Commentary on Political Economy

Sunday 23 October 2011

Mr. Keynes and the Neo-Classics

These are my notes for a chapter of 'Krisis' linking Keynes with the Neoclassical Revolution. The next instalment may look briefly at how Roosevelt's New Deal persuaded Keynes to re-order his ideas to allow for the "political" management of demand through the State-Plan. Finally, we will begin to look more closely at the "transmission mechanism" through which the Crisis-State now seeks to preserve the wage relation in the face of growing social antagonism from living labour.

The economic sphere of social life, and therefore that of economic analysis (literally, of the reflective classification and interconnection of its component concepts), concerns the production and exchange of “wealth” by and between human beings. In the definition of “wealth” there are obviously subjective and objective considerations: the objective consideration is that the “wealth” of a society must be reproduced (preserved and replaced) for the survival of its members; and the subjective element is that the “needs” of a society are not purely biological and physiological but also psychological and cultural.


If we consider a society to be made up purely of atomic individuals, then it will be next to impossible to work out the objective and subjective “needs” that constitute the “wealth” of a society, except as they are made “visible” by the observable conduct of those individuals. In that case, the only possible goal of “economic analysis” will be to describe as simply and comprehensively and “predictably” as possible the pattern of exchanges between the individuals in a given society that must be exclusively a market society in which only the market behaviour of those individuals can inform us about their objective and subjective needs, called “utilities”, and not the other way around. This is the framework of Neoclassical Economics.


Conversely, if we take an “objective” view of what the reproductive and subjective needs of a society are, then we will look for the type of “resources” that go into the “production” of the “wealth” of the society – whether these “resources” are quantifiable and measurable or else are dependent on cultural factors. The identification of an “objective measure of wealth” was the aim of Classical Political Economy from Smith to Mill, through Ricardo and Marx, and it found it in “labour”. Marx thought that “labour” was too abstract a designation because its “measure” could be given only by the political coercion of “the labour market” so that ultimately the fundamental measure of economic wealth was the “socially necessary labour time” for the production of a given “commodity”.


The problem with this definition, just as with the marginal utility of neoclassical theory, is that only “the market” can tell us what is “socially necessary labour time” because only the market can tell us what commodities are “socially necessary” to be produced! Clearly, therefore, both the “subjective” definition of “marginal utility” in neoclassic and the “objective” definition of “value” in the Classics are defective because they are “circuitous” in that they rely on “the market” – on what is observable – to explain what is observable! But no observation will ever amount to and provide its own “explanation”, because “explanations” must be expressed in terms that are “significantly different” from the mere “recording” of the observation. (Indeed, the very “means” we employ “to observe” phenomena are subject to definition because they already define what is observed and are therefore not “objective” at all! This is a restatement of Heisenberg’s Indeterminacy Principle in physics.)


So the most fundamental problem for economic analysis is “to measure” the total wealth of society both “in aggregate” and “in particular” in terms of the production of goods and services that constitute that aggregate wealth. Now, it is clear that if we take a “subjective” approach to the definition of “wealth” as the neoclassic do, we will never be able to calculate the “aggregate wealth” of society for the simple reason that “subjective exchanges” of goods and services “between individuals” can be “measured” only in terms of a “numeraire” that can be constituted by “any of the goods and services” exchanged in the market simultaneously and as a totality of transactions! (This is called Walrasian equilibrium.) It is also clear that such a “general equilibrium” contains no “substantive” definition of “wealth” but can describe only a “relative exchange” that occurs simultaneously because all exchange equations (quantities exchanged and relative prices) must be known before we can calculate all the relative prices in terms of a single numeraire (that can be any “one” of the goods exchanged).


It is obvious that neoclassical economics can only “describe” a situation (one that is “timeless”) of equilibrium – can ascertain “mathematically” only the “existence” of this equilibrium; but it cannot explain how an “equilibrium” is reached, nor how an economy can “get out” of equilibrium; and it cannot explain how an economy can “return” to equilibrium once it has gone into “dis-equilibrium”. The very notion of “dis-equilibrium” is simply im-possible because we would have to know “equilibrium relative prices” before we could say that an economy was in “dis-equilibrium” in the first place!


