Global Political Economy Chapters

Global Political Economy

Eddie J. Girdner

Dedication 

 

To Stinky

 

This book is dedicated to Stinky, my cat, who was my constant companion and loved to sleep next my computer as I typed. She gave me love, inspiration and support.

 

Table of Contents:

Part I: Theories and Approaches to Political Economy

Chapter One: Introduction

Historical Overview

Three Perspectives on Political Economy

The Liberal Perspective

The Realist Perspective

The Radical Perspective

Summary

Key Terms

Chapter Two: Classical Approaches to Political Economy

The Physiocrats

Francois Quesnay

Jean-Baptiste Say

Classical Liberalism

John Locke

Adam Smith

David Ricardo

John Stuart Mill

Robert Thomas Malthus

Herbert Spencer

Summary

Key Terms

Chapter Three: Alternatives to Capitalism: The Utopian Socialists

Saint Simon

Charles Fourier

Robert Owen

The Political Economy of Anarchism

Pierre Joseph Proudhon

William Godwin

Summary

Key Terms

Chapter Four: The Radical Critique

Early Socialists

Louis Blanc

Louis Auguste Blanqui

The Radical Critique: Karl Marx and Friedrich Engels

The Labor Theory of Value

Key terms

Chapter Five: The Marginalist Revolution and the Austrian School of Economics

The Marginalist Revolution

William Stanley Jevons

Leon Walras

Carl Menger

The Austrian School of Economics

Criticism

Key Terms

Chapter Six: Neoclassical Economics and the Neoclassical Synthesis

The Era of Neoclassical Economics

Alfred Marshall

The Neoclassical Synthesis

John Maynard Keynes

Summary

Key Terms

Chapter Seven: Toward Revolution: Modern Scientific Socialism

The Social Democrats and Theories of Imperialism

John Hobson

Rosa Luxemburg

Karl Kautsky

Revisionism: Eduard Bernstein

Rudolf Hilferding

Vladimir Lenin: Imperialism

Later Left Political Economists

Michal Kalecki

Oscar Lange

Piero Sraffa

Summary

Key Terms

Chapter Eight: Creative Destruction and Pareto Optimality

Schumpeter’s Economics: Joseph Schumpeter

Vilfredo Pareto

Summary

Key Terms

Chapter Nine: Critique of Modern Capitalist Society: Veblen, Polanyi and Marcuse

Thorstein Veblen

Karl Polanyi

Herbert Marcuse

Summary

Key Terms

Chapter Ten: Dependency and World Systems Theory

Modernization Theory

Dependency Theory

Hans Singer and Raul Prebisch

The Structuralist Approach and the Marxist Approach

Criticism of Dependency Theory

World Systems Theory

Fernand Braudel

Immanuel Wallerstein and the Modern World System

Summary

Key Terms

Chapter Eleven: Chicago School of Economics and the Virginia School of Public Choice Theory

The Chicago School of Economics

Milton Friedman

Gary Becker

Robert E. Lucas

Monetarism

Supply Side Economics

Arthur B. Laffer

Rational Choice Theory and Political Science: William H. Riker

The Arrow Impossibility Theorem: Kenneth Arrow

The Virginia School of Political Economy

Anthony Downs

James M. Buchanan

Gordon Tullock

Mancur Olson

Summary

Key Terms

Part II: The Global Economy

Chapter Twelve: The Post-War World and the United States

The Post-War World

The Bretton Woods Monetary System: 1944-1971

Political and Economic Arrangements

The Asian Side of Post-War Development

Economic Recovery in Europe

The Structure of the Post-War World

Making the World Safe for Democracy

The End of Bretton Woods and the Deindustrialization of America

The Study of Political Economy

Hegemonic Stability Theory

Regime Theory

Summary

Key Terms

Chapter Thirteen: The Dynamics of Economic Growth

The Neoclassical Economic Growth Model (Robert Solow)

Convergence Theory

Problems of Convergence Theory

The Endogenous Growth Model (Paul Romer and Robert Lucas, 1986-1988):

The Theory of Economic Geography

National Systems of Political Economy

The American System of Stockholder Capitalism

The System of Developmentalist Capitalism in Japan

Social Market Capitalism in Germany

Summary

Key Terms

Chapter Fourteen: Global Trade

Global Trade in Historical Perspective

The Free Trade Debate

Conventional Trade Theory (Comparative Advantage)

The Heckscher-Ohlin Model

Competitive Advantage and Strategic Trade Theory (STT)

The Product Cycle (Raymond Vernon)

Trade Negotiations Under GATT

The World Trade Organization (WTO

Multilateral Free Trade Areas

The New Trade Agenda

New Trade Deals

Summary

Key Terms

Chapter Fifteen: The International Monetary System

The Bretton Woods System

Operating the Global Monetary System

The Irreconcilable Trinity (The Trilemma)

Monetary Unions

Hegemony and Money

Summary

Key Terms

Chapter Sixteen: The International Financial System

Global Financial Flows

Financial Crises

Hyman Minsky and the Minsky Model of Financial Crises

Minsky’s Theory of Financial Crisis

Recent Economic Crises

The Mexican Peso Crisis (1994)

The Asian Financial Crisis (1997-1998)

Causes of the Asian Financial Crisis

The Turkish Financial Crisis (2001)

The US Financial Crisis (2007-2008)

Recent Trends in International Financial Flows

Financial Outflows from Developing Countries

Global Foreign Direct Investment

Regulating the International Financial System

Financial Crises and Austerity

Summary

Key Terms

Chapter Seventeen: The Multinational Corporation and the Global Economy

Profile of MNCs Today

The Study of Multinational Corporations

The Product Cycle Theory

John Dunning and the Eclectic Theory of the Reading School

Michael Porter’s Strategic Theory

Marxist or Radical Theories

MNCs: Benefits and Downsides

Intrafirm Trade

Transfer Pricing Between Divisions of MNCs

An International Regime for MNCs and FDI

Case Study: ExxonMobil

Chapter Eighteen: The Neoliberal Revolution and the New Political Economy

The Basis of Capitalism

New Political Economy

Rent Seeking Behavior

Justifiable Coalitions

Enter the Technocrats

The Neoliberal Era

Critique of New Political Economy

Summary

Chapter Nineteen: The Global Economy

The Top 20 Global Leaders (2012)

The Global Leaders (2020)

The G-8

The G-20

The BRICS

The Developing Countries

The Least Developed Countries

The Shanghai Cooperation Organization (SCO)

A Picture from Life’s Other Side

The Global Underground Economy

 

Chapter Twenty: Conclusion: Global Political Economy

Biographical Sketches

Glossary of Terms

Sources

 

Preface:

The purpose of this book is to first provide an easily accessible guide to the major ideas, perspectives, and thinkers in global political economy. The second part will cover the concepts and theories as a basis for understanding the contemporary global political economy. A profile of the major players in global political economy will also be briefly outlined. The field of political economy is vast and it is a challenge for both instructors and students to access the relevant information, including the historical background of the major ideas in a short course. In this book I have tried to bring together a broad body of information which will provide a foundation and reference for both teachers and students. It is hoped that the book will enable students to easily access and understand the basic ideas in global political economy in an enjoyable and intellectually stimulating way.

The first part of the book traces the major theories and approaches to understanding political economy in historical perspective. With these chapters as a reference, the student should be able to develop ideas through which they can understand the dynamics of the global political economy covered in the second part.

Economics, since the emergence of the neoclassical era at the end of the nineteenth century, has often been seen as a science free of ideological biases. This book takes the position that such a view is misleading. Ideological biases are clearly built into all approaches to political economy and the student should be aware of this. The book presents the different sides of the arguments as well as much empirical evidence about the complex contemporary global economy in which we live and from which we cannot escape.

It is hoped that this book will serve to spark the interest of students to pursue their areas of interest in discovering the global political economy on their own. We are all political economists now.

The book includes an extensive glossary of terms and biographical sketches of the major figures which should be of use to teachers and students in using the book.

The ideas presented here have been a joy to explore. Writing the book has been a rewarding learning experience for me. I would be pleased if the book is as useful for the reader.

October 22, 2014

 

Part I

Most people do not realize that the film, “The Wizard of Oz,” is about political economy. At the end of the nineteenth century in the United States, there was a political and economic struggle between the farmers of the great plains states in the Midwest and the emerging great monopoly corporations which were to dominate American capitalism in the twentieth century.

The editor of the South Dakota Weekly, Lyman Frank Baum, wrote a political allegory about the populist era in 1900. This was “The Wizard of Oz.” The Populist Movement grew out of the great structural changes in the American economy due to industrialization dominated by the big corporations. The populists challenged the powerful banks, railroads, and eastern corporate elites. The emerging monopoly capitalist system was seen to be keeping the farmers down by upholding the gold standard as a basis for currency. This was said to hurt farmers by keeping interest rates high. Farmers had to borrow money each year to produce their crops.

Populism was an alliance between the farmers and the workers. Their leader was William Jennings Bryan, a candidate for US President in the election of l896. He wanted to nationalize the railroads and put restrictions on the monopoly corporations.

The story opens with the wicked witch of the East, representing the bankers and capitalists who kept the plains farmers and workers in bondage. Dorothy lives on a farm in the plains state of Kansas. She represents the common people, without power and money. Her magic slippers are made of silver, which was a better standard of money than gold for the farmers. The munchkins are the little people, who lack any political power. The tin woodsman, who represents the industrial worker, is rusted solid. Many factories were shut down in the economic depression of l893. However the tin woodsman has been dehumanized. He does not have a heart, due to the dreadful alienating work in the factories that turned men into machines.

On the other hand, the Scarecrow, who represents the farmer, does not have a brain. He does not recognize where his political and economic interests lie. The Cowardly Lion can roar, but lacks courage. This is the populist leader, William Jennings Bryan.

They are all on the way to Emerald City, which is Washington, D.C., the capitol to meet the President. They travel the Yellow Brick Road, which is made of gold and so is the gold standard. The President represents different things to different people, but they realize that he is a fraud who rules by deceiving the people. The President is the Wizard of Oz. Oz is the symbol for an ounce of gold. In other words, the President is the wizard of the gold standard, which is destroying the livelihoods of the common people, the farmers and workers. This was the populist view.

When they finally reach Emerald City, they realize that the Wizard is really no genius, but just a small confused man pulling strings behind the curtains. It is all a charade which keeps people confused. Could this also be an allegory of economics as an ideology?

The populist dream was to replace the power of the industrial capitalists, the monopoly corporations, with a farmer-worker alliance. This never happened, of course, and the lion returned to the woods.

To make some sense of how the world is run, it is necessary to discover where the ideas came from that determine how things work. The great political economists are the wizards who tell the people in each age what they need. Do they really know, or are they only confused little men pulling strings behind the curtain? Whether their ideas are right or wrong is another matter. As John Kenneth Galbraith has pointed out, sometimes the ideas that are the most mistaken persist the longest and have the greatest influence on society. With that in mind, let us hit the road and dive into the often confusing minds of the great political economists. We will try to make some sense out of it. That is the task of the first part of this book. Good Luck! I hope that it will be an enjoyable tour.

 

Chapter One: Introduction

Political Economy: Theoretical Perspectives 

Historical Overview:

Thinking about how groups live and produce their means of living is at least as old as the Ancient Greeks. In The Politics, Aristotle discusses some fundamental aspects of the economy which for him was primarily household management. For example, he imagines automation. If a shuttle could weave itself it would save labor and free individuals for other activities. He discusses the concept of exchange value and use value. He sees economic activity carried out exclusively for the purpose of monetary gain to be unnatural and immoral. The desire for wealth should not be unlimited. He sees the pursuit of wealth as an end in itself as a perversion of economics. He also importantly argues that usury is unnatural since it makes something, namely money, which is not living, reproduce. This is what Karl Marx refers to as a fetish of commodities, something magical. Some of these ideas have had great importance in economic thinking. In Christian civilization usury was forbidden for many centuries, based upon Aristotle’s ideas. In some Islamic societies usury is still forbidden.

The term economics comes from Greek oikos (home) and nomos (law and order). As early as 1615, a book entitled “Economie Politique” appeared in France. Later, a book entitle Troite’de Economie Politique by Antoine de Montchretien was published in the same century.

More systematic attempts to understand the workings of the political economy emerged in the sixteenth century with the expansion of money and trade. An early venture in trade between Britain and Asia was the British East India Company, which was a sort of forerunner of today’s transnational corporation. India manufactured many products, such as fine textiles, which were in high demand in England. The employees of the British East India Company could become very wealthy in only a few years in this enterprise. Eventually, this trade resulted in British colonial rule in India.

Every political and economic enterprise needs to be grounded in an ideology which can plausibly be accepted and which legitimizes the emerging practices. This need to put a bright face upon early trading companies gave rise to mercantilism.

Among the early mercantilist thinkers was Thomas Mun (1571-1641). He was a British merchant-economist who became a director of the East India Company and defended its interests in his writings.

In the early Eighteenth Century, the Physiocrats in France developed a different approach to political economy. The most notable of these were Francois Quesnay (1694-1774). Basing their ideas upon the productivity of nature, they believed that all the wealth of society came from the soil. Therefore, they promoted the interests of agriculture over manufacture.

The late Eighteenth Century saw the emergence of another approach, which began the establishment of classical political economy or moral economy, as it was called at the time. This line of thinking began most notably with Adam Smith (1723-1790). The emergence of capitalist industry, linked to the colonial system, called for an alternative ideology to justify the emerging system of factory production and expanding trade between countries. Thinkers such as John Locke and Adam Smith began to construct an ideology of liberal capitalism.

An alternative view was seen in the utopian socialists. Capitalism and technology were starting to change society but where was it going? For the apologists of capitalism, such as Adam Smith, everything was fine and dandy and working to the best for everyone. Everyone in society was seen to be in the same boat. The Utopian Socialists and the radical socialists, however, did not think so. It did not seem that way in the real world. They thought that technology and capitalist production was launching a new, possibly hopeful, phase of society but that it must be guided and shaped to produce the good society. Leaving things in the hands of an imaginary laissez faire market was not the answer. In France, Saint Simon saw the new technology as making possible a society where everyone’s needs could be met in a systematic and organized way. Utopian socialism would usher in the millennium. In England, Robert Owen, who owned a textile mill, wanted to make profits, but in a way which was more humane to the workers and which would help improve the quality of their lives. He set up enterprises for this purpose to improve the welfare of the workers. Others drew up plans for model communities which would lead to what they imagined would be near perfect societies. Many experiments with new types of communities were attempted, particularly in the United States in the nineteenth century, based upon the thinking of the utopian socialists. Today few realize that dozens of experimental communist societies were being set up in the United States in the Nineteenth Century.

For Karl Marx, this was all pie in the sky. A rather useless exercise, he thought. Nice try, but it was not going to go anywhere, unfortunately, in Marx’s view. Marx and Engels had laid out their own model of how history actually unfolds in their earlier work, The German Ideology. One could not just start with fancy ideas and use them to transform society. One must start with the actual way that people in society produce their livelihood. This, after all, was the material basis for the institutions and ideology in society in their model of dialectical materialism. The schemes of the utopian socialists were just a fantasy which could never be realized as they imagined. Marx thought the utopian socialists had good ideas about how people should live, but were wasting their time.

For Karl Marx (1818-1883), and later Friedrich Engels, what had to be done was to understand “the laws of motion of modern capitalist society.” It had to be based upon real world facts, the way things actually existed, and then society would move on from there. Of course, Marx had to first read everything of importance that had ever been written by political economists before he laid out his own ideas. Then he would launch his critique of liberal political economy in the middle of the nineteenth century. This resulted in his major work, the three volumes of Capital. There has probably never been a more influential work in the way of political economy.

Perhaps it was Marx’s powerful radical critique of capitalism that brought about the marginalist revolution in the second part of the nineteenth century. Marx’s critique of many of the classical liberal precepts made necessary a reconstruction of liberal capitalist ideology which would be worker proof. That is, it had to present the world of production and political economy in such a way that the worker could not find a way to claim that he or she was being exploited. It should be a water-tight ideology that served the interests of the capitalist class. More specifically, it called for the discrediting of the labor theory of value, which ironically was a central plank in the works of both Adam Smith and David Ricardo. Marx had seized upon this classical understanding of labor to prove that according to their own systems, the ideas of the liberals about the benefits of capitalism to the working class, was bankrupt. And that, Marx said, was why the capitalists, or “moneybags as he called them,” were laughing. They were laughing all the way to the bank. If the workers really owned their own labor, then they should own the product of their labor as well.  Now the marginalists had to invent a new system.

This attack upon Marx, beginning with Carl Menger, William Stanley Jevons and Leon Walras, culminated in the construction of marginal utility theory. These ideas were consolidated in the seminal work of Alfred Marshall in 1890. The era of neoclassical economics had emerged. The rest is history as they say. The world would never be the same again. It would be modified by the Keynesians and neo-Keynesians but prove exceedingly durable in the service of Twentieth Century capitalism and beyond.

We must look at each of these systems of political economy in turn and attempt to understand why the historical shifts in thinking happened.

Three Perspectives on Political Economy

In general, there are three basic ways of approaching an understanding of the actually existing political economy. These are the liberal, realist, and radical approaches. This chapter will explain the main characteristics of each view.

We must make a distinction, however, between an analytical view and a normative view. The analytical view simply tries to understand how the existing system of capitalist political economy works. The second or normative view sets out what sort of political economy is desired and considered best. This depends upon the individual and how a person decides to understand the world. It also depends upon their values and how they think the social surplus of society should be divided. Or in the words of Harold Lasswell, who gets what, when, and how. That is the ultimate political question for society.

The Liberal Perspective on Political Economy:

We begin with the liberal view, which emerged in the eighteenth and nineteenth centuries with Adam Smith and David Ricardo. This perspective was constructed with the rise of capitalism and indeed served as an ideology of free markets and free trade. Liberalism served as an ideology for the needs of an emerging capitalist economy. While current political economies have been greatly changed since the eighteenth century, this perspective still serves this ideological purpose.

The liberal view begins with a vision of the individual in nature. Classical political economists or moral economists saw men and women as capable of creating a good society through human volition or rationality. God, in this view, had created man as a rational being who was fully capable of pursuing his personal interests for necessities and wealth through his own efforts. This was largely seen to be an individualistic endeavor. As long as individuals respected the rights and property of others, then they should have the freedom to acquire their needs and to even get rich. Political economy would be based upon nature and the results said to conform to what was natural.

John Locke saw such pursuit for a happy existence as being the natural right of human individuals. But since there was no security in a state of nature, men agreed to establish a civil society with a government. However, for liberals, the government would have the minimal role of providing security and allowing the free market to work and individuals to pursue their acquisitive interests. It led to the idea that “the government which governs least is best.”

Liberals argued that it is natural for man to use his labor to produce and to buy and sell. In this free exchange, men will agree upon a price in the market, which can be considered a natural price. Associating the production of society’s needs and wants with nature was a powerful argument and seemed to suggest that the emerging economic system had God’s approval.

Of course thinking of the economy in this way was an intellectual exercise which envisioned men having equal opportunity to pursue possessions and wealth. As time went along this was not the actual case, as great wealth also gave certain individuals and groups great political power over others. Individuals with money to use as capital could have command over the labor of those with no money to use as capital.

Nevertheless, liberalism served as an ideology of trade and the free market. David Ricardo forwarded the theory of comparative advantage and along with Adam Smith, argued that free trade would increase the wealth and well-being of nations. In short, liberalism views the workings of the political economy as a sum-sum game in which everyone has a stake and gains. As Keynes observed, “Capitalism is the extraordinary belief that the nastiest of men for the nastiest of reasons will somehow work for the benefit of us all.” Humans are selfish and greedy, but never mind. That is actually good, because when they act in selfish ways, it actually helps society and results in a good society. Pursuing wealth gives men an incentive to work harder and they produce more for society making everyone better off. So there is a sort of built-in work ethic in the pursuit of wealth.

According to this view, the best thing that the government can do is back off and let the market work. This is the idea of “laissez faire” or leave alone. It is only when property and the market is threatened that the government must act to protect this natural order. The primary function of the government, then, is to provide security to private property, including one’s own life. The watch words of the liberal economy became “Life, Liberty, and Property.” This is the historical legacy of the ideas underlying the ideology of capitalist globalization today. Whether the ideology is true in the real world is an empirical question which must be examined separately.

In modern times a foremost theorist of liberalism was Friedrich Hayek. His writings greatly influenced other free market ideologues such as Milton Friedman and others at the University of Chicago Economics Department. This group of economists came to be known as “the Chicago Boys” and urged developing nations, such as Chile, to adopt free market policies.

Hayek, an Austrian, became famous with his book The Road to Serfdom, published in 1944. Hayek argued that the social welfare system which was coming into operation in England would eventually lead to a totalitarian system in which people would be no better than slaves. This seems exaggerated, in retrospect, but nevertheless, it served as a powerful ideology and influenced governments and economists. It served to frighten people into thinking that socialism, and perhaps even social welfare, was their greatest enemy. It seemed a godsend for the needs of large corporations in pursuit of low taxes and greater profits. It was just the medicine the doctor ordered.

The famous economist, Milton Friedman, followed in Hayek’s tracks at the University of Chicago. He wrote a book called Free to Choose, which was the basis of a popular television program series in the United States. Surely this served as powerful propaganda to lessen the pressure for social welfare provisions in the United States. In fact, Americans enjoy less government assistance than any other developed nation.

The reemergence of liberal ideology in the l970s led to today’s dominant global political economy, namely neoliberalism. While neoliberalism is seen to rely upon classical liberal ideology, it is actually very different, as it uses the power of the state to protect business interests.

To summarize, for liberals the analysis of society is based upon individuals or households and firms. They see rational individuals acting to maximize utility. Society is guided by the dynamics of the market. The entire process is seen as harmonious and a sum-sum game. The ideology of laissez faire is always in the background. Liberals believe that the economic sphere should determine politics. The role of the state is to ensure the optimal functioning of the market. Liberals believe that the free market results in equilibrium in society, which shifts from time to time.

The Realist Perspective:

The Realist Perspective challenged and criticized the ideas of the liberals. Realism emerged from the thinking of the mercantilists. A key figure was George Friedrich List (1789-1846). His major work, The National System of Political Economy, was published in 1856.  Adam Smith claimed that he was writing about the wealth of nations. They simply assume that the free market will serve to make a nation wealthy. List, on the other hand, took a nationalistic view in which the economic health of the nation was paramount. The nation had to pursue its own interests over against the interests of other nations in the international arena. Unlike for the liberals, this was not a sum-sum gain, but rather a zero-sum game. Some nations would win and others lose. What the nation must do was to build up its national manufacturing capacity and seek to export to build up a trade surplus and a national reserve of gold. If necessary, the military and war must be used to achieve and maintain a positive balance of trade. The major actors in the international arena are nations and they must develop a strong military to remain powerful. The economic policy of the nation must be determined by politics and the economy and system of national production will serve the needs of the nation. Capitalists and firms will get rich, of course, but not at the expense of the national interest. The national interest is primary.

This approach to political economy is generally known as Mercantilism. Nations which pursue similar policies today are known as neomercantilist. An example of this is Japan, following World War II. The Japanese mostly rejected the desires of the United States to open their economy to foreign investments and pursue liberal economic policies. Instead, they used the state and government to build up the giant Japanese firms and promote exports. Imports were strictly limited. This sort of policy was not supposed to work in the global political economy, according to the liberals, but, in fact, it seems that it worked very well for the Japanese. It became a model of state-guided capitalist development to be used in other Asian nations, including Taiwan, South Korea, and the People’s Republic of China after the Maoist period.

List believed that one must take into account the stage of development of the political economy of a country before choosing a trade policy. A country has to go through several phases as it develops. A fully mature and developed economy with sophisticated manufactures can easily pursue an export strategy. But what about a developing economy which manufactures only primitive products and mainly produces primary or agricultural products? Does it make sense for such a country to go in for free trade? In fact, it is going to be hurt very badly by the terms of trade, according to List. It will be trading bananas and coffee and cotton for bulldozers and computers from the developing world. In years when the price of coffee is high, it will not be so bad, but when the prices of coffee and bananas drop, the country will suffer badly. So List made some very useful observations about the real conditions of free trade. Infant industries need protection to survive and flourish until they become strong. This is the practice of protectionism. The one size fits all theory of the liberals would militate greatly against underdeveloped nations. Again, it was a zero-sum game and the powerful developed countries were going to win every time. It was a useful observation. As is said today, it does make a difference whether a country exports potato chips or computer chips.

To summarize, realists or mercantilists base their analysis of society upon nation states. States are seen as rational actors that maximize their interests, such as power and wealth. Politics is a basis for increasing the strength of the state. The international arena is characterized by a zero-sum game between nations and is necessarily marked by conflict. Realists believe that politics should determine economics. Change occurs when there is a shift in the distribution of power between states. The purpose of the economy is to serve the state.

The Radical Perspective:

The radical perspective on political economy is based upon the ideas of a long line of thinkers beginning with Karl Marx. In other words, it is the politically left position of political economic analysis. First, radical thinkers view society in a dialectical way. This just means that whatever happens affects different groups in society differently. They see society as basically divided according to class interests. This is the major social cleavage in society. Those who own capital in society have interests which are opposed to members of the working class.

Radicals are critical of capitalism and believe that it is based upon the exploitation of the working class. They continue to believe in the economic analysis of the classical thinkers and Karl Marx, that the labor theory of value is the way to view the productive process under capitalism. They believe that capitalism creates inequality, while at the same time creating over-production and under consumption. For the most part, capitalism keeps the working class in a situation of poverty, according to radicals.

Radicals believe that capitalism tends to be in crises due to the contradictions in the system. For example, as capitalism develops, they believe there is a tendency for the rate of profit to fall. While there is the capacity for enormous production of commodities, the working class does not have sufficient income to purchase all their needs.

The continuous search for profits leads to continuous change, but the economy tends to reach stagnation as there are limited outlets for productive investments. This leads capitalists to seek investment opportunities in the international arena to increase their profits. So the emergence of imperialism is a result of capitalism. Imperialism and the attempt to control global resources and markets, in turn, often lead to war. War also must be seen in a dialectical way, as wars are generally fought in the interests of the capitalist class. In wars, workers of one country fight the workers of another country to ensure that the capitalists make more profits.

Global trade is also exploitative due to the terms of trade. The conditions for the mutual gain of both nations, as seen by David Ricardo, seldom exist in the real world. Powerful countries set up trade agreements, but these generally serve the interests of the most powerful countries and large multinational corporations. So trade agreements serve to increase global inequality and capitalist accumulation. They are seen by radicals as a new form of colonialism or neocolonialism. The US is seen as the global hegemonic country, linked to the European Union and Japan.

The international monetary and financial system set up at the end of World War II, The Bretton Woods System, is seen as another way of dominating and exploiting the world, rather than creating global prosperity. Radicals believe that the IMF and the World Bank were set up primarily to serve the interests of the powerful countries and keep global profits flowing to them.

Radicals have created an extensive body of work to understand colonialism and imperialism, including the works of Vladimir Lenin and Rosa Luxemburg. Later, theorists of the left developed dependency theory and world systems theory. Among these are Andre Gunder Frank and Immanuel Wallerstein. The world is seen to be increasingly infused with the capitalist system of production in every corner of the globe. While the US is the most powerful country at the center, the third world countries are a periphery, lacking access to capital for successful development.

Radicals see the global political economy as rigged in favor of the rich and powerful countries, with the poor countries trapped in poverty from which they cannot escape.  The powerful countries, corporations and currencies rule the world.

Summary:

Thinkers have attempted to understand the economy since the Ancient Greeks. As society began to shift from feudalism after the Middle Ages and trade and commerce developed on an international scale, more systematic attempts were made to understand how the economy of a nation works. The mercantilists needed to understand more systematically trade between countries. This gave rise to mercantilism in the sixteenth and seventeenth centuries. As capitalism emerged in the industrial revolution, Adam Smith and John Locke began to construct an ideology of free trade and liberalism.

The Utopian Socialists challenged the emerging system of capitalism and imagined how society could be organized to serve the entire community and not just the capitalists. A more systematic radical critique emerged with Karl Marx in the middle of the nineteenth century.

In fact, Karl Marx’s deconstruction of the workings of capitalism became a powerful tool for the working class. It became necessary to reconstruct the ideology to better serve capital. This was the historical task of the political economists of the marginalist revolution, such as Carl Menger, William Stanley Jevons and Leon Walras. Alfred Marshall completed the task with his treatise on economics in l890. Mainstream political economy would be narrowed, use a great deal of mathematics, focus upon the individual, and become just economics, not political economy.

Nevertheless, the radicals continued to analyze the economy in the Marxian world view.

Historical thinking has resulted in three major theoretical perspectives upon political economy, the liberal, the realist, and the radical views. Liberals, following Adam Smith see the economy as based on individuals and the free market. The state should allow the economy to function in a natural way. Realists, or mercantilists, believe that the economy should serve the needs of the state and make the state more powerful. Radicals are critical of capitalism as they believe that it is based upon the exploitation of the working classes. They believe that the system is irrational, due to contradictions in the system which produce crises. The attempt to overcome the contradictions of the capitalist system leads to imperialism and war. They believe that society should be reorganized to serve the majority of the people, rather than only the one percent of society which owns capital.

Key Terms:

Aristotle

Usury

Economics

British East India Company

Colonialism

Capitalism

Ideology

The Physiocrats

John Locke

Adam Smith

David Ricardo

Classical Political Economy

Neoclassical Political Economy

Radical Critique of Political Economy

Karl Marx

The Wealth of Nations

Laissez Faire

Utopian Socialists

Saint Simon

Alfred Marshall

John Maynard Keynes

The Liberal Perspective

The Realist Perspective

The Radical Perspective

Mercantilism

Neoliberalism

Laissez Faire

Rational Choice

Labor Theory of Value

Comparative advantage

Free market

Friedrich Hayek

The Road to Serfdom (1944)

The Marginalist Revolution

Protectionism

Class Cleavage

Capital Accumulation

Imperialism

Neoimperialism

The Bretton Woods System

Dependency Theory

World Systems Theory

 

Chapter Two: Classical Approaches to Political Economy

This chapter will explain the views of the Physiocrats and the classical liberal thinkers, John Locke, Adam Smith, David Ricardo, John Stuart Mill and Thomas Robert Malthus. Also we will look at some of the ideas of Herbert Spencer which also influenced economic thought. These thinkers were basically engaged in constructing an ideology of capitalism as the industrial revolution emerged first in England and later spread to the European continent.

The Physiocrats:

The Physiocrats in late eighteenth century France believed that the wealth of nations stemmed from the value of land and agriculture. Their writings are the first well-developed economic theory. They argued that productive work was the source of national wealth. They praised farmers and rural life and said that all life depended upon the productivity of the soil and the ability of the natural environment to renew itself. They also praised natural styles of living and condemned city life. The Physiocrats were influenced by Confucian thought from China. At the time, China had the largest economic system in the world.

According to the Physiocrats, there are three economic agents:

First, the proprietary class or landowners.  Second, the productive class, which includes agricultural laborers. Third, the sterile class includes artisans and merchants. Production circulates among these three classes.

The Physiocrats first developed the idea of diminishing returns. They said that inputs bring increases, but these gains decrease over time. There are limits to national wealth. Successive applications of the variable inputs will cause the product to grow at an increasing rate, at first. Later, however, the rate will diminish until a maximum is reached. So there is a limit to productivity gains.

In the case of farming, part of the produce should be used to increase productivity and provide for laborers. The Physiocrats believed that the sole source of public revenue should be from the rental value of land. The Physiocrats influenced the future political economists, Adam Smith, David Ricardo, John Stuart Mill and Henry George.

Francois Quesnay (1694-1774) was the main figure among the Physiocrats. He was influenced by thought from the Far East and was a Confucian. He is famous for his Economic Table in 1759 which is a diagram of how wealth circulates in society. His work became the foundation for the economic theories of the Physiocrats. For these thinkers, there was no social contract. They believed that people lived together through a natural order that allowed a good deal of freedom.

Another member of this school was Anne-Robert-Jacques Turgot (1727-1781). For Turgot, self-interest is the motivation for labor and production. He said that a man works harder for his own benefit than for others. He supported private property in land and individualism. He said that trade barriers are an unnatural restriction upon desires and goals.

Jean-Baptiste Say (1767-1832) was not a Physiocrat but a French economist and businessman. He developed classical liberal views, arguing in favor of competition, free trade and few restraints on business. His major work has a long title, A Treatise on Political Economy, or, the Production, Distribution, and Consumption of Wealth. Turgot’s thinking clearly anticipates some of the ideas of Adam Smith who began to write on political economy at around the same time.

Say is most famous for Say’s Law which says that “The supply creates its own demand.” He said that products are paid for with products. So a glut, or surplus of products, can take place only when there are too many means of production applied to one kind of product and not enough to another.

John Maynard Keynes later argued that the Great Depression showed that this law was not true.

The Liberals: Classical Political Economy

An attempt to explain the political economy of emerging states began in the era of rising industrial capitalism. The major architects of this period are Adam Smith, John Locke and David Ricardo. The era of classical political economy can be said to extend roughly from 1776, the date of publication of Adam Smith’s famous work, The Wealth of Nations, until 1890,when  the work of Alfred Marshall, Principles of Economics, appeared.

John Locke (1632-1704):

John Locke developed his economic and political ideas in his book, Two Treatises of Government (1690).  As one of the social contract theorists, Locke began his discussion by imagining man as a solitary creature in nature. On his own, he must provide for his most human needs, food, clothing and shelter. To get food, he simply gathers or hunts whatever he can find in nature. He may find fruits and berries, growing wild, to satisfy his appetite if nature provides them. Or he may find roots and nuts to make a meal. There may be wild animals and birds which he can kill and eat. Or perhaps the area is rich in fish. For clothing, he can make garments from grass or the bark of trees. In colder climates, he can make use of the warm skins and the fur of animals. He can also erect a shelter from rain and wind and the other elements of nature. If he can make simple tools, he can cut down trees to build himself a house.

For Locke, man in nature should live according to the laws of nature. Man, himself, is a part of nature. The individual knows that he should not harm his neighbor and that what he produces becomes his property. If everyone obeys the laws of nature, society will be peaceful.

Man in this state of nature uses his ability and rationality to provide for himself and if he has a mate he can reproduce and raise a family. When he mixes his labor with nature, such as building a house or collecting food, he acquires property. This results in a labor theory of property. Whatever man gathers in nature belongs to him. However, Locke says that there is a spoilage limitation. Man should not gather more than he can use before it spoils. He can gather enough nuts to last him through the whole winter but he cannot do the same with bananas which spoil quickly. In this way, man lives simply in nature. It is not possible for him to acquire a great deal of wealth. However, this situation will change for Locke, when money, which is made of metal, is invented. Since metal does not spoil, there is no limit on how much a man may acquire. Also if one mixes his labor with the soil to engage in agriculture, he comes to own the land.

However, the major problem in the state of nature is the lack of security. Even though Locke says that there are laws of nature, which individuals should know, there is no guarantee that everyone is going to obey these laws. Another man may come and take over his house or kill him. Therefore, even though nature is peaceful for the most part, the person, in nature, must be responsible for providing for his own security. This state of nature could be completely peaceful if all men would just obey these simple laws of nature and respect the rights of each other to their naturally acquired property. The problem is that there is an element of greed in human nature and some men succumb to this. Rather than build themselves a house, they try to steal the house of someone else. Maybe they also run off with his wife. Or they steal his nuts. Life becomes difficult for those decent humans who are just trying to obey the simple laws of nature and get along with their neighbors.

The need for security for life, liberty, and property, is the beginning of government. Locke believes that government is based upon a social contract. People consent to give up some of their individual rights in nature to the state which provides security. The concept of a social contract is the basis for the founding of government or civil society. It is important that the social contract is designed to have the central function of protecting private property.

So man then leaves the state of nature and agrees to live under the laws of society. To the greatest extent possible society is going to be based upon these natural laws. However, some curious changes do take place when government is established.

One great change is the invention of money. Money is something which can be traded for something else of value. Moreover, the most valuable money is going to be based upon something which is rare. This might be precious stones that are hard to find, or copper, silver, or gold. But the magical thing about money is that all of a sudden the spoilage limitation that existed in nature is magically removed. Money is not like bananas. It is not going to spoil. One can keep silver and gold as long as one wants. But also one can collect more and more of it. This allows one to become rich. It also allows one to stay rich, since now there is a government to protect the hoard of silver and gold. Simply, the creation of money is the basis of wealth and inequality in civil society.

The invention of money also begins to change the principle of the labor theory of property. In a state of nature, everyone worked for themselves and whatever they produced or acquired belonged to them. Now the situation has changed. Some men have become so rich with their pile of unspoiled money that they can just buy the poor man and make him his slave. Locke says that now when the poor man works, his labor no longer belongs to him, but to his owner. This is just going to make the owner richer, since now he owns the labor of other men. Locke is setting up the conditions which are needed to justify the emerging system of capitalism.

