these lower wages would generate even more economic activity and thus lead, in the long run, to higher wages. If only workers had only listened to the economists then they would realise that that not only did they actually gain (in the long run) by their wages, hours and benefits being cut, many of them also gained (in the short term) increased utility by not having to go to work. That is, assuming the economists know what they are talking about.
Then there is the question of income. For most capitalist economics, a given wage is supposed to be equal to the “marginal contribution” that an individual makes to a given company. Are we really expected to believe this? Common sense (and empirical evidence) suggests otherwise. Consider Mr. Rand Araskog, the CEO of ITT in 1990, who in that year was paid a salary of $7 million. Is it conceivable that an ITT accountant calculated that, all else being the same, the company’s $20.4 billion in revenues that year would have been $7 million less without Mr. Araskog — hence determining his marginal contribution to be $7 million? This seems highly unlikely.
Which feeds into the question of exploding CEO pay. While this has affected most countries, the US has seen the largest increases (followed by the UK). In 1979 the CEO of a UK company earned slightly less than 10 times as much as the average worker on the shop floor. By 2002 a boss of a FTSE 100 company could expect to make 54 times as much as the typical worker. This means that while the wages for those on the shopfloor went up a little, once inflation is taken into account, the bosses wages arose from £200,000 per year to around £1.4m a year. In America, the increase was even worse. In 1980, the ratio of CEO to worker pay 50 to 1. Twenty years later it was 525 to 1, before falling back to 281 to 1 in 2002 following the collapse of the share price bubble. [Larry Elliott, “Nice work if you can get it: chief executives quietly enrich themselves for mediocrity,” The Guardian, 23 January, 2006]
The notion of marginal productivity is used to justify many things on the market. For example, the widening gap between high-paid and low-paid Americans (it is argued) simply reflects a labour market efficiently rewarding more productive people. Thus the compensation for corporate chief executives climbs so sharply because it reflects their marginal productivity. The strange thing about this kind of argument is that, as we indicate in section C.2.5, the problem of defining and measuring capital wrecked the entire neoclassical theory of marginal factor productivity and with it the associated marginal productivity theory of income back in the 1960s — and was admitted as the leading neo-classical economists of the time. That marginal productivity theory is still invoked to justify capitalist inequalities shows not only how economics ignores the reality of capitalism but also the intellectual bankruptcy of the “science” and whose interests it, ultimately, serves.
In spite of this awkward little fact, what of the claims made based on it? Is this pay really the result of any increased productivity on the part of CEOs? The evidence points the other way. This can be seen from the performance of the economies and companies in question. In Britain trend growth was a bit more than 2% in 1980 and is still a bit more than 2% a quarter of a century later. A study of corporate performance in Britain and the United States looked at the companies that make up the FTSE 100 index in Britain and the S&P 500 in the US and found that executive income is rarely justified by improved performance. [Julie Froud, Sukhdev Johal, Adam Leaver and Karel Williams, Financialisation and Strategy: Narrative and Number ] Rising stock prices in the 1990s, for example, were the product of one of the financial market’s irrational bubbles over which the CEO’s had no control or role in creating.
During the same period as soaring CEO pay, workers’ real wages remained flat. Are we to believe that since the 1980s, the marginal contribution of CEOs has increased massively whereas workers’ marginal contributions remained stagnant? According to economists, in a free market wages should increase until they reach their marginal productivity. In the US, however, during the 1960s “pay and productivity grew in tandem, but they separated in the 1970s. In the 1990s boom, pay growth lagged behind productivity by almost 30%.” Looking purely at direct pay, “overall productivity rose four times as fast as the average real hourly wage — and twenty times as fast in manufacturing.” Pay did catch up a bit in the late 1990s, but after 2000 “pay returned to its lagging position.” [Doug Henwood, After the New Economy, pp. 45-6] In other words, over two decades of free market reforms has produced a situation which has refuted the idea that a workers wage equals their marginal productivity.
The standard response by economists would be to state that the US economy is not a free market. Yet the 1970s, after all, saw the start of reforms based on the recommendations of free market capitalist economists. The 1980s and 1990s saw even more. Regulation was reduced, if not effectively eliminated, the welfare state rolled back and unions marginalised. So it staggers belief to state that the US was more free market in the 1950s and 1960s than in the 1980s and 1990s but, logically, this is what economists suggest. Moreover, this explanation sits ill at ease with the multitude of economists who justified growing inequality and skyrocketing CEO pay and company profits during this period in terms of free market economics. What is it to be? If the US is not a free market, then the incomes of companies and the wealth are not the result of their marginal contribution but rather are gained at the expense of the working class. If the US is a free market, then the rich are justified (in terms of economic theory) in their income but workers’ wages do not equal their marginal productivity. Unsurprisingly, most economists do not raise the question, never mind answer it.