The Classical Political Economists instead approach economic “wealth” in terms of the “effort” that is needed to reproduce a society on an expanded scale. This is a more “objective” approach in that it seeks “to explain” market prices and not merely to observe or record them, and because market prices are not determined by “subjective evaluations” (marginal utility) made at a “microeconomic level”, but rather are determined by the “macroeconomic needs” of the totality of a “society” regarded as an entity.


If indeed “value” is an objective entity so that it determines “market prices”, then it is obvious that it can be expressed “independently” of any “one” good or service on the market in terms of “commodity money” used (a) as a unit of account, (b) as a means of exchange (as a universal equivalent), and (c) as a store of value, as “liquidity”.


But if no such “value” can be identified, as the neoclassics insist, then “wealth” cannot be defined by “effort” or any other objectively determined “quantity”, but rather by subjective “utility” which is derived from the goods and services exchanged on the market and from the goods and services (endowments) that go into their production. In that case “labour” does not have “utility” but has “dis-utility” because its “effort” is required to acquire “goods and services” that can satisfy the “marginal utility” of the worker. The essence of the Neoclassical Revolution consists in this: that “labour” is displaced from the central role it had in the Classics to a “negative” role: from the “creator” of value to the “need” for goods with “utility”!


And “money” can serve only as a convenient “medium of exchange” that serves as a token numeraire for the totality of market exchanges occurring and calculated at equilibrium. In such a case, money can only be a nominal or token entity with no “utility” or “value” whatsoever except that of faithfully indicating “equilibrium market prices” in the “real economy” made up of individual exchanges at equilibrium.


Consequently, the only way in which money can be “non-neutral” in a neoclassical economy is if and only if there is an “exogenous” and arbitrary interference with its “equilibrium supply” so that equilibrium market prices and the exchange of goods and services between individuals is “distorted” thereby – with the result that the economy is thrown into “dis-equilibrium”.


The question therefore becomes how “money” as a mere token used to facilitate market exchange can actually affect the equilibrium of the neoclassical market economy. This is the essential problem that will occupy three of the greatest economists of the early twentieth century – Wicksell, Hayek and Keynes. It may be said that their answers differ depending on their understanding of “the transmission mechanism” between the issuance of “credit money” and the regulation of interest rates by central banks through the monetary base or the money supply, on one hand, and the allocation of social “wealth” through its production and consumption regulated by relative market prices.


We can say that the difference between Wicksell, Hayek and Keynes is not at all, or not mainly, in the philosophical or scientific understanding of economic analysis in its fundamentals. Instead, their disagreement was over the effect that the creation and availability of money (liquidity) could have on the behaviour of the economy in terms of the adjustment of prices, of employment and of output.


This “transmission mechanism” has been the bane and despair of bourgeois economic analysis and theory for the very simple reason that the bourgeoisie is forever looking for the paradise in which “money” becomes completely “neutral”, in which it becomes a pure “medium of exchange” with no influence whatsoever on the “real economy”. In other words, the bourgeoisie believes that there is a “real economy” in which goods and services are “exchanged” freely between individuals with no connection between them (pure competition) in accordance with “original endowments” to which they have an unassailable “legal right” and which they exchange until the marginal utilities of each of these endowments are equal – that is, the last unit of each endowment has the same differential numerical value (relative price) in terms of an arbitrary good that is used as numeraire (as unit of account). Bourgeois economics never explains how “individuals” came to have the “endowments” they possess at equilibrium!


The chief aim of bourgeois economic analysis is to remove the antagonism, the conflict at the very centre and motor and heart of capitalist society: - the wage relation. (We have already described this in an earlier entry.) But to do so it has to present economic activity as a “pure exchange” between “free individuals” of their “legally held endowments” to the existing goods and services, subjectively needed (even in the case of the physical reproduction of the individual, because this reproduction is still left to “individual choice”) present in society. As we have seen instead, capitalist society is founded on the coercion of living labour to exchange itself for a portion of the goods and services that it produces in such a manner that this exchange does not “free” living labour from the need and coercion to continue to sell itself to capital, and in such a manner that capital can lay claim, through the portion of the goods that are not claimed by workers’ money wages, to even more living labour and social resources for the next round of production!