It seems that there are some contradictions here. If the purpose of government is to protect private property, then why does this arrangement protect the property of the rich, but not the property of the poor man? The only property the poor man has is his labor and the government is not ensuring that his labor belongs to him. Rather his labor becomes the property of the rich man. Under wage labor, the worker will have to sell his labor at the market rate just to live and reproduce. He becomes a sort of wage slave. We have entered the era of government and civil society, and also the era of capitalism.

While under liberal theory individuals gained a good deal of freedom, there are many contradictions which arise. Depending upon one’s social location in society, many of the promised freedoms may be only theoretical. Man has been liberated from some of the restrictions of the feudal era, but becomes enslaved in new ways under capitalism.

Clearly, John Locke contributed several ideas which contributed to the development of classical political economy. He justified the acquisition of private property through mixing one’s labor with nature. Money, which does not spoil and is based upon past labor, can be collected to produce wealth. The idea of individualism is also strong in Locke. To turn over one’s rights to the state and work to get rich are individual decisions, a central idea in liberal economics. Also the individual makes decisions based upon rational self-interest. The individual does what he considers will be best for him. Finally, Locke argued that the best government should be the government which governs least. It should provide security for one’s property. Locke also argued against usury laws, believing that interest rates would find their natural level in the free market.

Adam Smith (1723-1790):

Adam Smith was one of the first political economists to attempt to understand capitalism. He is sometimes called the father of economics and is generally considered to be one of the three most important thinkers in political economy, the other two being Karl Marx and John Maynard Keynes. This is largely because he believed that capitalism was a system that made everybody better off when allowed to function according to its natural laws. What Adam Smith taught in his day was called Moral Philosophy.

Adam Smith is generally associated with the concept of laissez faire, or wanting the government to leave the economy alone. However, this is an exaggeration and somewhat misleading. Adam Smith recognized that there were several important functions of the government in the economy. Smith wanted the government to provide policies which encouraged the benefits of competition. Sometimes, this would require the government to control the tendency of capitalists to form monopolies and control prices. Smith wrote about businessmen who get together and form a conspiracy against the public to control prices.

Adam Smith is also famous for his “invisible hand” image of capitalism. This just meant that when each individual in society followed his own selfish interests that this would promote the good of everyone in society, even though people had no intention of creating this result. This idea, whether true of not, has become a central pillar of capitalist ideology.

Another famous principle in the Wealth of Nations was that of division of labor. In factory production, manufacture becomes more productive if the production process is divided into small tasks. Smith’s famous example was that of making pins, where the process was broken into eighteen different operations. One man draws out the wire and another straightens it. Then a third man cuts off lengths of wire for the pins. The fourth man makes points on the wires. A fifth prepares the other end of the wire to receive the head. Three other men are making the heads of the pins and so on. In this way, many thousands of pins can be manufactured in a day. Of course this tells us nothing about how many people may have been driven insane by engaging in such inane tasks the live-long day. But anyway, Smith didn’t seem to care. Just get those pins out, and now! The owner of the pin factory could increase his profits in this way.

The mercantilists who wanted nations to protect trade and their infant industries were attacked by Smith. He argued that free trade gave advantages to both nations which engaged in trade. This is an early theory of comparative advantage. However, he thought that the state would be justified in limiting international trade if it contributed to the military strength of other nations.

Trade between individuals was also seen to be natural. There was a natural tendency to truck, barter and sell in human nature, it was said. This proposition has generally been accepted by most economists as true.

Adam Smith opposed monopolies, which is seldom mentioned by those who praise his work today. There were four reasons why he thought monopolies were bad. First, they made prices higher for consumers and made them worse off. Secondly, they tended to lead to bad management. Third, monopoly firms were likely to attempt to get government support for their businesses. Fourth, monopolies lead to excessive profits for the owners. Opposing monopolies, Adam Smith would surely criticize the oligopoly forms of capitalism one sees today in such states as the United States, the countries of the European Union and Japan.

Indeed, there were times when government should intervene in the economy, according to Adam Smith. First, the government should act to prevent monopolies. Major corporations today would hate to hear that! Secondly, it was necessary for the government to provide for military defense. Third, the government was responsible for ensuring domestic peace. Fourth, the government should provide public goods, especially where there are large externalities. Externalities are costs which are not paid for by the users of a commodity, such as pollution.

In his view of price, Adam Smith argued that commodities have a natural price, but that this was different from the market price. He said that the market price was determined by the quantity of goods in the market and the demand for those goods. The natural price was the price toward which the market moved and this price was determined by the cost of production of the commodity. In other words, this was a cost of production theory of price. This cost basis of price is essentially a labor theory of value of the commodity, which was to be used by David Ricardo and Karl Marx.

Like the other classical political economists, Adam Smith explained wages with a subsistence theory of wages. This simply says that the cost of labor falls to the level where the worker can only survive at the socially acceptable level of existence and reproduce. This, of course, was often a very low level of degradation in early capitalism and still today in many nations around the world.

Several of the economic concepts found in Adam Smith are not very clear. His ideas have often been taken out of context and exaggerated to serve capitalist ideology and profits. Nevertheless, his ideas, right or wrong, have endured in the history of economics and had great impact as an underlying liberal ideology of capitalism.

David Ricardo (1772-1823):

As a classical political economist, David Ricardo is most noted for his theory of comparative advantage in international trade and for his labor theory of value. He also explained how national income was divided between the factors of production, land, labor and capital. Rents went to land, wages to labor and profits to capital.

The theory of comparative advantage says that countries will be better off if they produce and export the goods which they can produce more efficiently than other countries. Therefore countries should specialize in producing those products which they can produce more efficiently than other countries. This is a strong argument for free trade.

In discussing income distribution to the factors of production, Ricardo developed a theory to explain rent, wages, and profit. He developed a differential theory of rent which says that rents on land depend upon the fertility of the land. The most fertile land will command the highest rents and that will be determined by the difference in productivity compared to the poorest land.

Ricardo also thought that wages would be determined by a subsistence level by which the worker could just live, according to the general standard of living of the society. If living standards rose, then wages would also have to rise. Profits, on the other hand, were determined by the income left over after the rent and wages to labor were paid. Over the long term, profit rates between different industries would equalize, as capital entered the most profitable industries. This would cause prices and profits to fall. At the same time, capital would leave industries earning low profits, causing prices and profits to rise.

Putting these ideas together, Ricardo believed that over time, the profits of capitalism would fall and there would be economic stagnation. This was because with rising wages and rents, profits would fall. There would then be less incentive for capitalists to invest their capital. This is the law of the falling rate of profit, also seen in the work of Karl Marx.

One partial remedy, Ricardo believed, would be to abolish the British Corn Laws, which were a tariff on imported grain. Ricardo believed that these laws kept the prices of food too high, raising wages and hurting the profits of industrialists. If the laws were repealed, then profits could recover.

Ricardo also developed a labor theory of value. The exchange value of products depends upon the cost of producing them and their scarcity. For Ricardo, scarcity was important only for those products that could not be readily reproduced, like famous paintings or special wine. In general, what determined the value of products was the amount of labor contained in them. Or in other words, the amount of labor needed to produce them. Part of this was direct labor or wage labor. Another part was indirect labor, the amount of labor contained in the machinery used for production, a small part of which was used up to produce each product.

In his view, all goods that could readily be produced would be exchanged at rates determined by the amount of labor which was required to produce them. This was the labor theory of value, which was also used by Karl Marx in his work, Capital. Ricardo’s labor theory of value was revised using the theories of Piero Sraffa in the twentieth century. Sraffa developed the basic ideas for the neo-Ricardian School of Economic thought.       

John Stuart Mill: (1806-1873)

John Stuart Mill was another important figure in classical political economy and helped to develop some of the concepts for marginalist economics which would emerge in the late nineteenth century. Mill was influenced by Jeremy Bentham, a utilitarian thinker, in his youth. Mill published his famous textbook, Principles of Political Economy (1848), which was the basic course book in England until the work of Alfred Marshall appeared in l890.

After reading other economists, Mill tried to evaluate the possible future direction of the emerging capitalist political economy. Thomas Robert Malthus had projected a pessimistic view of society, believing that the increasing population would lead to poverty and starvation for the worker. He thought that technology would not be able to solve this problem. Secondly, the opposite view had been projected by Adam Smith, who thought that production and wages would rise under capitalism making the worker better off in future. Third, another possibility emerged from the writings of David Ricardo. As capitalism developed, and the population increased, prices and rents on land would rise, while real wages remained the same. This would lead to a falling rate of profit. Finally, some economists were more optimistic that new technology might increase at a rate faster than capital and the population. In this case, the cost of producing food would decrease, leading to lower wages and rents and greater profits. Capitalism would then flourish.

Mill evaluated the possibilities and largely agreed with Ricardo, that it was likely that profits would fall and capitalist society would experience stagnation in future.

Mill agreed with the theory of comparative advantage and extended the theory to assert that most of the gains of free trade would go to the country where demand is least and where elasticity of demand is greatest. This means that if imports are cheap, they will be in demand, but if prices rise, people will quickly shift to using domestic substitutes. The country where people are willing to pay high prices for imported items will gain the least from free trade.

John Stuart Mill also worked on the problem of supply and demand. He realized that when the price of a commodity fell, the supply would also fall. But when the price rises, the supply will also rise.

Mill also has the reputation for being the first to discuss the concept of opportunity cost. This cost is what someone has to give up in order to do something else. If one wants to take a long holiday, one has to give up the money he or she would earn if they were working.

John Stuart Mill basically believed in utilitarianism, borrowed from his father, James Mill, and Jeremy Bentham. Utilitarianism essentially says that policies are best which provide the greatest good to the greatest number. Logically, this seems like a good principle, but there are ethical problems with such a view. For example, a utilitarian policy could mean that those who are weak and sick in society should be left to die, if the resources to treat them could be better used to make those who are strong happier. Rather than spend resources to treat the sick, they could be spent to give healthy people a foreign holiday. On the positive side, utilitarianism envisions some concept of social welfare.

Mill argued that economics could not be an empirical science, based upon empirical knowledge. The reason was that experiments could not be conducted in society to find the result. Therefore, economic principles would have to be derived through logical deduction. The central assumption for neoclassical economics is based upon the utilitarian presupposition that people will generally act to maximize pleasure, or what is called utility. In other words, rather than stick to a moral principle, they will stick to what gives them more pleasure, such as making money. This is not always true. Can the actions of a Mahatma Gandhi, who often went to jail for principles, be explained by economic rationality? Is this proposition true for everyone, or only the bulk of common humanity?

Mill is also seen to be a supporter of laissez faire, as he said it resulted in the greatest self-development. In general, it can be said that Mill contributed to several of the nineteenth century concepts of political economy and helped prepare the way for the marginalist revolution by popularizing utilitarian ideas.

Thomas Robert Malthus (1766-1834):

It was because of the pessimism of Thomas Malthus that Thomas Carlyle called economics the dismal science.  Malthus was England’s first professor of political economy at the East India Company College. He also taught at the College of William and Mary in the United States. He read Adam Smith’s Wealth of Nations but came to different conclusions about where the capitalist political economy was headed. He was not nearly as optimistic as Adam Smith that the result would turn out to be good. In fact, he differed in his views from many of the other classical political economists.

First, Malthus caused the most controversy over his population theory, which is still in dispute. Malthus argued that since the food supply could only increase arithmetically, food could not keep up with population growth which grew at much faster geometric rates. He believed that the future of humanity could only be misery and starvation.

Believing in such a thesis, he took sharp issue with all of those who remedy the situation with rational or utopian solutions. Among these were the utopian socialists, such as Robert Owen and others. He also believed that schemes such as that of William Godwin to distribute wealth more equally through taxation would not work. When the working classes were well fed, they would simply use their prosperity to produce more children and add to the problem. There was no way to improve the economic situation according to Malthus.

The root of the problem for Malthus was the insatiable drive for sexual pleasure. Marx made fun of this, since Malthus was a Christian minister, and the ministers in England were not always free of such sins. There were sometimes checks on population such as diseases, such as plague. War too killed off a portion of the population. Sometimes people perished in famines and sometimes in natural disasters, such as floods and earthquakes. But these were not sufficient to stabilize the population.

There might also be preventive checks on population, and Malthus advocated delayed marriage and birth control. He also advocated sexual abstinence, but he did not think that there was much scope for this approach. In the end, the population was bound to increase faster than economic development could provide for more hungry mouths.

Malthus set the tone for those who would argue in the future against social welfare for the poor. Providing help for the poor, he argued, would only harm them in the long run because it would also lead to higher prices and this would hurt everyone in society.

Beyond his ideas on population, Malthus developed a theory of profits. He believed that capitalists were justified in receiving profits due to their contribution of capital to the productive process. Their capital in machinery increased the productivity of workers and so profits were the return to capitalists for their contribution of capital.

Malthus believed that economic depressions or gluts were caused by too little spending. Inflation, on the other hand, was cause by the opposite, too much spending. These ideas are seen to have contributed to later theories of the business cycle as developed by John Maynard Keynes.

Malthus also suggested that major depressions were caused by capitalists over-saving and the lack of investment. Today Paul Krugman argues the same about the global economy. He also supported the Corn Laws to give more income to landowners rather than to manufacturers. When landowners got more income, they would spend it on conspicuous consumption and circulate the capital. Wages would also rise as also land rents causing profits to fall and also the savings of capitalists.

Malthusianism is still a major trend in economic thinking, and the argument that social welfare only hurts the poor is as prominent today as in the time of Malthus. It seems straight out of Tea Party thinking of Paul Ryan in the United States today. Malthus was certainly not on the worker’s side and one must read the biting comments of Karl Marx to see how much those on the left hated his views.
Herbert Spencer (1820-1903):

Herbert Spencer and his social statics had a great impact upon many fields of social and political thought. His importance for political economy lies in his influence on the Austrian school, including Friedrich Hayek and Ludwig von Mises. His influence was also seen in Milton Friedman, Ayn Rand, Ronald Reagan and Margaret Thatcher. The phrase used by Thatcher, “There is no alternative,” the TINA thesis, was first used by Spencer. Spencer saw exploitation in capitalism but, on the other hand, believed that “all socialism is slavery.”

Spencer was an English philosopher, biologist, anthropologist, sociologist and classical liberal political theorist. He advocated a theory of evolution before Charles Darwin. He coined the term “Survival of the Fittest” and was the most prominent European intellectual in the late nineteenth century. He published his Principles of Biology in 1864. Spencer borrowed from the theories of Charles Darwin and Lamarckism after reading Darwin’s On The Origin of The Species.

Spencer was an opponent of female suffrage in the 1880s, but opposed imperialism and militarism.

His view of philosophy can be said to be a mix of deism and positivism. He believed that the universe was “intended by the creator to promote human happiness.” However, he was not a religious man. Further as a positivist, he believed that it was only possible to have genuine knowledge of phenomena. Therefore, it is idle to speculate on the nature of ultimate reality, or God.

He believed that there was a “universality of natural law” which applied to the organic and inorganic realms, the human mind, and all of creation. He thought that all of natural law could be discovered and that there were “laws of morality” that applied to ethics. All natural laws can be summarized in the Law of Evolution and this leads to progress.

Spencer on Evolution: His views on evolution emerged around 1857. Evolution is the opposite of the Second Law of Thermodynamics. This law says that the universe is running down like a wound-up clock as its energy is expiated. On the other hand, Spencer thought that all structures in the universe develop from simple, undifferentiated homogeneity to complex differentiated heterogeneity. He sees this as a universal law in the universe. It applies to the stars, the galaxies, to biological organisms, to human social organizations and to the human mind.

Spencer’s view was different from that of Charles Darwin. He began with the approach of Lamarckian use-inheritance. This meant that organs are developed or diminished by use or disuse and that these changes were then transmitted to future generations. For example, those who play basketball will get taller. Frogs that need to catch flies will develop long tongues. This tended toward a final state of equilibrium. Also in sociology, lower forms evolve to higher forms.

The human mind evolves in the same way from primitive animal responses to man. There are two kinds of knowledge. The first is knowledge gained by the individual. The second is knowledge gained by the race. This is knowledge gained unconsciously, or through intuition.

Spencer decided that the state would decay and be replaced by a market organization. To protect against exploitation by capitalist bosses, the economy should be organized according to free worker cooperatives. These would be a replacement for wage labor. This would lead to the socialization of the means of production. But on the other hand, socialism is slavery as the individual is enslaved to the whole community.

Summary:

The Physiocrats began the task of attempting to understand the workings of the economy in a systematic way. They believed that all wealth in society was derived from the productivity of the soil and so therefore were biased toward farmers and the rural way of life. Cities and manufacturers just utilized the wealth that was produced from the soil, but did not add to the product of society.

Among the most prominent classical liberal political economists one finds John Locke, Adam Smith, David Ricardo, John Stuart Mill and Thomas Robert Malthus. They contributed several major propositions which have guided the thinking of political economists in later years. Among these are the justification for property and wealth, the ideology of laissez faire, which says that the economy and market should basically operate according to its natural laws. Adam Smith laid out a theory of division of labor, arguing that dividing production into small tasks could improve productivity. He also developed a theory of comparative advantage, along with David Ricardo, arguing in favor of free trade.

John Locke considered solitary man in a state of nature to derive ideas about how property, the economy, government, and civil society arose. He believed that man had a natural right to the resources in nature and utilized these to gain his needs. Man’s ownership of his labor gave rise to property when his labor was mixed with nature. But his insecurity in the state of nature led him to give up some of his rights in nature to a government in order to secure his life, liberty and property.

Adam Smith was not ready to dispense with government altogether, as is sometimes implied. A major function of government was to control the tendency of capitalists to form monopolies. David Ricardo observed some of the contradictions in a capitalist economy, which would later be developed by Karl Marx. Among these was the tendency of the capitalist system to stagnate and for the rate of profit to fall.

Another major contribution to political economy was the labor theory of value, or cost theory of production of David Ricardo. The value or price of a commodity was basically seen to be determined by the amount of labor used in producing that commodity. This concept was further developed by Karl Marx in Capital.

John Stuart Mill agreed with Ricardo that there was a danger of stagnation as profits fell. He began to develop ideas about the relation between supply and demand in society and contributed the idea of opportunity cost.

Thomas Malthus was pessimistic about the possibility of improving the economic condition of mankind due to his weakness in abstaining from sex. Malthus concluded that the provision of social welfare to the poor in society could only lead to the degeneration of society.

Herbert Spencer contributed to the idea that helping the poor was not a good idea and helped to lay the foundation for conservative social policies in future. The strength of classical political economy is that it does not attempt to separate economics and politics into separate spheres, as neoclassical economics does. Therefore it could consider many diverse dimensions of society and their ethical and political implications.

Key Terms:

Physiocrats                                                                             The Invisible Hand

John Locke                                                                             Division of Labor

Adam Smith                                                                           Mercantilists

David Ricardo                                                                        Externalities

John Stuart Mill                                                                     Subsistence Theory of Wages

Thomas Robert Malthus                                                        Economic Stagnation

Herbert Spencer                                                                      The Corn Laws

Francois Quesnay                                                                   Exchange Value

Robert Turgot                                                                         Labor Theory of Value

Jean-Baptist Say                                                                     Falling Rate of Profit

Social Contract                                                                       Elasticity

Natural Law                                                                            Opportunity Cost

Spoilage Limitation                                                               Jeremy Bentham

Labor Theory of Property                                                      Utilitarianism

Theory of Comparative Advantage                                        Laissez Faire

Differential Theory of Rent                                                   Malthusianism

Survival of the Fittest                                                            Charles Darwin

 

Chapter Three: The Road to Utopia

Alternatives to Capitalism: The Utopian Socialists and Anarchists

The Utopian Socialists were among the first modern socialist thinkers, beginning in the eighteenth century and continuing through the nineteenth century. Some major figures include Henri de Saint-Simon, Charles Fourier, and Robert Owen. These writers are generally referred to as utopian socialists, as opposed to the scientific socialists beginning with Karl Marx. However, the ideas of the utopian socialists clearly influenced both Karl Marx and Friedrich Engels.

Also several anarchist thinkers criticized capitalism and developed ideas about how society should be reformed. Among these were Joseph Proudhon and William Godwin.

Claude henri de Rouvroy, Comte de Saint Simon (1760-1825):

Saint Simon was an Aristocrat and Early French Socialist. His writings influenced Marxism and positivism. His influence can also be seen clearly in the ideas of Mustafa Kemal Ataturk.

Saint Simon envisioned a state technocratic socialism. In this view, industrialists would lead society and develop a national community based upon cooperation and technological progress. Science would direct society and not religion, bringing an end to poverty. He thought that industrialists who can organize society for productive labor should rule society. These ideas seem to have influenced Thorstein Veblen.

While Adam Smith talked of the “invisible hand,” Saint Simon talked of the “hand of greed,” meaning human avarice. Capitalism was a rational system based upon the development of technology and efficient production of the needs of society. With such development of the productive forces, it made no sense for poverty, suffering and inequality to ravage society. For Saint Simon and other utopian socialists, it was logical that the emergence of the productive forces should be harnessed to provide for the needs of all in society. Why should poverty and degradation remain, when the simple remedy for its elimination had been developed?

As scientific socialists would argue later on, the historical task of capitalism was to develop the forces of production as a basis for socialist society. The utopian socialists described their visions of that society, although most of them did not know how society could be reshaped into their utopia. However, Robert Owen and Charles Fourier did set up communities in the real world which were experimental socialist societies. Most of them were not successful and did not last very long. And these theorists did not have a theory of how society would reach their vision of utopia on a mass scale.

Francois Marie Charles Fourier: (1772-1837):

Charles Fourier was a French philosopher who is said to have invented the word “feminism.” Fourier designed models of utopian societies and several were actually set up. His model of utopian society was called a phalanx. One example was the community of Utopia, Ohio which was set up as an experiment in utopian living. Another called La Reunion was established near Dallas, Texas. Others included the North American Phalanx in Red Bank, New Jersey; Brooke Farm in West Roxburn, Massachusetts; and Sodus Bay Phalanx in New York State.

Fourier wanted to be an engineer and architect and was influenced by the 1848 Revolution and the Paris Commune. He believed that society should be based upon cooperation. Members of the community would live in grand hotels and work would be sexualized.

Robert Owen (1771-1858):

Robert Owen was a Welsh social reformer and industrialist. He is considered to be the founder of utopian socialism and the cooperative movement. He wrote A New View of Society. Owen became the manager of a textile mill in Manchester, England, and joined the Manchester Literary and Philosophical Society. Owen became the manager and part owner of New Lanark Mill. This mill employed some five hundred children from poor houses and charities in Edinburgh and Glasgow. The textile mills were then mired in drudgery for these poor children. The company also operated a company store. Owen wanted to sell goods to the workers at a low price and supervise their use of alcohol in order to improve their depressing condition of life.

Jeremy Bentham, the philosopher of utilitarianism, helped Owen to buy out the partners of the mill. While Bentham was a utilitarian and free marketer, Owen moved ever closer to socialism.

In his book, A New View of Society, Owen put emphasis upon the early training of the child. He published his Essays on the Principle of the Formation of Human Character (1813).  He said that youth must have the proper physical, moral and social influences to develop properly.

By 1817, Owen had become a socialist and decided to set up utopian communities. Each of his utopian societies would contain about twelve hundred persons settled on 1500 acres of land. The residents would live in one large building with a public kitchen and mess hall. Each family, however, would have its own quarters. After age three, the children would be taken from the parents and brought up by the community. Wages of workers would be equal for all those over fifteen years of age.

Owen set up some of these experimental communities in the United States. New Harmony in the state of Indiana was one such community. However, these communities in the United States failed after about two years.

The Political Economy of Anarchism:

Pierre-Joseph Proudhon (1809-1865):

Joseph Proudhon was a French philosopher, libertarian socialist and anarchist. He may have been the first person to define himself as an anarchist. His best known works are: What is Property? (1840) and The Philosophy of Poverty. Proudhon argued that property is theft and should be abolished.  Proudhon believed that social revolution could be achieved in a peaceful way. He formed worker’s associations or cooperatives. He defined anarchy as “an order without power.”

Proudhon was too poor to attend school but read much and was influenced by Charles Fourier. He participated in the Revolution of 1848 in France. He tried to establish a national bank, as a sort of credit union, but the enterprise failed.

For Proudhon, “Whoever lays his hand on me to govern me is an usurper and tyrant, and I declare him my enemy.”

As a socialist, he said that the workers should own the capital goods through associations, not the state. As a libertarian socialist, he wanted worker’s self- management. Proudhon rejected both capitalism and communism. His philosophy of mutualism meant that the workers would control the means of production. A federation of free communes would be established each in a small area of France. Government would be abolished. He opposed military dictatorship and war. He also clearly influenced Karl Marx. However, Marx attacked his book, The Philosophy or Poverty with another book, The Poverty of Philosophy. He thought that Proudhon did not understand the nature of capitalism and criticized his analysis.

William Godwin (1756-1836):

William Godwin was an English political philosopher, and anarchist. He was also a utilitarian. His most famous work is an extensive work, An Enquiry Concerning Political Justice. His desire was clearly to destroy the political, social, and religious institutions but without the use of violence. He said that “God himself has no right to be a tyrant.” Born in a Calvinist family, he became a minister but was an atheist. He said that all control of man by man is intolerable. He thought that man should live by pure reason. He believed that the present economic and political institutions created existing poverty and degradation of the working class and made them stupid.

Godwin engaged in a long debate with Thomas Malthus about population. Malthus did not think that Godwin’s ideas could succeed with the increasing population. But Godwin believed that the rational reorganization of society could eliminate poverty and inequality and usher in a better society.

Summary:

The thinkers in this chapter, unlike Adam Smith, believed that capitalism, as it existed, could not be the key to the good society. The Utopian Socialists imagined how communities could be set up to build an ideal society. One of the more eccentric thinkers was Charles Fourier who described in detail how a utopian society could work, with everyone assigned his and her own duties.

Robert Owen was an industrialist, but believed that something must be done about the degradation of the workers, including the children in the work houses of nineteenth century England. He proceeded with educational reforms and set up opportunities for those in his mill in England to improve their lives, while still remaining workers in his factories. His ideas also resulted in the setting up of several experimental societies in the United States. These societies, however, could not succeed in their goals of reforming society and were disbanded after a short period.

The anarchists Joseph Proudhon and William Godwin also believed that it was necessary to reform society and eliminate the system of capitalism which existed. They believed that governments primarily protected the property of the wealthy and helped to exploit the poor in society.

Key Terms:

Utopian Socialists                                                                  Joseph Proudhon

Anarchists                                                                               William Godwin

Saint-Simon                                                                            Phalanx

Technocratic Socialism                                                          New Lanark Mill

The Hand of Greed                                                                 New Harmony

Robert Owen

Charles Fourier

 

 

Chapter Four: Radical Critique

The Origins of Scientific Socialism and Karl Marx

This chapter will consider the early socialists, such as Louis Blanc, Louis August Blanqui, Karl Marx and Friedrich Engels. Socialism was a reaction to the exploitation of emerging industrial capitalism in the nineteenth century. Blanc and Blanqui set up revolutionary organizations in the attempt to establish socialist governments.

In the middle of the nineteenth century, Karl Marx began to construct his massive critique of capitalism. He began his critique with his Economic and Philosophical Manuscripts of 1844. Along with Friedrich Engels, he constructed the dialectical materialist theory of history in The German Ideology in the 1840s. In the mid-1850s, Marx used Hegelian logic to start to unravel the secrets of the capitalist system. This was done in a series of notebooks, an extensive outline for his three volumes of Capital. This was later published as the Grundrisse, or outline, and contains deep penetrating insights into the nature of money and capital. The Grundrisse contains only two chapters. The first chapter is on money. The second chapter, which, takes up most of the book, is an analysis of capital. It was during this time that Marx developed his concepts for Capital. The first volume of Capital appeared in 1863. Marx continued this massive critique until his death in 1883, but was unable to complete the work. The second two volumes of Capital were edited by Engels after Marx’s death. A fourth volume appeared as Theories of Surplus Value. In this work, Marx critiqued the works of many contemporary political economists.

Marx developed the foundation for the ongoing radical critique of capitalist political economy, which has continued since his death and still goes on today in the critique of the contemporary global political economy. The views of these political economists who take a radical approach will be examined in later chapters.

Early Socialists:

Louis Blanc (1811-1882):

Louis Blanc was a French politician, historian and socialist. Blanc wanted to create cooperatives to guarantee employment for the urban poor. His principle was: “From each according to his abilities, to each according to his needs.” This phrase was to become a famous slogan of Karl Marx and the communists. Blanc also demanded the equalization of wages. He wanted to establish social workshops, organized like trade unions.

In l848, Blanc became a member of the Revolutionary Provisional Government which was set up in Paris during the revolution. When the national funding for workshops failed and workers were exploited, Blanc was exiled to Britain. Nevertheless, he greatly influenced French socialism.

Louis Auguste Blanqui (1805-1881):

He who has iron has bread.” (Louis Blanqui)

A more radical thinker and political actor was Louis Blanqui, a French socialist and architect of the revolutionary theory of Blanquism. He took part in the July Revolution of 1830. Blanqui developed the Theory of Republicanism. He was imprisoned under the rule of Louis Philippe (1830-1848) and condemned to death in 1840. However his sentence was commuted to life in prison. Released in 1848, he was sent to prison again in 1849 and later elected President of the Paris Commune. He was an early Leninist in his theory of revolution. Blanqui demanded a just redistribution of wealth, but believed that revolution should be carried out by a small group of professional revolutionaries, not the working class. This idea is a forerunner of Vladimir Lenin’s theory of the revolutionary vanguard.  The group of revolutionaries would establish a temporary dictatorship by force. After this, power would be given to the people. Blanqui believed that radicalism must be enforced by violence. Half of his life was spent in prison.

The Radical Critique: Karl Marx and Friedrich Engels

Any new system of political economy is sure to meet with its critics. Intellectuals who examine the system will begin to find cracks in the logic and many contradictions. In the middle of the nineteenth century this began to happen to liberalism under the emerging system of capitalism.

The major radical critique of capitalism emerged from Karl Marx and Friedrich Engels in the mid-nineteenth century. In 1843, Karl Marx began writing the Economic and Philosophical Manuscripts in which he began his critique of capitalism. Marx knew that it was a formidable task to understand the inner workings of capitalism, but he thought that it was necessary to understand and change the world for the better.

He began to write about the nature of human individuals, particularly workers, and what was happening to them under the existing system of capitalism. For Marx, man was a species being. His activity was human activity, which Marx believed was different from the activity of animals. Animals engaged in producing their livelihoods, but not in the same way as man. Humans produced in a human way. This meant that they constructed things in their minds before constructing them in the real world. This was human production. It allowed individuals to develop their intellectual capacities to become more creative in art, music, philosophy and so on, which are human activities.

When it came to capitalism, Marx looked at the condition of the worker. What was happening to him and her? Workers were producing, but not in a human way. In fact when one looked closely at capitalism, one could see that it was rapidly reducing the worker to the level of an animal. One could only see animal functions in the activity of the worker. The worker ate, slept, reproduced, and carried on, not according to his nature, not as a species being, but as an animal, and a very poor animal at that. Even dogs would not be treated nearly as badly as the worker was being treated under capitalism.

There were many contradictions in the capitalist system. The harder the worker toiled, the poorer he became. He worked his entire life and died as a pauper. The only thing he could do was to reproduce a new generation of workers to take his place in the factory. This was the rule according to the subsistence theory of wages, which was accepted by classical political economists. His condition was reduced to something much less than human.

Marx and Engels engaged in a dialogue with some of the leading German thinkers and writers of the day. One of these was Max Stirner. In The German Ideology, Marx and Engels attempted to understand history theoretically. In doing so, they developed their dialectical materialist theory of history. They believed that history was marked by distinct eras, beginning with a period they called prehistory. An early period was a primitive society based upon slavery. This was followed by the system of political economy known as feudalism. Once feudalism broke down, the era of capitalism was ushered into being. With the breakdown of capitalism, in a likely revolution, Marx and Engels believed that the socialist era would begin. Eventually, a fully developed socialist system of society would be consolidated in an era of communism.

Marx believed that each of these periods of history was marked by characteristic economic, political, and ideological features. Marx produced a model of society, in each particular historical era of history. Society was divided into two basic parts, the economic or material base and the superstructure, which included political institutions, religion, philosophy and ideology. In each case there was a close correspondence between the material base and the superstructure which was thrown up by the economic base. This suggested that the way man produces his living, that is, the realm of production, largely determined the institutions and philosophical superstructure of society.

The economic base was divided into parts. The most basic element was the mode of production, which included technology. Feudal society was characterized by hand labor, while industrial capitalism was characterized by machine production. Associated with the mode of production and forces of production or technology, was the second tier, or the relations of production. While the feudal era gave rise to relations between feudal landowners and laboring serfs, capitalism threw up social relations between owners (capitalists or the bourgeoisie) and workers (the proletariat). Capital signified a social relation between two classes in society, those who owned capital and those who owned nothing except their labor power.

In the superstructure, feudalism was marked by feudal institutions, the church, the nobles and kings. Capitalism, on the other hand, threw up its own institutions, liberal society with laws which were tailored to protect private property. The capitalist society was sanctified by an ideology, such as the ideas of John Locke or Adam Smith, which justified the gaining of great wealth by the class which owned capital. And the whole system was sanctified by the belief in religion, by which God put his stamp of approval upon the entire social system.

For Marx and Engels, according to a dialectical historical process, each stage of history was bound to change into another stage of history. History moved from thesis to antithesis to synthesis. The transition was not to be a smooth continuous process, but rather a sharp break with the past through a revolution in which the old society was partially destroyed, but essential features carried forward to the next era. If feudalism was the theses, capitalism was the antithesis of feudalism. It was a negation which yet contained elements of feudalism. The emerging of socialism would be a synthesis in which the forces of production developed in capitalism would come together in a new social system.

Marx and Engels argued that one historical era changed into another due to the major contradictions in the system. Once these contradictions became too sharp, the binding forces of the society would be “burst asunder” and bring about a revolution.

For example, there were many contradictions in capitalism. At the root of the system, however, was the fundamental contradiction between the capitalist and the worker. As capitalism developed and technology increased, the worker could produce all his needs by working a few hours a day. But under capitalism, the worker worked long hours producing a massive amount of goods that were then owned by the capitalist. Technology, the development of the forces of production, had advanced to the point that the only rational organization of society was socialism in which everyone enjoyed the fruits of production. But the “fetters” of private property meant that only a small percentage of society, the ruling class, would enjoy the full fruits of society. As this contradiction grew more acute, Marx thought that the system would explode into a revolution at some point. These contradictions were like a ticking time bomb planted in the system that at some point would explode the whole system. While the liberals saw the capitalist system as rational, Marx believed that once the forces of production had been developed, it was irrational. A true democracy would mean that the universal class, the working class, must take power and rule.

Marx decided that it was necessary to further analyze the laws of motion of modern capitalist society. He would do this using Hegelian logic. In 1856, he began work on his outline for his great work, Capital. His notebooks were  published as the Grundrisse or outline for Capital, as noted above.

Marx noted that money in simple form was merely a medium of exchange. The principles of equality were in effect in that both the rich and the poor used money in the same way. It was simply a token of exchange. As long as money was used merely as a medium of exchange of use values, then there was no distinction in the market between the rich and the poor. However, once money became transformed into capital, then it turned the world upside down. Money as capital allowed one class in society who owned capital to gain political and economic power over those who owned nothing but their labor power. This metamorphosis of money into capital changed the nature of economic production and all of society.

There were many pithy observations made in Grundrisse, including the following. “Money gives…a general power over society, over the whole world of gratification, labors, and so on.” “Before money becomes capital the circulation of money and commodities is based upon freedom. When money has been transformed into capital, the processes which go on beneath the surface are the very opposite of freedom.”

Marx used these observations in his analysis of capitalism in the first volume of Capital, which was published in 1863. Marx thought that he had discovered the source of profit. For Adam Smith and David Ricardo, labor had to be the source of profit. For Marx, too labor was the source of profit. Marx showed that if the capitalist paid the worker the full value of his labor power that he used in the production process, it would not be possible to make any gain. The capitalist would go broke and have to turn to work himself. On the other hand, it was clear that there had to be an element of exploitation for the capitalist to make a profit. He had to get more value from the worker than what he paid him for in order to come out ahead.

To analyze this, Marx divided the working day into two parts, necessary labor time and surplus labor time. In the first part of the working day, the worker produced for himself or herself simply to live and reproduce a new generation of workers. In the second part of the working day, the worker worked for the benefit of the capitalist and what he produced belonged to the owner. The worker’s labor and life force was being alienated. This was unnecessary labor time for which the worker gained nothing. It was surplus labor. This surplus labor, over and above what it took to live, produced surplus value for the capitalist and was the source of profit. If in a ten hour working day, the worker produced his living in five hours necessary labor time, this was one-hundred percent exploitation. The rest of the day was spent working for the capitalist.

Note that Marx arrived at these conclusions based upon the assumptions of classical political and economic thinkers like Adam Smith and John Locke. This was the labor theory of value. But in this case, the value produced was only partly owned by the worker. Most of it was going to the capitalist and he became richer and richer.