So what is the reason for this extreme wage difference? Simply put, it’s due to the totalitarian nature of capitalist firms (see section B.4). Those at the bottom of the company have no say in what happens within it; so as long as the share-owners are happy, wage differentials will rise and rise (particularly when top management own large amounts of shares!). It is capitalist property relations that allow this monopolisation of wealth by the few who own (or boss) but do not produce. The workers do not get the full value of what they produce, nor do they have a say in how the surplus value produced by their labour gets used (e.g. investment decisions). Others have monopolised both the wealth produced by workers and the decision-making power within the company (see section C.2 for more discussion). This is a private form of taxation without representation, just as the company is a private form of statism. Unlike the typical economist, most people would not consider it too strange a coincidence that the people with power in a company, when working out who contributes most to a product, decide it’s themselves!
Whether workers will tolerate stagnating wages depends, of course, on the general economic climate. High unemployment and job insecurity help make workers obedient and grateful for any job and this has been the case for most of the 1980s and 1990s in both America and the UK. So a key reason for the exploding pay is to be found in the successful class struggle the ruling class has been waging since the 1970s. There has “been a real shift in focus, so that the beneficiaries of corporate success (such as it is) are no longer the workers and the general public as a whole but shareholders. And given that there is evidence that only households in the top half of the income distribution in the UK and the US hold shares, this represents a significant redistribution of money and power.” [Larry Elliott, Op. Cit.] That economics ignores the social context of rising CEO pay says a lot about the limitations of modern economics and how it can be used to justify the current system.
Then there is the trivial little thing of production. Economics used to be called “political economy” and was production orientated. This was replaced by an economics based on marginalism and subjective evaluations of a given supply of goods is fixed. For classical economics, to focus on an instant of time was meaningless as time does not stop. To exclude production meant to exclude time, which as we noted in section C.1.2 this is precisely and knowingly what marginalist economics did do. This means modern economics simply ignores production as well as time and given that profit making is a key concern for any firm in the real world, such a position shows how irrelevant neoclassical economics really is.
Indeed, the neo-classical theory falls flat on its face. Basing itself, in effect, on a snapshot of time its principles for the rational firm are, likewise, based on time standing still. It argues that profit is maximised where marginal cost equals marginal revenue yet this is only applicable when you hold time constant. However, a real firm will not maximise profit with respect to quantity but also in respect to time. The neoclassical rule about how to maximise profit “is therefore correct if the quantity produced never changes” and “by ignoring time in its analysis of the firm, economic theory ignores some of the most important issues facing a firm.” Neo-classical economics exposes its essentially static nature again. It “ignores time, and is therefore only relevant in a world in which time does no matter.” [Keen, Op. Cit., pp. 80-1]
Then there is the issue of consumption. While capitalist apologists go on about “consumer sovereignty” and the market as a “consumers democracy,” the reality is somewhat different. Firstly, and most obviously, big business spends a lot of money trying to shape and influence demand by means of advertising. Not for them the neoclassical assumption of “given” needs, determined outside the system. So the reality of capitalism is one where the “sovereign” is manipulated by others. Secondly, there is the distribution of resources within society.
Market demand is usually discussed in terms of tastes, not in the distribution of purchasing power required to satisfy those tastes. Income distribution is taken as given, which is very handy for those with the most wealth. Needless to say, those who have a lot of money will be able to maximise their satisfactions far easier than those who have little. Also, of course, they can out-bid those with less money. If capitalism is a “consumers” democracy then it is a strange one, based on “one dollar, one vote.” It should be obvious whose values are going to be reflected most strongly in the market. If we start with the orthodox economics (convenient) assumption of a “given distribution of income” then any attempt to determine the best allocation of resources is flawed to start with as money replaces utility from the start. To claim after that the market based distribution is the best one is question begging in the extreme.