The purpose of capital is therefore to reproduce the wage relation on an expanded scale by “annexing” new living labour and social resources that are not under its command yet and by increasing the potential command it has over living labour. Clearly, this means that capital and money-as-capital can only be understood “politically”, as “value”, as political command, as will and control of the capitalist over social resources, over “wealth” intended as all those goods and services and resources that reproduce the wage relation. It is also obvious that this political command occurs through the mediation of the satisfaction of human needs, whether physiological or social – none of which can ever be “measured” directly, however. “Money” therefore must be understood as “money capital”; and it cannot be simply a means of exchange but must also be both a measure and a store of “value”. But because “value” is not a “quantity” that can be “measured” and is instead a “social relation”, then we say that money cannot “measure” value but it can be a “social indicator”, a “symbol” of the political effectiveness and effectuality of the stability of the wage relation across the disparate “sectors” of capitalist and social activity.


The next question then becomes: how can such a system “work”, and how “does” it work in practice?
  (Edwards and Mishkin on decline of traditional banking – 1995) (list of Adrian/Shin, Borio and other articles from FAZ) (Tett’s review in FT – weak) (Measuring GDP or “growth”) (Krugman accepts wage downward rigidity but excludes it from IS-LM because it blames workers for disequilibrium!) (De Grauwe on need for ECB to act as LOLR)

The Neoclassics and Keynes do not differ in any significant manner about the political content of the categories used in neoclassical theory. In all significant respects, Keynes remains a neoclassical economist: his Weltanschauung remains identical to that of the negatives Denken that lay the foundations of the Neoclassical Revolution. Given his limited knowledge and understanding of Continental thought, Keynes had no cognition of the epoch-making significance of those theoretical underpinnings and their ability to shape, for better or for worse, our very conception of economic reality. By this we mean that Keynes did not challenge the basic tenets and principles of neoclassical theory, except in some “practical” respects that bring them closer to the “reality” of the functioning of the capitalist economy. The essential difference between Keynes and the Neoclassics is that whereas the latter consider that the economy will always adjust from any “external shocks” to reach equilibrium “in the long run”, Keynes acknowledges that there are important institutional aspects of capitalism, such as money and asset contracts, that profoundly affect the operation of the economy to a point where “neoclassical adjustment” may well result in the total political and social breakdown of “society”: hence, “in the long run, we are all dead”.

There are two crucial aspects to Keynes’s “turn” in the neoclassical approach to economics: the first is that money and “liquidity”, far from being “neutral” and therefore not being able to have any long-term impact on the “real” economy, that is, on the allocation of “endowments” in neoclassical theory, are actually extremely important as “signals” providing “information” about the “real” state of the economy. In other words, Keynes does not dispute that the capitalist economy “fundamentally” functions along the lines of analysis suggested by neoclassical theory. What he does dispute is that “money” is neutral and therefore can have no “real” effect – apart from “first round effects” – on the functioning of the economy. For Keynes, money is “a bridge between present and future”; money provides the link, the “quantification” of the use of physical resources in a pro-jected “income stream” that will be paid as “interest”, in the future, out of future “real production”. The first distinguo Keynes moves against the neoclassic is therefore that the existence of money and of legal instruments tying the physical production of assets to their expected future monetary income streams crucially conditions the operation of the “real” capitalist economy both in terms of the “rigidity” of prices in various markets – mainly the labour and capital asset markets – and therefore also in terms of the expected “yield” or “interest” or, more broadly, of the income streams flowing from capital assets.

The second point is that the social structure and the structure of markets may not be flexible enough to adjust to changes in expected economic conditions quickly enough to prevent a cascading collapse of the inverted pyramid of contractual obligations erected from a more liquid base to a less liquid vertex, with the result that if the income stream from leveraged assets is not realized there will be wholesale liquidation of those assets with their prices not adjusting downward quickly enough to restore the ability of borrowers to meet the contracted obligations based on the original estimate of that income stream. Similarly, and as a corollary, the losses involved in the firesale liquidation of assets makes the physical operation of those assets absolutely unprofitable, prompting a horizontal and vertical collapse of the financial inverted pyramid with consequent breakdown in the physical supply for other markets and the generation of price instability that threatens not just the financial structure but the very reproduction of the economy itself!