This concept of exploitation through surplus labor became a powerful tool for the working class as the workers began to organize themselves into trade unions. Marx was active in the International Working Man’s Association, the First International. It was difficult for industrialists to deny that the working men were being exploited after the powerful analysis of Marx and Engels. In the case of the industrialists, a new theory about where profit came from was needed to drive back the workers and crush the trade unions.

The Labor Theory of Value:

The classical labor theory of value occupies a large and important place in radical political economy. As we have seen, the idea that man acquires property through his labor, the labor theory of property begins with John Locke. This provides a basis for the labor theory of value which is found in Adam Smith and further developed in the works of David Ricardo and Piero Sraffa.

While it can be argued that Karl Marx did not believe that value was truly based upon labor, he employed the classical concept to analyze the workings of capitalism. For example, in Marx’s ideal social system, labor would not be the foundation for measuring value in society. Marx wanted to show that using the classical concepts of political economists that there were contradictions in the system which showed it as being a system of exploitation for the workers. Nevertheless, Marx saw the capitalist system as a necessary phase in the unfolding of history. The historical task of capitalism was to develop the forces of production, in other words, technology, which was necessary as a basis for the future socialist society.

The labor theory of value says that the value of a commodity is only related to the labor needed to produce that commodity. This generally includes elements which contain embodied labor. After the marginalist revolution in the nineteenth century, the labor theory of value became associated with radical or Marxist economics although it was a central plank in the work of Ricardo.

For Marx and Ricardo, the enterprise was to quantify and embody all the labor components in order to determine the price, sometimes considered a natural price, of the commodity. This value was therefore thought to be objective, rather than subjective. Ricardo believed that the subjective desire for products did not have very much to do with effective demand for commodities which could be readily reproduced, such as the items used every day. There was a natural price and this natural price could not skyrocket simply because of the scarcity of the item or its popularity.

Value, then refers to the amount of labor necessary for the production of a commodity for the market. Value and price become based upon the cost of production. This would include the labor embodied in the capital employed in the shape of technology, or machinery.

The development of the labor theory of value, however, was different for Adam Smith and Marx. That is, Marx tried to correct Adam Smith’s work and be more rigorous in his analysis, as laid out in the first volume of Capital.

Let us first see how Adam Smith approached the problem of value in The Wealth of Nations. First, in his determination of the labor value, Adam Smith did not include the quantity of all past labor needed to create the capital such as the tools used in production. He began by saying that the worth of a commodity was whatever labor it would command in trade with another commodity. Alternatively, it was worth whatever labor it would save one when in use. This was “value in use.” Or an item could also contain both of these types of labor value. Then he says that this value is subject to supply and demand at a particular time. This seems to add confusion, however, to his method.

From the Wealth of Nations (Book 1, Chapter V) Adam Smith says “The real price of everything, what every- thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What everything is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people.”

Many argue that for Smith, then, “price” is the same as “value.” It has nothing to do with the past labor spent in the production of the commodity. It involves only the labor that can be commanded or saved at present. This means that if it has no use, then it is economically worthless in use or trade.

For Smith, unlike Marx, nature can also generate value. This analysis seems to be quite fuzzy in Adam Smith.

Since the days of the classical political economists, a major difficulty which emerged is the transformation problem. How does one derive the price of a commodity from the value of the commodity, as determined by the amount of labor it contains? This was a problem to be worked out by later radical political economists.

The alternative system of deriving price by using the concept of marginal utility as developed by the marginalist revolution avoided this problem. However, the radicals believed that the marginalists had simply glossed over the problem rather than solving it. They were simply constructing a new ideology which justified capitalist profits, while avoiding the root of the problem.

Summary:

Louis Blanc and Louis August Blanqui were early social revolutionaries who wanted to change society in the early nineteenth century to help the working class. They struggled to foment revolution rather than constructing a utopian society, as the utopian socialists.

In the 1840s, Karl Marx began his analysis and critique of capitalism. Along with Friedrich Engels, he developed a dialectical materialist theory of history. In the l850s, Marx began a more systematic and deep penetration into the secrets of the capitalist system, using Hegelian logic. This resulted in his notebook outlines for his first approximation of the capitalist system published in the first volume of Capital in 1863. This was, in the words of Marx, a contribution to the critique of political economy and an attempt to understand the laws of motion of the modern capitalist system.

A major thrust of the work of Marx and other radical thinkers was the labor theory of value, which was derived from the work of the classical liberals, Adam Smith and David Ricardo. This approach has continued to be the basic foundation for radical political economists since this time.

The problem, however, of how to convert value, based upon labor content, into prices, or the transformation problem has proved to be a thorny issue for radical political economists.

The marginalists and the Austrian School of Economics avoided this problem with the theory of marginal utility. They also sought to repair the damage done to the image of industrial capitalism which followed from the massive radical critique of Marx and Engels. While the marginalists believed that they had solved the problem of the determination of value and price, the radicals thought that they had simply avoided coming to grips with the fundamental problems of the capitalist system.

Key Terms:

Louis Blanc

Louis Auguste Blanqui

Karl Marx

Friedrich Engels

Economic and Philosophical Manuscripts

The German Ideology

Grundrisse

Capital

Theories of Surplus Value

The Paris Commune

Radical Critique

Species Being

Human Production

Dialectical Materialist Theory of History

Economic Base

Superstructure

Forces of Production

Relations of Production

Money

Necessary Labor Time

Surplus Labor Time

Surplus Value

Rate of Exploitation

Labor Theory of Value

Value in Use

Exchange Value

Use Value

The Transformation Problem

Chapter Five: Putting Capitalism Back on Track

The Marginalist Revolution and the Austrian School of Economics

This chapter will explore the major ideas of the marginalist revolution of the late nineteenth century, including the contributions of William Stanley Jevons, Carl Menger and Leon Walras. These thinkers laid down the basic concepts for neoclassical economics of the twentieth century. The chapter will also cover the emergence of the Austrian School of Economics. With this development, approaches to the analysis of political economy split into two great camps, which we may roughly refer to as radical political economy and mainstream neoclassical economics.

Since 1890, the mainstream neoclassical approach to economic analysis is what has been taught primarily in economics courses in colleges and universities around the world, including emerging capitalist countries.

The Marginalist Revolution:

The early classical political economists were engaged in what was called “moral economy” at the time. Basically, this is what was later called political economy. It was only after the marginalist revolution and Alfred Marshall’s famous work in 1890 that the term “economics” came to replace “political economy” in the mainstream of economic thought. Still many economic thinkers, particularly those on the left, continued to refer to economic analysis as “political economy.”

At the same time that Karl Marx was engaged in his massive analysis and critique of capitalism, a group of thinkers in England and Europe began to look at political economy in an alternative way. The critique of political economy by the critics, particularly in light of the labor theory of value had clearly exposed the exploitation of the capitalist system. As working men began to organize themselves and demand higher wages, the critique of Marx and Engels provided a powerful tool in their struggle for living wages and an improvement in their life style.

The result was a counterattack from above. One form of the class struggle from above came as an attack on the Marxists and the labor theory of value. This was the emergence of the marginalist school in the second half of the nineteenth century. Value would not be seen as based upon labor, but upon utility. For the Austrians, this would be a subjective view of utility, rather than an objective view. This means that utility would be measured in terms of how much satisfaction it would give to the consumer. In their view, utility was subjective and this was what determined value and price.

At the same time, political economists, such as Leon Walras, began to use mathematical analysis to describe the workings of the economy. This started to make political economy more technical and narrow and to separate it from the political dimensions of the class struggle. At the same time, economic analysis started to become more specialized, abstract and not understandable by the working classes. One could remark that it was a sort of Sanskritization of political economy into an abstruse language which would be unintelligible to all but an academic circle schooled in the new mathematical methods. This would be very useful ideologically.

It is in the light of this development that we view the emergence of the marginalist revolution and the emergence of the Austrian School of Economics.

William Stanley Jevons (1835-1882):

William Stanley Jevons was a British economist and logician. He helped to devise the mathematical model in economics with a paper in l862 with the title of “A General Mathematical Theory of Political Economy.” Jevons used mathematical methods earlier than Alfred Marshall and wanted to make economics into a “science.”

Jevons helped devise the marginal utility theory of value, along with Walras and Menger and so made a contribution to the marginalist revolution. He also formulated Jevon’s Paradox. This says that “increases in energy production efficiency leads to more, not less consumption.” His book, The Theory of Political Economy appeared in 1871.

Jevon’s most significant contribution to economics is his theory of marginal utility. He also constructed a theory of the business cycle, based upon sunspot activity. This theory, however, has been long discredited as a rather crackpot idea.

Jevons believed that the utility of a commodity was not objective but a subjective measure. In other words, the utility of a commodity does not depend upon how much use value it contains, but rather how badly one desires to have or use the commodity. Secondly, Jevons argued that price was determined by the principle of diminishing marginal utility. This simply says that as people consume more and more of a good, they get less and less utility out or each additional unit. If one has a cold beer on a hot day, the first beer has a great deal of utility. The second beer has considerably less, and the third less than that.

The importance of this view is that it means that when there are no restrictions on free choice, this will result in the maximum utility for the consumer. Therefore, it becomes a strong argument for laissez faire policies. This is logical, in terms of an economic model, whether it is true in the real world or not.

Given his subjective view of utility, Jevons argued that Quesnay was wrong to argue that there were two kinds of labor, productive and unproductive. For Jevons, all labor was productive. He also argued that the classical political economists, Adam Smith and David Ricardo were wrong about the subsistence wage. For Jevons, there is no subsistence wage. Workers will continue to take jobs, regardless of how low the wages, as long as they get more gains out of the job than the utility they lose. In the twentieth century, University of Chicago economists have won Nobel Prizes for basically extending this argument.

Finally, Jevons did not believe that there was opposition between labor and capital. There was no class struggle between the proletariat and the bourgeoisie. Workers were simply making rational decisions about whether to work or not to work and capitalists were making rational decisions about whether to invest or not. But Jevons did not explain how a worker could live on a job which paid less than the subsistence wage.

Leon Walras (1834-1910):

Leon Walras was a French mathematical economist who formulated the marginal theory of value. He is noted for founding the Lausanne School of Economics. Along with William Stanley Jevons and Carl Menger, he is one of the three leaders of the Marginalist Revolution. He published Elements of Pure Economics (1874). This book dealt with supply and demand and general equilibrium theory. He formulated Walras’s Law which states that any particular market must be in equilibrium if all other markets in an economy are also in equilibrium.

Clearly, Walrus’s most significant contribution to economics was his general equilibrium model. According to this theory, all markets in an economy could be in simultaneous equilibrium. He was also responsible for making economics more mathematical with his work at the Lausanne Academy.  He argued that all markets in an economy would move toward equilibrium. To attempt to prove this theory, he set up a series of equations to describe the whole economy. There were four sets of equations in the general equilibrium model. The first set was based upon quantities of each good demanded by consumers. The second set of equations measured what determines the price of each good. These first two sets described the consumer side of the economy. The third set of equations described the quantity of inputs or factors of production, land, labor and capital. The fourth set of equations described the quantity of inputs bought by businesses, or investment. In solving the series of equations, Walras claimed that he could describe the relative price of all goods relative to a known price, which he called the numeraire.

Walras believed that his solution to his abstract model of the economy was close to the actual behavior of a real economy. This was because the desire of sellers and buyers to maximize utility and competition produced the result predicted by the model. He said that there was a process going on similar to an auctioneer, the tatonnement, which moved the markets to equilibrium prices. This was a “groping process,” sort of trial and error, in which the decisions of buyers and sellers determined the price and this would be the equilibrium price. Walras also suggested that this would be a natural process.

There have been critics of Walras’s general equilibrium model, however. First, if it is firms which set prices, they may be set too high, especially in a monopoly situation. Prices may be set in accordance with future expected demands. Secondly, there is a problem with Walras’s equations because the solution to some equations may yield negative prices. This is unrealistic in the real world. This problem was pointed out by the economist, John von Neumann.

Walras was also a strong believer in methodological individualism. This simply says that all explanations of economic phenomena should be based upon individual acts of choice. His work clearly tied in with the Austrian School of Economics.

Carl Menger (1840-1921):

Carl Menger was the founder of the Austrian School of Economics and also contributed to marginal utility theory. This was a radical departure from the classical views of Adam Smith and David Ricardo, who basically used cost-based or labor theories of value. His book, Principles of Economics, appeared in l871. According to his theory of marginality, price is determined at the margin. He became the Chair of Political Economy at the University in Vienna and also worked on monetary theory.

Menger’s two main contributions are central planks of the Austrian School of Economics. He developed the subjective theory of value and insisted that economic knowledge is based upon deductive consequences of assumptions which are obviously true. He claimed that this was the only way to obtain economic knowledge.

Most of Menger’s work as an academic economist was done at the University of Vienna. He was one of the economists who developed the marginal utility theory of value and the principle of diminishing marginal utility. The marginal utility theory of value says that each additional unit adds more utility, but as more units are added, each adds somewhat less utility.

In developing the subjective theory of value, which has become the mainstream way to measure value in economics, Menger thought that one must look at subjective values, not objective ones. The idea of value based upon cost is an objective way of measuring value. But when value is based upon subjective factors, it depends upon how badly one really wants a commodity. A fancy sports car may not be worth its price in terms of what it cost to produce it and because it will get one to another destination. But it may be worth it in terms of giving one satisfaction in driving it and impressing others and attracting their attention. Therefore, subjective value is based upon the satisfaction that one gets from the commodity. To buy the sports car may seem irrational to some, but nevertheless, it is seen as a rational decision to spend a large amount of money to acquire the powerful sports car and the prestige which goes with owning it.

Menger believed that there were degrees of satisfaction. He classified goods into categories, such as those that preserve life, goods that preserve health, goods for individual welfare or future health and life, and different types of diversions, like watching films. He then set up tables to show principles of value which measure the relative satisfaction coming from different goods. In general, people must buy goods that satisfy their greatest needs first. One needs food more than one needs a car. One needs a car more than one needs a yacht.

This theory put Menger at odds with Quesnay, because it said that any activity that yields subjective satisfaction is a productive activity. It does not need to produce a tangible commodity. Singing and producing art are productive activities. The subjective value theory of Menger also was designed to prove that the labor theory of value of Ricardo and Marx was wrong. A commodity can contain high value, even though it contains little labor, according to this line of thinking.

Methodological individualism and marginal productivity are also important planks of the Austrian School from Menger. Economics must begin by studying the decisions of the individual. Also the value of a factor of production, such as land, labor or capital, is the value of the marginal productivity of the factor. To find the value of labor, one must determine how much value one extra worker adds to the productive process. The same holds true for the other factors of production, capital and rent or land.

Menger argued that real world empirical evidence could not be used to derive economic knowledge. Such knowledge must be derived a priori, that is according to a principle that one knows to be true. One knows that one would prefer to have a salary of twenty dollars per hour rather than a salary of ten dollars per hour. One knows that a worker would prefer to work 30 hours a week for the same pay, rather than 40 hours a week. Menger thought that the experience of real world economics could be misleading in terms of true economic knowledge based upon sound principles. This became a central tenet of the Austrian School of Economics. It is clear that these ideas influenced economic thinkers such as Milton Friedman at the University of Chicago and James Buchanan at the University of Virginia. It is clear that they became a part of mainstream economics in the neoclassical era of economics beginning with Alfred Marshall in l890.

The Austrian School of Economics: Also called the Psychological School, the Austrian School and the Vienna School.

The Austrian School of Economics is considered to have been founded with the publication of Carl Menger’s 1871 book, Principles of Economics. This book also advanced the theory of marginal utility. The early proponents were Carl Menger, Eugen von Bohm-Bawerk, and Friedrich von Wieser. At the end of the nineteenth century, they launched an extensive critique of Marx and attacked the Hegelian approach.

The Austrian school is based on methodological individualism, the purposeful actions of individuals. It originated in the late nineteenth and early twentieth centuries in Vienna. It was developed from the work of Carl Menger, Eugen von Bohm-Bawerk and Friedrich von Wieser. Later, Ludwig von Mises contributed to this school of thought. These economists developed a subjective theory of value and marginalism in price theory, as noted above. The Austrian School criticized mainstream economics rejecting econometrics, experimental economics, and aggregate macroeconomic analysis.

The Austrian School of economics claims that one can reach economic conclusions from pure logical deduction, unlike mainstream economists. They used what they call praxeology to deduce a priori theoretical economic truths. They believed that deductive economic thought experiments could yield conclusions which follow irrefutably from the underlying assumptions.

The fundamental views of the Austrian School are as follows.

Principles:

1.Methodological Individualism: The explanation of economic phenomena is based on actions of individuals. They say that groups or collectives cannot act except through individual actions.

  1. Methodological Subjectivism: In explaining economic phenomena, one must look at judgments and choices made by individuals based on their knowledge and expectations. This results in methodological subjectivism.
  2. Tastes and Preferences: Prices are influenced by consumers through tastes and preferences. They make subjective valuations of goods and services and this determines demand.
  3. Opportunity Costs: Producers and other economic actors calculate costs which reflect the alternative opportunities which must be given up.
  4. Marginalism: In all economic designs, the values, costs, revenues, productivity, and so on, are determined by the last unit added or subtracted from the total.
  5. The Time Structure of Production and Consumption: Decisions to save reflects time preferences regarding consumption in the immediate or distant future. Investments are made in view of larger outputs expected.
  6. Consumer Sovereignty: The government should not interfere with the market. There should be no restrictions on buyers and sellers.
  7. Political Individualism: Only with full economic freedom is it possible to secure political and moral freedom.

The Austrians attacked Karl Marx’s Labor Theory of Value. The dilemma involves the Economic Calculation Problem. Frederick Hayek dealt with the problem in The Road to Serfdom. Hayek said that socialist governments lacked individual incentives. In socialism, individuals cannot make optimal decisions. He argued that because of this, socialism is not sustainable. He was von Mises’s student and von Mises said that rational economic activity is impossible in a socialist commonwealth.

After 1940, a split occurred in Austrian economics between Frederick Hayek and von Mises. Von Mises believed that neoclassical methodology was badly flawed. However, Hayek accepted much of neoclassical methodology and some degree of government intervention. Hayek was awarded the Nobel Prize in economics in l974. His thought is associated with the Cato Institute, George Mason University, and New York University.

Criticism:

The school has been criticized by many economists, including Gordon Tullock, Milton Friedman, Paul Krugman, John Maynard Keynes, and Piero Sraffa. For Friedman, the theory was not consistent with empirical evidence. Friedman also argued that the Austrian’s explanation of the business cycle was wrong.

Paul Krugman said that there were holes in their thinking. Jeffrey Sachs said that Hayek was wrong to argue that high government spending harms an economy. A general welfare state is not the road to serfdom, but provides fairness, economic equality, and international competitiveness. Sachs showed that among developing countries, those states with high taxation and more social welfare spending had a better economic performance.

Nevertheless, the concepts of marginal utility, opportunity cost and time preference have been absorbed into mainstream economics.

Summary:

The marginalist revolution in economic thinking took place in the second half of the nineteenth century and turned political economy on its head. The concept of the labor theory of value from David Ricardo seemed to be inadequate to explain the production process, once the radical critique from Karl Marx and other critics had shown that it meant that the worker was being exploited.

Jevons, Menger and Walras helped to revise capitalist economic ideology with the marginal theory of utility. Viewing capitalist production in this way made it more difficult to argue that the worker was suffering any degree of exploitation in the work place. Also the trend toward using mathematics to describe economics further tended to make economics an abstract science difficult to grasp by those not familiar with mathematical techniques. Rather than focusing upon groups in society, these economists focused upon individuals and their decisions made individually. These decisions were defined as logical. The labor theory of value was scrapped and value came to be seen as subjective, rather than objective. This meant that the price was determined simply by the dynamics of the market, supply and demand, and had nothing to do with the amount of capital contained in the product.

For Marx and the radicals, this new approach merely covered up the processes taking place in the real world and obscured the capitalist production process. Marx had shown in Capital that if the worker was paid the full value of his labor, there would be no profit left over for the capitalist. It was just like the old Wobbly song said: “If I got paid all the money I earn, the boss would go broke and to work he must turn.” The Wobblies were members of a leftist trade union, The Industrial Workers of the World (IWW).

The radical critique of Marx and Engels had exposed the deep ideological fallacy in classical political economy. Adam Smith, along with John Locke, began with the argument that the process was a natural one. That in the free market economy prices would find their natural price. Marx and Engels had argued that there was, in fact, nothing natural about this whole process. It just depended upon the fact that the boss had the capital and the worker only had his labor power and he must work for a wage that only kept him alive.

It was this radical process of denaturalization of the prevailing view of the world that made the marginalist revolution necessary. The marginalists put the ideology back on its track and with the argument that there would be a general equilibrium in the economy it could again be argued that prices would find their natural level. Perhaps the marginalist revolution can be seen as a necessary correction to the ideological superstructure of capitalism. It laid the basis for neoclassical economics. With the work of Alfred Marshall, economics, seen as a science, was viewed as separate from politics. It came to be seen as a neutral science based upon truths which could be learned through a deductive process. The science of economics became worker proof. Nevertheless, the radical critique of capitalism continued to develop along its own line, still seeing value as based upon labor.

Key Terms:

William Stanley Jevons

Carl Menger

Leon Walras

Austrian School of Economics

Marginalist Revolution

Jevon’s Paradox

General Equilibrium

Groping Process

Methodological Individualism

Objective Value Theory

Subjective Value Theory

A priori economic truths

Deductive Methodology

Praxeology

Methodological Subjectivism

Time Structure of Production and Consumption

Consumer Sovereignty

Frederick Hayek

Chapter Six: The System

Neoclassical Economics and the Neoclassical Synthesis

We now come to Alfred Marshall (1842-1924), the economist who systematized the marginalist revolution in his famous textbook, Principles of Economics in 1890. This laid the foundation for later mainstream neoclassical economics. Neoclassical economics would be modified by Keynesianism in the l930s, with Keynes’ General Theory. Neoclassical economics was a watershed between the classical period of political economy and the new “science of economics.” Henceforth, economics was seen to be separated from politics as an independent discipline.

The study of economics became increasingly narrow. For Adam Smith, political economy was a guide to the prudent management of the economy. For John Stuart Mill, political economy is the science that teaches a country how to become rich. For Alfred Marshall, economics was seen as “value free” and empirical. We get to Lionel Robbins at the London School of Economics in his textbook in 1932, The Nature and Significance of Economic Science. For Robbins, “economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses.” Today economics has become applied to more areas of society. The logic of methodological individualism, since the 1950s, has been applied to many non-economic areas of social life to the point that it has largely taken over mainstream political science. This is seen in the Rational Choice approach, as a basis for Public Choice Theory. Clearly, the “rats” or rational choice theorists have taken over social science, if not our lives as well. Today economics is seen as “a universal science of decision-making under conditions of constraint and scarcity.” It is seen to apply to not only voting, but to deciding who to marry, whether to have children, whether to rob a bank, or whether to buy and sell drugs. All can be seen as rational, given certain assumptions.

Alfred Marshall’s Principles of Economics became the dominant textbook in England for many years. It included supply and demand curves, the concept of marginal utility, costs of production, elasticity, consumer surplus, and increasing and diminishing returns, and integrated them into a coherent whole. It built upon the work of William Stanley Jevons and Leon Walras. Other influences were Vilfredo Pareto and Henry Sedgewick. Carl Menger of the Austrian School was also important on marginal utility.

The Era of Neoclassical Economics:

Alfred Marshall:

The period of neoclassical economics began around 1870 with the ideas of Alfred Marshall. This was a necessary attempt to do away with the arguments of the radicals, namely, Marx and Engels.

In the new theory which was being devised, profit was said to come, not from surplus labor, but from marginal utility. It was argued that when the worker worked, he added some value to the materials with which he was working during the production process. And it was this extra value or utility that the worker was being paid for. Therefore, Marx was wrong. The worker was not being exploited at all.

Obviously the neoclassical paradigm was designed to create a new ideology and new models to underwrite the systems of industrial corporate production and monopoly capitalism which were emerging.

Some other things happened with the emergence of neoclassical economics. The first was that the analysis of politics and economics came to be separated. In the classical era, scholars such as Adam Smith had been doing political economy, or moral economy as it was then called. Now economics became very narrow. Secondly, economic models came to be based upon rational mathematical models. Economists constructed models that worked on paper, if not in the real world. They forwarded the proposition that people acted rationally in the market in making individual choices. But this also assumed that they had enough information to make rational decisions. That this was generally not the case in the real world was not a serious consideration. New models of the economy were constructed based upon theoretical supply and demand curves. In the real world, things are more complicated.

Another aspect of neoclassical economics was that using abstract mathematical models meant that it was more difficult to understand the actual situation going on in society. While one could understand how the worker was being exploited and dehumanized by reading Marx, this was not possible reading neoclassical economics. Everything was described as simply the process of making rational decisions and maximizing utility.

Let us look more closely at some of the major contributions of Alfred Marshall which are still the basis of microeconomics in most economics courses. Characteristic of his textbook was the use of graphs to illustrate economic relationships between variables. This has been called “diagrammatic economics.” The supply and demand curves drawn by Marshall depict partial equilibrium analysis, which does not apply to the entire economy but to a particular firm or industry. This is a more narrow approach than the general equilibrium analysis of Walras which was meant to apply to the entire economy.

Marshall illustrated economic equilibrium in the market by a graph with price on the vertical axis and quantity on the horizontal axis. The demand curve starts at the upper left corner and slopes downward, indicating that when the price is higher, fewer units will be demanded. As the price decreases, demand increases in quantity. The supply curve starts in the lower left corner and slopes upward, indicating that when the price is low, the supply will be low but will increase as the price rises. Where the two curves cross is the point of market equilibrium, where supply equals demand.

 

Price                                                    supply

 

 

demand

 

Quantity

 

Figure 1: Supply and Demand

 

Marshall then noted that there could be a shift in both the demand curve and the supply curve. If the price remains the same but people want to buy more of the particular good, then the demand curve can shift to the right. This might be caused by a change in taste, change in the population, change in wealth and other causes.

 

Price                                                                supply

 

demand

D2

D1

Quantity

 

Figure 2: The demand curve shifts to the right when demand increases. This results in a higher equilibrium price if the supply remains the same.

 

In the same way, the supply curve can also shift to the right or left, indicating that more goods or fewer goods will be produced at each price. The main reason is the cost of production. An increase in wages would shift the supply curve to the left. It would lead to higher prices. An increase in technology would lower the cost of production and shift the supply curve to the right. This would in turn, mean that prices would fall.

 

 

Price

supply

 

demand

 

Quantity

Figure 3: Supply Curve Shifts to the Right when supply increases. This results in a lower equilibrium price. If supply decreases, the curve shifts to the left.

 

The concept of complementary goods means goods that are consumed together. If the price of one good rises, the demand for both goods would decrease. For example, if the price of airline tickets increases, the demand for airline tickets will decrease and demand for tours will also decrease because they are consumed together.

Another concept introduced by Alfred Marshall was elasticity of demand. Elasticity is a measure of how much a given change in price shifts the amount of goods purchased. There are several factors that can affect the elasticity of a commodity. One is the ease of substitution. If one needs medicine and there is no substitute, one must keep buying the medicine, even of the price rises sharply. The elasticity will not change much. On the other hand, if another cheaper medicine is available, consumers will shift to buying that medicine and the elasticity will be high.

Secondly, price affects elasticity. If the price of salt is low, an increase in price will not affect the quantity purchased very much. On the other hand, for expensive items, like computers, a sharp increase in price can greatly affect the quantity that people can purchase.

A third factor is time. People may not be able to change their consumption patterns overnight, but will be able to adjust over a longer period of time. Another factor is how much the person desires to have the commodity. This could be due to its pleasant affects upon one, especially if one is addicted to it. If one is used to smoking cigarettes, many people will keep buying them even if the cost goes very high as it is so difficult to stop smoking.

Marshall argued that poverty was caused, essentially, by the Malthusian population principle. This means that when wages rise, the workers just respond by producing more children. This in turn, serves to keep wages low at poverty levels. It is true that wage levels have risen historically when some disease wiped out a considerable portion of the working class population. In Marxian terms, it reduces the size of the reserve army of the unemployed. Marshall thought that taxes could be raised to help the poor, but never went so far as to advocate a minimum wage.

Finally, Marshall discussed the concept of purchasing power parity. This is a measure of the quantity of goods that can be purchased in different countries with the same amount of currency. In India, one may be able to stay in hotels for a week for two hundred dollars, but in France for only one night. Therefore, a lower salary in a poor country may actually give one a better standard of living than a higher salary in an expensive country. Those people retiring on a fixed income may generally be able to increase their standard of living by moving to a poor country. That could be seen as one of the advantages of underdevelopment in this case.

In doing much to separate economics as a separate discipline from politics, Marshall established economics as a science in its own right. Nevertheless, it is not clear if this contributed to the understanding of the dynamics of modern society. It may be that this development contributed more in terms of the reconstruction of an ideology of modern capitalism.

Neoclassical economics laid down an ideology to underwrite industrial capitalism. But there were contradictions which were papered over in the real world, which was far more turbulent. For this Keynes would have to come onto the scene.

The Neoclassical Synthesis: Keynesianism and the Neo-Keynesians

John Maynard Keynes (1883-1946):

When the great economic crisis came in the United States in 1929 and spread around the world, the mainstream economic models used by economists were not capable of understanding what was happening in the real economy. As interest rates dropped lower and lower, economic theory predicted that at some point, capitalists would see new opportunity and begin to invest in production. As deflation made goods cheaper, the market would revive and people would start to buy again. But none of this was happening. It seemed that there was something badly wrong with the theory.

This was a problem for the British economist, John Maynard Keynes. He believed that there were major flaws in neoclassical economic theory. Keynes began to reread Marx and gained some insight into how to revive the economy in the Great Depression. Keynes was about to turn economic theory on its head. In order to save capitalism, he was about to suggest that the medicine that was needed was a strong dose of state intervention, rather than laissez faire policies. The neoclassical theory said that the government should stay out of the economy, but Keynes believed that the only way to revive the economy was to use the government. For Keynes, the problem was aggregate demand. Consumers could not buy commodities since they did not have enough money in their pockets. The only way to create demand was to use the government to create jobs. The government did not need money to spend money. It could simply print money and put people to work doing all sorts of jobs in society. To some extent the Works Progress Administration (WPA) in the US was a make-work program, but nevertheless, it put people to work doing useful things like building roads, dams, schools, and sports stadiums. The joke became that the initials of the program stood for “we piddle around,” meaning that these workers working for the government did not have to work very hard. Whether true of not, people earned money and spent it for consumer goods.

Keynes has come to be seen as the savior of capitalism with his theory of government intervention. Writing on monetary reform, Keynes wanted the central bank to control the money supply, which would also control prices and prevent inflation. He also argued that it was the duty of the central bank to make sure that savings and investment in the economy were equal. He thought economic fluctuations happened because savings and investments were out of balance with each other. If people saved too much, this led businesses to invest too much and end up with excess capacity. All the goods produced could not be sold.

On the other hand, when people saved less, they spent more. Businesses hired more workers and produced more goods. Then wages would rise and prices increase. On the other hand, the central bank could prevent inflation and recessions. When there was too much savings, interest rates could be lowered. When there was too little savings, interest rates could be raised. This could keep investment and savings in balance and prevent fluctuations in the business cycle.

In his book, The General Theory of Employment, Interest and Money, Keynes criticized economists and professors for teaching their students theories which were wrong and did not work in the real world. The theories in the economics text books would only work under special conditions which never existed in the real world. Keynes thought that it was unethical to teach these economic theories to students as if they were not true in the real economy.

In the General Theory, Keynes attacked Say’s Law, which says that supply creates its own demand. Say’s Law says that unemployment is not possible because there will always be a demand for workers, no matter how many appear on the market. Keynes said that instead, it was the total demand that determined how many workers would be employed. If more goods were demanded, business would expand and produce more goods.

Keynes went on to develop the modern theories of why consumers spend money and why businesses invest money. In regard to consumer spending, there were subjective factors and objective factors. Subjective factors include uncertainty about the future or the desire to save money to leave to one’s children, which would encourage saving. If one’s future is certain, it would encourage spending. Objective factors include present income, expected future income, and other factors like interest rates and taxes. If one is certain about the future and has a good income, they will likely spend more freely.

Business investment mainly depends upon how much businesses expect to profit from returns on investments and the interest rate. If interest rates are higher than the expected rate of return on the investment, then businesses will not expand.

Keynes also supported the creation of money, through a monetary policy, and fiscal spending or greater government spending to stimulate the economy. Consumer spending was not as variable as business investment which depended upon “animal spirits.” Businesses had certain feelings about whether to invest, not necessarily based upon sound economic analysis. Optimism or pessimism could become self-fulfilling prophesies. If they were optimistic, they would invest more and the economy was likely to flourish. If they were pessimistic and invested less, then the opposite would probably happen.

On the other hand, the government could intervene and smooth out the variations in investment. If investments were low, then the government could borrow money and build public projects. If investment was high, the government would cut back spending and pay off its loans. This would smooth out the business cycle.

Another tool that the government could use was compulsory savings, especially during wars. The money saved would help the government finance military spending and consumers would enjoy interest on their savings.

Keynes also had a solution to the tendency of countries to engage in competitive currency devaluations to export more. This solution was built into the Bretton Woods Monetary System at the end of World War II. Exchange rates between nations would be fixed. They would be pegged to gold and in this way, they would be fixed to each other and this would help to guarantee the collective prosperity of nations after the war. The US dollar was pegged to gold at the rate of 35 US dollars per ounce of gold. Other currencies were then pegged to the US dollar.

Keynes was also influential in setting up the International Monetary Fund (IMF) and the World Bank after the war. The IMF functioned in the early years to settle monetary accounts between countries and loan money to countries that were in deficit. The World Bank provided money for infrastructural projects in developing countries.

Post-Keynesian economists, such as Joseph Stiglitz, have continued to advocate a role for the government in the economy. In contrast, more right-wing economists believe that the government does damage when it intervenes in trying to balance the economy.

Keynesianism worked and helped to get the US economy back on its feet in the l930s. It was actually too little, too late, but it helped to give people jobs and put food on their tables. However, the real recovery probably did not happen until the country mobilized for war in World War II. Keynesianism, or the regulation of the economy by the state, became a staple of Western economies after this. Keynes believed that it took a strong dose of state intervention to save capitalism.

After World War II, the United States benefited by having the strongest and most productive economy in the world with roughly half of the world’s production and an expanding global market. Nevertheless, much of the Keynesianism was, in practice, military Keynesianism. The US used military production to boost the economy and to provide funds to private corporations through the Pentagon budget.

This model of the economy provided some degree of social welfare at home while providing some development assistance to new nations emerging from the colonial era. This was necessary as there was competition between the US and the USSR to gain the favor of new nations. If the US did not provide foreign aid, then the Soviet Union would, and so it became the era of development assistance.

Summary:

The era of neoclassical economics began with the publication of Alfred Marshall’s Principles of Economics in 1890. Marshall consolidated and systematized ideas from the marginalist revolution of the second half of the nineteenth century. Neoclassical economics became a separate division of university study and students began to major in economics. Textbooks started explaining relations between economic variables with graphs which largely left out political factors.

Alfred Marshall built up an economic world view by seeing the individual as a lonely individual making rational decisions in the economic realm. He explained markets with diagrams which depicted supply and demand and economic equilibrium in the market. He also explained diminishing returns in production and consumption, and elasticity of demand. He theorized about why workers remained in poverty even when the economy flourished. Alfred Marshall’s work laid the basis for mainstream economics courses in universities ever since the publication of his textbook.

For Keynes, many of the concepts laid out in Marshall were misleading to the students. Keynes attempted to correct some of these wrong directions. First, he argued that Say’s Law was wrong. Otherwise, there would be no unemployment. However, this was not the case. Rather, Keynes argued that it was total demand that determined how many workers would be employed and how much unemployment there would be. He extended his critique in his General Theory of Employment, Interest and Money, arguing that it must be the duty of the central bank to regulate the economy and smooth out business cycles. This could be done through a range of tools from fiscal policy or government spending, controlling the money supply, setting interest rates, and organizing savings by the public.

Keynes set the tone for the political economies of modern welfare states after World War II. Also, he was a principal architect of the Bretton Woods Monetary System after World War II. His contributions produced the neoclassical synthesis, a blend of Alfred Marshall’s economics and Keynesianism. It provided the fundamental supply of tools for the modern welfare state up until the l970s, when neoliberal conservative economists began to gain the upper hand. Opposed to Keynesianism, they believed that the government did more harm than good when it intervened in the economy.

This would be a wake-up call for the working class, who had begun to take many of their hard-earned benefits for granted.