In other words, under capitalism, it is not individual need or “utility” as such that is maximised, rather it is effective utility (usually called “effective demand”) — namely utility that is backed up with money. This is the reality behind all the appeals to the marvels of the market. As right-wing guru von Hayek put, the “[s]pontaneous order produced by the market does not ensure that what general opinion regards as more important needs are always met before the less important ones.” [“Competition as a discovery process”, The Essence of Hayek, p. 258] Which is just a polite way of referring to the process by which millionaires build a new mansion while thousands are homeless or live in slums or feed luxury food to their pets while humans go hungry. It is, in effect, to dismiss the needs of, for example, the 37 million Americans who lived below the poverty line in 2005 (12.7% of the population, the highest percentage in the developed world and is based on the American state’s absolute definition of poverty, looking at relative levels, the figures are worse). Similarly, the 46 million Americans without health insurance may, of course, think that their need to live should be considered as “more important” than, say, allowing Paris Hilton to buy a new designer outfit. Or, at the most extreme, when agribusiness grow cash crops for foreign markets while the landless starve to death. As E.P. Thompson argues, Hayek’s answer:
“promote[s] the notion that high prices were a (painful) remedy for dearth, in drawing supplies to the afflicted region of scarcity. But what draws supply are not high prices but sufficient money in their purses to pay high prices. A characteristic phenomenon in times of dearth is that it generates unemployment and empty pursues; in purchasing necessities at inflated prices people cease to be able to buy inessentials [causing unemployment] . . . Hence the number of those able to pay the inflated prices declines in the afflicted regions, and food may be exported to neighbouring, less afflicted, regions where employment is holding up and consumers still have money with which to pay. In this sequence, high prices can actually withdraw supply from the most afflicted area.” [Customs in Common, pp. 283-4]
Therefore “the law of supply and demand” may not be the “most efficient” means of distribution in a society based on inequality. This is clearly reflected in the “rationing” by purse which this system is based on. While in the economics books, price is the means by which scare resources are “rationed” in reality this creates many errors. As Thompson notes, “[h]owever persuasive the metaphor, there is an elision of the real Relationships assigned by price, which suggests . . . ideological sleight-of-mind. Rationing by price does not allocate resources equally among those in need; it reserves the supply to those who can pay the price and excludes those who can’t . . . The raising of prices during dearth could ‘ration’ them [the poor] out of the market altogether.” [Op. Cit., p. 285] Which is precisely what does happen. As economist (and famine expert) Amartya Sen notes:
“Take a theory of entitlements based on a set of rights of ‘ownership, transfer and rectification.’ In this system a set of holdings of different people are judged to be just (or unjust) by looking at past history, and not by checking the consequences of that set of holdings. But what if the consequences are recognisably terrible? . . .[R]efer[ing] to some empirical findings in a work on famines . . . evidence [is presented] to indicate that in many large famines in the recent past, in which millions of people have died, there was no over-all decline in food availability at all, and the famines occurred precisely because of shifts in entitlement resulting from exercises of rights that are perfectly legitimate. . . . [Can] famines . . . occur with a system of rights of the kind morally defended in various ethical theories, including Nozick’s. I believe the answer is straightforwardly yes, since for many people the only resource that they legitimately possess, viz. their labour-power, may well turn out to be unsaleable in the market, giving the person no command over food . . . [i]f results such as starvations and famines were to occur, would the distribution of holdings still be morally acceptable despite their disastrous consequences? There is something deeply implausible in the affirmative answer.” [Resources, Values and Development, pp. 311-2]
Recurring famines were a constant problem during the lassiez-faire period of the British Empire. While the Irish Potato famine is probably the best known, the fact is that millions died due to starvation mostly due to a firm believe in the power of the market. In British India, according to the most reliable estimates, the deaths from the 1876-1878 famine were in the range of 6-8 million and between 1896 and 1900, were between 17 to 20 million. According to a British statistician who analysed Indian food security measures in the two millennia prior to 1800, there was one major famine a century in India. Under British rule there was one every four years. Over all, the late 1870s and the late 1890s saw somewhere between 30 to 60 million people die in famines in India, China and Brazil (not including the many more who died elsewhere). While bad weather started the problem by placing the price of food above the reach of the poorest, the market and political decisions based on profound belief in it made the famine worse. Simply put, had the authorities distributed what food existed, most of the victims would have survived yet they did not as this would have, they argued, broke the laws of the market and produced a culture of dependency. [Mike Davis, Late Victorian Holocausts ] This pattern, incidentally, has been repeated in third world countries to this day with famine countries exporting food as the there is no “demand” for it at home.
All of which puts Hayek’s glib comments about “spontaneous order” into a more realistic context. As Kropotkin put it:
“The very essence of the present economic system is that the worker can never enjoy the well-being he [or she] has produced . . . Inevitably, industry is directed . . . not towards what is needed to satisfy the needs of all, but towards that which, at a given moment, brings in the greatest profit for a few. Of necessity, the abundance of some will be based on the poverty of others, and the straitened circumstances of the greater number will have to be maintained at all costs, that there may be hands to sell themselves for a part only of what which they are capable of producing; without which private accumulation of capital is impossible.” [Anarchism, p. 128]
In other words, the market cannot be isolated and abstracted from the network of political, social and legal relations within which it is situated. This means that all that “supply and demand” tells us is that those with money can demand more, and be supplied with more, than those without. Whether this is the “most efficient” result for society cannot be determined (unless, of course, you assume that rich people are more valuable than working class ones because they are rich). This has an obvious effect on production, with “effective demand” twisting economic activity and so, under capitalism, meeting needs is secondary as the “only aim is to increase the profits of the capitalist.” [Kropotkin, Op. Cit., p. 55]). George Barrett brings home of evil effects of such a system:
“To-day the scramble is to compete for the greatest profits. If there is more profit to be made in satisfying my lady’s passing whim than there is in feeding hungry children, then competition brings us in feverish haste to supply the former, whilst cold charity or the poor law can supply the latter, or leave it unsupplied, just as it feels disposed. That is how it works out.” [Objections to Anarchism, p. 347]
Therefore, as far as consumption is concerned, anarchists are well aware of the need to create and distribute necessary goods to those who require them. This, however, cannot be achieved under capitalism and for all its talk of “utility,” “demand”, “consumer sovereignty” and so forth the real facts are those with most money determine what is an “efficient” allocation of resources. This is directly, in terms of their control over the means of life as well as indirectly, by means of skewing market demand. For if financial profit is the sole consideration for resource allocation, then the wealthy can outbid the poor and ensure the highest returns. The less wealthy can do without.
