Neoclassical economics, which remains the prevailing orthodoxy, emerged in the late nineteenth century in the context of rising working-class opposition to capitalism. The theory’s appeal in certain circles as an apologetic for the status quo probably assisted its rise to prominence, which is not to imply that this was necessarily a motivation of the neoclassical economists themselves. The rise of any economic theory requires a receptive audience. Classical political economy had not provided defenders of the system with a comparable apologetic. Not only had it informed Marx’s analysis of capitalism but there were socialist movements drawing on interpretations of Ricardo’s labor theory of value. Class was central to the understanding of capitalism in both classical political economy and Marx, and no attempt had been made to conceal the class antagonisms characterizing the system.
The approach of the neoclassical economists changed all this, with explicit references to class notably absent from the theory. However, three key claims of early neoclassical theory that were particularly adaptable to apologetic ends – that distribution reflects marginal productivity, that a market economy automatically tends to full employment, and that money is neutral – have each fallen into disrepute. The first claim was the chief casualty of the capital debates. The second claim lost credibility in stages, with the onset of the Great Depression, the contributions of Kalecki and Keynes, certain implications of the capital debates, and results derived within neoclassical general equilibrium theory itself. It is increasingly evident that the third claim cannot withstand the implications of endogenous money and, for modern monetary systems, currency sovereignty.
In opposition to the three claims of early neoclassical theory are three corresponding ideas, each in its own way threatening to defenders of the status quo – first, that profit is surplus labor or, alternatively, a property-based claim; second, that capitalism is prone to demand deficiency; and third, that money matters, including in the long run.
1. Profit as surplus labor or as a property-based claim
One idea threatening to the defenders of the status quo is the recognition that profit income reflects capitalist property relations rather than productive contribution.
Most famously, Marx identified living labor as the sole source of surplus value (meaning profit, prior to its distribution into various sub-categories such as retained earnings, rent, interest, and so on). In Marx’s theory, surplus labor is appropriated by the capitalist class, which includes industrial capitalists, landlords and rentiers.
The significance of this is that the capitalists’ appropriation of – and control over – the social surplus, in the form of surplus value, is due solely to their ownership of society’s means of production (the product of dead labor) and their private ownership and control of natural resources. Their claim over the social surplus is not due to any productive contribution they themselves make.
Marx’s insight exposes capitalism as an undemocratic system of dependency. The majority, who lack access to means of production, are dependent on capitalists or capitalist governments for an opportunity to sell their labor power in exchange for a wage.
Denial of the nature of surplus value was, for a time, given credence by the neoclassical attempt to explain income distribution in marginalist terms on the basis of relative factor prices. As is well known, this claim was discredited in the capital debates, an episode that dominant forces within the economics profession attempted to erase from history.
It may seem strange today, but the capital debates played out in the most prominent journals, with Paul Samuelson, perhaps the leading neoclassical economist of his generation, ultimately conceding. The timing of this defeat seems interesting, to say the least, in view of the introduction, shortly after, of The Sveriges Riksbank Prize in Economic Sciences (often referred to colloquially as the “Nobel Prize in Economics”), the closing of ranks in academic hiring, and the refusal, from that point on, to publish non-neoclassical work in the leading – neoclassical-controlled – peer-reviewed journals. Combined with the tying of research funding to journal rankings designed to privilege neoclassical economics (for a recent example of this in Australia, see here), these actions undermined the financial viability of undertaking non-neoclassical economic research. (Further reflection on this history is given in an earlier post, Nobel-nomics).
The central implication of the capital debates is that there is no basis for persisting with the idea that income distribution is determined by marginal productivity. This is consistent with Marx’s position that the source of profit is surplus labor. Equally, it is consistent with the view, held for instance by proponents of the surplus approach, that profit income reflects ownership rather than productive contribution.
2. Capitalist economies are demand constrained
The Keynesian or Kaleckian principle of effective demand may not seem quite such a hindrance to defenders of the status quo as knowledge of the nature of profit, but the motivation for its denial – at least in the long run – is easy enough to perceive.
Recognition that a capitalist economy, under normal circumstances, is demand constrained rules out the notion of a deregulated market economy’s automatic tendency to full employment. In neoclassical theory, this was meant to occur – in the absence of market imperfections – irrespective of demand or monetary factors via real-wage and real interest-rate adjustments.
In light of the Keynesian revolution, neoclassical economists adapted their position, distinguishing a short run, in which demand matters, from a long run in which it supposedly does not. They attempted to maintain the position that full employment would be delivered eventually, irrespective of demand or money.
This position, however, ultimately hinged on arguments that were discredited in the capital debates (see Martias Vernengo’s The capital debates: A brief introduction). The modified neoclassical claim essentially amounted to viewing the macroeconomic outcome as predetermined, with operation of the price mechanism supposedly adjusting aggregate demand to a potential output that solely reflected real factors such as productivity, endowments, and preferences.
Neoclassical theorists failed to establish a general validity for this claim. To the contrary, general equilibrium theory generated the conclusion that there is no general tendency to the full employment of resources. Various aggregation problems (an important result is the Sonnenschein-Mantel-Debreu theorem) mean that, even starting from the axioms of neoclassical theory, there is no tendency to the full utilization of resources outside of highly unrealistic special cases, such as a one-commodity or one-consumer economy.
The upshot is that there is currently no valid theoretical basis for supposing that aggregate output will respond to relative price movements in a systematic way, and no such general tendency has been established in theory.
3. Money matters, including in the long run
Also threatening to defenders of the status quo is any analysis that subjects the monetary system to scrutiny, whether it be the endogeneity of money or the implications, applicable to modern monetary systems, of currency sovereignty. (Money as Taboo for Economists illustrates this sociological dynamic in operation.)
Money endogeneity follows from the capacity of private banks to influence the money supply (usually defined, in the present context, as demand deposits plus currency on issue) as well as the essentially passive, accommodating role of the central bank. The monetary authorities can attempt to influence the demand for loans and the deposit-creation process indirectly through interest-rate setting and other measures but cannot directly control the quantity of money in circulation.
An implication of this, in a deregulated environment, is that monetary expansion and contraction both occur on the say-so of capitalists, including on the whims of speculators, through their demand for loans, mediated by the risk-return assessments of private banks. Defenders of the status quo are not in any hurry to call attention to this aspect of the current institutional framework.
At the same time, a key implication of currency sovereignty is that the central bank can control the short-term rate of interest (and, if it chooses, the interest rate on government bonds of any maturity) as a matter of policy, which in turn means that currency-issuing governments – even when they subject themselves voluntarily to various self-imposed constraints – are in a position to enable activity of whatever kind is deemed appropriate, irrespective of the attitudes of market participants and the invisible bond vigilantes.
This, for a different reason, is not something that defenders of the status quo wish to highlight, because if electorates ever became aware of the implications it would potentially be a game changer. It makes full employment alongside low, stable inflation easily attainable through appropriate fiscal policy, including implementation of a job guarantee. It also makes feasible any form of activity – including not-for-profit, not-for-growth, or socialist – that society, through democratic means, might deem desirable.
This potential for economic democratization may be what has motivated various attempts to put governments in a fiscal straitjacket, through the gold standard, Bretton Woods, currency boards, and the European common currency. It also motivates the currency issuer, in federal systems, giving currency-using states responsibilities that are disproportionate to their revenue-raising capacities and then restricting fiscal transfers.