Key Terms:

Alfred Marshall

Diagrammatic Economics (Graphs)

Partial Equilibrium Analysis

General Equilibrium Analysis

Law of Supply

Law of Demand

Demand-Supply Curves

Shift in Demand Curve

Shift in Supply Curve

Complementary Goods

Diminishing Returns

Diminishing Returns

Elasticity of Demand

Population Principle

Purchasing Power Parity

Economics as a Separate Discipline

John Maynard Keynes

The General Theory of Employment, Interest and Money (1936)

Macroeconomics

Microeconomics

Aggregate Demand

Monetary Policy

Fiscal Policy

Bretton Woods System

Animal Spirits

Compulsory Savings

Competitive Currency Devaluations

Fixed Exchange Rates

International Monetary Fund

World Bank

Chapter Seven: Modern Scientific Socialism

The Social Democrats and Theories of Imperialism

In the Communist Manifesto Karl Marx and Friedrich Engels viewed capitalism as a progressive force which was expanding trade across the globe. In this sense it was a creative force, a dynamic process in the historical dialectic. The historical task of capitalism was to develop the means of production, the technology, which would make socialism and ultimately communism possible. Later Vladimir Lenin viewed imperialism as a late stage of capitalism which was capable of promoting economic development in the colonial countries, although in an uneven way. Following this tradition, other theorists analyzed the emergence of imperialism in the late nineteenth and early twentieth centuries. Among these were John A. Hobson, Rosa Luxemburg, Karl Kautsky, and Rudolf Hilferding. Others, such as Eduard Bernstein and Jean Jaures, associated with the social democrats and the broader European left, attempted to understand the historical unfolding of capitalism in the Marxist or radical tradition. We look at these thinkers in this chapter. Their contributions were important early attempts to understand the laws of motion of the global political economy.

In the twentieth century, Michal Kalecki, Oskar Lange, and Piero Sraffa extended the tradition of the critique of capitalism and mainstream neoclassical economic thought. For Kalecki, profits under capitalism were equal to the sum of capitalist consumption and investment. Oskar Lange devised a method of applying neoclassical market concepts to a system of market socialism. For Piero Sraffa, the important task was to reconstruct David Ricardo’s labor theory of value on a more scientific basis. He tried to show that there were logical inconsistencies in the neoclassical marginal utility theory as presented by Alfred Marshall.

John Hobson (1858-1940):    

We begin with John A. Hobson, who was an English economist and a critic of imperialism in his book, Imperialism: A Study in 1902. This book influenced the views of Lenin. Hobson criticized Say’s Law and argued that the economy was characterized by under-consumption and the problem of unemployment. Hobson’s heretical views were not welcomed among mainstream academics. He became a correspondent of the Manchester Guardian during the Second Boer War.

Hobson argued that imperialism arose due to the expansionist dynamic of modern capitalism. In South Africa, imperialism involved profits from mining. The search for new markets and investment opportunities overseas was the driving force behind imperialism. In the home capitalist economy, the maldistribution of income led to unemployment. There was over-saving and under-consumption. The remedy was eradicating the surplus capital by the redistribution of income through taxation and other macroeconomic policies. Instead, capitalists sought to invest the surplus capital overseas where there was scope for reaping greater profits when investment opportunities were lacking in the domestic economy.

Hobson thought that a communist revolution was not the favored solution to the problem of the capitalist economy, but rather the peaceful reform of capitalism. He recognized that his approach was non-conventional in his autobiography, Confessions of an Economic Heretic (1938).

His work found favor with Vladimir Lenin and influenced his work, Imperialism, The Highest Stage of Capitalism (1917).

Rosa Luxemburg (1871-1919):  

Rosa Luxemburg also contributed to ideas about imperialism, although they were only partially accepted by left theoreticians. Luxemburg was a Polish Marxist and revolutionary socialist who was murdered by members of the Freikorps, a right-wing paramilitary group in Germany. As a social democrat, she belonged to the Social Democratic Party in Germany. She co-founded the Sparticus League with Karl Liebknecht. She was an internationalist who attacked imperialism and militarism. She and Liebknecht tried to prevent the onset of World War I. When she called for conscientious objection to the war, she was jailed. She criticized the Bolshevik Revolution and warned of a dictatorship in Russia, although she advocated a dictatorship of the proletariat. She became famous for her statement: “Freedom is always the freedom of the one who thinks differently.”

Luxemburg argued that imperialism is a specific method of accumulation of capital and that the continuous accumulation of capital is not possible without foreign markets for capitalist commodities. Luxemburg came to this conclusion after she decided that the reproduction model of Karl Marx in the Second Volume of Capital was wrong. She argued that the accumulation of capital is impossible in an exclusively capitalist environment. Therefore, capitalism must expand into non-capitalist areas of the world. This can take place through colonialism which destroys the local artisans and creates proletarians. Without imperialism, she thought, capitalism would collapse and so it serves to prolong the existence of capitalism. This accounts for the European colonization of Africa and Asia.

Nikolai Bukharin (1888-1938) criticized Luxemburg’s model saying that she did not understand the true nature of imperialism. Luxemburg believed that the collapse of capitalism would come about when there were no longer non-capitalist areas and non-capitalists to sustain accumulation. Bukharin said this was a wrong explanation. One must look at all of the contradictions in capitalism: the contradiction between production and consumption; the contradiction between different branches of consumption; the contradiction between industry and agriculture which was limited by rent; and the anarchy of the market and competition. Bukharin, himself, thought that capitalism was on the way to collapse after the Bolshevik Revolution.

Luxemburg’s thesis that imperialism and the collapse of capitalism was necessary was accepted. Bukharin also accepted her thesis that to overthrow imperialism, one must overthrow capitalism. But Luxemburg’s thesis that capitalism will collapse due to a lack of third persons, who were not in capitalist society, was rejected. Nevertheless, she contributed much to the debate on imperialism in the early part of the twentieth century.

Karl Johann Kautsky (1854-1938):     

Karl Johann Kautsky was a Czech-German philosopher and Marxist. He was also a critic of the Bolshevik Revolution and discussed the nature of the Soviet State with Lenin and Leon Trotsky. He edited the three volumes of Marx’s Theories of Surplus Value, which became Volume Four of Capital. He had an influence upon Eduard Bernstein. He was also a close friend of Rosa Luxemburg.

For Kautsky the Bolshevik Revolution was a coup d’ etat by a conspiratorial organization. It quickly turned into a bureaucratic state with more problems than western capitalism. Kautsky believed that in the big projects being launched, the Bolsheviks were merely exploiting and enslaving the laboring people.

Kautsky wrote: “Imperialism is a product of highly developed industrial capitalism. It consists in the tendency of every capitalist industrial nation to subjugate and annex an ever larger agrarian area, without regard to the nations inhabiting this area.” He said that in industrialism, industry expanded at the expense of agriculture. Consequently, an ever-larger agrarian zone was needed for exploitation. Since this process could not be completed within national boundaries, it became necessary to subjugate external zones. He said that this was a “vital prerequisite” for capitalism. Nevertheless, he thought that imperialism was just one of the possible specific forms of capitalism. It might also take the form of free trade, which was another form. For example, it might take the form of the World Trade Organization (WTO). At that time in history, however, Kautsky saw that imperialism put an end to free trade.

He wrote: “Modern imperialism was born of the need for general control of industrial expansion. The export of capital, technology, and skilled labor, combined with the development of an infrastructure (such as railways) in the subject territories themselves, had generated imperialist policies aimed at the creation of either colonies or spheres of influence.” He thought these were the “important roots” of imperialism.

Kautsky thought that this imperialist tendency could only be blocked by the political victory of the proletariat when they “throw off the capitalist yoke.” Imperialism could be overcome with socialism. On the other hand, there might be an emergence of “ultra-imperialism.” With this development, the capitalists would unite and denounce destructive conflicts and anarchic competition for raw materials and so on. This new phase of ultra-imperialism would not be an arms race, but it should still be opposed by the proletariat as imperialism.

Kautsky believed that World War I would bring the US to the colossus of global capital. Anti-colonialist struggle was emerging and Tsarist Russia was being transformed.

The debate centered on whether continued capitalism was necessary to develop the basis, that is, the productive forces to make socialism possible. Kautsky thought that imperialism was not a necessary form of capitalist development and that it could be successfully opposed by the proletariat. What would bring the era of socialism to pass? Some thought that capitalism had to first collapse, but then this might be a long way off. On the other hand, Marxists believed that the utility of capitalism lay in its historical task of developing technology or the forces of production upon which socialist society would be based. Therefore, Kautsky did not advocate the collapse of capitalism because socialism could not be built upon the ruin of society. The ruin of capitalism would make socialism impossible. He said that the proletariat needed peace, not war. Revolution might just be a form of opportunism.

This dilemma can yet be seen in China as many in China argue today that developing the forces of production under some degree of capitalist production is necessary to make a future socialism possible.

Lenin, on the other hand, argued that capitalism must collapse to make way for socialism.

Revisionism: Eduard Bernstein (1850-1932):

Eduard Bernstein, on the other hand, was a German Social Democrat who said that there was no need for a revolution. He became a revisionist arguing that socialism would be achieved through capitalism. There was no need for capitalism’s destruction. Workers would win their rights through parliament. With less cause for grievances, the motivation for revolution would dissipate. The important thing was for workers to work for progress toward socialism.

As a political theorist of the Social Democratic Party and a politician, Bernstein became the founder of evolutionary socialism and revisionism.

Challenging Marx’s materialist theory of history, he rejected Hegelian metaphysics as the dynamic of history. He believed that late in life Marx had acknowledged that socialism could be achieved through peaceful means. This would happen through legislative reform in democratic societies. Therefore there was no need of a revolution.

In Bernstein’s vision, the workers could use the state to achieve socialism and a more ethical form of society. He disputed Marx about “the imminent and inevitable demise of capitalism.” Rather than wait for capitalism to collapse, the workers must work to improve their lot through legislative reform. He believed that Marx had been wrong about the trajectory of capitalist development. First, the centralization of capitalist industry was not on a wide scale as Marx had predicted. Secondly, he believed that the ownership of capital was becoming more diffuse, rather than concentrated. Finally, the middleman had not disappeared under capitalist industrial development.

Bernstein argued that since the entrepreneurial class was being recruited from the proletariat progress could be achieved in the regulation of hours of work, old age pensions and other social improvements for workers. The workers should interest themselves in politics. Bernstein also saw flaws in Marx’s labor theory of value. Through reforms, workers would achieve socialism in a peaceful way.

Bernstein also opposed protectionism and believed that closing international trade would help only the few and have a negative effect on the masses. Free trade, on the other hand, would lead to the end of capitalism. A policy of autarky among nations was a dangerous course toward war.

Rudolf Hilferding (1877-1944):

Rudolf Hilferding developed a theory of imperialism which argued that yet another historical path was open for the emergence of socialism. Hilferding was an Austrian Marxist economist who joined the Social Democratic Party of Germany during the Wiemar Republic. He developed the theory of “organized capitalism” and defended Marx against the attacks by Eugen von Bohm-Bawerk.

However, Hilferding’s theory of the historical trajectory of capitalism differed from that of Marx. He disputed Marx about the instability and break-down of capitalism. He believed that the concentration of capital, which was taking place, was actually stabilizing. He published his most notable book, Finance Capital in 1910.  Hilferding worked with Karl Kautsky and Rosa Luxemburg and taught political economy at the party training school in Berlin.

Hilferding believed that competitive capitalism was being transformed into monopoly finance capital. With the unification of industrial, mercantile and banking interests, the liberal capitalist demands for the reduction of the economic role of the state were weakened. Now capitalists wanted a centralized state which ensured privileges to the ruling capitalist class. After 1860, finance capital had sought state intervention on behalf of the wealth-owning classes. The nobility no longer dominated the state as the capitalists had taken over power.

Nevertheless, this opened an alternate path to socialism different from the Marxist path of revolution. Once capitalism has brought the most important branches of economic production under its control the workers can gain control of finance capital by conquering the state apparatus. The small businesses and the peasantry will already be dependent upon finance capital. The broad working class will take over from the narrow bourgeois class that has dominated capitalism. Hilferding is referring to what is called the one percent today. This development will open socialistic possibilities. Without such a development, the policy of finance capital is bound to lead to war and this will then bring revolutions.

These thinkers on the left opposed the emergence of monopoly capitalism and imperialism in Europe in the late nineteenth and early twentieth centuries. Their theories of imperialism influenced the thinking of Vladimir Lenin on the issue of imperialism. They were the forerunners of later theories of imperialism on the Left, such as the dependency and world systems theories. Also they influenced those who wrote at the Monthly Review School in New York, such as Paul Sweezy, Harry Magdoff and Samir Amin.

Vladimir Lenin: Imperialism, The Highest Stage of Capitalism

In l916, Lenin (1870- 1924) wrote a tract on Imperialism, which was published in l917. In this work, he noted the development of capitalism from the stage of free competition to a monopoly and imperialist stage. He sharply criticized Karl Kautsky and other social democrats for suggesting that imperialism could be overcome by peaceful means. For Lenin, a proletarian revolution was necessary to overthrow capitalism.

Much of the analysis in Imperialism is based upon the writings of non-Marxist writers, particularly John A. Hobson’s book published in 1902. Another important source was Rudolf Hilferding. He first chronicled how capitalism had become characterized by monopoly industries in the early twentieth century. He noted that “capitalism has been transformed into imperialism.” He made the well-known observation that capitalist production had become social, but appropriation of the profit remained private.

A second observation was the new role of the banks and the concentration of banking enterprises. While old capitalism was characterized by free competition, new capitalism was characterized by monopoly. Finance capital was now in the driver’s seat. He wrote: “Finance capital is capital controlled by banks and employed by industrialists.” This allowed the banks to control industry and their production. Another development was holding companies which further consolidated capital.

Third, imperialism could largely be explained by the superabundance of capital in a few rich countries, like Great Britain, Germany, and the United States. Lacking promising investment opportunities at home, the big firms began to export capital for higher profits abroad. Profits were higher in “backward countries.” Land, raw materials and wages were low and so profits were higher. Much capital was going to the British colonies, to America, and to Asia.

Fourth, Lenin made his famous observation that this export of capital accelerates the development of capitalism in these peripheral countries. At the same time, it slows down development in the home countries. This thesis is at odds with dependency theory, which says that capitalist investment abroad keeps countries from developing. Capitalist countries were able to extract many concessions from countries where they wished to invest capital, especially in terms of loans.

Fifth, Lenin noted how the capitalists had divided up the global market among themselves. Capital was becoming concentrated on a global scale. This also led to conflict between nations. Here, Lenin criticized Kautsky’s idea that imperialism might promote world peace. Lenin said this was absurd.

Sixth, there had been a great surge of colonialism by the European powers and Japan in the late nineteenth century. Lenin noted that they had carved up the world for themselves, particularly, Great Britain, France and Germany. Some writers suggested that this colonialism was necessary to prevent a civil war at home between the working class and the capitalists. This new phase of colonialism was one marked by finance capital colonialism and was dominated by monopolies. Firms had to chase all over the world to obtain the raw materials and markets to keep capitalism profitable.

Seventh, imperialism was the monopoly stage of capitalism. This new capitalist imperialism was marked by five basic features. First, the decisive role of monopolies in the economy; second, the merging of bank capital with industrial capital to produce finance capital and a financial oligarchy; third, the export of capital as more important than the export of commodities; fourth, “the formation of international monopolist capitalist combines which share the world among themselves; fifth, the territorial division of the world among the major capitalist powers.

Lenin finally criticized Kautsky’s argument that imperialism was a policy and not a necessary aspect of capitalism. Kautsky had suggested the idea of ultraimperialism in which companies would cooperate in global business enterprises, rather than engage in conflict and thought that this might promote world peace. Lenin sees this as just papering over the contradictions in capitalist imperialism. The drive for profits produces conflict by its nature. Therefore, he sees Kautsky’s argument as “ultra-nonsense.”

Nevertheless, capitalist monopoly had a tendency to stagnate because it often prevented technological advance in order to protect profits. This was the parasitism of global imperialism.

Further, a United States of Europe was seen as a great peril of parasitism. It would be a sort of collective imperialism. Also typical of imperialism was the ability of capitalists to buy off the working classes of the home countries by allowing them to share some of the benefits of imperialism. This was seen in England. In this way, imperialism could be a useful tool to divide the working class. A portion of the working class becomes penetrated with the ideology of imperialism.

Lenin criticized social democrats like Kautsky who believed that capitalism might be reformed and a peaceful democracy established. Lenin had no use for such “bourgeois reformism.” On the other hand, imperialism tended to produce national independence movements in the colonial and exploited countries. The natives learned to use the political tools of the bourgeois countries to fight for their own freedom.

Nevertheless, in a dialectical way, imperialism had a role to play in history. Monopoly capitalism grew out of the free competition of early capitalism and became imperialistic. Nevertheless, it is the “transition from the capitalist system to a higher socioeconomic order.” It increases the socialization of production on a global scale. Lenin seems to suggest that this was laying the necessary groundwork for a future international socialism.

Later Left Political Economists:

Michal Kalecki (1899-1970): Kalecki was a polish economist and Keynesian who taught at the London School of Economics, Cambridge University, Oxford University and the Warsaw School of Economics. He also served as an economic adviser to the governments of Cuba, Israel, Mexico, and India. His ideas, similar to Keynes, were developed before Keynes. His achievement was to integrate Marxist class analysis and the new studies on the theory of oligopoly. He was influenced by the neo-Marxian and post-Keynesian schools. He was also influenced by Mikhail Tugan-Baranovsky and Rosa Luxemburg.

In 1933, he published “An Essay on the Theory of the Business Cycle.” After learning of Keynes’ General Theory in 1934, he went to London and made friends with Richard Kahn, Joan Robinson, and Piero Sraffa. In 1937, He met Keynes. He established Kaleckian Economics with an essay on the theory of economic fluctuations. Another article appeared called: “Political Aspects of Full Employment.”

Kalecki predicted that the Keynesian revolution would not endure. He thought that full employment as a result of Keynesianism would lead to a more militant working class. This would weaken the social position of business leaders, although they would still make good profits. Elites would then use their political power to weaken Keynesian policies. A loss of social prestige would not be acceptable to the business elites.

Kalecki spent time in Poland and New York, returning to Poland after 1955. He became “Chairman of the Perspective Plan,” but resigned before long to do teaching and research. He taught a seminar on the socioeconomic problems of the third world with Oskar Lange and Czeslaw Bobrowski. He was pessimistic about the future, believing that the government could manipulate situations to their own advantage.

Kalecki was clearly influenced by Marxian economics. He went on to develop the Profit Equation.

The Profit Equation: Kalecki set out to determine the volume of profits and profit sharing in a capitalist economy. He was following Marx’s work on the rate of surplus value, the organic composition of capital, and the trend of profits.

Kalecki divided the whole economy into two groups: First, workers who earn only wages. Secondly, capitalists, who earn only profits. He assumed that workers do not save and that the economy is closed with no international trade and no public sector. Then:

P + W = Cw + Cp + I  where

P = volume of gross profits (profits plus depreciation)

W = volume of total wages

Cp = capitalist consumption

Cw = worker’s consumption

I = gross investment in the economy

Since workers do not save, W = Cw. The equation can be simplified as:

P = Cp + I

It means that profits are equal to the sum of capitalist consumption and investment. So it is the capitalist’s investment and consumption decisions which determine profits. Kalecki says that the capitalists are the “masters of their fate.” The consumption of one capitalist becomes the profits of another capitalist.

Profits can be made on worker’s consumption only if they consume more than their wages.  The main point is that profits are largely determined by investments. This is similar to the analysis of Keynes.

Oscar Lange (Oskar Ryszard Lange) (1904-1965): Lange was a Polish economist and diplomat. He produced a model of market socialism and advocated the use of marketing and pricing tools in a socialist system. He was a socialist who immigrated to the US in 1937 and taught at the University of Chicago. He returned to Poland in l945. He rejected the Marxian Labor Theory of Value and used the neoclassical theory of price. In 1936, he integrated Marxian and neoclassical economics to create an early model of market socialism. Market tools would be used in economic planning in socialism. The central planning board would set prices through trial and error. They would later make adjustments, rather than relying upon the free price mechanism. During shortages or gluts, prices could be readjusted. In shortages, prices would be raised. In gluts, prices would be lowered. In this simulation of the market mechanism, supply and demand would be managed. Lange thought that the state-run economy could be as efficient as a capitalist or private market economy.

Piero Sraffa (1898-1983):

Piero Sraffa was an important Italian economist. He founded the Neo-Ricardian School of Economics. His most influential work was Producing Commodities by Means of Commodities. He studied at the London School of Economics and reconstructed Ricardo’s theory of surplus value. He believed that there were flaws in the neoclassical theory of value. He wanted to show that Marshall’s marginalist theory was logically inconsistent and return to the classical theory of value of Ricardo and Marx. He was also an opponent of the theories of the Austrian School.

Sraffa claimed to expose the logical mistakes in Alfred Marshall’s supply curve and attempted to construct a more correct theory of supply that was based upon the classical notion of surplus value. Essentially, Sraffa said that Marshall’s supply curve for an industry, which simply added up the supply curves for every firm in the industry, was wrong. Marshall could do this because he assumed that the supply curve of each firm was independent of the supply curves of all other firms. Sraffa pointed out, however, that this was not the case. These supply curves for firms within the industry were not independent of each other. The supply curve of one firm affected the conditions for production in all the other firms. This is because when a firm uses inputs, materials and labor, it makes these factors of production rise for all other firms.

Another important insight of Sraffa, especially given the rise of monopoly capitalism, was to point out that the assumption of diminishing returns in production was incorrect. Sraffa showed that general consumer goods were produced under conditions of increasing returns. This is true of economies of scale, where large quantities are produced. Moreover, since industries were not isolated from each other, the cost of production in each industry affects the cost of production in other industries. This also meant that the neoclassical model of perfect competition was misleading and there must be an alternative model.

Sraffa set out to construct a model which would take account of the interdependence of firms and also the existing condition of monopoly and oligopoly in the twentieth century. Sraffa’s model fell back on the surplus value model of David Ricardo. In this model, there is a surplus when after production there are more goods than one started with. Sraffa used this model to explain value and relative prices. He also explained how income is distributed between wages and profits.

Sraffa concluded that the distribution of income between wages and profits depends upon monetary policy, competition, interest rates, wages, and other factors. This helped to explain why high wages, for example for bankers, has nothing to do with productivity of the employee. Rather they result from political decisions, interest rates, economic power of the actors and technology.

Sraffa’s deconstruction of the economic ideology laid out in Marshall’s neoclassical system was not welcomed by most economists. Sraffa thought that the neoclassical system and marginal utility theory papered over many of the contradictions of capitalism. Sraffa claimed that he exposed the cracks in the system. Therefore, Sraffa is an important figure in the radical perspective in political economy and the critique of actually existing monopoly capitalism.

Summary:

The early twentieth century was marked by the emergence of imperialism as capitalists sought profits outside the home countries. Analysts generally agreed that the powerful monopolistic firms of a few rich countries had gained control of the global economy. However they did not agree upon whether it was good or bad and what should be done about it. Among the left, some thought that the only answer was a proletarian revolution to overthrow capitalism. Others believed that capitalist imperialism could be transformed through peaceful reform.

John A. Hobson published his analysis of imperialism at the beginning of the twentieth century. He believed that this development grew out of the dynamics of capitalism in which firms invested their capital abroad to make higher profits. Hobson argued that a proletarian revolution was not the solution. He believed that capitalism could be reformed peacefully.

Rosa Luxemburg, as a Marxist, also wrote on imperialism. She thought that the workers must unite and ultimately overthrow the capitalist system. Karl Kautsky, on the other hand saw the problem differently. He agreed that imperialism was a problem but thought that capitalism could exist without imperialism. It was simply one form that capitalism could take. Therefore, a peaceful reform could take place. Revolution was not the answer as it would destroy the basis of production and organization of the economy.

Bernstein agreed that capitalism could be reformed peacefully and that there was no need for a revolution. Capitalism was developing the necessary forces of production and at some point in its development capitalism would transform itself into socialism in a peaceful way.

Rudolf Hilferding also wrote on imperialism, seeing the main development as finance capital. This development was resulting in “organized capitalism.” A few big firms controlled production and capital and so dominated the global economy. This development opened up a new path to socialism. It would be possible for the workers to take over the command of the economy at some point and bring about socialism. This meant that revolution was not necessary to bring socialism.

Lenin on the other hand took a different view. He believed that the analysis of Hobson and Hilferding was correct. But their approach to the future was “bourgeois reformism.” What was needed was a proletarian revolution. Capitalism had developed the forces of production and expanded social production on an unprecedented scale, but the only way to reach socialism was through a proletarian revolution that would end capitalism and bring a revolutionary vanguard to power.

Michal Kalecki was a left economist who believed that the Keynesian economic system would not survive. This was not because it was not beneficial to the capitalists, but because the capitalists did not want to share their profits with workers. The capitalists would fight back to crush working class resistance. This seems to have partially happened after the l970s.

Kalecki derived the profit equation, which simply says that profits are equal to the sum of capitalist’s consumption and investment. It is investment decisions that determine profits. This is similar to Keynes who saw profits as dependent upon investment in the economy.

Oscar Lange was an economist who believed that neoclassical economics could be used in market socialism. Lange developed a model of market socialism for socialism planning.

Piero Sraffa was also an important leftist economist who reconstructed Ricardo’s theory of surplus value. He claimed to show that Marshall’s supply curve was logically inconsistent and that his assumption of diminishing returns in production was wrong under conditions of monopoly capitalism. His critique of neoclassical economics claimed that neoclassical economics was not scientific but ideological.

Key Terms:

Imperialism

The Communist Manifesto

Karl Marx

Vladimir Lenin

The Periphery

John A. Hobson

Rosa Luxemburg

Karl Kautsky

Rudolf Hilferding

Eduard Bernstein

Jean Jaures

Sparticus League

Karl Liebknecht

Bolshevik Revolution

Dictatorship of the Proletariat

Leon Trotsky

Ultra-Imperialism

Collective Imperialism

Samir Amin

Revisionism

German Social Democrats

Wiemar Republic

Organized Capitalism

Concentration of Capital

Finance Capital

Michal Kalecki

Piero Sraffa

Oskar Lange

The Profit Equation

Neo-Ricardian School of Economics

 

Chapter Eight: The Ruling Class

The Dynamics of Creative Destruction and Pareto Optimality

“History is the graveyard of elites.” Vilfredo Pareto

Joseph Schumpeter and Vilfredo Pareto were conservative economists who saw the political Left and the rise of the working class as a threat to society. Schumpeter studied business cycles and believed that the innovations of entrepreneurs and new technology were the keys to a dynamic capitalism and economic growth. He called for creative destruction. The dynamics of capitalism resulted in business cycles of various lengths of time.

Nevertheless, the seeds of destruction were built into the capitalist system in a dialectical way. As capitalists consolidated power and society became more affluent, resentment against capitalism would arise and left academics, other critics, and workers would establish restraints against business entrepreneurship and creative destruction. So education in the universities was also a threat to capitalism and the entrepreneurial spirit. Schumpeter predicted that because of this, capitalism would not survive. It would be replaced by socialism. There would be no need for a Marxist revolution.

Vilfredo Pareto also feared the rise of the political Left. However in his view, democracy was not possible. It was a farce. A ruling elite class would always emerge and take power in society. He observed that income distribution was almost the same in every society with a ruling elite holding most of the wealth and power. It was futile to try to change this, he thought, as it seemed to be grounded in human nature itself.

Pareto tried to solve the problem of measuring utility by using a system of ordinal utility rather than cardinal utility. Pareto Optimality was primarily a formula to preserve the status quo. It asserted that society was in equilibrium when no one could be made better off without making someone else worse off. But almost any change in policy was sure to make someone worse off. Therefore, how would the inequality and exploitation in society be corrected under such a formula? Pareto believed that there was no need to change the status quo as there seemed to be something natural about the unequal distribution of goods in society. There can be no redistribution under Pareto Optimality. One super rich man cannot be made unhappy to make ten-thousand poor people happy.

Pareto was cynical about any change in society for the better. He was a pessimist about helping those at the bottom of society. Elites came to power and ruled but then at some point, they lost the ability to rule and were relegated to the historical graveyard. They were replaced by a different elite class.

Schumpeter’s Economics: Joseph Schumpeter

Joseph Schumpeter (1883-1950) was an Austrian-American economist and political scientist. He is famous for coining the term “creative destruction.” For Schumpeter, “capitalism can only be understood as an evolutionary process of continuous innovation and creative destruction.” Schumpeter opposed both Marx and Keynes. After teaching at the University of Bonn (1925-32), he came to the United States and taught at Harvard University.

In l942, he published a well-known book, Capitalism, Socialism and Democracy.  Schumpeter used history and sociology to understand economic processes based upon empirical evidence, rather than abstract economic models. He studied development and business cycles and how these cycles unfold in waves. He said that circular flow with no innovations result in Walrasian Equilibrium. The main course of economic development, however, happens when the entrepreneur disturbs the equilibrium. This proceeds in a cyclical way, through several time scales. These include the Kondratiev Cycle, a 50 year cycle, from Nikolai Kondratiev.

For Schumpeter, there are four main cycles:

The Kondratiev Cycle, about 54 years.

The Kuznets Cycle,  about 18 years.

The Juglar Cycle, about nine years.

The Kitchen Cycle, about four years.

Added together, these form a composite wave, however, Schumpeter did not accept the Kuznets Cycle as valid.

Schumpeter predicted, like Marx, that capitalism would collapse and be replaced by socialism. However, unlike Marx, he thought it would not be by revolution. It would happen through creative destruction. He described how this process might happen.

First, the success of capitalism would lead to a form of corporatism and lead to the rise of values hostile to capitalism. Corporatism is an alliance between the state, capital and labor. Hostility to capitalism would be especially strong among intellectuals. This development would have a tendency to destroy the climate needed for entrepreneurship in advanced capitalism. This would be replaced by laborism and social democratic parties would be elected. The restrictions put upon entrepreneurs would destroy capitalism. Industrial democracy was on the rise along with regulatory institutions.

At the same time, under capitalism, education becomes more widespread but the jobs which exist are not satisfactory work for the educated. More unemployment increases discontent. Also intellectuals organize, protest and develop critical ideas.

Schumpeter, like Pareto, considered that democracy was unrealistic. People are too ignorant to identify the public good. So they can continuously be manipulated by politicians. The best system would be a minimalist system, such as for Max Weber, where democracy is merely competition between political leaders. This is a sort of market structure and the role of the voters will be to just legitimize the government. Policies come from the elites, the people’s participation being severely limited. All of these ideas contributed to the emergence of public choice theory later.

In society, according to Schumpeter, innovation and new technologies come from the “entrepreneurial spirit” of entrepreneurs. It is possible that innovations can create monopolies and high profits for a period of time before competition sets in. High profits provide incentives for more innovation.

Schumpeter advocated the gold standard which he said was necessary for free trade and a laissez faire economy. It means that the money rates and prices of all nations are linked. Further, it forces restrictions upon governments more powerful than parliaments. It is a sort of bourgeois freedom. Schumpeter recognized that the workings of the global economic system would serve as a sort of virtual parliament. In the end, Schumpeter’s writings influenced many future political economists, especially rational choice theorists, as part of public choice theory.

Vilfredo Pareto (1848-1923):

Vilfredo Pareto is known as an economist who made three significant contributions to economics. These include the law of income distribution, the concept of ordinal utility, and Pareto Optimality. While he is known for being a part of the movement that shifted political economy away from the ideas of moral economy to a mathematically-based science, he also is known for his integration of sociological and political aspects of society into his theories.

As an engineer in his early career, he was enthusiastic about the laissez faire approach of Adam Smith. Studying political economy and sociology, he switched careers and was appointed to the chair in political economy at the University of Lausanne previously held by Leon Walras.

In studying income distribution in several countries, he discovered that the distribution followed generally the same pattern in different countries and at different times in history. He devised the 80-20 rule which meant that eighty percent of the wealth in Italy was owned by twenty percent of the people. Pareto studied other countries and found roughly the same distribution of wealth. The graph of society was fat on the bottom and very thin at the top where the wealthy elites were. Wealth increased geometrically from the poorest to the richest families in society. Pareto concluded that this could only be explained as a “social law.” It was based upon something in human nature. Any attempts to change this redistribution in society would not work, in his view, because of the political power of elites to hold onto their wealth.

Pareto attempted to get around the difficulties of the utilitarian economists in measuring utility. For him, good or utility could not be measured. However, one could determine ordinal utility, that is, whether one preferred one commodity or good over another. One may prefer bananas to apples or a Mercedes to a Volkswagen. These are the decisions that one makes every day in society and in the market. When one traded one good for another, it meant that they preferred one thing over another. In this way, they would increase their utility, although it was not clear by how much. They did not have to decide that they liked bananas five times as much as apples.

The concept of Pareto Optimality is another well-known concept in microeconomics. Pareto suggested that where there is a perfectly competitive market, Pareto Optimality will be the result. Pareto Optimality is obtained when “no one can be made better off without making someone worse off.” This is the best that society can do. The principle actually says that making any redistribution in wealth will be bad because it will make at least one person worse off.

In terms of policy, however, it is possible that a tax cut for the wealthy might spur economic growth and help both the rich and the poor. In this case everyone would be seen to gain making the whole society better off. But, in a very unequal society, redistribution would upset Pareto Optimality. To put a heavy tax on the rich to save the poor from starving, would upset the Pareto Optimality of society because the rich would be made worse off, at least in terms of income. This principle makes redistribution impossible. It is a basis for those who want no taxation of the wealthy and no social welfare for the poor.

The economist Amartya Sen has pointed out that a society suffering from a famine could be Pareto Optimal. Redistribution of some food which the rich had stored up would not be Pareto Optimal, but might make society better off. A society with great equality as well as a society with great inequality could be equally Pareto Optimal, but perhaps the more egalitarian society would be more ethical. This, however, depends upon one’s values.

It appears that Pareto favored fascism under Mussolini and was the fascist ruler’s adviser. He was certainly conservative in his political views and believed that socialists were wrong and would spoil the country if they ever took political power. He was disturbed about worker’s strikes and thought the government should crack down on worker’s organizations.

A ruling elite class could only survive by employing force and violence.

Conservative elites come to power through force and rule but gradually, they lose their prowess and become weak and more humanitarian. They hesitate to use force and violence. They are then overthrown and new elites take power and rule. It means that force and violence is an essential element in political rule and one must not hesitate to use it. Here are shades of Machiavelli in The Prince.  Pareto’s ideas about the circulation of elites reminds one of the ideas of Ibn Khaldun in the Muqaddimah. Pareto said that “history is the graveyard of elites.”

When the weak in society perished, on the other hand, this could only strengthen society as the social body rid itself of undesirable elements. Without this purging of its poison, society would succumb to disease and also perish.

Pareto thought iron rule, which created a minimal state, could unleash the creative forces of capitalism and make society stronger. He believed that Mussolini might successfully bring about such a policy.

Pareto was amused that mathematical equations could not describe human actions that were too often non-rational. He concluded that there were non-rational residues in human nature which accounted for this.

Power is used to control wealth in society which is a sort of human jungle. It was Darwinian and the strongest and fittest must rule and the weak perish for the good of society. These are power laws which must control society. In the wealth distribution, men and women at the bottom starve and their children die young. In the middle people claw their way into a job, and try to hang onto it through luck or talent, but many fall by the wayside through bad luck, fall into alcohol or are slain by disease. Some get unlucky and others cannot care. At the top, the elite is sitting and controlling wealth and power. They stay on top until they are taken down by revolution or overthrown by another group of aristocrats.

This cynical view means that there is no progress in history and democracy is just a fraud. Human nature is primitive. So the strong get most of the good things of society. Moreover, the weak must perish for the good of society, before they drag the whole society down. They are the poison of the society and so society must get rid of them. This fits very well with the cynical thinking of public choice theorists today. Indeed, they have borrowed much of their thinking from Pareto. They reject democracy.

Politicians speak in terms of democracy, but it is an illusion for Pareto. A ruling class always comes to power and rules and becomes the new wealthy. Successful rulers must be active and use force and violence. Pareto thought that a minimal state would unleash the creative forces of the market. He believed that Mussolini’s rule was bringing this minimal state into existence. Mussolini followed Pareto’s policy prescriptions by carrying out privatization, cutting taxes on property, and encouraging industrial development. He also wanted free trade. These are the parameters of neoliberal economic policies today.

At the same time, both Mussolini and Pareto disliked parliamentary rule.

His contributions to economic thought are sometimes conservative but go beyond his political beliefs.

Summary:

Joseph Schumpeter was a conservative Austrian economist who later taught at Harvard University. He is best known for his concept of creative destruction. By this, he meant that entrepreneurs were the driving force of a dynamic capitalism in replacing the existing productive techniques with new innovative methods and technology. However, he was not optimistic that capitalism could survive due to opposition in society to the methods of capitalism. Socialism would come, not through a Marxist revolution, but through the dialectics of its own dynamic.

Vilfredo Pareto was another conservative economist who was pessimistic about reforming society for the better, in terms of social equality. He thought that there was a natural ruling class who always took the lion’s share of the wealth and power in society. This was shown in the law of income distribution which tended to be constant in different societies and at different times. He thought utility need not be measured quantitatively, but that one could use ordinal utility to understand market behavior. His concept of Pareto Optimality asserted that the free market resulted in the best distribution of values in society. No one could be made better off without making someone worse off when this equilibrium existed in society.