All in all, the world assumed by neo-classical economics is not the one we actually live in, and so applying that theory is both misleading and (usually) disastrous (at least to the “have-nots”). While this may seen surprisingly, it is not once we take into account its role as apologist and defender of capitalism. Once that is recognised, any apparent contradiction falls away.
Yes, it is but it would be unlikely to be free-market based as the reality of capitalism would get the better of its apologetics. This can be seen from the two current schools of economics which, rightly, reject the notion of equilibrium — the post-Keynesian school and the so-called Austrian school.
The former has few illusions in the nature of capitalism. At its best, this school combines the valid insights of classical economics, Marx and Keynes to produce a robust radical (even socialist) critique of both capitalism and capitalist economics. At its worse, it argues for state intervention to save capitalism from itself and, politically, aligns itself with social democratic (“liberal”, in the USA) movements and parties. If economics does become a science, then this school of economics will play a key role in its development. Economists of this school include Joan Robinson, Nicholas Kaldor, John Kenneth Galbraith, Paul Davidson and Steven Keen. Due to its non-apologetic nature, we will not discuss it here.
The Austrian school has a radically different perspective. This school, so named because its founders were Austrian, is passionately pro-capitalist and argues against any form of state intervention (bar, of course, the definition and defence of capitalist property rights and the power that these create). Economists of this school include Eugen von Böhm-Bawerk, Lugwig von Mises, Murray Rothbard, Israel Kirzner and Frederick von Hayek (the latter is often attacked by other Austrian economists as not being sufficiently robust in his opposition to state intervention). It is very much a minority school.
As it shares many of the same founding fathers as neoclassical economics and is rooted in marginalism, the Austrian school is close to neoclassical economics in many ways. The key difference is that it rejects the notion that the economy is in equilibrium and embraces a more dynamic model of capitalism. It is rooted in the notion of entrepreneurial activity, the idea that entrepreneurs act on information and disequilibrium to make super profits and bring the system closer to equilibrium. Thus, to use their expression, their focus is on the market process rather than a non-existent end state. As such, it defends capitalism in terms of how it reacts of dis-equilibrium and presents a theory of the market process that brings the economy closer to equilibrium. And fails.
The claim that markets tend continually towards equilibrium, as the consequence of entrepreneurial actions, is hard to justify in terms of its own assumptions. While the adjustments of a firm may bring the specific market it operates in more towards equilibrium, their ramifications may take other markets away from it and so any action will have stabilising and destabilising aspects to it. It strains belief to assume that entrepreneurial activity will only push an economy more towards equilibrium as any change in the supply and demand for any specific good leads to changes in the markets for other goods (including money). That these adjustments will all (mostly) tend towards equilibrium is little more than wishful thinking.
While being more realistic than mainstream neo-classical theory, this method abandons the possibility of demonstrating that the market outcome is in any sense a realisation of the individual preferences of whose interaction it is an expression. It has no way of establishing the supposedly stabilising character of entrepreneurial activity or its alleged socially beneficial character as the dynamic process could lead to a divergence rather than a convergence of behaviour. A dynamic system need not be self-correcting, particularly in the labour market, nor show any sign of self-equilibrium (i.e. it will be subject to the business cycle).
Given that the Austrian theory is, in part, based on Say’s Law the critique we presented in the last section also applies here. However, there is another reason to think the Austrian self-adjusting perspective on capitalism is flawed and this is rooted in their own analysis. Ironically enough, economists of this school often maintain that while equilibrium does not exist their analysis is rooted on two key markets being in such a state: the labour market and the market for credit. The reason for these strange exceptions to their general assumption is, fundamentally, political. The former is required to deflect claims that “pure” capitalism would result in the exploitation of the working class, the latter is required to show that such a system would be stable.
