Three Ideas Threatening to Orthodoxy

Neoclassical economics, which remains the prevailing orthodoxy, emerged in the late nineteenth century as apologetics in the context of rising working-class opposition to capitalism. Classical political economy had not provided defenders of the system with a comparable apologetic. Not only had it partly 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 inherent in the system. The neoclassical economists, with transparent intent, sought to change all this. Ever since, they have worked hard to deny or obfuscate any aspect of capitalism that might be damaging to this apologetic project. Three theoretical insights in the history of economic thought seem particularly relevant in this respect.

1. Profit Reflects Ownership, Not Productive Contribution

One idea threatening to orthodoxy is Marx’s identification of living labor as the sole source of surplus value (profit). In Marx’s theory, surplus labor is appropriated by the capitalist class, which includes capitalists and rentiers.

The significance of this is not that workers miss out on receiving all the value they create. What matters for living standards is the production of use values (real wealth), and these are produced not only by living labor but also by machines (dead labor), animals, and nature. The entire output of commodities is not solely due to the efforts of workers, so there is no suggestion that they are entitled to the entire output of the production process. (See, for example, the opening to Marx’s Critique of the Gotha Program.)

The significance, rather, 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.

It is an indication of how mystified the process has become when welfare recipients can be widely derided by an ignorant public as succumbing to a culture of dependency. It reveals an unawareness that the entire system is one of dependency for almost everybody. Workers and their families are at the mercy of capitalists and capitalist governments for whatever employment or welfare crumbs come their way.

Denial of the real source of surplus value no doubt motivated the orthodoxy’s 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 the orthodoxy has tried hard to erase from history ever since.

It may seem strange today, but the capital debates played out in the most prominent journals, with Paul Samuelson, the leading neoclassical of his generation, ultimately conceding. The timing of this embarrassment for the orthodoxy seems interesting, to say the least, in view of the introduction, shortly after, of the pseudo Nobel Prize in economics, soon to be followed by the closing of ranks in academic hiring, and the refusal, from that point on, to publish heterodox work in the leading – neoclassical-controlled – journals. (For a polemical take on this history, see Nobel-nomics).

The most fundamental implication of the capital debates is that there is no basis for persisting with the fiction that income distribution is determined by ‘marginal productivity’. This is consistent with Marx’s position that profit reflects property rights predicated on the separation of workers – forcibly, initially, in most cases – from the means of production.

2. Capitalist Economies are Demand Constrained

The Keynesian or Kaleckian principle of effective demand may not seem quite such a hindrance to the orthodoxy’s designs, but the motivation for its denial – at least in the long run – is still easy enough to perceive.

Recognition that a capitalist economy, under normal circumstances, is demand constrained would rule out the apologetic notion of a deregulated market economy’s automatic tendency to full employment. In the neoclassical long run, this is meant to occur irrespective of demand or monetary factors via wage, price and interest-rate adjustments. Associated with this claim is the implication that a market economy tends to deliver equal opportunity for all.

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 doesn’t. They clung to the position that full employment would be delivered eventually, irrespective of demand or money.

This position, however, also hinges on arguments that were discredited in the capital debates. The orthodox claim amounts to viewing the macroeconomic outcome as predetermined, guaranteed through the operation of a price mechanism that will supposedly adjust aggregate demand to whatever potential output happens to be, reflecting real factors such as productivity, endowments, and preferences.

The claim is baseless. There is simply no reason to expect aggregate output to 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

Even more beyond the pale for the apologists is the audacity of those who subject money and the monetary system to scrutiny, whether it be the endogeneity of money or the implications of monetary sovereignty. (See here for an example of this taboo in operation.)

Money endogeneity refers to the capacity of private banks to determine the ‘money supply’ (usually defined, in this context, as demand deposits plus currency) as well as the essentially passive, accommodating role of the central bank. The latter can attempt to influence ‘money demand’ and the expansion of private credit indirectly through its choice of interest rate but cannot directly control the quantity of money in circulation.

An implication of this, in a deregulated environment, is that money expansion and contraction occur on the whims of capitalists and speculators, through their demand for loans, mediated by the risk-return assessments of the private bankers. The orthodoxy is 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 set the rate of interest as a matter of policy and government is in a position, if it so chooses, to enable activity of whatever kind is deemed appropriate, irrespective of the attitudes of private market participants and the invisible bond vigilantes.

This, for a different reason, is not something the orthodoxy wishes to highlight, because it is potentially a game changer. It makes full employment alongside low, stable inflation easily achievable through appropriate fiscal policy. But more disconcertingly for apologists, it makes possible any form of activity – including not-for-profit, not-for-growth, or communist – that society, through democratic means, might deem desirable.

This potential for democratized money is probably what has motivated 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 non-sovereign states responsibilities that are disproportionate to their revenue-raising capacities and then deliberately restricting fiscal transfers.


6 thoughts on “Three Ideas Threatening to Orthodoxy

  1. From Prof. Bill Mitchell’s blog today:

    “public deficits are required to support the private deleveraging process via aggregate demand support…

    Translation…the credit circuit requires deficit spending to fund (at least partially) debt service.