Walrasian equilibrium was the desired condition for society, according to Pareto. But for Schumpeter, equilibrium meant the lack of innovation and advance. It was the function of entrepreneurs to disturb this equilibrium through creative destruction and advance society. Nevertheless, the resistance of the intellectuals and the working class made this prospect problematical in the long run. One could only look forward to socialism in the future, which Schumpeter saw as a bleak historical development.

Key Terms:

Joseph Schumpeter

Vilfredo Pareto

Creative Destruction

Capitalism, Socialism and Democracy

Business Cycles

Walrasian Equilibrium

Entrepreneur

Nikolai Kondratiev

Kondratiev Cycle

Kuznets Cycle

Juglar Cycle

Kitchen Cycle

Corporatism

Laborism

Innovation

Competition

Gold Standard

Law of Income Distribution

Ordinal Utility

Pareto Optimality

80-20 Rule

Amartya Sen

Circulation of Elites

Ruling Class

 

Chapter Nine: The Dissidents

Critique of Modern Capitalist Society: Thorstein Veblen, Karl Polanyi and Herbert Marcuse

These theorists sought to burst the big pretentious bubble built up over the years by professional economists. This task was admirably accomplished by three figures who challenged orthodox economic thinking. Thorstein Veblen (1857-1929) was an influential American economist and sociologist. He is best known for his book The Theory of the Leisure Class (1899). This is a book which pokes fun at the lifestyle and habits of the rich and the business class. For Veblen, religious denominations that set up churches were “chain stores.” Veblen was the leader of the Institutional Economics Movement and used anthropological analysis to understand “economic man.” He was a student of the famous economist, John Bates Clark, at Carleton College in Minnesota.

Karl Polanyi (1886-1964) was a Hungarian economist who immigrated to the United States. In 1944, he published his book The Great Transformation. In this book, Polanyi challenged the Austrian School of Economics, arguing that the idea of a historical free market was a myth. He claimed to show that economic markets were controlled by the state and that a free market was utopian and could never exist.

Herbert Marcuse (1898-1979) was a German philosopher and a member of the Frankfurt School. He became a leader of the New Left Movement in the l960s. Marcuse developed a critique of modern capitalism in One Dimensional Man. We will look at each of these thinkers below.

Thorstein Veblen (1857-1929):

Veblen challenged the central truths of classical and neoclassical economic theories.  Capitalism was a form of modern barbarism according to Veblen, and savage. He laid out these views in his first and most famous book, The Theory of the Leisure Class (1899), which was a satire on the aristocratic class.

Veblen seemed to be observing society as if he had just arrived from outer space and observed that people were engaged in strange but interesting behavior. Veblen was alienated from society. He did not feel a part with his fellow man and was cynical about their motives. This was the perfect perspective for analyzing society the way an anthropologist observes primitive tribal behavior.

The American economy did not fit the theories coming from European economic thinkers which had laid the basis for neoclassical economics. Unlike the assumptions of neoclassical economics, humans did not exhibit rational behavior in conspicuous consumption. Businesses often used brutality and violence to crush their competition. Economic behavior was socially determined, according to Veblen, and not based upon individual rational action. More important were the human instincts of emulation, predation, workmanship, parental bent, and idle curiosity.

Veblen thought that there was a fundamental split in society between those who make their livelihood through exploitation and those who make their way through industry. In early barbarism, the difference is seen between the hunter and the gatherer. Later the division is between the landed gentry and the indentured servant. The enterprise of the leisure class is to exploit.

Veblen defines the leisure class as those who lack productive economic activity and who are committed to demonstrate their idleness. This conspicuous leisure gives way to conspicuous consumption. The demonstration of wealth is the basis for social status. The way one can gain status is through wasteful consumption. If it is not wasteful, it is not reputable.

In Veblen, emulation and predation play major roles. People try to impress others, whether rich or poor. Engaging in conspicuous leisure and conspicuous consumption are useful ways to gain social status. This also produces conspicuous waste, which also has an important economic function. Imagine, if everyone used their purchases to their full utility, what the effect upon the economy would be. Economic health depends upon increasing consumption and vast waste.

The economic behavior of the leisure class must be predatory. That is, the members of this class must obtain their wealth by force or cunning, rather than in actual labor in production. Society would then see them as strong and able when they used force and violence. Gaining wealth by force was honorable and dignified, but human productive work was just the opposite.

Environmentally, it was typical that the elite laid waste to nature, with hunting and killing things in the wild.

Society was still barbarian in nature and human nature was savage. While force was no longer used to seize women, it could be used to seize money. The motives behind human behavior are not rational, as the mainstream economists thought, but irrational and come from deep within human nature.

In emulation, the poor and working class try to appear as the rich. This is a sort of different type of class struggle. The lower classes admire the savage values of the upper classes. Marx thought that struggle between the classes would lead to revolution, but Veblen believed that the revolution did not happen because the lower classes have a common attitude and values with the leisure class. They actually admire their conservative and brutal behavior. So they emulate the rich. Veblen believes that this leads to social stability.

Mark Twain understood this too, when he wrote about the poor putting on shows and pretending to be dukes and kings from some European country in his novel Huckleberry Finn. In this way, they got all the farmers around to come to their entertainment.

Veblen gives many examples of how one demonstrates that they spend their time in idleness. One way is to demonstrate much useless knowledge, like knowing the names of all the fancy breeds of dogs and their characteristics. There is no economic utility to such knowledge, unless one is in the dog business, and so it is impressive and admirable. Another example is sports trivia, such as knowing all the names of players on many teams and how many games they have won over the years.

Veblen then published The Theory of Business Enterprise (1904).  In this book, he turned economic theory upside down. For Veblen, the businessman, as the central figure, was actually out to sabotage the system. Why? It opened up opportunities for profit. With the rise of machine production, Veblen saw economic progress as mechanical. Society could be seen as a big machine, like a clock, produced by the rational machine.

However, while those technicians and engineers who ran the machines were interested in production, the businessman only wanted to make money. He did not care about production. Profits could best be made by working against the machine. If the businessman could cause breakdowns in the system, values would fluctuate and in this confusion, open up avenues for making a profit. Economic crises present the greatest opportunities to make a killing in the market. Capitalist enterprises which survive the crisis emerge stronger than before.

One way to profit was to build a financial superstructure on the real economy. This involved loans, phony capitalization, credit and today, derivatives. This is the financial sector, versus the real economy. This opened up great opportunities for profit. This profit seeking was disrupting society and not infrequently leading to financial crises. Financial crises were the big apples which opened up unprecedented opportunities for accumulation, if one was lucky. Veblen surely had great foresight, as the financial sector has virtually taken over the American economy in terms of where profits are made today. It has extended its tentacles across the globe.

For Veblen, the businessman works against production. He is interested in making money, not in producing commodities. The financial bubble becomes much bigger than the real economy. Businessmen are predators, for Veblen. They are engaged in “watchful waiting” for opportunities to make a killing in the market. For Veblen, they are like a fat toad waiting for flies and bugs to come along so that they can snatch them.

In the end, Veblen thought that the machine would do away with the businessman. The engineers who ran the machinery would take over production. It was a case of the machine verses the businessman and the businessman was fully dispensable. The machine was driving social change. Engineers would take over the business system and end the chaos caused by the businessmen. This was necessary to progress.

Veblen thought that if this revolution did not happen, then society would turn into a brutal struggle and lead to fascism. Veblen contributed the perspective that the machine was the leading cause of change in the twentieth century. It was the triumph of science and technology. Society was not the peaceful equilibrium suggested by Walras, Marshall, and the Austrians. And it was also not the class conflict as thought by Marx. It was more like a primitive jungle raised to a slightly higher plane. Veblen tried to discover why people behave as they do. And this was not the way predicted by the mainstream economists through the previous ages.

The machine was rational. Man was human, not rational. Human nature must give way to the dictatorship of the machine, the dictatorship of technology in modern times. We have now reached the point where the computer tells us what we can do and cannot do and there is nothing we can do about it.

Veblen was sympathetic to state ownership of industry. His views are often compatible with Marxism, socialism or anarchism. He attacked production for profit. Veblen thought that society would reach socialism through the technological developments of engineering. His ideas are similar to those of Saint Simon.

In l918, Veblen helped to establish the New School for Social Research in New York.

Karl Polanyi (1886-1964):

Karl Polanyi was a Hungarian economic historian and political economist. He launched a critique of traditional thought, particularly the free-market ideas of the Austrian School of Economics. The Austrians used abstract models which, according to Polanyi, lost sight of the reality of economic processes.

While teaching at Bennington College in Vermont, Polanyi wrote his most influential book, The Great Transformation (1944). It was published the same year as Frederick Hayek’s book, The Road to Serfdom. Polanyi looks at economic history. He discusses the enclosure process and the beginnings of the industrial economic system in the early nineteenth century. In this way, Polanyi argues that the idea of a self-regulating free market is a myth. The assumptions of Frederic Hayek and Ludwig von Mises, along with others of the Austrian school, are ahistorical.

Polanyi argued that there is nothing in human nature that drives people to involve themselves in trade, to “truck, barter and sell,” as Adam Smith argued. Polanyi looks for historical evidence of this and finds nothing. There is no historical evidence of the world-wide prevalence of markets. For Polanyi, markets are “human artifacts,” that is, man-made. They are created and maintained by government.

Polanyi argues that the Austrian idea of self-regulating markets is “utopian” and a “fantasy.” It is, however, a powerful myth that most people have come to believe in. These markets have never existed and if they did, they would destroy society.

Polanyi writes:

“Our thesis is that the idea of a self-adjusting market implied a stark utopia. Such an institution could not exist for any length of time without annihilating the human and natural substance of society; it would have physically destroyed man and transformed his surroundings into wilderness.”

Polanyi is pointing out that every economic system is embedded in societies with different social values. Economics cannot be separated from those values, as the Austrian School tries to do. In any economy, the state must intervene to deal with problems created by the actually existing market. There must be worker’s compensation, unemployment benefits and other protections and regulations. The state must deal with externalities such as pollution, loss of environmental habitat, and financial crises, created by reckless greed. Another serious externality of capitalism is crime and the locking up of vast numbers of people in prison.

However, such government intervention in the market goes against free-market principles. The free-marketers say that everything would be fine if the government would just go away and leave things alone.

Markets under capitalism create great inequality in society and this is called “equilibrium” by economists. It is also seen as Walrasian equilibrium or Pareto Optimality. Economics cannot be stripped of human values and when the equations leave these out, the theories are just based upon myth.

Polanyi produced a powerful critique, but the existing economic system and ideology is more powerful and his work has been pushed aside and largely ignored.

Herbert Marcuse (1898-1979):

Herbert Marcuse, who was a German philosopher of the Frankfurt School, launched a critique of contemporary capitalist society in One Dimensional Man (1964). He also criticized the communist society in the Soviet Union. He saw parallel forms of social repression and totalitarian aspects in both societies. He thought that the revolutionary potential in the West had declined. Advanced industrial society creates false needs. Individuals are integrated into the existing system of production and consumption through mass media, advertising, industrial management, and contemporary models of thought.

Contemporary society creates a one-dimensional universe of thought and behavior. Consequently, the ability for critical thought withers away. Marcuse promoted the “great refusal,” negative thinking as a disruptive force against the prevailing positivism. He gives an analysis of the working classes. New forms have been devised to stabilize capitalism, so that the idea of a revolutionary proletariat has to be questioned. There is no inevitability of capitalist crises. Probably one only needs to provide sufficient sports and beer for pacification of most members of the working classes.

Modern capitalist society allows totalitarianism to be imposed without the use of terror. Private domains such as sexuality become part of the system of social and political domination. Technological rationality provides the material basis for freedom, but instead serves the interests of repression. Established “facts” have ideological power and prevent negative thinking or dialectical thinking. Marcuse was pessimistic about the ability of people in modern society to overcome this domination. He believed that any alternative to the status quo could easily be prevented.

While the system claims to be free and democratic, it is actually dominated by the ideas of a few individuals who serve the system. Consumerism as a form of social control was strongly condemned by Marcuse. It induces consumers to work harder than they need to in order to provide for their needs. They ignore the psychological effects, the colossal waste and the environmental destruction. They seek social connection through material items.

Objectification under capitalism becomes alienation. People become dehumanized as functional objects. People begin to recognize themselves in their commodities. “They find their soul in their automobile.” These commodities are extensions of people’s minds and bodies.

New products continually dispense with the old products, no matter how good they were or how well liked. The purpose is to drive the economy and force people to buy more products. So the individual becomes a tool in the industrial machine, a cog in the consumer machine.

Further, advertising is an integral part of the economy. It tells consumers that happiness can be bought, which is a largely a lie. Everything becomes a commodity. Even radicalism is appropriated and sold. One sees this in the marketing of peace paraphernalia and Che Guevara T-shirts. Even a peace symbol is marketed. Mock poverty and shabbiness in clothes, such as new jeans with holes in them, is marketed. This is a particularly American trend. They look like they are worn out from the beginning. It is social utility, not use value.

Bureaucracy in Marxist countries is equally opposed to freedom. Revolutionary thought is crushed in both societies. The working class is no longer a subversive force capable of bringing a revolution. People buy commodities, but the system has bought their loyalty with these products. Marcuse put some faith in an alliance of radical intellectuals and those groups not yet integrated into one-dimensional society, such as the socially marginalized, outsiders, the exploited, the unemployed and the unemployable. He thinks that their opposition may have some potential for revolution.

Some people criticized Marcuse, believing that if the one-dimensional society could be overthrown, a new similarly repressive society would be established to replace it.

Summary:

The three critical views of capitalism and mainstream economics in this chapter challenge the traditional views of classical and neoclassical economic thought. Veblen noted that “economic man” did not demonstrate the behavior of a rational utility-maximizing animal as predicted by classical economic theory. Rather, existing economic society was savage and barbaric. The production of commodities through useful work was looked down upon in society as unworthy, while idle leisure was highly admired. Violence and force were the preeminent values in human society. In the business world, the businessman gained money and wealth, not through rational management, but by sabotaging the system. This could be done through constructing a financial superstructure to disrupt the system, to cause economic turbulence, and open up the path to grab great profits. Sometimes, the lucky businessman would hit the jackpot, with a great financial crisis, to bring the whole system crashing down. When the dust settled and the pieces were picked up, the lucky ones would emerge greatly enriched in this game.

But all of this chicanery lay hidden beneath the superstructure of ideology. The culprits behind the curtain, pulling the strings, like the Wizard of Oz, were never exposed. They were never seen in this game. The bankers who bring down the financial system while reaping their enormous and obscenely swollen bonuses are behind the scene. All this would have to end or else society would degenerate into fascism. Society might be saved by the rationality of the machine, but not by the irrationality of the businessman.

Polanyi set out to puncture the big free-market balloon of the Austrian school of Hayek and von Mises. He claimed that it was built upon a historical myth. Indeed, if such a self-regulating market had ever existed, it would have destroyed society itself.

Marcuse claimed to show that the freedom in capitalism was just another version of control by the forces that be, with strong totalitarian elements. The working class was objectified, exploited, and alienated into one-dimensional man. He was bought off with cheap commodities through which he could not realize his true essence.

This consumerist circus dulled the human urge to freedom. Everything became a commodity, including the consumer. The sanction of being deprived of the ever-new stream of commodities largely kept the rabble in line. Only a few alienated intellectuals and the disfranchised elements in society would see through the sham of the system. They were the only class in society capable of mounting resistance to the one-dimensional society, but they were economically and politically marginalized.

These thinkers believed that to understand the economic system under which one lives, it is necessary to engage in negative thinking.

Key Terms:

Thorstein Veblen

Karl Polanyi

Herbert Marcuse

The Theory of the Leisure Class

Institutional Economics Movement

Economic Man

The Great Transformation

The Austrian School of Economics

Free Market

The Savage Society

Emulation

Predation

Conspicuous Leisure

Conspicuous Consumption

Conspicuous Waste

The Theory of Business Enterprise

The Road to Serfdom

Frederick Hayek

Self- Regulating Market

One-Dimensional Man

One-Dimensional Society

Consumerism

Objectification

Alienation

Dehumanization

 

Dependency and World Systems Theory

Modernization Theory and Dependency Theory were different ways of viewing development in the twentieth century after the breakdown of the colonial era. Modernization theory as constructed by Walt Rostow in the l950s followed liberal economic theory. Dependency theory was based upon both Marxist and non-Marxist views of the development process. The Monthly Review School in New York developed the Marxist approach of Paul Baran. The non-Marxist structuralist approach was largely developed by Latin American scholars. The Egyptian political economist Samir Amin also developed dependency theory in his works.

World Systems Theory, related to dependency theory, was developed by Fernand Braudel and Immanuel Wallerstein. Here the globalist capitalist system is seen as a world economic system dominated by a hegemonic capitalist center and a periphery. There is also a semi-periphery between the core and periphery which is partially developed. These parts of the global economy are interconnected and engage in unequal trade and relations. Powerful institutions maintain this relationship, under the guise of a liberal global economy.

Modernization Theory:

Dependency theory was an alternate and critique of modernization theory as developed by Walt Rostow in the l950s. So it is necessary to look at modernization theory as a background.

Rostow theorized that development unfolded in five stages of economic growth. He saw each country developing along the same lines as the historical development of Great Britain, Western Europe, and the United States. The five stages of growth are traditional society; preconditions for take-off; take-off; the drive to maturity; and the age of high mass consumption. This model was laid out in Rostow’s book, The Stages of Economic Growth: A Non-Communist Manifesto (1960).

This is a structuralist model which is based upon liberal economic ideology following Adam Smith and the theory of Comparative Advantage of David Ricardo. From the title of his book, it is clear that Rostow imagined that modernization would take place through the development of western-style capitalism, rather than communism or socialism. Anti-imperialist theorists such as Vladimir Lenin had seen revolution as destroying the bourgeois state and building socialism from the ground up in all sectors of the economy on a socialist basis. For Rostow, development would not take place independent of the capitalist global economy, but the developing state would be integrated into the international economic sphere as the process unfolded. Rostow criticized the Marxist revolutionary push for self-reliance. Development would begin with only one or perhaps two sectors of the economy.

The traditional society was marked by subsistence agriculture or a gathering-hunting economy, mostly producing products in the primary sector. The market was not developed and there was very limited technology. Society was static with a lack of economic mobility. Most people did not desire social and economic change.

Traditional society was marked by minimum economic output, with trade either local or barter. There is no developed monetary system. There is a lack of capital. The primary factor of production is human labor. Often there is an absence of political stability. Transportation is slow, primitive, and underdeveloped. Industry lacks technology and labor productivity is very low. Tradition plays a large role in society, particularly such as weddings and religious festivals in the villages and rural countryside. Political power is often in the hands of rural land-owning elites, even if a liberal democratic political system is in place. This situation could be seen in Punjab, India, in the l960s, for example. Rostow believed that the development process would follow the path seen historically in Europe and the United States.

In the development of preconditions for take-off, there must emerge an external demand for raw materials, either agricultural produce or minerals or other primary products. This starts the trend to economic change. Agriculture starts to develop commercially, rather than being purely for subsistence. Cash crops may be grown for export. The investment in infrastructure picks up, including in irrigation, canals, roads, dams, ports, and rail facilities. There is an increase in technology. With economic change, comes a change in social structure, as people relocate to new jobs. This allows the beginning of individual social mobility. At the same time a national identity may be strengthened. Trade spreads out from local areas and becomes international.

Also an important factor is the prevention of conspicuous consumption and waste of money which might be used for capital investment. For example, as shown in the studies of Malcolm Lyall Darling in The Punjab Peasant in Prosperity and Debt (1925), rural families were under social obligation to spend vast fortunes on gold jewelry and feasts during weddings. This was a mark of their social prowess in the village and there was no reasonable way to escape it, regardless of how bitter it was for small farmers who were ruined economically by the misfortune of having daughters, rather than sons. They complained bitterly about this social system in the l960s. Therefore social change must be encouraged, which was a problem in most peasant societies.

In general, Rostow advised that the investment rate should rise to at least five percent of national income to prepare for economic take-off.  Agricultural production should be increased as a basis for capital formation for industry and to support a growing urban population. In fact, most development planning has been urban biased, as seen in the development plans of India after independence in 1947.

When society reaches the take-off stage, manufacturing picks up in a few leading industries and firms produce for both export and the domestic market. The secondary manufacturing sector expands to exceed the primary sector. Historically, textiles have been the basis of manufacturing in the take-off stage, as was seen in the industrial revolution in Great Britain.

Historically, the take-off phase in Great Britain was in the period 1783-1802; in Russia in 1890-1914; in the United States (1843-1860); in Canada (1896-1914); and in China and India around 1952.

The Drive to Maturity begins and industries diversify, with new manufacturing taking shape. The manufacturing sector shifts from capital goods to manufacturing consumer durables (sewing machines, automobiles), and items for domestic consumption. Transportation develops. There is a need for investment in the social infrastructure, schools, hospitals, universities, but this must be sponsored by the state. Savings should be encouraged and organized by the state.

In the age of mass consumption, the country has now caught up with the most developed countries in Western Europe and the United States. The industrial base, or secondary sector, dominates the economy, with the primary agriculture sector occupying a smaller proportion of the economy. Consumer goods are produced, such as automobiles and a considerable portion of the population is affluent enough to have disposable income beyond basic needs. They have income for summer holidays or trips abroad.

This model was based upon American and European history and so could not apply to the whole world. Alexander Gershenkron showed that capital accumulation would take place in different ways in different historical phases of development. It was a long historical and gradual process in the United States, but much more truncated in Germany and Japan. Further, it was unrealistic to see American consumption patterns, and American style waste, as taking over the whole world. Rostow saw neoliberal free trade policies as ideal for every country around the world. Also it seemed that once the economy reached the take-off phase, it would fly on auto-pilot and would be unlikely to crash. This model opened up opportunities for rich countries to relocate industries to low-wage countries, which is what happened in the l970s. The model was obviously western biased and also biased against any degree of socialism in society. How the model would apply to small countries with a small market was also not clear. The model did not take account that these countries were already integrated into the global economy but played a different role than Rostow imagined. Further, what happened to the high mass consumption countries like the United States?  Beginning in the l970s, the US was deindustrialized by large corporations to increase profits.

Dependency Theory:

The critique of liberal modernization theory led to dependency theory. Dependency theorists believe that in the global economy, resources flow from the periphery of poor, underdeveloped states, to the rich core of capitalist states, enriching the core at the expense of the periphery. It should be noted that this thesis differs significantly from the theory of imperialism of Vladimir Lenin that the export of capital to underdeveloped countries spurs capitalist growth in these countries.

Rejecting modernization theory, dependency theorists said that underdeveloped countries are not just states in an earlier stage of development, but have their own economic characteristics. They are weak states and under the economic and political hegemony of the center.

There are three basic premises of dependency theory. First, the periphery is the source of raw products, agricultural products, and cheap labor. The periphery serves as markets for the capital intensive products of the core countries. Through unequal exchange, and other mechanisms in the market, the periphery subsidizes the core countries.

Secondly, wealthy states in the core purposely ensure that the peripheral countries are in a state of dependency. This can be done through economic arrangements, media control, politics, banking and finance, education, culture, sport, and human resources development. International institutions and trade agreements under the World Trade Organization, for example, ensure that this relationship continues.

Third, when nations in the periphery attempt to defend their interests in the global economy, these actions are resisted by the powerful countries. They can also act to bring economic sanctions, often provided for in so-called free-trade agreements, the World Trade Organization and other organizations. The core can resort to the use of military force if these sanctions are not effective. Consequently it is practically impossible for the countries in the periphery to break out of dependency.

Poverty is not a matter of a lack of integration into the global world system. The peripheral countries are already integrated, but it is the way that they are integrated that either keeps them from developing, or results in a distorted, uneven or dependent pattern of development.

Hans Singer and Raul Prebisch:

The origins of dependency theory lie in two influential papers by Hans Singer and Raul Prebisch in l949. These authors stressed that the terms of trade militated greatly against the peripheral countries as time went along. This meant that the prices of primary agricultural products and minerals tended to fall, while the price of technological products, airplanes and earth-moving equipment from the United States, increased. The poor countries could not gain the needed technology for development. This was known as the “Singer-Prebisch Thesis.”

Prebisch was from Argentina and worked for the United Nations Commission for Latin America. He believed that developing states must use protection to help their industries become stronger. To do this, he thought that a pattern of Import Substitution Industrialization (ISI) was the best approach, rather than trying to develop through an export orientation.

The Structuralist Approach and Marxist Approach:

Dependency theory developed along two lines. The first was the structuralist approach of Latin American scholars, such as Prebisch, Celso Furtado, and others. A second approach was developed by Paul Baran in The Political Economy of Growth (1957). This was a Marxist approach and later developed further by Paul Sweezy, Andre Gunder Frank, Walter Rodney, and Samir Amin. These theorists were associated with the American Marxist journal, Monthly Review, in New York and produced many books and articles on dependency in the l960s and 1970s. Their work has been exceedingly influential in the way the left has understood the process of development in the peripheral countries. They also borrow many concepts form Lenin and Rosa Luxemburg on imperialism.

There is broad agreement between the two schools of dependency theory although the goals are different. The Marxists want to see the eventual emergence of socialism in the periphery, while the non-Marxist school primarily want national independence for a national bourgeoisie to develop capitalism on their own terms. Nevertheless, major strands of their analysis are virtually the same.

First, it is agreed that the center controls the technology and that there is an international division of labor. Skilled and high paid workers are employed in the center, with low-skilled laborers employed in the periphery. For development, surplus must be produced and reinvested to increase capital accumulation in the country. However, much of the surplus is drained off with luxury consumption and the repatriation of profits to the home country which controls the capital. Much of the surplus is extracted, as noted by Baran.

In the periphery, there are basically two types of economic production. First, agriculture tends to enrich a few landowners who engage in luxury consumption and invest little back into the local economy. In the case of enclave economies, based upon oil or minerals, only one sector of the economy is at the heart of the economy and the economy suffers resource scourge as the wealth is misused and squandered. Secondly, industry emerges, but it is foreign-owned and directed. Profits are high under tariff protection and much of the profit is either consumed or repatriated. Some is concealed and hidden offshore. So the local economy does not develop. Capitalist investment is inadequate.

Some of the Latin American structuralists conceded that some development was taking place in the periphery, but it was “dependent development” which was still under the control of forces in the core countries. They gave Argentina, Brazil, and Mexico as examples of this. They stressed that the state promotion of technology was important but difficult. Another problem was that the hegemon, the United States, controlled the global reserve currency, the US dollar. This gave them unprecedented advantage in controlling the global financial system.

Samir Amin listed several characteristics of capitalism in the periphery. First agriculture, both large and small scale, is underdeveloped. Secondly, the unequal international specialization means that the periphery largely produces primary products, agriculture and mining. In industrial enterprises, wages are low. Productivity increases but at a slow rate. Still exchange is unequal. Third, there is a rapidly growing tertiary sector in services, banking, and finance but also a high amount of hidden unemployment. Fourth, current account balances go against the peripheral countries as much of the profits of foreign investment are repatriated. The poor countries provide markets for the center during times of prosperity. Fifth, there are many structural and political imbalances in political and social relationships. There is a strong comprador element. That is, local businessmen team up with foreign owners to profit from high exploitation of the workers. There is a large degree of state capitalism with an indebted state class.

Giovanni Arrighi, who also wrote on dependency, emphasized the dominance of finance capital. His view is similar to Rudolf Hilferding.

Criticism of Dependency Theory:

Dependency theory was somewhat weakened by empirical evidence after the l980s and the theory became less popular. One example is India. After the end of import substitution, the slow Hindu rate of growth, typically about three and a half percent annually, increased to as high as eight or nine percent in the l990s with economic liberalization. Also several states in East Asia, such as South Korea, Taiwan, and Thailand had fairly high rates of growth after the l980s.

Free market economists launched the major criticism of dependency theory, charging that state-owned industries had higher rates of corruption. This is an empirical question, of course and has little to do with the actual argument of dependency theory. Free marketers have a better point in arguing that there will be less innovation with less competition with the outside world. This was certainly a problem with import substitution in India.

Free market advocates also argued that subsidies to firms have opportunity costs, as capital is used which cannot be used otherwise for infrastructure or social welfare. All of these arguments need to be examined for particular countries. Whether the thesis on underdevelopment is correct is a complex question which needs to be examined more closely for particular countries in the international structure.

World Systems Theory:

World Systems theory is primarily associated with Fernand Braudel and Immanuel Wallerstein. Karl Polanyi also contributed to World Systems Theory.

Fernand Braudel:

Fernand Braudel (1902-1985) was a French historian who studied Mediterranean civilization and the emergence of capitalism. His work is a background to world systems theory. Braudel saw long-term cycles in the capitalist economy which developed in Europe in the twelfth century. The emergence of capitalism moved from Venice and Genoa in the thirteenth and fifteenth centuries, Antwerp in sixteenth century and to London in the eighteenth and nineteenth centuries.

According to Braudel, capitalists have typically been monopolists, rather than entrepreneurs operating in competitive markets. Capitalists did not specialize and did not use free markets. Empirically, capitalism has operated differently from that described by both Adam Smith and Karl Marx in the Communist Manifesto. He says that the state has served as the guarantor of monopolies and not the protector of competition. Generally, capitalists have opposed the interests of the majority of the population.

Braudel studied long periods in history along with the effects of space, climate and technology. He did not believe that history should lead societies to revolution. The works are based upon historical materialism, but in a way different from Karl Marx. This is because Braudel gives equal importance to the infrastructure and the superstructure of institutions and ideology. The structures which are built up are both mental and environmental and determine the long course of events. It is not possible for the actors to accurately predict the results of their actions.

Immanuel Wallerstein and The Modern World System:

Immanuel Wallerstein has published four volumes of his work The Modern World System, beginning with the first volume in l974. Wallerstein draws upon ideas from Karl Marx, Fernand Braudel, Dependency Theory, Andre Gunder Frank, Samir Amin, Giovanni Arrighi, Frantz Fanon and others.

There are several arguments within Wallerstein’s work which largely follow Dependency Theory. Wallerstein has argued that since the l980s, the United States has been a hegemonic country in economic decline. The capitalist world economy, guided by the IMF, the World Bank and the World Trade Organization goes against the interests of the largest part of the world’s population. Wallerstein agrees with Karl Marx that socialism will replace the capitalist world economy at some time in future.

The modern world system is interconnected and different from former empires. It is characterized by the control of the capitalist center which dominates the world. The relation between the center and the periphery is systemic. Economic and political relations between the core, semi-periphery and periphery are institutionalized in the international global capitalist system. He agrees that there is a global struggle between capital and labor in the continuous drive for profits by global corporations and nations which control the system.

Wallerstein traces the origins of the Modern World System to sixteenth century Western Europe. Large-scale capital accumulation began in Great Britain, the Dutch Republic and France with the demise of feudalism. The entire globe was largely incorporated into this global system by the nineteenth century. The global inequality between regions has continued to grow wider and contrary to traditional liberal development theory, there is no way for the periphery to catch up with the center within the global capitalist system. The established global institutions ensure the global stability of this inequality and unequal exchange.

The semi-periphery consists of states in Eastern Europe, China, Brazil, Mexico, Turkey and others. They have some of the characteristics of the center and many of the characteristics of the periphery. For example, the semi-periphery is a periphery for the center, but it is a center for the periphery.

If one takes Turkey as an example, Turkey has a number of large multinational corporations which operate in underdeveloped countries and control capital and technology. On the other hand, much capital and industries in Turkey is controlled by the United States and Western Europe. The few remaining regions not dominated by the global capitalist system have not been integrated within the system and labor and resources in these regions have become a commodity. This system embraces the entire world in a single system.

Summary:

Dependency Theory emerged in the l950s and 1960s and became prominent in the 1960 and 1970s as an alternative to modernization theory. Walt Rostow theorized five stages of economic growth: traditional society, preconditions for take-off, the take-off stage, the drive to maturity and the age of high mass consumption. This model based upon European History was challenged as not being relevant to post-war underdeveloped societies.

Raul Prebisch and Hans Singer pointed out that the global economy was divided into a center and periphery. The periphery was controlled and exploited by the center through the structure of the global political economy. Paul Baran and Paul Sweezy, among others, constructed a Marxist analysis of this relationship. The theory seemed to explain much but was attacked by free market theorists who followed traditional theories of comparative advantage.

Immanuel Wallerstein extended dependency theory to a world systems perspective. In this view, the entire world was a single system with a directing and controlling center, a semi-periphery with some degree of independence and a periphery which provided primary products, labor and markets.

Dependency Theory and the World Systems perspective lost ground with the emergence of capitalist globalization and neoliberalism in the l980s.

Key Terms:

Dependency Theory

World Systems Theory

Walt Rostow

Modernization Theory

Paul Baran

Samir Amin

Fernand Braudel

Immanuel Wallerstein

Center/ Periphery

Stages of Economic Growth

Traditional Society

Preconditions for Take-off

Take-off Stage

Drive to Maturity

Age of High Mass Consumption

Subsistence Agriculture

Primary Sector

Secondary Sector

Conspicuous Consumption

Singer-Prebisch Thesis

Import Substitution Industrialization (ISI)

Export Orientation

Paul Sweezy

Andre Gunder Frank

Dependent Development

Unequal Exchange

Economic Liberalization

The Modern World System

Capital Accumulation

 

Chapter Eleven: The Economic Conquest of Politics

The Chicago School and the Virginia School of Public Choice Theory

To understand what has happened to mainstream social science since the l950s, it is necessary to see how the assumption of methodological individualism which arose in the nineteenth century, has been extended to other areas of society, such as politics and sociology. Mainstream economics increasingly became a narrow right-wing ideology, serving the interests of capital, rather than the broader interests of society. Similar trends can be seen in political science. If in economics, individuals only act to maximize their utility, then in politics and indeed all human activity, they do the same. This has pushed political ideology to narrow right-wing ideologies as well. The public is largely ignored. Or as right-wing ideologues, like Margaret Thatcher once said: There is no such thing as society.

There are three main approaches in this trend today, which overlap: First, neoclassical institutionalism claims that the functioning of every institution can be explained using economic utility maximizing theory. This approach is associated with Douglas C. North and others. Secondly, the Public Choice School, uses economic theory to explain political decision-making. Third, is New Political Economy, which largely concentrates upon “rent seeking.” These will be discussed below and in chapter eighteen.

The shift in economic thinking from liberal Keynesianism to conservative neoliberalism began in the l950s. Economists began to construct arguments which claimed that Keynesianism did not work to regulate the economy and only made a bad situation worse. They also began to engage in empirical research which purported to show that their arguments were correct.

Most prominent in this revolt against Keynesian economic management of the economy were the academic economists at the University of Chicago. The proponents of the Austrian School also began to have a stronger influence on economic thinking. Finally the Virginia School became influential in applying economic rational models to politics. From these trends emerged neoliberal economics and the New Political Economy. This body of ideology became a tool which could be applied to deindustrialize the American economy beginning in the l970s. With the weakening of Communism, the ideology could be exported to economies around the world. This would pave the way for accelerating global corporate profits.

It is this direction of economic thinking beginning in the l950s which we look at in this chapter.

The Chicago School of Economics:

Developed at the University of Chicago, the Chicago School of Economics is associated with right-wing anti-welfare politics. A major thrust has been the rejection of Keynesianism and the effort to refute claims by the Keynesians on the regulation of the economy by the state. The old Chicago School, however, were Keynesians up until the l950s. The rejection of Keynesianism began in the 1950s. Major figures who have shaped this approach to “free market” economics are Milton Friedman, Gary Becker, Richard Posner, and George Stigler.

The Chicago School was outside the mainstream of Keynesian economics in the l950s. These economists developed monetarism in the l950s. Their views would come into the mainstream by the l970s. By this time, they were turning to rational choice theory, sometimes called public choice theory. This approach is part of what has been called “New Political Economy.” Some economists have used rational choice theory without giving up the traditional Keynesian focus upon imperfect competition in the market.

Public Choice Theory, which will be explained below, started taking over the field of political science in the United States in the l980s. It follows the work of Anthony Downs and argues that economic rational choice methodology can be used to understand politics and political processes. It is clear that this approach to economic and political thinking has greatly influenced public policy in the United States, One example is the rise of the Tea Party, which takes the position that the main problem with the country is not the markets but government interference in the market. The Tea Party rejects most social welfare programs of the government.

We will look at some of the major figures of the school here.

Milton Friedman (1912-2006):

Friedman, along with George Stigler, is one of the founders of the Chicago School of economics. Friedman was a monetarist, which is explained further below. Monetarism says that the amount of money in the economy is extremely important in terms of prices and inflation. Friedman argued that Keynesian efforts by the government to stabilize the economy in terms of controlling inflation and unemployment do not work. This kind of fiscal policy will worsen the business cycle and cause even greater unemployment, according to Friedman. He argued that there is a natural rate of unemployment in the economy which the government cannot correct.

According to Keynes, consumer spending was mainly influenced by current income. But Friedman alternatively used the permanent income hypothesis. This says that consumer spending was ruled by consumer’s expectations of income over a longer period. If this is true, consumers will save less than expected as their income rises. Friedman claimed that empirical evidence showed this to be true, in contrast to Keynes, who thought that savings would rise. Friedman thought that average spending depended upon average income over a number of years.