Looking at the labour market, the Austrians argue that free market capitalism would experience full employment. That this condition is one of equilibrium does not seem to cause them much concern. Thus we find von Hayek, for example, arguing that the “cause of unemployment . . . is a deviation of prices and wages from their equilibrium position which would establish itself with a free market and stable money. But we can never know at what system of relative prices and wages such an equilibrium would establish itself.” Therefore, “the deviation of existing prices from that equilibrium position . . . is the cause of the impossibility of selling part of the labour supply.” [New Studies, p. 201] Therefore, we see the usual embrace of equilibrium theory to defend capitalism against the evils it creates even by those who claim to know better.
Of course, the need to argue that there would be full employment under “pure” capitalism is required to maintain the fiction that everyone will be better off under it. It is hard to say that working class people will benefit if they are subject to high levels of unemployment and the resulting fear and insecurity that produces. As would be expected, the Austrian school shares the same perspective on unemployment as the neoclassical school, arguing that it is “voluntary” and the result of the price of labour being too high (who knew that depressions were so beneficial to workers, what with some having more leisure to enjoy and the others having higher than normal wages?). The reality of capitalism is very different than this abstract model.
Anarchists have long realised that the capitalist market is based upon inequalities and changes in power. Proudhon argued that “[t]he manufacturer says to the labourer, ‘You are as free to go elsewhere with your services as I am to receive them. I offer you so much.’ The merchant says to the customer, ‘Take it or leave it; you are master of your money, as I am of my goods. I want so much.’ Who will yield? The weaker.” He, like all anarchists, saw that domination, oppression and exploitation flow from inequalities of market/economic power and that the “power of invasion lies in superior strength.” [What is Property?, p. 216 and p. 215] This is particularly the case in the labour market, as we argued in section B.4.3.
As such, it is unlikely that “pure” capitalism would experience full employment for under such conditions the employers loose the upper hand. To permanently experience a condition which, as we indicate in section C.7, causes “actually existing” capitalism so many problems seems more like wishful thinking than a serious analysis. If unemployment is included in the Austrian model (as it should) then the bargaining position of labour is obviously weakened and, as a consequence, capital will take advantage and gather profits at the expense of labour. Conversely, if labour is empowered by full employment then they can use their position to erode the profits and managerial powers of their bosses. Logically, therefore, we would expect less than full unemployment and job insecurity to be the normal state of the economy with short periods of full unemployment before a slump. Given this, we would expect “pure” capitalism to be unstable, just as the approximations to it in history have always been. Austrian economics gives no reason to believe that would change in the slightest. Indeed, given their obvious hatred of trade unions and the welfare state, the bargaining power of labour would be weakened further during most of the business cycle and, contra Hayek, unemployment would remain and its level would fluctuate significantly throughout the business cycle.
Which brings us to the next atypical market in Austrian theory, namely the credit market. According to the Austrian school, “pure” capitalism would not suffer from a business cycle (or, at worse, a very mild one). This is due to the lack of equilibrium in the credit market due to state intervention (or, more correctly, state non-intervention). Austrian economist W. Duncan Reekie provides a summary:
“The business cycle is generated by monetary expansion and contraction . . . When new money is printed it appears as if the supply of savings has increased. Interest rates fall and businessmen are misled into borrowing additional founds to finance extra investment activity . . . This would be of no consequence if it had been the outcome of [genuine saving] . . . – but the change was government induced. The new money reaches factor owners in the form of wages, rent and interest . . . the factor owners will then spend the higher money incomes in their existing consumption:investment proportions . . . Capital goods industries will find their expansion has been in error and malinvestments have been incurred.” [Markets, Entrepreneurs and Liberty, pp. 68-9]
This analysis is based on their notion that the interest rate reflects the “time preference” of individuals between present and future goods (see section C.2.6 for more details). The argument is that banks or governments manipulate the money supply or interest rates, making the actual interest rate different from the “real” interest rate which equates savings and loans. Of course, that analysis is dependent on the interest rate equating savings and loans which is, of course, an equilibrium position. If we assume that the market for credit shows the same disequilibrium tendencies as other markets, then the possibility for malinvestment is extremely likely as banks and other businesses extend credit based on inaccurate assumptions about present conditions and uncertain future developments in order to secure greater profits. Unsurprisingly, the Austrians (like most economists) expect the working class to bear the price for any recession in terms of real wage cuts in spite of their theory indicating that its roots lie in capitalists and bankers seeking more profits and, consequently, the former demanding and the latter supplying more credit than the “natural” interest rate would supply.
Ironically, therefore, the Austrian business cycle is rooted in the concept of dis-equilibrium in the credit market, the condition it argues is the standard situation in all other markets. In effect, they think that the money supply and interest rates are determined exogenously (i.e. outside the economy) by the state. However, this is unlikely as the evidence points the other way, i.e. to the endogenous nature of the money supply itself. This account of money (proposed strongly by, among others, the post-Keynesian school) argues that the money supply is a function of the demand for credit, which itself is a function of the level of economic activity. In other words, the banking system creates as much money as people need and any attempt to control that creation will cause economic problems and, perhaps, crisis. Money, in other words, emerges from within the system and so the Austrian attempt to “blame the state” is simply wrong. As we discuss in section C.8, attempts by the state to control the money during the Monetarist disasters of the early 1980s failed and it is unlikely that this would change in a “pure” capitalism marked by a totally privatised banking system.