    …For the private sector to increase its saving overall, there must be economic growth and that has to be supported with public deficits.”

    Translation… profit, a form of saving, must be supported by public deficits.

    Monetary flows are simultaneously a flow and a stock…they are moving stocks that can accumulate as saving.

    GDP is a flow (not a stock) and never accumulates to a stock. GDP does not add to wealth, its a measure of the movement of wealth over some period of time.

  2. paul,

    If the amount of private stock of debt is to reduce the stock of public debt has to increase – unless you are prepared to reduce activity or the level of savings by force (cyprus!).

    ” profit, a form of saving”

    Profit is not a form of saving. Profit is the wage of capitalists – from which they may choose to save some and spend some. And if they borrow, then they have to spend some on bank interest.

    If you’re seeing profit entirely as saving I can see where the confusion is arising.

  3. For what’s worth, I find it easier to explain what a capitalist is in terms of the concept of “shareholder”.

    A shareholder, for instance, doesn’t need to know what the firm does or where its main offices are; may have bought the share out of a whim in the secondary market; may not even breathe (as institutions can own shares) or buy whatever the firm sells, it still has a right to share in the profits the firm gains for as long as the firm gains a profit and the shareholder holds the share.

    Therefore, it seems impossible to attribute this right to share in the profits that shareholders have to anything the shareholder contributes to the firm, as it need not contribute anything; if, qua shareholder, it doesn’t contribute anything, then the only explanation to its right to share in the profits is its legal ownership of the firm.

  4. Neil, any accumulation of a financial asset as a stock is saving in the mathematical sense. Alternate semantic framing does nothing to change this fundamental fact.

    I know that profit is the wage of the capitalist…the question becomes from where does it originate.

    In a closed system it cannot originate from within…dollars don’t multiply, they must be actively entered into the system by spending from an external source.

    Spending =Income…from the business to households and in the return loop from households to business. There is no room for gain in this sequence of transactions because the spending of households is limited by the income received from business without some external add. Apparently this idea is so simple the mind repels it.

    The production of goods and services merely provides the carrot-on-the-stick to (hopefully) bring the dollars back as revenue. There aren’t enough dollars in this transaction loop (circuit) to fund profits even under perfect settlement. Best-case is break-even and even this is unlikely, let alone profit.

    There are only two external sources of funds possible (if we exclude trade, a special case), deficit spending and spending created through issuance of private debt…both actions enter state money created from thin air into the system.

    From this perspective both sources are external to the system.

    One of these is required to fund profits (or any form of saving) if a necessary level of spending is to be achieved to maintain unemployment.

    Only one of these is sustainable….

    The possible level of private debt is limited by income (ability to service debt) and if saving occurs the level of income in the aggregate will grow more slowly than the level of debt and hence the level of debt service. This becomes a self-limiting dynamic which we have witnessed first hand.

    In a mechanical system the friction that makes perpetual motion impossible is mostly energy lost as heat, but there are other frictions.

    In a monetary economy the main friction is saving. In addition we have imperfect settlement.

    I don’t believe it is possible to eliminate friction in any case. There can be no perpetual motion because there can be no perfect frictionless system in the real world.

    Without deficit spending a monetary economy cannot function (at a level that maintains employment of more than a small subset of workers).

  5. “I don’t believe it is possible to eliminate friction in any case.”

    Nobody is suggesting that you can.

    But dollars do multiply within the system. If I sell you goods/services on 30 day terms for example. Balance sheets are now expanded until that is cleared, and real activity multiplies because of that additional temporary debt injection.

    That’s one of the reasons why you have to model it dynamically. You can only really feel what it is doing by watching the simulation. It’s mightily difficult to describe on the page – the mathematics don’t do it justice.

  6. Paul,

    Just 2 comments on points of your argument (I am not taking sides on your debate with Neil Wilson):

    Comment 1:

    “GDP is a flow (not a stock) and never accumulates to a stock”.

    I may be mistaken, but that doesn’t sound true to me:

    “Mathematically a stock can be seen as an accumulation or integration of flows over time – with outflows subtracting from the stock. Stocks typically have a certain value at each moment of time – e.g. the number of population at a certain moment.”

    “GDP does not add to wealth, its a measure of the movement of wealth over some period of time.”

    I also have some difficulty with that: in a more general level, GDP is a measure of all the newly produced output of an economy over some time. It can be aggregated in different ways (among them, who gets what), but it is still a measure of newly created output.

    More specifically: GDP is to a country’s balance sheet what a profits-and-losses statement is to a firm’s balance sheet. Indeed, GDP can be seen as a horizontal aggregation of business’ profits-and-losses statements.

    And, clearly, the profits-and-losses statement for an accounting period provides the addition to equity (net wealth) in the balance sheet prepared at the end of the accounting period.

    Comment 2:

    This is more a request for additional detail on the use of physical systems and thermodynamics as a metaphor for the economy. I am not saying it’s a wrong metaphor, let me be clear on this.

    I will be frank: I find it intriguing, but I really don’t get it.

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