Friedman argued that this meant that government attempts to get people to spend money by generating employment and incomes during a recession would not work. People would realize that this income was temporary and so the government policy would have little fiscal impact on the economy.

Instead of focusing upon fiscal policy, or how much the government spent, Friedman thought it was more important to focus upon money and monetary policy. Friedman based his argument upon the quantity theory of money. This says MV=PQ, the amount of money in the economy (M) times the number of times each dollar is spent to buy goods (V) is equal to the economic output sold during the year. V is the velocity of money and Friedman argued that it was not institutionally determined as classical monetary theorists had believed. Friedman thought that the velocity of money was relatively stable over time, even though it could be influenced by such factors as interest rates and expected inflation. If this is true, then Friedman concluded that the most important factor was the amount of money in the economy that affected the level of economic activity.

Friedman said that the Keynesian stimulus of money might affect economic activity in the short run, but over time, this infusion of money could have no economic impact. He thought that it would bring inflation in twelve to eighteen months after an increase in the money supply. Friedman said that all inflation stemmed from too much demand for goods and there is too much demand when there is too much money.

Therefore, what the central bank should do is to increase the money supply by only three to five percent in a year in the US and whatever was the normal rate of growth in any economy. This would be the way to control inflation.

Monetary authorities can cause inflation and depressions through mismanagement, according to Friedman. And in fact, Friedman blames the United States Federal Reserve (the Fed) for causing the Great Depression. The Fed tightened the money supply when it should have pumped more money into the system. The economic crisis was caused by a sharp drop in the money supply, according to Friedman.

Friedman also became noted for his argument that there was a “natural rate of unemployment.” Why is this? Not everyone will always have a job for several reasons. Some workers quit their job to look for another. Others have just entered the work force to look for a job and will remain unemployed for some time. Since there are always workers in such positions, there will never be full employment with everyone having a job. Also if the government provides unemployment benefits, workers can take more time to find a new job. If their spouse is employed, the pressure is much less to find a job immediately to pay the bills.

If the government tries to provide more jobs, it just raises the rate of inflation, according to Friedman. With higher prices, people buy less and this will lead to a decline in production and employment. The eventual economic downturn will return the economy to the natural rate of unemployment. In other words, government efforts to get people employed may help some people for a short time, but does no good in the long run.

In this argument, Friedman was arguing that there was no Phillips Curve. The Phillips Curve says that there is a trade-off between inflation and unemployment. When inflation is higher, unemployment is lower and vice versa. Friedman argued that there was no such relationship. When the two moved together in the same direction, this caused stagflation as in the l970s, according to Friedman. In fact, Friedman blamed Keynesianism for stagflation.

In the international arena, Keynes argued in favor or fixed exchange rates, but Friedman said that exchange rates between currencies should be flexible. Flexible rates, theoretically, provide a correction when there is a balance of payments deficit, and monetary authorities do not have to worry about the value of the national currency.

The theory is that if the exchange rate is fixed, the central bank cannot change the money supply and interest rates to affect the domestic economy. On the other hand, with flexible rates, if the national currency falls, which is generally the case, interest rates can be raised and foreign currencies sold by the central bank. This will strengthen the national currency.

A second part of the theory is that flexible exchange rates promote international trade. This is because the exchange rates adjust automatically when there is a trade deficit. When there is a trade deficit, the value of the national currency falls, and this helps to increase exports. When there is a trade surplus, the value of the currency rises which makes exports more expensive.

The third part of the argument is that flexible exchange rates prevent inflation from spreading from one country to another. With fixed exchange rates, if there is inflation in a country people will buy more imported goods, as they will be cheaper. But the increased exports in the second country will tend to cause inflation there as demand increases. On the other hand, with flexible exchange rates, if there is inflation, the value of the currency falls and prevents inflation from spreading to the second country.

Friedman notably argued that in their work, it did not matter if the assumptions of economists were realistic or unrealistic, in scientific analysis. All theory involves abstractions, so all assumptions are unrealistic to some degree. What is important is whether the theory makes good predictions in economics. If the data supports the theory, then it is good. Otherwise, the theory is useless.

These ideas show the direction of the Chicago School of Economics. There is general opposition to government controls on the economy. People are prevented from making individual decisions. They argue against wage and price controls, including rent controls. They oppose tariffs on international trade. They also oppose minimum wage laws. Friedman also opposed the Social Security System in the United States. However, when there was no social security, the country was full of homeless people riding the freight trains from town to town and living in hobo jungles.

Gary Becker (1930-2014):

Gary Becker was another prominent member of the Chicago School. He mainly used rational choice theory to study political and economic problems in the United States. He saw all forms of behavior as being based upon human rationality in attempting to maximize utility. This applies to love and marriage, divorce, crime and punishment, labor markets and human capital. Are people really that cold and calculating? Are they really that rational?

Becker studied the family as if he was studying a business firm. The spouse should be that one which will provide the maximum amount of utility.

Becker argued that there was no discrimination against women in American society in terms of pay. Women choose to specialize in household production and men generally specialize in market production. Consequently, women earn less money as a result of their own choosing.

It is the same way with crime. The criminal makes a rational decision to rob a bank or a house. The chance of getting away with the money or loot without getting caught or getting light punishment means that there is a good chance that crime will pay dividends.

In terms of human capital, the same rationale applies. People go to the university to invest in themselves for future payoffs in a higher salary and better job.

Perhaps more dubious is Becker’s argument that inequality in incomes between whites and blacks in the United States does not show that blacks and minorities are discriminated against. He made the similar argument about women. Blacks make less money, he argued because they have invested less in human capital in themselves. Further, if employers prefer to hire whites and not blacks, this is just a preference for whites over blacks. They may think it will be better for their business and so it is perfectly legitimate. Perhaps this is true, although the common names for these practices are racism and sexism. This certainly figures into many business decisions. Again, we see the conservative bias demonstrated by the Chicago school of Economics.

Robert E. Lucas, Jr. (1937-):

Another University of Chicago economist who worked with Milton Friedman is Robert E. Lucas. His approach is called “rational expectations” and he is the strongest proponent of this theory. The theory of rational expectations says that individuals use information when making decisions to try to achieve a better future. He rejects Keynesian economics and believes that unemployment will go away by itself with no assistance from the government when people make informed rational decisions.

According to the theory of rational expectations, people are “rational agents” who make decisions based upon information and upon past mistakes. And since people are rational, the government cannot use policies to improve the economy. Economic policy tools do not work and there is no Phillips Curve trade-off between inflation and unemployment. This rational expectations model is said to represent Frederick Hayek on laissez faire economics.

The explanation goes like this. Keynes thought that an economy could experience extensive periods of time when unemployment remained high. But according to Chicago School economics, unemployment is the result of wages being too high. This creates a surplus of workers. All workers have to do to find a job is to accept lower pay. If they do not, then it means that they just like leisure, that is, being unemployed, better than working for lower wages. For Lucas, unemployment is voluntarily chosen. For Keynes, unemployment was involuntary. This is called the New Classical School of Economics. Another implication is that if workers are unemployed it is their own fault. They just do not want to work.

For Lucas, if the market is allowed to work, unemployment decline and there will be no problem. Unemployment is just a reflection of decisions made by individual workers and firms and the government cannot do anything about it. This thinking is seen in the Tea Party in the United States which tends to blame the government for any and all economic problems.

In summary, we can say that the Chicago School favors free-market policies with little government interference in the market. Some argue that this school has encouraged government policies which have increased inequality. Inequality has certainly grown by leaps and bounds in the United States in recent years. Also the belief in economic rationality in general may have contributed to building up bubbles in the economy and economic crises.

Monetarism:   

Monetarism, associated with the Chicago School, has had great influence on political economy since the decline in influence of Keynesianism in the 1970s. It is also an aspect of supply-side economics, over against Keynesianism or demand side economics. It is important to understand the basics of monetarism.

Monetarism is a school of economic thought that claims that the main role of the government in the economy should be to control the amount of money in circulation. It argues that the variation in the money supply has major influences on national output in the short run and on the price level over longer periods. The objectives of monetary policy can be met by focusing upon the growth rate of the money supply. A major proponent of monetarism was Milton Friedman as seen above.

Friedman first accepted Keynesian economics, but later came to criticize Keynes on government intervention in the economy. Rather, the Fed should be able to keep supply and demand for money at equilibrium as measured in productivity and demand. For Friedman, the excessive expansion of the money supply is inflationary. Those responsible should focus only upon maintaining price stability.

It is considered ironic that the theory is based upon two completely opposed ideas, namely the nineteenth century desire for hard money and the monetary theories of John Maynard Keynes. For Keynes, it was a demand-driven model for money as the foundation of macroeconomics.

While Keynes focused upon the value stability of the currency, Friedman focused upon price stability. Keynes said that money did not matter. Friedman said that it did matter and this was the origin of the monetarist label.

Friedman studied the monetary policy of the United States in “Monetary History of the United States 1867-1960.” He claimed that there was inflation during times when there was an excess money supply and depreciation when there was a shortage of liquidity. He formulated “Friedman’s k-percent rule.” This targeted a range of inflation.

Friedman believed that a pure gold standard was impractical because the supply of gold was too limited during deflationary periods. Friedman argued that the Great Depression had been caused by a massive contraction in the money supply, and not by the lack of investment as Keynes argued. The proper action of the Fed was to increase the money supply.

Friedman argued that the demand for money depended upon a small number of economic variables. With more money supply, demand would rise. If there was less money supply, aggregate demand would decrease. In the l970s, stagflation had arrived in the United States. It seemed that Keynesianism as an economic tool was not curing it. There was both unemployment and inflation. This situation followed the collapse of the Bretton Woods System in l971. Inflation seemed to call for one type of measure and unemployment the opposite.

For Friedman, “Inflation is always and everywhere a monetary phenomenon.” The monetarists saw market economies as stable and Keynesian measures as harmful. Friedman believed that an economic stimulus had no effect on the economy because the large fiscal spending just raised interest rates. It was a sort of crowding out. The stimulus just shifted demand from the investment sector to the consumer sector.

In l979, Margaret Thatcher won the election in Great Britain. Inflation was running at ten percent. Thatcher imposed monetarism and the inflation fell to 4.3 percent by 1983. But at the same time, factories closed and unemployment doubled to three million people. The economy was thrown into recession.

When US President Jimmy Carter appointed Paul Volker to be the head of the Federal Reserve, Volker restricted the money supply to fight inflation.

For Friedman, the way to restrain the growth in the money supply was to cut government spending. So the monetarists concentrated upon government spending. They believed that the era of demand-driven fiscal policies had come to an end in the l970s because they could not restrain inflation and produce economic growth.

After this, inflation would be fought through the central bank using austerity and shock treatment. This was also the IMF solution. Thatcher had drastically cut government spending. However, it was just the opposite with Reagan, because of the defense budgets. Spending grew at more than four percent, but only 2.5 percent under Jimmy Carter. Unemployment remained high in both the US and the UK, while inflation dropped.

The use of credit for economic expansion is anti-monetarist but was expanded.

With the crash in the US economy in l987, it was not clear that these monetarist policies had worked. At the same time, the Savings and Loan system collapsed. In the late 1980s, Paul Volker was replaced at the Fed with Alan Greenspan. Greenspan was also a monetarist and ran a tight money policy. When Bill Clinton took office in l993, he continued Greenspan’s policy.

The next shock came with the Asian Financial Crises in l997. The Fed responded by massively pumping dollars into the global economy.

It seems that the evidence since the l990s is quite confusing and that monetarism does not provide an explanation. First, the money supply growth and inflation did not respond as predicted. They became “unhinged.” Further in the early 2000s, monetary policy failed to stimulate the economy. Greenspan believed this was due to “irrational exuberance” and a “virtual cycle of productivity and investment.”

Ben Bernanke took over at the Fed and was also a monetarist. Still the Fed did not prevent the financial crises which began in the US in 2008. Bernanke ran a policy of quantitative easing to stimulate the economy for years after this. Simply, the Fed printed dollars to stimulate the economy.

Supply-Side Economics:

Supply side economics is related to monetarism. It argues that economic growth can be created most effectively by lowering barriers to producing goods and services. Among these measures are lowering the income tax, cutting the capital gains tax, and reducing government regulation. It is argued that with lower marginal tax rates and less regulation, consumers will benefit from goods and services at lower prices.

Arthur B. Laffer (1940- ):

Arthur B. Laffer influenced the supply-side economic policies of the Ronald Reagan Administration in the 1980s. His argument resulted in the famous “Laffer Curve.” This says that government revenues are the same for some specific tax at 100 percent tax rates and zero percent tax rates. However, the optimal or highest government revenues are somewhere in between these two rates. Critics say that the Laffer Curve is a form of “trickle-down economics.”

Supply side economics, along with monetarism, was a response to the stagflation of the l970s. It drew on conservative economics of the Chicago School. Supply side theorists argued that cutting taxes creates jobs. This was a form of Say’s Law, that “supply creates its own demand.” Keynes had said the opposite, namely that “demand creates its own supply.” According to Say’s Law, supply creates demands for other products to the full extent of its own value.

Supply side economics was part of the popular tax revolt at the time. Many came to believe that the high tax-rate progressive income tax system in the US had failed. Some believed the system could be returned to the gold standard and a Bretton Woods type monetary system. They argued that lowering taxes to the proper level would not only increase economic growth but also increase government revenues. Investment would pick up.

It seems that all of this was badly mistaken. Paul Krugman has said that supply side economics failed and that monetarism left the economy in ruins. He said that supply-side economics promised “free lunches.”

During the Reagan years (1981-1989) budget deficits increased with the massive defense spending. The political economy debate moved to the right with the main agenda to cut social welfare. By 2003, the Bush tax cuts made things worse. They resulted in cuts to social security, medicare, education and health care spending in the United States.

For John Kenneth Galbraith, supply side economics was just a cover for trickle-down economics. He said it is just the old “Horse and Sparrow Theory.” If you feed the horse enough oats, some will pass through to the road for the sparrows.

Rational Choice Theory and Political Science: William H. Riker (1920-1993)

Since the l980s, rational choice theory has largely taken over the theory of American Political Science. It has replaced pluralist interest group theory developed by Arthur Bentley, David Truman and Robert Dahl. The base of rational choice theory is in nineteenth century economics and the Austrian School, based upon methodological individualism.

According to Interest Group Theory, groups organize and make demands upon the government, which is seen as a sort of neutral black box. The government processes these political demands and produces policy outputs in the form of public policies. Since there are many or a plurality of groups making demands, this results in a sort of equilibrium in society, with moderate policies. This is seen as democratic and rational for society. It denies that there is anything like social classes and class struggle in society, as the Marxists believed.

Rational Choice theory turns this traditional theory of American politics on its head. While people make rational choices in society in pursuing their interests these rational choices do not add up to rational policies, but rather to irrational policies which waste the resources, particularly the capital, of society which could be put to better use if it was invested in the economy, rather than being consumed by the people. These ideas gave rise to Public Choice theory.

The Godfather of the rational choice approach in Political Science is William H. Riker. Simply, he is the father of all modern “rats.” The theories are based upon much game theorizing and complex mathematics, which looks complicated and impressive and is hard to critique for those not versed in mathematical methods.

Riker published The Theory of Political Coalitions (1962). This founded “positive political theory.” It introduced social choice theory to political science. Riker argued that politicians manipulate the order in which decisions are made. This makes it possible to change political outcomes without changing people’s preferences.

Riker then published The Art of Political Manipulation (1986). He taught at Rochester, New York and founded the Rochester School of Analytical Political Science. (Rat Choice theory) He developed the Theory of Heresthetics. Heresthetics is defined as “the structuring of the world so that you can win.”

There are three assumptions to Rational Choice Theory in Political Science:

First. Rationality: Individuals make rational decisions.

Second. Component Analysis: Only small parts of a system are important in predicting human behavior.

Third. Strategic Behavior:  Individuals take into account what others may do before making decisions.

Politics involves “choosing and electing.” This is done through the use of rhetoric or persuasion. It is also done through heresthetics, the method of structuring political processes so that one is sure to win. It may involve effective coalitions.

Riker borrows his definition of politics from David Easton. “Politics is the authoritative allocation of values.” He borrows his theory of decision-making from game theory. He adopts von Neuman-Morgenstern’s Theory of n-person games. Agents attempt to win by creating groups or coalitions. There are zero-sum games and n-person games, in which the unequal winnings are distributed. Rational action is defined economically as maximizing utility, either money or power.

Riker does not say that all human behavior is rational, but that which structures economic and political institutions is. Institutions can be set up so that if one wants to win, they have to play the game in a certain way.

Important in heresthetics is:

First. Agenda Control: One decides what gets discussed and which problems get solved.

Second. Strategic voting. Using voting procedures. Who wins depends upon how the process is set up, not upon the voting. (Joseph Stalin said the same thing. The winner is not determined by the voters but by whoever counts the votes.)

Third. Manipulation of the dimensions. The situation can be redefined to create a stronger coalition.

For Riker and other “rats,” the only possibility is an oligarchy and the winners are the ones who form the oligarchy and rule.

The Arrow Impossibility Theorem (Kenneth Arrow):

This theorem is designed to prove that all voting systems produce some results that no one voted for and that it is impossible to create a voting system that is completely fair. But Arrow believes that the American majority voting system is the most fair. When all the voting, preference orders, are aggregated this is called a “social welfare function.”

Arrow makes five assumptions about fairness:

First. Universality: Given a set of individual voting preferences, the result, or universal preference order, should be the same every time. (That is, the rules should not produce different results for the same preference orders.)

Second. The Pareto Principle: The result of the election should reflect the preference orders of the voters.

Third. Non-Dictatorship: One voter’s preferences should not be able to determine the results.

Fourth. Independence of irrelevant alternatives:  Only certain preferences are represented in the issues being voted upon. The voting should not respond to other issues, such as environmental, social welfare, health and other issues.

Fifth. Monotonicity: The voting result should not give a higher rank to low-ranked options.

The theorem says that all voting systems have some degree of unfairness built into them and produce some results that no one voted for. Also the result may be no winner or the wrong winner when preferences cycle.

The Virginia School of Political Economy:

Anthony Downs:

Anthony Downs is an important figure in the development of New Political Economy and Public Choice Theory. Downs was not part of the Virginia School, but helped lay the basis for the theories. Thinkers, such as Downs, tried to understand society and politics by using the methods of economics, particularly methodological individualism. Downs became famous with his book, An Economic Theory of Democracy, published in l957. This book influenced the Public Choice School. He sees most of society’s problems as being caused by the government.

Downs studied the logic of voting from an economic angle. In a two-party system, like the United States, both parties move toward the center to try to get the most votes. Ideologically, both parties essentially agree on the same thing, the liberal capitalist system dominated by big corporations. Voters generally do not have enough information to make good decisions as to who they should vote for. So they are mostly voting in terms of economic issues.

There is a fairly stable distribution of political ideology from left to right. The political left is very small in the United States. The extreme political right is also small, but US political ideology tends to be very conservative by global standards. Since ideologies among the people stay pretty much the same, this delivers a quite stable political system. One could argue that a considerable shift occurred in the l960s due to the Vietnam War and the Civil Rights Movement that produced a shift to the left with the sixties generation. Later it shifted back to the right, however.

Downs says that it would take a change in the distribution of ideological values in order for new political parties to be successfully launched. For example, the Greens Party after the increase in environmental awareness. However, in America the system is clearly biased against third parties. They can contribute ideas, but cannot win due to the winner take all electoral system.

Downs also argued that in a two party system, it is rational for each party to encourage voters to be irrational by launching a vague and ambiguous platform.

Actually, from an individual, utility maximizing, standpoint, voting seems irrational. Not voting is not going to affect others’ voting and one vote is not going to make any significant difference. One can win the lottery easier than one can swing the result, except perhaps in a very small constituency. On a collective basis, however, voting is rational. Otherwise one just concedes everything to the opposition. So voting is actually a socially cooperative activity.

It is interesting, however, that recently, the Republican Party in the United States has moved farther and farther to the right, even though this has tended to hurt the party in elections. So perhaps the theory does not always explain behavior.

Later Downs wrote Stuck in Traffic (1992), advocating putting prices on roads, which he thought would help alleviate traffic. These ideas, good or bad, often start in the US.

The Virginia School was developed by James Buchanan, G. Warren Nutter, and Gordon Tullock, first at the University of Virginia in the l950s. Their approach became known as Public Choice Theory and has had great influence in developing ideological grounding for neoliberal economics after the l970s. It is conservative and largely anti-welfare and also influenced economists of the Chicago School, as seen above.

James M. Buchanan (1919- 2013):

Buchanan is known as the primary founder of the Virginia School of Economics, which developed Public Choice Theory. Public Choice Theory was founded by Duncan Black in l948. The theory is used to study voting behavior, legislative behavior, and other political processes.

Again, economic theory is being used for the analysis of politics. Buchanan was anti-state and had libertarian views. The Public Choice School looks at the decisions of public officials, politicians and bureaucrats, as making rational decisions to maximize utility for themselves. They expect to gain from their choices.

Buchanan began by arguing that the government could not use Keynesianism to improve on the outcome that comes from the market. First according to radical subjectivism, it is only individuals who can know what is good for them. No other party can make an objective determination to decide what is good for them. Especially, the government cannot decide what is good for people, what is good for society and what is bad for society. Economic policy-making by the government cannot promote the public good, according to this view. This also means that all modern welfare economics must be rejected.

According to this view, politicians will not do what is good for the public, but rather what will help them get reelected. They generally like big government and big budgets and so government grows to an unwieldy size. This also leads to firms engaging in lobbying politicians for laws and policies that serve their interests. This leads to large government and huge government debt through the use of Keynesian economics. So there is no hope that the budget will be balanced.

Buchanan was one of those who thought that in the United States, there should be a constitutional amendment requiring a balanced budget. One can see how this ideology became a basis for the conservative Tea Party Movement in the United States. The Public Choice perspective has taken over much of the literature in the field of political science in the United States.

Gordon Tullock:

Gordon Tullock was another main figure of the Virginia School and published The Calculus of Consent: The Logical Foundation of Constitutional Democracy. In l983, the Center for the Study of Public Choice at Virginia, moved to George Mason University.

These thinkers also borrowed methodology and ideas from the Austrian School. The ideas are also associated with the Chicago School. There is a strong belief in the outcome of the free market. There is a strong criticism of public sector institutions, particularly government.

Buchanan and Tullock applied an economic analysis to national constitutions. Tullock is the father of the modern rent-seeking literature and criticism of special interest groups. Their ideas provide part of the ideology for conservative so-called free market economics and neoliberalism. They became a part of what has been called the New Political Economy. This is conservative and rejects much of liberal thinking on economics as seen in Chapter Eighteen.

Mancur Olson (1932-1998) was also a contributor to the Virginia School and Public Choice Theory. Basically, he tried to show that interest group behavior in society, which is economically rational, does not result in a good society. It is just the opposite as it results in rent-seeking behavior and wastes capital. This view goes against the traditional theory of interest groups in American political science that was constructed by Arthur Bentley and David Truman.

Olson studied how people behave in groups, publishing The Logic of Collective Action: Public Goods and the Theory of Groups in l965. In small groups, one can act on a shared objective. But in large groups, there must be some personal gains if they act in the common interests of the large group.

The work here has great importance for political economy. If much of political activity is conducted by interest groups and results in a coalitional distribution, which is detrimental to society, it means that democracy is not desirable. It also ties in with the idea in New Political Economy that excessive democracy is not good for economic growth. For maximum economic growth, it is better to have a technocrat run the economy, through technocratic management.

Among the problems of such groups, Olson mentions cotton farmers who have a strong political base, but gain income above the market rate through rent seeking. This is costly to society. Labor unions are similar as they also distort the market for labor according to this idea. They also tend to be protectionist and anti-technology. While they hurt economic growth, there is little public opposition to them. When there are great numbers of such groups, they burden the nation and it falls into economic decline. This reminds one of Joseph Schumpeter on capitalism.

On the other hand, there are positive and beneficial coalitional distributions. For example those entrepreneurs (business groups) who produce economic growth are desirable as they are believed to produce wealth. It is OK for business to tell the government what to do, but common people have little influence. The approach is conservative as it suggests that democracy is damaging to society.

Another book by Olson in 1982, applied this theory more broadly: The Rise and Decline of Nations. It tries to account for why nations collapse.

In public choice theory, it is argued that there is a serious defect in the way people make decisions in a democracy. They believe that they make rational decisions. However, these rational decisions do not result in rational policies. In the case of voting, voters are very badly informed. In fact, informed voting is not rational because the worth of one’s vote in the collective is far less than the cost of informing one’s self of the issues, in time and effort. Most people vote blindly. Also the candidates are not aware of the results of the policies they propose, even if they were possible to carry out. So it is actually rational to be ignorant when one votes, and also even more rational, perhaps, not to vote at all. One vote is not likely to change anything. So the voters are irrational and the policies which will emerge will also be irrational. In short, democracy is hopeless.

Some groups are able to gain much in terms of rent-seeking. People do not notice very much the tax breaks given to religious groups or the subsidies to cotton farmers or tariffs on imports. But these policies are often not rational from an economic point of view. The public has to pay the cost of subsidies to “special interest groups.” Politicians do not care if it is rational, they just want to win elections. They pass laws without ever reading them, just to get to the next election safely and win again.

Public Choice theorists usually support “emission rights” for businesses, and also a market in these rights to pollute. They see this as economically rational and a way to deal with negative externalities. However, the public generally disagrees and this is seen as irrational. This type of approach casts doubt on democracy itself. For example, many types of political activity, such as students asking for lower fees to attend a university, can be seen as “rent seeking” by a special interest group. Yet, it is really at the center of democratic participation as traditionally understood. Therefore public choice theorists can be seen as anti-democrats. They generally approve of measures which tend to help big business but disapprove of those which increase social welfare.

Most public choice economists are anti-state in significant ways. However, they might like to turn the economic management over to a technocrat. Democracy is seen to waste resources.

Economists such as Jagdish Bhagwati, Gordon Tullock and Ann Krueger, have argued that rent-seeking causes wastes, especially in developing countries. In some ways, the Public Choice approach is a revolt against traditional interest group theory. Amartya Sen has argued that Public Choice Theory is absurd and does not explain how the world works. Even Buchanan and Tullock claimed that it did not explain all collective action, but only some fraction of it.

A later chapter will deal in more detail with the New Political Economy approach.

Summary:

The rejection of Keynesian economics in the l950s by some American economists, particularly at the University of Chicago, produced the Chicago School of Economics. Pivotal figures included Milton Friedman and Gary Becker. This new conservative rational choice approach had links with Frederick Hayek and the Austrian School of Economics. Economists also borrowed ideas from the Virginia School of Public Choice Theory, dominated by James M. Buchanan. By the l970s, this approach began to take over the economics profession and become part of the mainstream ideology.

The thrust of the new rational choice approach was that all economic and political behavior could be understood as individuals making rational individual decisions. These conservative economists argued that Keynesian economics did not work and only led to inflation, unemployment and stagnation. It provided an ideological basis for cutting back on social welfare programs and public spending, particularly in the area of human services by the government.

Economists also turned traditional American interest group theory on its head, arguing that interest groups making rational decisions only led to an irrational result, wasted capital and led to slower economic growth. The implications were anti-democratic as it meant that when people participated in politics they tended to make things work badly for capital and the market. All decisions should be left to the dynamic of the market.

The resulting New Political Economy provided a powerful ideological basis for implementing neoliberalism, privatization and structural adjustment programs by the IMF around the world. At the same time, it meant that there would be a struggle to cut back public spending on welfare programs in the United States. It seems clear that the new rational choice approach led to much greater inequality in the Unites States and probably contributed greatly to the economic crisis.

Key Terms:

The Chicago School of Economics

The Virginia School of Economics

Milton Friedman

Gary Becker

Richard Posner

George Stigler

Anthony Downs

Public Choice Theory

Monetarism

Quantity Theory of Money

US Federal Reserve (Fed)

The Great Depression

Natural Rate of Unemployment

Phillips Curve

Fixed Exchange Rates

Flexible Exchange Rates

Robert Lucas

Rational Expectations

New Classical School of Economics

Supply Side Economics

K= Percent Rule

Alan Greenspan

Asian Financial Crises

Ben Bernanke

Irrational Exuberance

Arthur B. Laffer

Laffer Curve

Trickle-Down Economics

John Kenneth Galbraith

The Horse and Sparrow Theory

James M. Buchanan

Gordon Tullock

Rent Seeking

Mancur Olson

Interest Group Theory

William Riker

 

Part II:

Part two covers the political economy of the contemporary global economy. We first look at the structure of the world after World War II, with the US as the most powerful country. We then examine such topics as economic growth, global trade, the international monetary system, the international financial system, and multinational corporations.

The neoliberal revolution since the 1970s has ushered in the New Political Economy which has significantly changed the shape of the global economy. The post-war Bretton Woods Era still shapes the contemporary global economy, given the role of the US dollar as the global reserve currency. The emerging countries as the new workhouses of the world are beginning to challenge this system, however, as their share of global GDP increases relative to the United States. Finally, we take stock of the shape of the contemporary global political economy including a brief look at the hidden or underground global economy. This part of the global economy, generally off the books, is more significant than is generally recognized.

 

Chapter Twelve: The Post-War World and the United States

The Post-War World:

At the end of World War II, global power had shifted to the United States. The United States emerged as the world’s most powerful nation, economically and politically. Half of the world’s industrial production was in the United States at the end of the war, and it was the one great global power. As such, the United States was able to set up the framework of a global economy which would serve its national interests, namely global military power and profits for big American corporations. The resources and markets of the world would be kept open for American multinational corporations. The institutions were put into place for the post-war world, including the International Monetary fund (IMF), and the International Bank for Reconstruction and Development (World Bank). Efforts were made to increase free trade. This resulted in the framework called the General Agreement on Tariffs and Trade (GATT). Several rounds of trade talks were carried out under this framework.

As the world’s most powerful nation, the US would also have the world’s most powerful money, or currency. The monetary arrangement which would give the US dollar this powerful position was established in Bretton Woods, New Hampshire in l944.

The Bretton Woods Monetary System: 1944-1971

The Bretton Woods Conference in l944 established the monetary system for the post-war world. The British economist John Maynard Keynes was a major participant and helped shape the proceedings.

It was clear that the US dollar would be the anchor for the other major currencies of the world, namely those of the countries of Western Europe and Japan. This reflected that the basis of the emerging global economy was to be based upon the capitalist economies of the United States, Western Europe and Japan. These would be the “great workhouses” of the world and engines of growth for surrounding countries. The US would underwrite capitalist economic development in these key areas in order to restore the global economy. At the same time, a political goal would be to sabotage any country which opted for communism or tried to establish any alternative system of political economy.

At Bretton Woods, with key figures such as John Maynard Keynes, the dollar was given the legal status of gold. Officially, the dollar was equated to gold at the rate of 35 dollars an ounce. The European currencies which were weak and not yet convertible were linked to the dollar with fixed exchange rates. This was a modified gold standard, as the dollar was backed by gold at a specific official exchange rate. This arrangement would last until l971.

The Bretton Woods System gave the United States great power and unique privileges in the global economy. With the dollar as the hegemonic currency linked to gold, it was the only currency in the world which could not be devalued. Also the dollar would be the de facto global currency as the world’s reserve currency. It meant that every country in the world, outside the communist orbit, must have a reserve of US dollars and pay its balance of payments deficits in dollars.  It is important to realize that this gave the US privileges which no other nation had. While other countries were subject to restrictions upon how much they could spend without weakening the value of their currency, the US did not have to worry about this. It could spend as much and engage in as much deficit spending as it desired with no dire economic consequences. In fact, this gave the US the power to go to war in countries such as Korea and Vietnam and put part of the cost on other countries which held dollars as foreign exchange to pay their bills. This was to happen massively during the Vietnam War in the l960s. It caused a virtual revolt in France and eventually brought the system down in l971 when the dollar was overvalued.

The Bretton Woods Monetary System served the interests of the United States, Western Europe and Japan as Western Europe and Japan rebuilt their economies after the war. Both political and economic guarantees were provided to these parts of the world. First, the United States, as the greatest capitalist power, would ensure that the world served the needs of its capitalist economy. This meant that the political and economic framework in Europe and East Asia must serve to shore up a capitalist world economy.

Political and Economic Arrangements:

In Europe, the United States initiated the Marshall Plan of some eighteen billion dollars of aid for economic recovery. A major purpose was to tie the economy of Western Europe to the United States as an outlet for capital and a market for US products as the countries recovered from the war. Politically, the United States was determined to keep the socialists and communists marginalized in Western Europe. Political control was also part of the US objective.

Germany was favored over France, which preferred a greater role for the government in the economy. The Central Intelligence Agency (CIA) was established to carry out secret operations when social democratic parties threatened to come to power. For example, the US used the Italian Mafia to prevent the social democrats from coming to power in Italy in the late l940s.

In East Asia, the agenda was essentially the same. In Japan, the socialists and communists were kept politically marginalized. This was not so difficult, given that the Japanese Constitution had been written by the United States and the electoral system ensured that the conservative pro-business Liberal Democratic Party (LDP) would win every election. Still there were political struggles and the US had to remain vigilant.

The Asian Side of Post War Development:

After World War II, the US promoted Japan as the engine of capitalist growth in Asia. Japan had been under US military control after the end of the war. The US wrote the constitution for Japan which would basically ensure that the government and economy would be controlled by the big capitalist corporations, the keiretsu, in Japan under the Liberal Democratic Party.

The US envisioned that Japanese capitalism would operate something like American capitalism, but produce light consumer goods for the American market, rather than heavy industry and high tech goods. This trade would be based upon traditional comparative advantage theory. America would produce the high tech goods and sell to Japan and buy consumer products from Japan.

However, the Japanese model turned out to be very different. The Japanese chose to engage in a model of state led capitalist development which would become a model for other emerging Asian nations. In the 1950s, the US was importing cheap toys and goods from Japan. For example, small toy cars that one would wind up and watch them run. When they fell apart, one could see that they were actually made out of a beer can. Because of such products, the phrase “made in Japan” became a joke in the United States in the l950s. However, this situation was to change quite rapidly.

In fact, the Japanese set out to beat the United States at its own game. Japan had been engaged in pursuing national development since the previous century, the Meiji period. The Japanese copied the American products, radios, TVs, video machines, cameras, and automobiles and made them better. By the late l950s, there was a transistor radio cult in the United States in which every young person wanted to have a transistor radio and these were imported from Japan. Television followed so that the Japanese took over the TV market in the United States and many TV companies in the United States went out of business. The takeover of the electronics and camera market in the l960s was followed by the arrival of Japanese autos in the l970s. The cars that were made in Detroit by US companies were generally of quite low quality. However, they were relatively cheap for workers who benefited from real wage rises in the l960s. Detroit turned out junky products for Americans but those who invested in the stocks of the auto companies made good profits. The producers did not pay much attention to quality. Moreover, with economic prosperity in the United States, it was possible for middle class families with good jobs to change their cars quite frequently and they wanted to drive the latest model. Having the latest model became a status symbol in America for middle class families. They were not buying the car to drive for ten years, but just for two or three at the most. Those with less money, of course, would get the cars second hand.

But as real American wages reached a peak and began to decline by the end of the l960s, Americans could no longer buy a new car every year. They began to look for cars that were more reliable and would last longer. This is where the Japanese came in. When Japanese cars arrived, Americans discovered that they were more reliable and a better deal for the money than buying American cars. Eventually the Japanese took over a large portion of the American automobile market. The US was forced to limit the number of cars that Japan exported to the US.

The Japanese learned marketing techniques from the Americans. One day the President of Datsun Motors saw a huge sign along the freeway in San Diego, California. The sign had been put up by Christians to promote religion and read “Jesus Saves.” The Datsun executive suddenly got a brilliant idea. “Datsun Saves.” This became the marketing slogan of the company in the US.

It is interesting that the Japanese emerged as a major developed economy by ignoring American advice and ignoring traditional trade theory. According to liberal economic theory, countries are supposed to develop by allowing the market to work and largely keeping the state out of the economy. On the other hand, the Japanese economy developed under the guidance of the Japanese Ministry of International Trade and Industry (MITI). This was a form of state-guided and state-sponsored development. The big Japanese banks were used to finance industries which did not make profits for years in order to develop niche products and capture the market for these products in the United States, Europe and Asia. This was not the way it was supposed to happen and went against liberal economic theory. It was, in fact, a form of neomercantilism, in which the state acts to sponsor national development. Consumption was kept low at home to force the Japanese to save and help to promote capitalist development. This was to provide a model of development later for South Korea, Taiwan, and later China.

It is interesting how development in Asia was also spurred by American wars. Japanese industry benefited from the US war in Korea (l951-53). Later, Korea produced materials for the war in Vietnam (l963-1975). Korea and Vietnam were to be kept free of a communist take-over in order to provide an area for the investment of Japanese capital in Asia.