It should also be noted that in the 1930s, the Austrian theory of the business cycle lost the theoretical battle with the Keynesian one (not to be confused with the neoclassical-Keynesian synthesis of the post-war years). This was for three reasons. Firstly, it was irrelevant (its conclusion was do nothing). Secondly, it was arrogant (it essentially argued that the slump would not have happened if people had listened to them and the pain of depression was fully deserved for not doing so). Thirdly, and most importantly, the leading Austrian theorist on the business cycle was completely refuted by Piero Sraffa and Nicholas Kaldor (Hayek’s own follower who turned Keynesian) both of whom exposed the internal contradictions of his analysis.
The empirical record backs our critique of the Austrian claims on the stability of capitalism and unemployment. Throughout the nineteenth century there were a continual economic booms and slumps. This was the case in the USA, often pointed to as an approximately lassiez-faire economy, where the last third of the 19th century (often considered as a heyday of private enterprise) was a period of profound instability and anxiety. Between 1867 and 1900 there were 8 complete business cycles. Over these 396 months, the economy expanded during 199 months and contracted during 197. Hardly a sign of great stability (since the end of world war II, only about a fifth of the time has spent in periods of recession or depression, by way of comparison). Overall, the economy went into a slump, panic or crisis in 1807, 1817, 1828, 1834, 1837, 1854, 1857, 1873, 1882, and 1893 (in addition, 1903 and 1907 were also crisis years). Full employment, needless to say, was not the normal situation (during the 1890s, for example, the unemployment rate exceeded 10% for 6 consecutive years, reaching a peak of 18.4% in 1894, and was under 4% for just one, 1892). So much for temporary and mild slumps, prices adjusting fast and markets clearing quickly in pre-Keynesian economies!
Luckily, though, the Austrian school’s methodology allows it to ignore such irritating constrictions as facts, statistics, data, history or experimental confirmation. While neoclassical economics at least pretends to be scientific, the Austrian school displays its deductive (i.e. pre-scientific) methodology as a badge of pride along side its fanatical love of free market capitalism. For the Austrians, in the words of von Mises, economic theory “is not derived from experience; it is prior to experience” and “no kind of experience can ever force us to discard or modify a priori theorems; they are logically prior to it and cannot be either proved by corroborative experience or disproved by experience to the contrary.” And if this does not do justice to a full exposition of the phantasmagoria of von Mises’ a priorism, the reader may take some joy (or horror) from the following statement:
“If a contradiction appears between a theory and experience, we must always assume that a condition pre-supposed by the theory was not present, or else there is some error in our observation. The disagreement between the theory and the facts of experience frequently forces us to think through the problems of the theory again. But so long as a rethinking of the theory uncovers no errors in our thinking, we are not entitled to doubt its truth“ [emphasis added, quoted by Homa Katouzian, Ideology and Method in Economics, pp. 39-40]
In other words, if reality is in conflict with your ideas, do not adjust your views because reality must be at fault! The scientific method would be to revise the theory in light of the facts. It is not scientific to reject the facts in light of the theory! Without experience, any theory is just a flight of fantasy. For the higher a deductive edifice is built, the more likely it is that errors will creep in and these can only be corrected by checking the analysis against reality. Starting assumptions and trains of logic may contain inaccuracies so small as to be undetectable, yet will yield entirely false conclusions. Similarly, trains of logic may miss things which are only brought to light by actual experiences or be correct, but incomplete or concentrate on or stress inappropriate factors. To ignore actual experience is to loose that input when evaluating a theory.
Ignoring the obvious problems of the empirical record, as any consistent Austrian would, the question does arise why does the Austrian school make exceptions to its disequilibrium analysis for these two markets. Perhaps this is a case of political expediency, allowing the ideological supporters of free market capitalism to attack the notion of equilibrium when it clearly clashes with reality but being able to return to it when attacking, say, trade unions, welfare programmes and other schemes which aim to aid working class people against the ravages of the capitalist market? Given the self-appointed role of Austrian economics as the defender of “pure” (and, illogically, not so pure) capitalism that conclusion is not hard to deny.