[Durkheim] Put differently, the economy of a given society may be seen as an interdependent “organic” structure (rather than as a homogeneous mechanical structure whose component parts are simple units that can be added and subtracted at will) that will implode catastrophically once the price and contract system collapses. Interestingly, Keynes is prepared to aggregate the capitalist economy in monetary terms (income, demand, output, employment, interest), yet he is unwilling to discuss the differential impact of interest-rate and money-supply policy by sector – whereas Hayek does the exact opposite. Ironically, it is Hayek’s approach that suggests greater systemic stability of the price mechanism than Keynes’s aggregate approach which therefore makes monetary policy far more effective than Hayek’s precisely because its transmission mechanism feeds through directly uniformly to all sector markets. With Hayek, it is the sector markets that need to adjust to any shocks from changed expectations and monetary policy can only interfere with this process of adjustment; with Keynes instead monetary policy and money supply have direct and immediate impact on markets, helping to stabilize prices (avoiding deflation) and holding up demand unless the economy falls into a liquidity trap, at which stage only direct state intervention through fiscal policy can restore full employment equilibrium.

These aspects of Keynes’s work are drawn quite adroitly by Minsky (“Can ‘It’ Happen Again?”). Despite the fact that Keynes (and Minsky) presents a much more accurate “institutional” analysis of how capitalism works, he still obfuscates the centrality of the wage relation in capitalism and the antagonism on which it is founded and presents instead an economy that is “motivated” along neoclassical lines but that has institutional features (money and contracts – liquidity preference – price rigidity - decentralized decision-making in an interdependent “organic” society prone to “crises of confidence”) that may result in “underemployment equilibrium” with excess of savings over investment and with debt-deflation and with stagnation due to the liquidity trap. Debt deflation in particular may result in deep depressions.

So steeped in the worldview of neoclassical theory was Keynes his entire economic approach may be said to rest on two basic “dysfunctions” of the capitalist economy (dysfunctions that “Keynesians” of all stripes have sought “to correct” by suggesting “appropriate policies of demand management and monetary and fiscal “fine-tuning” that leave intact the entire “scientific rationale” of neoclassical theory). The first dysfunction is that capitalist crises are due to underinvestment and “liquidity preference” resulting from the “declining marginal utility of capital” over time. This decline, in turn, leads to underinvestment and therefore to lower aggregate demand which then results in the debt-deflation downward spiral to which lower wages and unemployment are no answer because they serve only to suppress aggregate demand further and because money wages are sticky downwards. The second dysfunction is that money introduces an element of uncertainty created by the discrepancy between the expected returns of debt-leveraged investment with contractually-agreed interest rates and the actual income streams that may lead to widespread liquidation and implosion of the inverted financial pyramid and of physical production and employment, with knock-on effects on aggregate demand.

Both these dysfunctions hinge on liquidity preference or the aversion to risk of capitalists more intent on “rent-seeking” behaviour, which is why Keynes came to share the “money-less economy” ideas of Silvio Gesell. Two obvious objections can be raised. The first is that, as we saw from our study of Schumpeter, Keynes completely overlooks the ability of capitalism to renew and re-invent itself in response to the antagonism of the wage relation (indeed, Schumpeter acutely dubs Keynes "the father of modern stagnation" in his 'History of Economic Analysis', and Hicks calls the General Theory "the Economics of Depression" in his 'Mr.K and the Classics'). The second is that Keynes never examines the theoretical relation between money and real economy in terms of wage-relation antagonism and therefore of the creation of “value” and the realization of “profit” as determining investment and consumption levels in the capitalist economy, save to rely on incantations such as “animal spirits”, “beauty contests”, “bootstraps” (regarding  the determinant of interest rates), “uncertainty”, “bridge between present and future” and a myriad other expressions more remarkable for their conceptual vagueness than for any analytical merit.

[The New Deal]

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