Japan was seen during the l970s as the paradigm example of a “miracle economy” with full employment and life-long employment for Japanese workers in the major firms. But if it was a miracle, it was not brought about by free market economics. Japanese consumption patterns were quite restricted and food prices, such as rice, were high. Cheap rice imports from America were banned. Chalmers Johnson called the Japanese model the “state developmentalist model.”

At the same time, a large number of American military personnel were stationed in Japan which helped to pump dollars into the Japanese economy.

Japan played the role of a major hub of the global political economy following World War II and the US used the country to promote its interests in Asia. In order to drive emerging capitalist economies in Asia, the US sponsored Japan and allowed it to discriminate against American products and export to the US. Finally, by the l970s, restrictions were placed upon the import of Japanese products.

Economic Recovery in Europe:

The US was to play a very different role in the economic recovery in Europe. Much is made of the famous Marshall Plan. The eighteen billion dollars of the Marshall Plan was a replacement for capital flight from Europe. There were many strings attached to the aid, however. For the most part, it had to be spent for American products. So a large portion of it went directly to American corporations shipping products to Europe which were not always needed. The need to get dollars into Europe to buy American products was actually carried out more by the large number of American soldiers stationed in Europe for decades after the war.

The idea was to “prime the pump” to get the economy moving again. In the first phase, the US would sell products to Europe. This was actually a stimulus for the American economy. In the second phase, European businesses would begin to produce for the local market.

The US also set out to ensure that the old European conservative political parties were returned to power. This was done with the help of the US CIA. In Italy, the CIA used the mafia to help ensure a win for the Christian Democrats.

Europe became split between the East and the West with two economic systems, one linked to the Soviet Union and one linked to the United States.

By the l960s in Europe, economic recovery had reached the point where the major European currencies were convertible. Still the exchange rates remained linked to the US dollar. Currency flows were restricted during this period in order to provide stable economic growth.

The Structure of the Post-War World:

Academics analyzed the world according to the three-world formula. The First World was the United States, Western Europe, Japan and Australia, with developed, industrialized economies. The Second World was the Communist countries including the Soviet Union, Eastern Europe and China, after the Chinese Revolution in l949. There were a few other countries that became communist, such as North Korea and later Cuba. These countries meant that the world would be split into halves, one capitalist and one communist with different economic systems. The Third World consisted of the so-called developing countries, many of which had been colonies under Great Britain and European countries. The Cold War was a struggle over which half of the world these countries would join, whether they would be capitalist or communist, and which countries would have access to their resources and markets.

Making the World Safe for Democracy:

The US may have begun with a revolution, but after World War II the US was the major country opposing revolution in the world. The Third World consisted of the less-developed and the least-developed countries of the world. Many of them had strong anti-western sentiments after the nineteenth century era of revolution. Most of the people in these countries were very poor. Socialism, patterned after the Soviet Union, had a great deal more legitimacy for many, including the elites, than the capitalist model in the United States and Western Europe. Therefore the US had a problem. If there were to be markets and sources of raw products for US production, it was vital that these countries be prevented from having socialist revolutions and aligning themselves with the Soviet Union.

The US carried out counterinsurgency to prevent revolution, either by outright war or through assassinating leaders through secret operations carried out by the CIA. These wars to prevent revolutions were referred to as “police actions.” The US was the policeman of the world and so officials believed its job was to keep all these small countries in line.

The first police action was the Korean War in l951 to l953. The US forces fought North Korean forces. A large number died, both soldiers and civilians, but the result was a stalemate at the end of the war. Korea was divided into a capitalist south and a Communist north.

The second and larger quagmire which the United States found itself in was the Vietnam War (1961-1975). French colonialism was defeated in l954 by the Vietnamese at the Battle of Dien Bien Phu. The US took over where the French left off to prevent a nationalist revolution from succeeding in Vietnam. The North of the country was controlled by the nationalist forces led by Ho Chi Minh, who believed that the US should support their cause for national independence. Instead, the US supported the corrupt pro-western government in the south of the country, even though there was a local civil war going on in the south to overthrow the government. The war dragged on for some fifteen years, as the US sank into the “quagmire.” The communists eventually won and took over the US Embassy in Saigon (Ho Chi Minh City) in 1975. Some 59,000 American soldiers died in the war and as many as three million Vietnamese were killed.

Even though Vietnam became a communist country in l975, the country eventually opted to follow the Asian state developmentalist model and invite in US capital, as well as capital from Taiwan and other centers in Asia. Today Vietnam, like China, is a desired country for US capital investment, with an abundance of cheap labor.

The US also carried out operations to attempt to prevent communism in such countries as Cuba, Nicaragua, Grenada, and many other countries around the world. By the l970s the revolutionary trend had waned as the Soviet Union was no longer seen by so many as the model society for the future. A major problem was both the lack of democracy as well as the lack of consumer products in the Soviet Union. Also the desire of many in Eastern European countries to flee to the West suggested that the Soviet Union was not the ideal society that many on the left believed.

Third World Development:  

Influenced by dependency theory and to some extent the Soviet model of five-year development plans, many countries such as India went in for Import Substitution Industrialization (ISI) after World War II. It was thought that the Walt Rostow model of modernization and development would keep them in dependency and neocolonialism. Development in China under the Communism of Mao Zedong similarly sought to develop independently of foreign capital and foreign markets.

The import substitution model was encouraged by the Non-aligned Movement, of which India was a major force. This model of development was only partially successful and usually led to a slow steady rate of growth. For example in India, the Hindu Rate of Growth of three and a half percent persisted over several decades until economic liberalization in the l980s. The rate of economic growth increased, but inequality increased greatly.

The End of Bretton Woods and the Deindustrialization of America:   

The overstretch of the US empire by the l970s with hundreds of military installations around the world and the huge spending for the War in Vietnam began to sink the real value of the US dollar, although it could not be officially devalued. This forced the end of the Bretton Woods System and took the world’s monetary system off gold in l971. US President Nixon devalued the dollar by ten percent with the Smithsonian Agreement.

At the same time, the full recovery of the economies of Western Europe and the strength of the Japanese economy and other East Asian economies meant US exports declined in relation to the rest of the world. The domestic economy in the United States began to experience stagflation, unemployment and inflation at the same time.

Monetary theory and supply side economics gained strength and strongly challenged Keynesian economic management of the economy. The US turned sharply to the right. Global corporations turned to globalized production for higher profits. By the end of the l970s, the US economy was being dismantled and jobs sent overseas. With the emergence of the European Union, the US played a less significant role in the European economy.

Ronald Reagan was elected in l980 after Margaret Thatcher in the United Kingdom. Deregulation and privatization not only domestically, but globally became the new game in the global economy. The watershed came with the collapse of the Soviet Union at the end of the l980s. With no model to challenge all-out global capitalism, globalization became the watchword. The US was able to force countries around the world to open up to the global market and foreign investment. The age of neoliberalism had begun.

Under the new “free market” gospel laid out for the global economy, capital and trade flows would be increasingly liberalized. Industrial production would be moved to cheap-labor countries like China, Mexico, and Brazil. Financial flows would also be liberalized and exchange rates increasingly floated on the currency markets.

There would be little aid for developing countries, as under the old model. Instead, countries would be told to produce and export their way to riches or sink into poverty. The parameters of New Political Economy would be the rules around the globe.

After the fall of the Soviet Union and Eastern Europe and their integration into the global economy in the l990s, China went flat out for capitalist production, pleading that capitalism, after all, was the historical path to the development of the forces of production and eventually socialism. An enormous amount of foreign capital, mostly Western, flowed into China as it became the new great workhouse of the world.

Under this new dispensation, global growth slowed, while some countries like China, Turkey and India experienced high rates of economic growth for some periods. A number of countries were designated as Big Emerging Markets (BEMs). The most successful of which were the BRICS: Brazil, Russia, India, China and South Africa.

In the second decade of the twenty-first century, the picture became mixed. Much of the world’s production was taking place under slave-like labor conditions in China and other countries, such as India. Inequality and decline has marked those countries on the down-side of history such as Western Europe and the United States. Economic growth was weak in the United States and almost absent in the Eurozone after the 2008 economic crisis.

The Study of Political Economy:

As should be clear the study of political economy is much broader than the study of neoclassical economics. We are dealing with many more elements of society than a narrow economic approach. Political economy is concerned with the actual distribution of power and wealth within countries and within the global economy. In doing this, we must take into account the power and nature or states. How power and wealth is distributed in society is critical. The national and international institutions which establish the rules for the operation of the economy need to be understood. We must examine how the world produces goods and how they are distributed. The role of monopoly corporations and oligopoly explains much about the distribution of the spoils. Corporate power and business propaganda has mounted on a global scale. Global production seeks cheap labor for the production of commodities.

Hegemonic Stability Theory:  

Hegemonic stability theory and regime theory are two approaches which provide a perspective on the post-war global political economy and the role off the US in the global economy in theoretical ways.

Hegemonic Stability Theory is associated with Charles P. Kindleberger, sometimes considered to be the father of hegemonic stability theory. The theory is based upon his l973 book The World in Depression 1929-1939.  Hegemonic stability theory simply says that an international system needs a hegemon, a single powerful nation state, to serve as the dominant power and thereby provide global economic and political stability. The hegemon may exercise leadership in various ways. For example the hegemon will set and enforce the rules of the international system, support and maintain international institutions, impose sanctions on countries that break the rules and carry out police actions and wars if necessary.

To qualify as a hegemonic power, a country needs to have great political and military strength in the international arena, have a large and growing economy, have the will to lead and enforce the rules, and persuade the leading states of the system that its leadership is for the benefit of the other great powers.

Kindleberger argued that the period between World War I and World War II was characterized by economic chaos due to the lack of an international hegemon to enforce the rules. This tended to militate against free trade. Great Britain was no longer able to play this role and the US was not willing. This led to the Great Depression and made the global economic problems deeper and longer than was necessary.

Liberals have argued that Great Britain provided stability in the late nineteenth century by keeping the international system open to free trade. Liberals argue that even though the international system is largely one of anarchy, cooperation can be achieved among states in many areas, including free trade. The research of Barry Eichengreen in l989 generally supports the theory that Great Britain played a useful role in keeping the international system open for trade. Robert Keohane, Robert Mundell, Robert Gilpin and Mancur Olson also supported hegemonic stability theory. However, some on the left have argued that the system of British colonialism was not one of free trade, generally. Trade patterns served the needs of the Empire.

Neoliberals argue that a hegemon is needed today to enforce the rules of the international institutions, such as the IMF, the World Bank and the World Trade Organization. Once international institutions become firmly established, they usually have a long life. Robert Gilpin has argued that after a major war, such as World War II, the global hegemon establishes the rules for the emerging system and plays the role of maintaining these rules. This is the case with the United States and the Bretton Woods System, the IMF, the World Bank and the General Agreement on Tariffs and Trade (GATT) after World War II.

Paul Kennedy has argued that at some point the hegemon may become burdened with imperial overstretch and begin to weaken. When this happens, the system may break down. Johan Galtung believes that the US Empire is greatly overstretched and will probably collapse by the year 2025. He compares the decline of the US Empire with the fall of Rome and many other historical empires.

Regime Theory:

Regime Theory is associated with Robert Keohane, who published a major book, After Hegemony, in l984. Regime theory claims that the contemporary global system need not depend upon gunboat diplomacy, but that international organizations have replaced the older systems based upon military power. Today international regimes include the World Trade Organization, The International Monetary Fund, the World Bank and the international monetary system. This is referred to as “embedded liberalism,” meaning that liberalism has been institutionalized as part of the system.

These international organizations are based upon explicit principles, norms, rules and decision-making procedures. They allow the international political economy to function more smoothly by reducing uncertainty, minimizing transaction costs, preventing market failures, furthering individual and collective interests, and stabilizing the whole system. Keohane stressed that cooperation in the international arena would replace US hegemony as the US weakened relative to emerging states.

But others, such as Susan Strange pointed out that this argument was merely an argument to justify continued American hegemony. The US continues to structure the rules of the international system to protect and strengthen its role in the world

Stephen Krasner is another major contributor to regime theory with his book: International Regimes (1983). Krasner, along with Robert Gilpin, has argued that the US, as a hegemon, created a liberal international trading order after World War II to promote its own interests around the world. The US allied with other major powers to oppose the Soviet Union. Gilpin basically follows a state-centric approach in his analysis. International regimes are seen as providing “public goods” which have “non-excludability.” That is, everyone benefits from the liberal trading regime. This again is a liberal view of the international system.

Neoliberals, such Robert Axelrod, have used a rational choice approach. They use game theory to study international cooperation. His 1984 book, The Evolution of Cooperation, argues that states learn to cooperate by a process of iteration. By playing the game again and again, they learn that the best strategy is one of cooperation, rather than opposition to the international rules.

Summary:

The United States assumed the leadership of the non-communist world after World War II. Along with Great Britain, France and Germany, international institutions were set up for the economic and political operation of the post-war world. Under the trilateral system, the engines of economic growth would be the United States, Western Europe and Japan. Other emerging countries would provide markets and cheap labor for these capitalist centers.

Those countries which opted for socialist forms of government, such as the Soviet Union and China and any other country which joined them would be declared enemies and destroyed. National liberation movements in which a socialist form of government might emerge were seen as a “communist threat” and measures taken for their defeat, including military invasion if necessary.

As the most powerful industrial producing country after World War II, the United States pushed for free trade in manufactured products. The US Congress dragged its feet on free trade, however, as free trade in agricultural products threatened the price of crops for farmers back in their home states. Trade rounds were carried out under the General Agreement on Tariffs and Trade (GATT) since an international trade organization could not be established.

By the l970s, the Bretton Woods Monetary System had collapsed and the US economy experienced great competition from Western Europe and the new emerging export oriented economies of East Asia. The US economy had reached its historical peak and began to decline, on the down slope of the historical Kondratiev Cycle. Capitalists realized that profits for US corporations could best be preserved by the deindustrialization of America and moving production offshore to cheap labor countries. Profits in the US economy would be made primarily in the finance sector, rather than manufacturing. The US population would be marginalized as jobs were exported.

It was also necessary to ensure that capital and labor be kept in the private sector and social welfare rolled back to the greatest extent possible to clear the way for global monopoly corporate profits. What was known as the gospel of “globalization” declared war on the public sector and people’s democracy in countries around the world. Privatization was the order of the day. The new dawn of global neoliberalism emerged, rosy or not, to usher in the New Political Economy.

The future of America, as the empire declined, remained uncertain.

Key Terms:

Theory of Hegemonic Stability

Robert Keohane

Susan Strange

Robert Axelrod

Game Theory

Barry Eichengreen

Mancur Olson

Stephen Krasner

Charles Kindelberger

Embedded Liberalism

 

Chapter Thirteen: Business on a Global Scale 

The Dynamics of Economic Growth and National Systems of Political Economy

The Neoclassical Economic Growth Model (Robert Solow):

The neoclassical growth model from the l950s comes from Robert Solow. The model says that growth is a function of labor and capital. These are endogenous variables. Technology, on the other hand, is an exogenous variable.

Endogenous variables, such as labor and capital, are those that are included in the model. Exogenous variables, such as technology in this case, are those that are outside the model.

There are three basic assumptions of the model.

  1. There are constant returns to scale.
  2. Marginal returns diminish over time.
  3. Investment continues until a steady state is reached.

The first assumption means that if the amount of labor and capital is doubled, production will double. This means constant returns to scale.

The second assumption means that as more labor or capital is added, at some point, the additional utility from each unit added will decrease.

The third assumption means that investment will continue until there is no gain from adding more units of capital or another worker. At this point, production has reached a “steady state.” The amount of capital per worker is optimal.

The supply curve shifts to the right with new technology.

Technology is an exogenous variable. The Solow model assumes that when a new technology is invented, such as vacuum tubes or transistors, that the technology will be available to all firms in the same way. So a single firm cannot benefit from having an exclusive access to the new technology.

New technology can shift the supply curve to the right because production will become cheaper. Production will increase and prices fall. This will cause demand to increase.

According to this neoclassical model, the long-term growth of the economy depends upon the accumulation of the factors of production, capital and labor, and technological progress. Technological innovation raises productivity and tends to decrease the tendency toward decreasing returns.

The rate of economic growth of the economy is determined by “steady state.” This is the point where the amount of capital per worker reaches an equilibrium and remains unchanged. Conventional theory assumes that the government can do little to accelerate this long-term growth rate. The government can increase the savings rate or increase capital investment, but this increases growth only in the short term, There is no effect on the long-term rate of growth. Increasing the ratio of capital to worker causes the marginal return to capital to decline. So there will be no major impact over the long run. This is what classical political economists called the “falling rate of profit.”

Convergence Theory:

Convergence theory assumes that the less developed countries will catch up with the developed countries at some time in the future. That is, the economies will “converge” or have similar features. There are several hypotheses:

First, labor productivity and per capita income levels of the less developed countries should, over the long run, catch up with the developed countries.

Second, the developing countries can benefit by technology transfer from the developed countries. This will speed up growth.

Third, capital will tend to flow to the less developed countries, as profits are generally higher. This will speed up economic growth rates.

Fourth, the marginal gains to capital investment will be greater in the less developed countries than in developed countries.

Fifth, there will be economic growth in both developed and less developed countries. However, economic growth will be slower in the developed countries and faster in the less developed countries. Therefore, the less developed countries will be getting rich quicker and tend to catch up. Convergence theory seems to work for some countries in advantaged places and situations (such as Japan, South Korea, and Turkey). But under monopoly capitalism and oligopoly it does not work for every developing country.

Problems with Convergence Theory:

The problem is that the real world does not always work as the hypothesis logically predicts. In fact, it does not work this way most of the time due to several things.

First, the theory says that economic growth is primarily due to technological progress, but does not explain how innovation takes place. It is unlikely that a less developed country will gain cutting edge technology through technology transfer alone.

Second, the theory sees innovation (R & D) as exogenous to economic growth, which has clearly not been the case for many decades.

Third, the theory assumes that technological innovation is a “public good” and that every firm everywhere in the world has access to the new technology. This is clearly not the case. Today firms own and try to monopolize their innovative technologies.

Fourth, the convergence theory does not explain why a large gap between rich and poor countries remains when logically they should be catching up.

Fifth, convergence does not deal with the structure of the global economy which may keep many countries in a position of dependency.

Sixth, the theory ignores the factor of human capital.

Nevertheless, the theory persists and is considered to be sound by most neoclassical economists. The defects of neoclassical growth theory and convergence theory were addressed in Endogenous Growth Theory.

The Endogenous Growth Model (Paul Romer and Robert Lucas, 1986-88):  

In the endogenous growth model, economic growth is a function of labor, capital, technology, and R & D (research and development). Now technology and R &D have now become endogenous variables. This is because a firm with a large amount of capital can engage in research and develop its own technology which it owns exclusively for some period of time before other firms catch up.

The assumptions of the model include:

  1. Technology and R & D are endogenous variables.
  2. New technology will spill over to other firms but after some time during which one or more firms can have exclusive access to the technology.
  3. There are economies of scale, not constant returns to scale.
  4. There may not be diminishing rates of return, due to economies of scale. There can be increasing rates of return.
  5. Government policies, such as those used in Japan after World War II can increase the long-term rate of growth.
  6. This model especially applies to the high-tech sector where rates of economic growth may be higher.
  7. The government can encourage savings, the investment rate, and provide support for R & D to sustain growth. (In the US, R & D is massively subsidized through the Pentagon military budget.)
  8. Firms become oligopolistic. That is, a few firms control the market and can therefore set prices.
  9. Human capital is important.
  10. The social return to society is high since no one firm can monopolize knowledge.
  11. The government can use universities and other institutions to increase growth.
  12. The model weakens convergence theory. A country needs a high level of R & D and capital to catch up.

Theory of Economic Geography:

How do centers and peripheries form in the global economy? There are several principles that are proposed by economic geography.

  1. The location of the center or core of an economy may just be due to an historical accident. For example a port city, such as Istanbul, Athens, or New York which is close to the sea may become a core. There were many possibilities for the location of the core, but certain trade routes became established and built up over time.
  2. There is a tendency of agglomeration or cumulative forces. This means that once trade and manufacture starts in a location it builds up more and more like a snow ball and eventually becomes the center or core.
  3. The principle of path dependence is at work. This is a concept from Brian Author and Paul David. This determines the choices available. It may not result in the most efficient production technology, but it is just the one that gets there first. For example, the Windows operating system for computers is not the most efficient one, but it is the one that got established and became the most widely used. Therefore it gets firmly established.

To take another example, traveling by automobiles, especially in cities, is not the most efficient mode of transportation. However, the automobile became firmly established in the culture and public transportation lagged behind. So in some countries one is largely forced to buy and use a car, even when it is inconvenient. One has to go with what is available and that may not be the best.

  1. Path dependence can also be related with location. For example, the generation of new technology became located in Silicon Valley in California. Another example is the practice of firms subcontracting their data processing out to firms in India. Here employees know English and labor is cheap.
  2. There is imperfect competition and transportation costs. Suppliers will tend to locate near large markets. This reinforces the relationship between the core of the economy and the periphery. There are centripetal forces which increase the prominence of the core and centrifugal forces which tend to disperse activity toward the periphery.

For example, when transportation becomes cheaper, this encourages location of production in the core (a centripetal force). It is better to produce near other suppliers of goods and services. Products can be sent anywhere cheaply, so there is no need to produce in the periphery.

Higher costs of labor, land, services, and so on in the core will encourage firms to relocate in the periphery, or outside the core (a centrifugal force).

When the government imposes trade barriers, such as Canadian protection against US goods, this encourages investment in the periphery. US firms relocated to Canada to get around trade barriers before the establishment of the North American Free Trade Agreement (NAFTA). Japanese and German auto makers relocated production facilities in the United States to get around US quotas on how many autos they could export to the US market.

NAFTA, the free trade agreement between Mexico, the United States and Canada, has encouraged US forms to relocate to the periphery, in Mexico, to take advantage of cheap labor in Mexico (a centrifugal force). However, in general, “free trade” may be either centripetal or centrifugal, depending upon many factors and the particular industry.

National Systems of Political Economy: 

Not every system of capitalism works the same. While there are common features, there are significant differences between the way capitalism operates in The United States, Japan, and Germany. In this section, we will take a brief look at each of these systems.

Capitalism in the United States is a system of stockholder capitalism. As the United States has increasingly been deindustrialized since the l970s, the financial sector has become the primary venue for the generation of profits. This is sometimes referred to as the FIRE Sector, finance, insurance and real estate.

Japanese capitalism, on the other hand, followed a policy of state-guided industrial development. The German economy has been called stakeholder capitalism.

The American System of Stockholder Capitalism:

By US law, American corporations must attempt to maximize profits for their stockholders. While theoretically, the purpose of economic activity is to benefit consumers, it is probably more accurate to say that the underlying goal is capital accumulation, primarily by the monopoly corporations which dominate the system.

Economists assume that markets are competitive and this is promoted through anti-trust policies. In reality, this is an exaggeration. By the early twentieth century, The American system of capitalism had become monopoly capitalism.

American capitalism is free-wheeling with little restrictions on the types of activities permitted. In recent years, education and medicine have increasingly been privatized. Prisons are also being privatized. Services previously carried out by the public sector in municipalities are being privatized. Privatization in the US military has proceeded by leaps and bounds in recent wars. It is generally believed that anything carried out by the private sector is more efficient than that in the public sector. This is not always true.

American capitalism emphasizes consumption and produces a vast quantity of waste, an observation made by Thorstein Veblen in the early part of the twentieth century. In some cases, the greater the waste, the higher the profit. However in recent years it has become profitable to recycle part of the waste created by the system.

The American system of capitalism lags behind European countries in the provision of social welfare. It is last among the countries in the developed world in this category. This has become critical with the rise of the Tea Party and fiscal conservatism which has blocked many programs of government spending for social welfare by the national government.

Since the l970s, America has largely been deindustrialized. The manufacturing sector has declined as much industrial work was sent to Mexico and other countries, such as China. This tends to produce greater profits. However, large corporations are awash with mountains of cash of which they can find no profitable investments. Austerity tends to make this situation worse, as it cuts effective demand. Some of this capital finds its way into the financial sector in derivatives and financial speculation, which is not a part of the real economy.

Large American corporations have taken over almost all sectors of the US economy, replacing thousands of small locally owned businesses which existed in the past. For example, when a Wall-Mart store moves into a community, it wipes out many small businesses which cannot compete with the world’s largest retail company. The small family-owned restaurants which used to make real food have mostly been taken over by the fast food giants, McDonalds, Burger King, Pizza Hut, and Hardees. Fast food, which is not as healthy as traditional meals, has taken over the restaurant sector, even though the country has plenty of good, wholesome fresh food.

Corporations take over the restaurants, the motels, the hotels, mortgages, banks, insurance, medicine, schools, prisons, farming, law enforcement, and other sectors of the economy.

Creative destruction tends to quickly destroy whatever is old or traditional more quickly than elsewhere in the world. Few historical buildings remain in the US. Even the art deco buildings from the l950s, which people tried desperately to save, have generally been demolished to make way for more profitable businesses, such as hotels. Generally, profits trump all, with some exceptions, where the people put up a sustained struggle and sometimes get some help from the courts.

American capitalism is marked by corporate oligopoly. This means that a few firms control the market in many areas of the economy. Sometimes this is referred to as “managerial capitalism.”

American capitalism may tend to create a herd mentality or a “one-dimensional man,” as observed by Herbert Marcuse. Wealth is seen to be the most admired value, as seen in such figures as Warren Buffet, Bill Gates and Donald Trump. Intelligence and a critical dimension, such as negative thought, are sometimes viewed as strange or subversive. In the l950s, intellectuals were seen to be “nerds” in the popular culture.

Management is generally separated from ownership in American capitalism. Corporations make the laws and have a great deal of control over American politics. The corporate owners, sometimes referred to as “the masters of the universe,” are an important government constituency. They have great power over public policies.  Most politicians are influenced by corporate money through the system of lobbying to vote for legislation that forwards corporate interests. Politicians depend upon corporate donations to win elections. Some critics such as Noam Chomsky see both political parties, the Democratic Party and the Republican Party, as just two halves of a single business party. Both parties generally serve the interests of big business.

In American capitalism, the corporation is legally a person. In terms of law and legality, money is speech. The courts have said so and nailed this down in Supreme Court decisions. A famous Supreme Court decision in the nineteenth century said that a corporation is a person with all the legal constitutional rights of a person. This changed the nature of the corporation. Originally, a corporation was just a chartered company charged with serving the needs of the people. If the company did not carry out this duty, the charter could be abolished. But the decision to give the corporation the legal status of a “person” made it much harder to regulate big corporations. It was also good for corporate lawyers who would never be out of a job. Almost any government regulation of corporations could be seen as violating the property rights of corporations. The state found it very difficult to regulate corporations due to this decision.

In American capitalism, corporations have traditionally received great public subsidies. This includes huge lands given to the railroads in the nineteenth century, timber, mineral, and oil resources, practically free. American corporations enjoy huge R &D subsidies through the defense department budgets.

In the l920s, the age of roaring capitalism, minimum wages were ruled by the Supreme Court to be illegal and equivalent to taking the private property of corporations. In the l930s, Franklin Roosevelt’s New Deal was ruled by the US Supreme Court to be illegal as the government sought to control the prices of basic commodities such as bread and milk. By the mid l930s, President Roosevelt began to win some battles against the corporate sector, but progress was slow.

In American capitalism, the state bails out failing corporations, especially banks that are considered too big to fail. The managers are too big to jail when they bring about an economic crises through risky investments. Some of the biggest banks were bailed out by taxpayers in the 2008 US financial crises. People are forced to pay the bills through taxes and austerity. Government help to those losing their homes in the mortgage crises was minimal.

The Taft-Hartley Law in the l930s restricted labor unions in the United States. Labor unions cannot strike in sympathy with other companies in the United States, as in other countries. Wages rose in the l950s and l960s, the heyday of American capitalism, after the war, but real wages were rolled back after the l970s. Deindustrialization began to set in. Beginning in the l980s, under President Ronald Reagan, social welfare benefits began to be rolled back. Americans work some 44 days a year more than Europeans and enjoy much less social welfare.

The consumer protection movement organized by public interest groups has had considerable effect on product quality. A leader of this movement is Ralph Nader who criticized the safety of products beginning in the l960s. For example, some automobile designs are unsafe and get people killed, unnecessarily in accidents.

Sometimes big corporations promote higher safety standards for products as it helps them build a monopoly in particularly industries. This is true in the waste industry, where it takes millions of dollars to build a state-of-the-art landfill. With such regulations, small companies are forced to sell out to the giants and consolidation of the industry continues in the hands of the monopoly waste firms. Regulatory standards may help capital intensive industries or hurt them, depending upon the circumstances.

However, it is also true that government regulatory agencies, such as the Environmental Protection Agency (EPA), get captured by big corporations. This is especially true, since it is not uncommon for someone from the industry to be appointed to head the regulatory agency. If the head of the EPA has a primary interest in helping industries to continue to pollute, then the regulations are not likely to decrease the amount of pollution. This happens in other areas too, and is called agency capture.

Another feature of American capitalism is that big businesses generally see little responsibility to the society, the people or the country. The bottom line is profits. It is seen to be perfectly legitimate for the corporation to take the country down to make profits elsewhere, on a global basis.

In American capitalism, the role of the state is fragmented. There are three branches of government and fifty different state governments in the United States. Each of these governments has a different set of environmental laws and regulations. While national law is theoretically supreme, there can be great variation in safety standards in practice. Most of the dirty chemical industries operate in Arkansas, East Texas, and Louisiana, along the Mississippi River. This is cancer alley, where pollution can go on more freely than in some other areas. However, the US Congress has the power to regulate such activities under the Commerce Clause of the US Constitution if they have the political will.

In the United States, the financial system is shaped by the Treasury Department, the Federal Reserve, and federal agencies. They generally serve the interests of banks and capital.

Individual states compete for capital. This tends to create a race to the bottom. States which allow the maximum interest rates on credit cards, such as South Dakota, attract bank capital. States with low standards of environmental pollution, such as Texas, Louisiana and Mississippi attract capital in the form of polluting industries. The Texas economy profits from specializing in dirty polluting industries.

In the American system of capitalism, government mainly serves corporate interests. There is no national economic strategy. Corporations do the economic planning, but for themselves, not for the country. This includes deindustrialization and financialization of the economy.

Theoretically, the US Government is neutral. Politicians, however, cannot afford to be neutral when they need millions of dollars to win elections. Most departments of the Federal Government are headed by the heads of large corporations. A banker is generally chosen to run the Treasury Department.

Negative externalities are huge. But the people pay the costs. There is inadequate consumer information, blocked by big business propaganda and lobbying. Some economic enterprises are irrational and damaging to the people, the environment, the country and the world. Two examples immediately come to mind. Both are in the areas of energy. First the production of ethanol, which is a fuel for autos made from crops such as corn. It takes more energy to produce this fuel than one gets back. So the real purpose is not to produce energy, but to subsidize agriculture and the companies that process the product.

Another example is the production of natural gas through hydraulic fracturing. Again, more energy is used up than is gained. So what is the point of doing it? It produces profits for the industry while inflicting great damage on the environment and local communities and also may cause cancer. The real product is not energy but profits. Environmental groups have begun to challenge this industry in court as a breach of the public trust. What the courts will decide is yet to be seen.

The disposal of the social surplus is achieved through several avenues. First advertising is huge on television and the internet. This is a huge waste of national resources that could be put to better use elsewhere. Secondly, a huge amount of social surplus is expended in military and police operations. Military intervention in other countries and the production of weapons and military equipment, which may never be used, is highly profitable to the defense industry.

A third area is government spying on the domestic and international communities, after 9-11. A huge amount of resources is being used up by the National Security Agency and other government agencies spying on the telephone calls and emails of the citizens under the name of security.

A fourth area is corporate conspicuous consumption. Enormous bonuses for bankers and corporate CEOs are handed out even when performance is dismal. Huge salaries for the heads of corporations dispose hundreds of millions of dollars of surplus. There are sometimes huge golden parachutes when corporate heads retire. Private planes for global travel, and plush resorts and golf clubs are some of the perquisites. Expensive parties, all written off as business expense is normal.

A fifth area is agricultural subsidies to southern feudal landlords, the planter aristocracy in Mississippi, Louisiana, Arkansas, Texas and other American semi-feudal strongholds. This is rent seeking but serves a useful political purpose to keep certain parties in power at the taxpayer’s expense. Bank bonuses are not generally included under the rubric of rent seeking by rational choice theorists.

In terms of corporate governance, there is rivalry between companies to control technology. Stockholding is more dispersed than in Japan and Germany. Industry and finance are more separated.

There are strong business associations such as the National Association of Manufacturers (NAM), the Chamber of Commerce, and the Business Roundtable. These represent big business and lobby for favorable legislation.

The people are not stakeholders, as in Germany. The system works for the stockholders or owners of capital. Some ten percent of the people own eighty percent of the corporate stock. There is minimal obligation to employees. Companies can flee overnight. There is a minimal obligation to the host community, as seen in the devastation left behind in Michigan where the auto companies once produced most cars in America. There is practically no concern with the social consequences of corporate decisions. There were many leveraged buyouts in the l980s and l990s. This was typical of Bain Capital, Mitt Romney’s equity company, which he ran before becoming a candidate for US President.

Paul Sweezy in The Theory of Capitalism Development, described American capitalism as monopoly capitalism.

Capitalism in Japan and Germany, on the other hand has been designated as stakeholder capitalism. This means that the people have a stake in the outcome and are sometimes more than just pawns in the system.

The System of Developmentalist Capitalism in Japan:

After World War II, the Japanese rejected US advice on comparative advantage. Since the Meiji Restoration in 1868 the goal of Japan was to launch a strategy to catch up with the West. After the war, Japan would develop a high-tech economy and produce quality products for the world markets, overtaking America and Europe in competitiveness.

Japanese capitalism is nationalistic. The Japanese used the economy for the social and political objectives of society. They were disciplined, possibly following Zen Buddhism. Japanese capitalism is also neomercantilist, with state assistance to firms, regulation, and the protection of strategic sectors of the economy. The zaibatsu and keiretsu would be used to beef up international competition.

Japan was one of the countries which have been called “late developers” by Alexander Gershenkron. The economy is also ethnocentric with a belief in the superiority of Japanese culture and “manifest destiny.” That is, that Japan was destined to become a great power. Terms which have been applied to Japanese capitalism include Shinto Capitalism, Developmental State Capitalism (Chalmers Johnson), Tribal Capitalism, Collective Capitalism, Welfare Corporatism, Stake Holder Capitalism, Strategic Capitalism, and Japan, Inc.

Japanese Capitalism has included the following key features.

Japan as a capitalist developmentalist state is essentially a corporatist model. This means that there is a close alliance between capital, labor and the state. Unlike in America, individualism is discouraged. The group takes importance over the individual. Sacrifices by the individual are expected in order to ensure social solidarity and loyalty to the company and society. In exchange for going along with the corporate agenda, the big firms provide lifetime employment, which tends to promote a peaceful society.

There is an important, even crucial, role for the state. The state plays the central role in the economy. The bureaucracy and the big firms, such as the keiretsu, and the ruling Liberal Democratic Party (LDP), work together for the good of the firm and the country.  Rapid industrialization was promoted by the state using neomercantilist methods, such as trade protection, export led growth, and strict controls on capital. Capital was made easily available to the big firms. The state invests heavily in human capital, education and training to improve the quality of the work force. There is a strong emphasis on savings.

Powerful bureaucracies promote the interests of particular groups while the executive is relatively weak. The welfare function is achieved through private sector employment and distribution of benefits. There is much privatization of public functions. Even law and order to a considerable extent is privatized, as the Japanese Mafia, the Yakuza, patrol the streets. The regulation of business is carried out by private business associations.

The Japanese Government provides support for favored industries linked to the GDP and high-tech industries. The Government provides low-cost housing. According to Chalmers Johnson, it was the Ministry of International Trade and Industry (MITI) that organized economic and technological success. The state provides administrative guidance in industrial policy. Firms are pressured to invest in high-tech and high-value projects. Mainstream economists claim that Japanese state guidance was largely wasted resources, but this is not a very plausible argument.

In Japan, there is a dual labor market with core workers in the large corporations, or Keiretsu, having lifetime employment. They are stakeholders. But this is not true of small firms. The majority of workers in small firms have little job security. While American firms rely on the stock market for capital, in Japan, capital for firms mostly comes from the banks. Bank loans are guaranteed by the government. The cost of capital is low and banks are linked with the postal savings system.

While American firms try to maximize profits, Japanese firms work to maximize sales and corporate growth. Big business is centered on the Keiretsu, a business group. It is a conglomerate or holding company. These consist of a set of companies with interlocking business relationships which appeared after World War II, with the “economic miracle.” They are actually the reintegration of the Zaibatsu, which were broken up at the end of the war.

Traditionally there were four big Zaibatsu, which were controlled by specific families. These were Mitsubishi, Mitsui, Sumitomo and Yasuda. A keiretsu can be organized as a horizontal group or a vertical group. Mitsubishi, Mitsui and Sumitomo are horizontal groups which include a major bank, a few dozen companies, manufacturing firms, and distribution networks. Others are Fuyo, Dai-Ichi Kangyo and Sanwa.