Rejecting equilibrium is not as straightforward as the Austrians hope, both in terms of logic and in justifying capitalism. Equilibrium plays a role in neo-classical economics for a reason. A disequilibrium trade means that people on the winning side of the bargain will gain real income at the expense of the losers. In other words, Austrian economics is rooted (in most markets, at least) in the idea that trading benefits one side more than the other which flies in the face of the repeated dogma that trade benefits both parties. Moreover, rejecting the idea of equilibrium means rejecting any attempt to claim that workers’ wages equal their just contribution to production and so to society. If equilibrium does not exist or is never actually reached then the various economic laws which “prove” that workers are not exploited under capitalism do not apply. This also applies to accepting that any real market is unlike the ideal market of perfect competition. In other words, by recognising and taking into account reality capitalist economics cannot show that capitalism is stable, non-exploitative or that it meets the needs of all.
Given that they reject the notion of equilibrium as well as the concept of empirical testing of their theories and the economy, their defence of capitalism rests on two things: “freedom” and anything else would be worse. Neither are particularly convincing.
Taking the first option, this superficially appears appealing, particularly to anarchists. However this stress on “freedom” — the freedom of individuals to make their own decisions — flounders on the rocks of capitalist reality. Who can deny that individuals, when free to choose, will pick the option they consider best for themselves? However, what this praise for individual freedom ignores is that capitalism often reduces choice to picking the lesser of two (or more) evils due to the inequalities it creates (hence our reference to the quality of the decisions available to us). The worker who agrees to work in a sweatshop does “maximise” her “utility” by so doing — after all, this option is better than starving to death — but only an ideologue blinded by capitalist economics will think that she is free or that her decision is not made under (economic) compulsion.
The Austrian school is so in love with markets they even see them where they do not exist, namely inside capitalist firms. There, hierarchy reigns and so for all their talk of “liberty” the Austrian school at best ignores, at worse exalts, factory fascism (see section F.2.1) For them, management is there to manage and workers are there to obey. Ironically, the Austrian (like the neo-liberal) ethic of “freedom” is based on an utterly credulous faith in authority in the workplace. Thus we have the defenders of “freedom” defending the hierarchical and autocratic capitalist managerial structure, i.e. “free” workers subject to a relationship distinctly lacking freedom. If your personal life were as closely monitored and regulated as your work life, you would rightly consider it oppression.
In other words, this idealisation of freedom through the market completely ignores the fact that this freedom can be, to a large number of people, very limited in scope. Moreover, the freedom associated with capitalism, as far as the labour market goes, becomes little more than the freedom to pick your master. All in all, this defence of capitalism ignores the existence of economic inequality (and so power) which infringes the freedom and opportunities of others. Social inequalities can ensure that people end up “wanting what they get” rather than “getting what they want” simply because they have to adjust their expectations and behaviour to fit into the patterns determined by concentrations of economic power. This is particularly the case within the labour market, where sellers of labour power are usually at a disadvantage when compared to buyers due to the existence of unemployment as we have discussed.
As such, their claims to be defenders of “liberty” ring hollow in anarchist ears. This can be seen from the 1920s. For all their talk of “freedom”, when push came to shove, they end up defending authoritarian regimes in order to save capitalism when the working classes rebel against the “natural” order. Thus we find von Mises, for example, arguing in the 1920s that it “cannot be denied that Fascism and similar movements aiming at the establishment of dictatorships are full of the best intentions and that their intervention has, for the moment, saved European civilisation. The merit that Fascism has thereby won for itself will live eternally in history.” [Liberalism, p. 51] Faced with the Nazis in the 1930s, von Mises changed his tune somewhat as, being Jewish, he faced the same state repression he was happy to see inflicted upon rebellious workers the previous decade. Unsurprisingly, he started to stress that Nazi was short for “National Socialism” and so the horrors of fascism could be blamed on “socialism” rather than the capitalists who funded the fascist parties and made extensive profits under them once the labour, anarchist and socialist movements had been crushed.
Similarly, when right-wing governments influenced by the Austrian school were elected in various countries in the 1980s, those countries saw an increase in state authoritarianism and centralisation. In the UK, for example, Thatcher’s government strengthened the state and used it to break the labour movement (in order to ensure management authority over their workers). In other words, instead of regulating capital and the people, the state just regulates the people. The general public will have the freedom of doing what the market dictates and if they object to the market’s “invisible hand”, then the very visible fist of the state (or private defence companies) will ensure they do. We can be sure if a large anarchist movement developed the Austrian economists will, like von Mises in the 1920s, back whatever state violence was required to defend “civilisation” against it. All in the name of “freedom,” of course.
Then there is the idea that anything else that “pure” capitalism would be worse. Given their ideological embrace of the free market, the Austrians attack those economists (like Keynes) who tried to save capitalism from itself. For the Austrian school, there is only capitalism or “socialism” (i.e. state intervention) and they cannot be combined. Any attempt to do so would, as Hayek put it in his book The Road to Serfdom, inevitably lead to totalitarianism. Hence the Austrians are at the forefront in attacking the welfare state as not only counterproductive but inherently leading to fascism or, even worse, some form of state socialism. Needless to say, the state’s role in creating capitalism in the first place is skilfully ignored in favour of endless praise for the “natural” system of capitalism. Nor do they realise that the victory of state intervention they so bemoan is, in part, necessary to keep capitalism going and, in part, a consequence of attempts to approximate their utopia (see section D.1 for a discussion).
