Commentary on Political Economy

Thursday 29 September 2011

THE STATE OF EQUILIBRIUM: Historical Antecedents of ‘Supply-Side Economics’ in the Austrian School – Labour vs. Utility – Part 3

In Hayek’s circuitous reasoning, “the co-ordination problem” is central to economic analysis because its solution will explain “the social synthesis”, what holds together “the social fabric”, “the economy”. The market “works”, it is the most efficient form of co-ordination of economic activities, because its “price mechanism” is the most efficient means for “individuals” to communicate their individual choices to other market agents…because these “prices” are set “competitively” by individuals… “in the market”. And although these “prices” may not be “optimal”, although they may be “imperfect”, yet the “price mechanism” is the best available…because prices are set by separate individuals in the competitive market! This reasoning is an obvious petitio principii; it begs the question: “the market is ‘best’ compared with what?” What could explain Hayek’s blindness to the “circularity” of his analysis?
The first chapter of Adam Smith’s ‘Wealth of Nations’ had clearly specified the source of economic “wealth”: it is in its title – “Of the causes of Improvement in the Powers of Labour” contains a most detailed study of “the division of labour”. It is this “division of labour” that comes “first”. It alone constitutes “the social synthesis”. As Brian Loasby has put it, “The central issue of modern economics… is the co-ordination of economic activities. The reason is… that individual self-sufficiency is not usually thought to be a good idea. Adam Smith’s analysis of the causes of the wealth of nations begins with two propositions: first, wealth depends fundamentally on productivity, and second, the principal cause of increases in productivity is specialization” (in ‘Equilibrium and Economics’, p.10).
Yet in trying to explain “market prices” by theorising “the labour theory of value”, Classical Political Economy had been unable to explain “profits” or “interest”: - because if the “value” of a good is the amount of “labour” that goes into its production, then there will be no “profit” left for the capitalist; so how could this theory “explain’ the existence of “profit” and, indeed, of “economic growth”? In the end, “labour value” was simply “unobservable”, it was “invisible” – which is why Smith had to invoke “the Invisible Hand” to characterise his solution to “the co-ordination problem”. But this “solution” did not explain the “visible” part of economic exchange – “market prices”. The labour theory of value therefore was an essentialist “metaphysics”, an inscrutable “substance” that did not correspond to empirical reality.
In announcing triumphantly this “collapse” (Abschluss) of the labour theory of value through his critique of Marx’s ‘Capital’, the Austrian economist Bohm-Bawerk traced the “scientific” source of the Classics’ error in his tirade against the German Historical School: “The experience from which the general theory of value is to be derived was about as complete for the classical economists as it is for us. What did they make of it? Some declared that the creative principle and measure of value was the amount of human labor involved; others, more numerous, that it was the cost of production. Both definitions are false, as every one to-day knows. But and this is the point to be emphasized they were branded false, not by the discovery of some new and startling fact which advanced empirical investigation has brought to light, but by the everyday experiences of the world, experiences which were necessarily as familiar to the classical economists as they are to us. It was not that in this case their empirical knowledge was insufficient, but that they here, as in countless other cases, "distilled" badly,” (“Hist. vs. Deductive Method in Pol.Econ.”, 1890).
Rather than see “prices” and “the market” as historical institutions themselves the historical pro-duct of the division of labour and the ensuing “unobservable labour value” as the true original source and measure of the “prices” of market goods, the Austrian School headed by Bohm-Bawerk moves prepotently from the “scientific” solidity of “observable market prices” to reveal what prices presumably “express” – the “subjective”, “individual preferences” of market participants, the “utility” they derive from the goods on sale. Here the turnaround is complete! From the sphere of production we have moved to that of “consumption”. Thus, whereas Classical Political Economy could still locate the source of “wealth” as “value pro-duced” outside (!) the institution of “the market”, the neoclassical theory of “marginal utility” now made “the market”, the sphere of consumption, the only “mechanism” that could assign “utility” to the existing (!) goods in that market. Both “value” and “utility” are “metaphysical” concepts: but whereas “value” has a teleological, moralistic aura to it, “utility” has the self-assuredness, rock-certainty of the “efficient” price and market mechanisms.
The social and political implications of this transformation of “economic analysis” brought about by neoclassical marginal utility theory are now evident. The Classical Political Economists interpreted “economic activity” as the “production of wealth” by means of an ineluctably “social” human reality, “the division of labour”, that represented the culmination of human social co-operation. From their perspective, the economy and the “wealth” it pro-duced was entirely dependent on a pre-existing “social fabric” that certainly could be, and often needed to be (!), “regulated politically” – by the State.
On the contrary, Neoclassical Theory could only interpret and oppose every “political” intervention in “the price and market mechanism” as a “distortion” of the market, as a “distortion” of the “individual preferences” that ensured its proper (though “imperfect”, but “best available”) operation and functioning to ensure the most efficient “distribution of utilities” to individual consumers.
The very fact that Neoclassical Theory and the Austrian School define “market prices” and “market equilibrium” circuitously serves to highlight, apart from the “metaphysical” notion of “utility”, the unscientific faith in the “market mechanism” and its foundation on the “spontaneous individualist choices” of market participants (among which [see quote below] Hayek even enumerates “corporations and monopolies”(!).
In contrast to the “self-regulating/equilibrating” market, the State becomes the scapegoat, the “residual” that can be blamed for any and every “dysfunction” of the market mechanism. (Curiously here, we use “residual” as the ideological object, whereas Pareto would apply it to the “logico-experimental” market mechanism while the appeal to “the State” he would regard as a “derivation”.)

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