Not that Hayek’s thesis has any empirical grounding. No state has ever become fascist due to intervening in the economy (unless a right-wing coup happens, as in Chile, but that was not his argument). Rather, dictatorial states have implemented planning rather than democratic states becoming dictatorial after intervening in the economy. Moreover, looking at the Western welfare states, the key compliant by the capitalist class in the 1960s and 1970s was not a lack of general freedom but rather too much. Workers and other previously oppressed but obedient sections of society were standing up for themselves and fighting the traditional hierarchies within society. This hardly fits in with serfdom, although the industrial relations which emerged in Pinochet’s Chile, Thatcher’s Britain and Reagan’s America does. The call was for the state to defend the “management’s right to manage” against rebellious wage slaves by breaking their spirit and organisation while, at the same time, intervening to bolster capitalist authority in the workplace. That this required an increase in state power and centralisation would only come as a surprise to those who confuse the rhetoric of capitalism with its reality.
Similarly, it goes without saying Hayek’s thesis was extremely selectively applied. It is strange to see, for example, Conservative politicians clutching Hayek’s Road to Serfdom with one hand and using it to defend cutting the welfare state while, with the other, implementing policies which give billions to the Military Industrial Complex. Apparently “planning” is only dangerous to liberty when it is in the interests of the many. Luckily, defence spending (for example) has no such problems. As Chomsky stresses, “the ‘free market’ ideology is very useful — it’s a weapon against the general population . . . because it’s an argument against social spending, and it’s a weapon against poor people abroad . . . But nobody [in the ruling class] really pays attention to this stuff when it comes to actual planning — and no one ever has.” [Understanding Power, p. 256] That is why anarchists stress the importance of reforms from below rather than from above — as long as we have a state, any reforms should be directed first and foremost to the (much more generous) welfare state for the rich rather than the general population (the experience of the 1980s onwards shows what happens when reforms are left to the capitalist class).
This is not to say that Hayek’s attack upon those who refer to totalitarian serfdom as a “new freedom” was not fully justified. Nor is his critique of central planning and state “socialism” without merit. Far from it. Anarchists would agree that any valid economic system must be based on freedom and decentralisation in order to be dynamic and meet needs, they simply apply such a critique to capitalism as well as state socialism. The ironic thing about Hayek’s argument is that he did not see how his theory of tacit knowledge, used to such good effect against state socialist ideas of central planning, were just as applicable to critiquing the highly centralised and top-down capitalist company and economy. Nor, ironically enough, that it was just as applicable to the price mechanism he defended so vigorously (as we note in section I.1.2, the price system hides as much, if not more, necessary information than it provides). As such, his defence of capitalism can be turned against it and the centralised, autocratic structures it is based on.
To conclude, while its open and extreme support for free market capitalism and its inequalities is, to say the least, refreshing, it is not remotely convincing or scientific. In fact, it amounts to little more than a vigorous defence of business power hidden behind a thin rhetoric of “free markets.” As it preaches the infallibility of capitalism, this requires a nearly unyielding defence of corporations, economic and social power and workplace hierarchy. It must dismiss the obvious fact that allowing big business to flourish into oligopoly and monopoly (as it does, see section C.4) reduces the possibility of competition solving the problem of unethical business practices and worker exploitation, as they claim. This is unsurprising, as the Austrian school (like economics in general) identifies “freedom” with the “freedom” of private enterprise, i.e. the lack of accountability of the economically privileged and powerful. This simply becomes a defence of the economically powerful to do what they want (within the laws specified by their peers in government).
Ironically, the Austrian defence of capitalism is dependent on the belief that it will remain close to equilibrium. However, as seems likely, capitalism is endogenously unstable, then any real “pure” capitalism will be distant from equilibrium and, as a result, marked by unemployment and, of course, booms and slumps. So it is possible to have a capitalist economics based on non-equilibrium, but it is unlikely to convince anyone that does not already believe that capitalism is the best system ever unless they are unconcerned about unemployment (and so worker exploitation) and instability. As Steve Keen notes, it is “an alternative way to ideologically support a capitalist economy . . . If neoclassical economics becomes untenable for any reason, the Austrians are well placed to provide an alternative religion for believers in the primacy of the market over all other forms of social organisation.” [Keen, Debunking Economics, p. 304]
Those who seek freedom for all and want to base themselves on more than faith in an economic system marked by hierarchy, inequality and oppression would be better seeking a more realistic and less apologetic economic theory.