Vertical Keiretsu include Toyota and Matsushita. A vertical Keiretsu has a parent manufacturing company, and a large group of sub-contractors and suppliers of services. There are some twenty-four vertical keiretsus, many in autos and electronics.

The dominant driving force for Japanese firms as a corporate strategy is market share. The competition is oligopolistic and Schumpeterian, based upon technological innovation and high-quality products. Consumer prices are kept high, but prices are sometimes set low to gain the market overseas.

The keiretsu is highly efficient and successful for national and global competition. Mutual trust between the companies leads to a high degree of innovation. Companies are protected against hostile takeovers which reduces the cost of capital. Companies enjoy independence from outside shareholders and the large size of the company stabilizes the firm against economic shocks, such as oil price hikes. The company can take a long-term perspective, has large resources, and can produce new products and new production techniques. Japanese companies are closed to outsiders both in Japan and abroad. It is almost impossible for foreign firms to take over Japanese firms. On the other hand, a Keiretsu can easily purchase a foreign firm. Non-Japanese firms are kept out of the Japanese market.

Social Market Capitalism in Germany:

German capitalism is sometimes called stakeholder capitalism. This is because of the greater social concern, compared to American individualistic capitalism. One finds an emphasis upon exports, as in Japan, national savings and investment. These are more important than consumption.

German capitalism, as in America and Japan, is highly oligopolistic. One finds many alliances between the major corporations and private banks. However, German capitalism attempts to reach a balance between social concerns and market efficiency. The private sector has provided a good deal of social welfare to employees, although this has changed significantly in recent years.

German capitalism, similar to the system in Japan is corporatist. It is sometimes called welfare state capitalism. The state plays a major part in the economy and the banks provide the capital.

According to the Law of Codetermination, supervisory boards must have equal representation of the employees and management. This results in better relations between labor and management than in the US. The German welfare state has roots in the rule of Chancellor Otto von Bismarck in the late nineteenth century. There is an emphasis upon social harmony and the community, unlike in the US.

The German state works to encourage a high savings rate, rapid accumulation of capital, high economic growth, and a stable business climate. The banks are at the core of the system. Banks defend the Euro and keep inflation and interest rates low.

German capitalism also encourages heavy spending in R & D. The Government provides subsidies and protects some state industries such as Lufthansa. Corporate governance in Germany includes powerful national organizations which represent business interests. Labor is well organized at the national level and is a partner in corporate governance. This is part of “codetermination.” There is a large role for medium-sized private firms, or mittelstand. These companies are strong exporters and suppliers of intermediate goods like chemicals and machine-tools.

The German stock market has many fewer companies compared to the US. There is integration of finance and industry in corporate governance with cross ownership and interlocking boards. The big banks and corporations resemble the Japanese Keiretsu. Banks also play a large role in economic planning and can engage in almost any type of financial activity. Banks own large portions of German companies and industries get cheap credit. Companies also avoid hostile takeovers, as in Japan. There is a large concentration of economic power in banks and corporations.

In recent years, there has been some convergence under neoliberalism. Americans would like to see Anglo-Saxonization of European economies. But this system is too individualistic for Germans and most Europeans.

Key Terms:

Robert Solow

Neoclassical Growth Theory

Marginal Returns

Endogenous Variables

Exogenous Variables

Steady State Production

Technology

Endogenous Growth Theory

Paul Romer

Robert Lucas

R & D

Spillover

Economies of Scale

Constant Returns to Scale

Oligopolistic Firms

Price Setters

Human Capital

Convergence Theory

Keiretsu

Zaibatsu

Anglo-Saxon Economics

MITI

Stockholder Capitalism

Stakeholder Capitalism

Market Oriented Capitalism

Taft-Hartley Law

Technology Transfer

Economic Geography

Core (Center)

Periphery

Agglomeration

Path Dependence

Imperfect Competition

Centripetal Forces

Centrifugal Forces

Cumulative Processes

Falling Rate of Profit

R & |D Spillover

Leveraged Buyouts

Developmental Capitalism

Chalmers Johnson

Yakuza

Late Developer

Law of Codetermination

Mittelstand

Social Market Capitalism

Chapter Fourteen: Global Trade

Historically, the issue of free trade has been a disputed area in international political economy. This situation remains today. Liberal scholars, following Adam Smith and David Ricardo, argue for free markets as a win-win situation for every country. In practice, however, every country practices neomercantilism to some extent, including the United States. The purpose is to protect certain domestic interests and home markets. Radicals argue that the global trading system, free trade agreements, and the existing terms of trade, militate against developing countries in today’s global economy. They argue that the rules of the World Trade Organization and its dispute-settlement bodies prevent national autonomy, including the possibility of domestic measures to protect the environment. Some environmentalists argue that trade in agricultural products increases the ecological rift. All of this presents a complex picture. Clearly, free trade does not benefit all citizens of a country equally. There will be winners and losers, depending upon one’s location within the domestic and global political economy.

Global Trade: Historical Perspective

The classic era of free trade, from the repeal of the Corn Laws in l846 to the l870s, was quite short. The Corn Laws, tariffs on imported grain in the United Kingdom, protected the high prices of grain for landlords, but was opposed by industrialists, because it tended to keep wages higher and hurt their profits. Trade protectionism increased in the late nineteenth century and continued into the first half of the twentieth century. But after World War II, the US as the most powerful industrial country in the world, pushed for trade liberalization. Several rounds of trade negotiations were carried out under the General Agreement on Tariffs and Trade (GATT) between the l950s and the end of the century when the World Trade Organization (WTO) came into existence.

Liberal economists warn that “free trade” cannot be taken for granted. Under globalized production, transnational corporations can structure their global operations in such a way as to maximize profits. Developing countries are at a disadvantage in dealing with the WTO. Global trade is often seen as unfair. There is resistance from workers, welfare groups, environmentalists, and human rights advocates who fight child labor and sweatshop labor in countries such as Bangladesh.

In 1999, this struggle came to a head at the “Battle of Seattle” meeting of the G-8, the world’s most powerful countries. Opposing the global trading system were workers, environmentalists, human rights activists, and those who opposed capitalism outright. Many issues involving trade are still on the agenda and are far from being resolved.

The Free Trade Debate:

The argument for free trade, as we have seen, was made by Adam Smith and David Ricardo based upon the principle of comparative advantage. Today liberals argue that removing barriers to free trade allows national specialization, facilitates optimal use of scarce resources, and leads to efficient trade patterns based upon comparative advantage. It is argued that the welfare of each trading partner increases. It is also argued that free trade benefits individual consumers and maximizes global wealth. It is also pointed out that free trade maximizes consumer choice, reduces prices, makes efficient use of the world’s resources, encourages the spread of technology, helps poor countries catch up with the rich, and leads to world peace.

All of these claims, however, cannot be accepted at face value without an empirical examination of the claims. First, it is necessary to break the situation down and look at society dialectically. Free trade may not affect workers and consumers in the same way. Cheaper goods may bring environmental destruction, destroy agricultural and ruin local enterprises.

To take one example, the North American Free Trade Agreement (NAFTA), has allowed American and Canadian firms to produce goods more cheaply in Mexico. Consumers in the US and Canada may get better prices, but the arrangement has hurt some workers in all three countries resulting in lower wages. The United States has been forced, by the rules of the WTO, to allow toxic substances from Mexico to be imported into the United States for disposal in toxic waste dumps. The United States was unable to stop the import of asbestos, a cancer causing building material, from Canada. On the other hand, many transnational corporations have been able to increase profits through NAFTA. In 2014, the issue of building the Keystone Pipeline to carry oil produced from tar sands in Canada was being fought out on the ground and in the courts of the United States. Many environmental groups opposed the project due to its potentially great damage to the environment. Farmers in Nebraska went to court to keep the pipeline from crossing their lands. In every case whether free trade is actually beneficial is an empirical question which must be examined. The abstract principles of economists, such as comparative advantage, are theories which may fall apart in the real world.

Liberal economists also claim that protectionism costs consumers much money in higher prices while it does not save many jobs. They claim that such protectionism damages the economy of a country. They also claim that tariffs shift income to protected sectors of the economy and sometimes create monopolies.

The Infant Industry Argument made by Alexander Hamilton says that protectionism is necessary to protect start-up industries in developing countries until they are strong enough to compete in the international market. Friedrich List was also an advocate of protectionism. He argued that free trade was just the policy of the strong countries which could beat the competition. Theoretically, when the “infant industry” becomes competitive, the tariffs will be removed. In practice, while the argument may be sound, in practice it has been the case that such industries often never become competitive under protectionism. They gain the political power to continue protectionism, which increases their profits, at the same time they are producing sub-standard products.

An example was seen in the Indian telephone industry after the country became independent from Britain in l947. In the l980s, Indian companies were still producing telephones based upon l940s technology. In a protected market the companies profited from producing obsolete products. Once the market was liberalized and cell phones entered the market, these older products quickly became useless.

By the end of the l980s, it was still difficult to make a long-distance telephone call from one city in India to another. A land-line telephone connection took up to two years to obtain. In l986, there were only three million telephone connections in the entire country with one million applicants waiting for a telephone connection. Only one-half of one percent of people had telephones and these were those with power and money. In offices it was not unusual to hear people shouting into the mouthpieces of telephones at the top of their lungs to try to get their messages through to someone a few blocks away.

A famous incident happened in 1986, when the former Home Minister of India, P.C. Sethi, was trying to call his relatives in Bombay from Delhi. After trying to make the call for more than two hours, he went to the Central Telephone Exchange in Delhi and pointed an automatic pistol at the head of an operator demanding that his call be put through. The next day, the headlines in the local newspaper read “P.C. Sethi goes berserk.” In this case a good principle had gone to the point of driving a high official in the Indian Government crazy. Once cell phones from private companies became available, people could just forget about land lines and buy a pocket telephone.

Many countries, such as India, protected their domestic industries during the era of import substitution industrialization (ISI) after independence. There were clearly positive and negative aspects of the policy. While the countries became more self-sufficient, the products were generally of poor quality and often old-fashioned. Local jobs were produced, but factories were inefficient with low productivity. Some big domestic firms became monopolists and enjoyed high profits with government protection.

Protectionism, on the other hand, had much greater success in Japan, where the government supported high-tech industries and forced companies to become global players.

The classical argument against protectionism by David Hume (1711-1776) is still valid to some extent. He argued that protectionism would decrease exports over the long run and make products less competitive. This is because exports cause foreign currency to flow into a country. The value of the local currency then rises, making exports more expensive. This tends to slow down exports.

Most liberal economists, following economic models, reject the idea that imports from low-wage countries destroy jobs and lower wages in industrialized countries. However, the evidence seems contradictory in the case of NAFTA in the United States and Canada. Domestic interest groups such as farmers and workers, and sometimes small business, oppose free trade.

Conventional Trade Theory (Comparative Advantage):

Traditional trade theory is based upon the Comparative Advantage Model of David Ricardo. This is the Heckscher-Ohlin Model (H-O Model) from Eli Heckscher and Bertel Ohlin. It was developed in the l930s. According to this model, a country should produce those goods in which it has a cost advantage in factors of production. However, conventional trade theory was not able to explain global trends in trade after the l960s and has generally been replaced with theories of strategic trade.

The Heckscher-Ohlin Model says that a country will specialize in products in which it has a cost advantage over other countries. The model assumes constant returns to scale, the universal availability of production technologies, and that a country has a comparative advantage in some product which it can export.

The Heckscher-Ohlin Model has four Hypotheses:

First Hypothesis: A country will export those things that it has in abundance. A capital-rich country will export capital intensive goods. A labor-rich country will export labor intensive goods.  This is the principle of comparative advantage.

Second Hypothesis: The Stolper-Samuelson Theorem: Trade will benefit those who own abundant factors and hurt those who own scarce factors.  All sectors of the economy will benefit but there will be redistribution to either labor or capital.

Third Hypothesis: The Mundell Equivalency: Trade in the factors of capital or labor and trade in goods will have the same effect over time, and one can fully substitute for the other.

Fourth Hypothesis: Factor-Price Equalization Theorem: Under certain circumstances, over time, trade in goods will equalize the returns (wages to labor and profits to capital), for each factor of production.

For example, the United States is a capital-rich country. It will export capital intensive goods like airplanes, bulldozers, and supercomputers. A labor-rich country like India will export textiles and carpets which tend to be labor intensive.

According to the second hypothesis, in the United States, oligopoly firms producing aircraft, earth moving equipment and supercomputers will gain more than workers. On the other hand, workers will gain more in India over time, as wages tend to rise.

Thirdly, according to the Mundell Equivalency, a country will benefit equally, whether the goods are produced domestically and exported, or whether the capital is exported to produce the goods in a foreign country. Foreign direct investment can be substituted for trade in useful commodities.

Fourth, according to the Factor-Price Equalization Theorem, in the United States, while the capitalists gain the most in the beginning, over time, the gains of workers will equal the gains of the capitalists. In India, workers will gain the most in the beginning, but returns to capital will increase to equal the returns to labor.

All of this is logical, according to the liberal economic Heckscher-Ohlin Model. However, not surprisingly, in the real world, these theorems do not hold true much of the time. Global corporations learn how to beat the system and keep profits high.

Competitive Advantage and Strategic Trade Theory (STT):

Oligopolistic firms may engage in competitive advantage, rather than comparative advantage. Competitive advantage has weakened the H-O Model, especially when it comes to high-tech sectors. This relates to strategic trade.

The Product Cycle Theory (Raymond Vernon 1966):

Raymond Vernon constructed a theory of foreign direct investment which applied to US investment in Europe after World War II. According to Vernon, every product has a life cycle, from invention to obsolescence, when it can be thrown on the trash heap or recycled.

First, the product cycle begins with the US producing products, such as household appliances, refrigerators, stoves, sewing machines, and so on, for export to Europe after World War II. Europe’s manufacturing capacity had been depleted by the war and there was a pent-up demand for domestic products as people returned to a normal life-style. The models exported were not state of the art, but one generation behind, so profits could be high in their production and sale. Europeans would buy American products and start to prefer them. A market for American goods would then be firmly established.

Second, at some point, after a few years, local producers in Europe begin to produce their own products and come into the market. At this point, the American firms flood the market to keep prices low so that it is hard for local firms to compete. Also by this time, American products have gained a reputation for being “better” than local products.

Third, in order to preempt the competition from European manufacturers, American firms begin to produce their products in Europe. That is, they export the means of production, but produce second generation products using older processes. This tends to keeps profits high.

Fourth, when a new technology is invented, the old technology is abandoned and a new product replaces it. This is the product cycle, from invention until obsolescence.

The process then repeats itself. This process described fairly well what went on in the l960s, until globalized production began to come into use. After this, the products could be produced almost anywhere, the only restriction being the arrangement which produced the highest profits.

Strategic Trade Theory (STT) challenges the neoclassical theory of trade based upon comparative advantage.

Strategic Trade Theory assumes:

  1. There is imperfect competition due to oligopoly firms which can control and set prices.
  2. There are economies of scale and firms engage in R & D.
  3. There are cumulative processes and technology spillover.
  4. Governments may use protectionism, such as is done in both Japan and the United States, and subsidize industries.
  5. The government may use other policies to subsidize firms and help them compete in the international arena. The US subsidizes the R & D of firms through the military defense budget. Japan has many policies to subsidize large firms and help them compete. The European Union also subsidized European firms.
  6. Governments may use protectionism by accusing foreign firms of “dumping” when it is not necessarily true.
  7. Firms may develop niche products to capture certain markets.
  8. A few oligopolistic firms may dominate the market, such as in the airline industry, cell phones, computers, and so on. Production is globally based to cut costs and maximize profits.
  9. Under the principles of strategic trade, firms can often make super-profits.
  10. Strategic trade is relevant to information technology (IT) and biotechnology areas. This is true of both the military and mainstream economy.
  11. Firms may build up access capacity in order to keep out foreign firms.
  12. High tech is more important than the service industry. In strategic trade, it matters whether a country produces potato chips or computer chips.

At Harvard Business School, Michael Porter studied why some industries do better in different countries. For example, electronics do better Japan and aircraft in the United States. Porter studied the international characteristics of the national economy, the national culture, the status of capital and labor, the nature of effective demand, supporting industries, the industrial structure of the economy, the competitive nature of the domestic economy and price competition. These factors can contribute to the success of national industries.

According to Strategic Trade Theory, competition is oligopolistic. This means that a few large firms can control the market and set prices. There are monopoly rents and high profits. Firms can sometimes engage in dumping and can use preemption. This means that they saturate the market with their products to keep out other brands. Oligopolistic industries include computers, semiconductors, and biotechnology. These companies also produce products for the military sector.

Governments can play a large role in helping firms become oligopolies, as in Japan. According to strategic trade theory, manufacturing is more important than the service economy. Governments can assist companies in entering capital-intensive high-tech industries.

Trade Negotiations under GATT:

Several rounds of trade negotiations were carried out beginning in the l960s to liberalize global trade in different sectors of the global economy. Following World War II, the effort to establish the International Trade Organization failed. This failure was largely due to the refusal of the US Congress to ratify the deal. Congressmen coming from rural areas dependent upon agriculture knew that free trade would hurt the interests of farmers. So they would not go along with an international trade organization. By default, the General Agreement on Tariffs and Trade (GATT) became the organization for conducting trade negotiations up to the establishment of the World Trade Organization (WTO) in 1995.

The Kennedy Round (l964-1967): Under the Kennedy Round, tariffs were lowered between the United States and Western Europe. The Common Market in Europe had been established. The round achieved some thirty-three percent reductions in tariffs on manufactured goods and gave preferential treatment to less developed countries.

The Tokyo Round (1973-1979): The Tokyo Round reduced tariffs on most industrial products and liberalized agricultural trade. It also established codes of conduct to deal with unfair trade practices. It prohibited export subsidies.

The Uruguay Round and the World Trade Organization (1986-1993: This round of talks was launched at Punta del Este in Uruguay in l986. It brought the World Trade Organization into being in l995, which was largely an American creation. The talks continued for 87 months, involving 123 countries. Issues addressed included tariffs, non-tariff measures, rules, services, intellectual property rights, dispute settlement, textiles and agriculture. Besides establishing the WTO, the talks resulted in major reductions in tariffs and agricultural subsidies, an agreement to allow full access for textiles and garments from developing countries, and the extension of intellectual property rights. The round was said to have the potential of increasing world welfare by 270 billion US dollars. However, this does not specify who the welfare actually goes to.

The Doha Round (2001- ) The first round of trade talks under the World Trade Organization is sometimes referred to as “the Millennium Round.”  The talks, which involved 159 countries, were not yet concluded in 2014. Issues involved tariffs, non-tariff measures, agricultural subsidies, labor standards, environment, competition, investment, transparency, patents, and a number of other issues.

The World Trade Organization: The World Trade Organization has more extensive and binding rules than GATT. The organization established in l995 under the Uruguay Round of Trade negotiations replaced the General Agreement on Tariffs and Trade (GATT). As of 2014, there were 159 member states in the WTO.

The WTO is based on multilateral rules that apply to all 159 members. It is clear that it serves the interests of the American service-oriented economy and high-tech economies. The WTO has a very strong dispute-settlement mechanism which is meant to prevent the blocking of international corporations from their global operations. Fines will be levied on countries that are ruled to be at fault. Clearly, the most powerful countries are in control of the organization. Agriculture, labor standards, environmental regulations, and human rights continue to be giant issues. There are generally strong disagreements between the rich West and the less developed countries on these issues.

The World Trade Organization has a provision called the Investor-State Dispute Settlement procedure. This allows a panel of corporate lawyers to overrule the will of national parliaments and destroy legal protections for citizens. Big business can sue governments which pass laws to protect citizens in terms of environmental protection and other legislation.

Under the Investor-State Dispute Settlement mechanism, hearings are held in secret. The judges are corporate lawyers. Citizens and communities have no legal standing and no right of appeal. Since the companies can overrule courts and parliaments, this makes democracy problematical. Many environmental regulations have been challenged under NAFTA. In this way, the World Trade Organization can strip countries of sovereignty, deprive people of democracy, and become a business parliament which has the real power. Some argue that this is democracy for capital and not for the people.

Recently, some companies have sued governments claiming huge damages. In Australia, Philip Morris Tobacco Company sued the government over a law which said that cigarettes must be sold in a plain package. Philip Morris argued that the law violated “intellectual property rights.”

In Argentina, the government put a freeze on energy and water bills. When the Argentine Government was sued, it had to pay billions of dollars in compensation.

In El Salvador, a gold mine threatened water supplies. The mining company was refused permission to operate. The company sued the government for 315 million dollars in lost profits. In a Canadian case, two Eli Lilly patents on medicines were revoked when the Canadian Government said that the company could not show beneficial results. Eli Lilly sued for 500 million dollars.

Due to the above, many groups still believe that trade restrictions are in the interests of poor and developing countries. A main area of dispute is in agriculture. Under the World Trade Organization free trade, most of the world’s agriculture and food production is likely to be carried out by giant global agricultural corporations. What happens to the millions of peasants who are pushed off the land and lose their livelihood? They will likely end up in cities without jobs and become part of the world’s precariat. These are people who live on the edge of existence with no secure livelihood. This is a real danger of the WTO global agenda in agriculture. Therefore many groups in India fight to preserve the right of farmers to government subsidies, which the WTO fights to eliminate under the auspices of free trade. Several thousand Indian peasants have committed suicide in recent years, unable to make a living under increased free trade in agriculture.

Multilateral Free trade Areas:

Free trade agreements are being formed on a regional basis for the most part. They include the following in 2014 and others are likely to be formed over the next decade.

The European Union (EU): Composed of twenty-eight states, the EU comprises a large free trade area. The aim of the policies of the European Union is the “free movement of people, goods, services, and capital.” Eighteen members of the European Union used the Euro as of 2014.

The ASEAN Free Trade Area (AFTA): Includes ten countries in Asia.

The Central European Free Trade Agreement (CEFTA): This is a free trade agreement between the European Union and countries in southeast Europe.

The Commonwealth of Independent States Free Trade Agreement (CISFTA): As of 2014, it included five states.

The Common Market for Eastern and Southern Africa (COMESA): This trade agreement includes nineteen states.

The Greater Arab Free Trade Area (GAFTA): This agreement includes fourteen countries of the Council of Arab Economic Unity.

The Cooperation Council for the Arab States of the Gulf also called the Gulf Cooperation Council (GCC): This is a pact between Arab states in the Persian Gulf.

The North American Free Trade Agreement (NAFTA): A free trade pact between the United States, Mexico and Canada.

The South Asian Free Trade Area (SAFTA): Includes Bangladesh, Bhutan, India, the Maldives, Nepal, Pakistan and Sri Lanka.

The Central American Integration System or Sistema de la Integracion Centroamericana (SICA):

The Trans-Pacific Partnership (TPP): Includes Australia, Brunei, Canada, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the United States and Vietnam. Potential members include Taiwan and South Korea.

The New Trade Agenda:

Today many countries and the World Trade Organization must struggle with issues which powerful global oligopoly corporations would like to sweep aside. Among these are labor standards, human rights, environment, ecological destruction, and national sovereignty.

Some liberals, conservative economists, businesses, governments and large corporations see environmentalists, trade unionists, human rights advocates, nationalists, peasants, tribal groups, and the people in general, as a threat to global trade or free trade. These groups have a very small voice in the global economy and must fight to be heard. In many cases protection for the environment and the people from global corporations is seen as “trade protectionism.” It is certainly viewed that way much or the time in the WTO. It is well known and well-documented that multinational corporations, such as mining companies, sometimes devastate the ecology of a region, take their profits, and leave environmental destruction behind. Governments may side with the companies which are destroying the environment and people’s health through environmentally destructive practices.

Free trade agreements have become opposed by large numbers of people around the world. This has led countries to resort to “fast-track” legislation to get trade pacts established quickly before political opposition arises. This process was used, for example, in l992 to get the North American Free Trade Agreement (NAFTA) through the US Congress.

When the fast track procedure is taking place, parliaments are prohibited from debating the issues. They just vote on the deal. The IMF can put this condition on other countries. It is extremely difficult to address environmental issues in free trade agreements. For example, GATT ruled against an American ban on tuna which was caught in nets that kill dolphins in 1991. Mexico did not like the law because the Mexican Government said that it discriminated against Mexican fishermen. In l998, there was a ruling against an American law to protect sea turtles.

Many environmentalists believe that free trade, in general, is a threat to the environment. Important environmental concerns may not be addressed in trade talks. More stringent laws could force companies to follow cleaner industrial processes.

When there is global competition for capital and the corporate agenda must be to make profits, this can create a race to the bottom in environmental regulation. If China has regulations and this costs companies more money, then why not produce the products in Vietnam or India? Corporations are forced to compete with others in the international arena. They have to produce products at the lowest possible cost.

Robert Gilpin argued that nuclear and hazardous wastes, water contamination, air pollution, toxic dumps, and carbon dioxide emissions have little or nothing to do with international trade. If one studies the issue of toxic waste and its movement to poor countries, however, one sees that this statement is misleading. Lawrence Summers wrote that it was economically rational to dump hazardous waste in the poorest countries. The reason is that killing a person in a poor country is far cheaper than in a rich country. This simply follows economic logic.

Child labor is another global trade issue. This involves social dumping. Both global companies and countries bear responsibility for dumping on the rights of children. When poor countries claim that child labor is their comparative advantage in the global market place, they are making an unethical argument. It is surely not right to exploit children and deprive them of a childhood and education to enrich countries, people or companies. Surely, countries should protect the human rights of children.

New Trade Deals:

At the beginning of 2014 two new trade pacts were being negotiated. One was the Transatlantic Trade and Investment Partnership. The stated purpose of this deal is to remove regulatory differences between the United States and European nations. Another was the Trans-Pacific Partnership (TPP). This has been under negotiation for several years between the United States and twelve Pacific-rim nations. Note the friendly name “partnership.” All parties are seen as just “partners,” except that some of the partners are much bigger and have much more power than others. The negotiations are held secretly and involve internet services, civil liberties, publishing rights and medicine accessibility. US Trade Representative Michael Froman typically asked for fast-track authority to get the deal established. WikiLeaks published the draft of the TPP which critics say limit internet freedom. The complex rules for intellectual property rights for the internet have not been clearly established.

The economist Dean Baker argues that there is merit to the argument on free trade, but most “free trade pacts” are about structuring trade. They serve the purpose of redistributing income upwards. For countries that sign on to free trade pacts, they provide a process for evading democratic processes. They provide tools which allow corporations to block health, safety and environmental regulations that are needed.

NAFTA was designed to push down the wages of manufacturing workers and make it easy for companies to set up overseas. Many argue that it lowered wages in the United States in the steel and auto industries. In Canada, NAFTA reduced the number of manufacturing jobs.

One area where free trade could benefit the United States is in the area of medicine. Drug companies in the United States have monopolies which result in drugs costing about twice as much as in other wealthy countries which generally have controls on the prices of medicines.

Summary:

The debate on free trade goes back to the classical era of political economy. Liberals like Adam Smith and David Ricardo argued in favor of free trade. Others such as Friedrich List and Alexander Hamilton pointed out that it was to a country’s benefit to restrict trade for certain purposes. Even Adam Smith did not advocate complete free trade when it came to the defense of the country.

Some scholars have claimed that global trade was free under British hegemony at the end of the nineteenth century. This is somewhat of an exaggeration, as the British regulated trade to serve the British Empire. Trade restrictions increased as European countries rushed to colonize the world and gain access to global resources. Some theorists have argued that trade restrictions led to the Great Depression in the l930s.

After World War II, the United States as the world’s top manufacturing country had a vested interest in free trade. Attempts to establish an international trade organization failed, but a series of trade negotiations were carried out under the General Agreement on Tariffs and Trade (GATT). It is interesting that it was the domestic interests, particularly farmers in the United States that blocked international trade.

The World Trade Organization (WTO) finally emerged in l995. Farming in the United States was increasingly being taken over by the corporate sector. Liberals argue that free trade pacts benefit everyone. In the real world, things are more complex. Some sections of society will benefit while others suffer.  Neoclassical trade models argue that free trade would allow developing nations to “catch up” with rich nations. Again, the real world is more complex. Some nations seem to be catching up, but there are many more that are falling further behind. Under strategic trade, firms and governments can structure global trade to serve their own interests. Today the World Trade Organization allows powerful nations to structure trade in their own interests.

Economists are generally reluctant to bring in crucial issues related to trade such as environmental pollution, child labor, health issues, sweat shops, dumping of toxic wastes and global warming. When it comes to global trade, there is a lot more to think about than just the bottom line of profits. It often determines whether people live or die.

Key Terms:

Corn Laws

Protectionism

Infant Industries

Alexander Hamilton

Friedrich List

David Hume

Heckscher-Ohlin Model (H-O Model)

Stolper-Samuelson Theorem

Mundell Equivalency

Factor-Price Equalization Theorem

Leontief Paradox

Raymond Vernon

Product Cycle Theory

Strategic Trade Theory

Trade Rounds

Intellectual Property Rights

Battle of Seattle

Multilateral Agreement on Investment (MAI)

Fast-Track Legislation

Social Dumping

Investor-State Dispute Settlement

Transpacific Partnership (TPP)

Transatlantic Trade and Investment Partnership

Trade Barriers

NAFTA

Traditional Trade Theory

Eli Heckscher

Bertil Ohlin

Niche Products

Information Technology (IT)

Service Industry

Biotechnology

Chapter Fifteen: The God of Commodities:

The International Monetary System

“The best things in life are free,

But you can keep them for the birds and bees,

Now give me money.

That’s what I want.” (The Beatles)

“Thus much of this will make black white, foul fair,

Wrong right, base noble, old young, coward valiant

…This yellow slave

Will knit and break religions, bless the accursed,

Place thieves and give them title…

Shakespeare (The Tragedy of Timons of Athens)

“…Money is the general form of wealth… Money is therefore the god among commodities… It represents the divine existence of commodities, while they represent its earthly form.” Karl Marx, Grundrisse.

The international monetary system which was designed at the end of World War II served to facilitate transactions in the real economy in trade, manufacturing and finance. The global financial system will be considered in chapter sixteen. The Bretton Woods System provided a stable monetary framework for global economic development after World War II. A key architect of the system was John Maynard Keynes. The key feature of the system was the establishment of fixed exchange rates between the major currencies of the world to facilitate economic growth in the real economy. Some forty-four countries joined the Bretton Woods System agreeing to maintain their currencies at a fixed rate with the dollar to within one percent variation. Countries would buy or sell dollars to maintain the fixed exchange rate.

The contradiction between the global monetary system and the global financial system is that a stable monetary system which serves the interests of the real global economy, trade and manufacturing, and global economic development, impedes the making of profits in the financial superstructure by the global business elites. The global big business class is sometimes referred to as the “masters of the universe.” While they are not elected, they have a great deal of political power.

As noted in a previous chapter, the Bretton Woods System, designed in l944, made the dollar the King currency of the world. It possessed seigniorage. The US was given the privilege of printing the global reserve currency. The dollar was linked to gold at the rate of thirty-five dollars per ounce. This was a sort of modified gold system. The major West European currencies and the Japanese Yen were then linked or pegged to the dollar at fixed exchange rates. This system gave great economic and political power to the US dollar and the country which could print dollars, the United States. The dollar became the world’s reserve currency, the foreign exchange in which every country outside the communist orbit had to pay its bills, and settle its accounts in the international system.

The International Monetary Fund (IMF) was set up to keep track of accounts between nations. A current account deficit meant that more dollars had flowed out of the country than had flowed in. A surplus was the opposite. This mechanism had a great impact upon countries, except for the United States, which could simply run the printing presses and print its own dollars.

The Bretton Woods System worked quite nicely for two and a half decades. However, it contained the seeds of its own destruction. As a global power, the United States could resort to paying its own bills by simply printing dollars. Part of the cost of wars could be put off on other countries, as holding dollars was actually a loan to the United States. But the US could devalue the dollar simply by printing large amounts, although the official rate remained the same. Dollar overhang, the amount of dollars overseas, due to US spending for the Vietnam War, finally brought the system crashing down in l971. The world was awash with dollars.

In December l971, President Richard Nixon devalued the dollar by about ten percent with the Smithsonian Agreement. This was simply a late recognition that the real value of the dollar had fallen due to an oversupply. But under the Bretton Woods System, the dollar could not be officially devalued. With the end of the Bretton Woods system, the US would no longer redeem dollars for gold. A new system was to come about with the Jamaica Conference in l976 in which the major industrial powers began to regulate their currencies according to flexible exchange rates. Western European currencies were regulated by a complex European Monetary System (EMS) called “the snake in the tunnel.” Countries were to maintain the value of their currencies within 2.5 percent of a fixed rate. This worked after a fashion, but not very well. The weak currencies, like the Italian Lira would fall through the bottom of the tunnel, while the German Mark kept going through the roof.

In 1969, the Special Drawing Right (SDR) was created. This is a weighted currency basket of the Euro, US dollar, British Sterling and Japanese Yen. It is used as an IMF unit of account and also fluctuates in value. Used mainly for credit, it is some four percent of global foreign reserves.

Global reserves were 9,200 billion US dollars in 2010 (9.2 trillion dollars). Some 65 percent was in US dollars, 25 percent in Euros and the rest in Sterling, Yen, SDRs and gold. The BRICS (Brazil, Russia, India, China and South Africa) had over four trillion dollars global reserves. By March 2013, China alone had 3.44 trillion US dollars in foreign exchange reserves. This indicates that the wealth of the global economy was shifting to the Eastern Hemisphere.

The Post Bretton Woods System:

“Foreigners are out to screw us, and it is our job to screw them first.” (John Connally, US Secretary of the Treasury under President Richard Nixon)

The end of Bretton Woods brought about a financial revolution. Whether one was happy about the collapse of the Bretton Woods System depended partly upon ideology and partly upon one’s location in the global economy.  While the Bretton Woods System collapsed, the Bretton Woods Era continued, as the dollar was still the global reserve currency. Only when the dollar is replaced by other reserve currencies can we say this era has completely ended. Today use of the Euro as a reserve currency has changed things somewhat. But the big emerging market countries, particularly the BRICS, are hoping to replace the US dollar as the global reserve currency.

Many free-market economists argued that it would greatly benefit the global economy and let countries follow their own economic policies with the collapse of fixed exchange rates. A minority of economists argued that this would be deflationary and destabilizing. There would be a lack of trust in governments when their currencies were not linked to gold.

The beginnings of the Eurodollar market in the l960s soon created an international financial market. This was to mushroom with the great rise in the price of oil in the early l970s and the need to recycle massive amounts of dollars from the Organization of Petroleum Exporting States (OPEC) in the Middle East. International financial flows greatly increased. Some of these dollars were recycled through loans to Latin American countries creating more problems as these economies sank into a debt trap. The IMF began to impose harsh austerity measures on them.

One effect of greater financial flows was that countries began to lose the ability to control their macroeconomic autonomy. National economies became more closely linked to each other. Exchange rates of currencies were no longer controlled by trade flows. Now they were controlled by the increasing currency flows which exceeded trade flows by 100 times by 2013.

Destabilizing, it clearly was. The system became highly volatile. If Thorstein Veblen had been around, he would have probably laughed and said, “Well, I told you so. Now the money sharks and businessmen will see their chance to make a killing in the global market. The fat frogs will catch their juicy flies.” And they did. It was difficult to know from day to day what the exchange rate should be and where it would go next, but in this new global casino economy, some would get lucky, and some would simply lose.

The major currencies came to be regulated according to the “reference range system.” This was essentially a system of muddling through. The central banks did whatever they needed to do or could do to keep the international system stable. In Europe the European Monetary System (EMS) was used with an Exchange Rate Mechanism (ERM) known as the Snake in the Tunnel.

Operating the Global Monetary System:

The mechanisms of the global monetary system must provide a method of adjustment (correcting balance of payments problems), provide sufficient international liquidity, and provide a stable reserve currency (or currencies). There are great inequalities in the system, in which some countries gain and some lose. Also inside each country the operation of the monetary system affects workers, small businesses and those companies with large amounts of capital differently. Historically, the monetary system has been run largely by a hegemon, such as Great Britain or the United States.

The current account of a country is the amount of inflows (payments and remittances) minus outflows. In the short term, if a country is in deficit, it may draw down its national reserves. In a surplus, it may use inflows to build up its national reserves.

On the other hand, if the deficit goes on for a long time, or there is a financial crisis, the country may have to devalue the currency. In a surplus, the currency can be allowed to appreciate. Macroeconomic policies may also be used such as raising or lowering interest rates. A deficit country must lower the standard of living for the people for a period for at least part of the population. The cost of imports will rise. If a country must import most of its energy, for example, oil, almost all prices are going to rise. This will hurt all of those who earn fixed incomes. On the other hand, with devaluation exports should increase and this should help correct the imbalance for those who have jobs over a period of time.

When a country is in surplus, the currency will tend to rise. This will hurt the export sector but should help consumers. Countries in deficit could also use an economic stimulus package to provide jobs and pump more money into the economy. On the other hand, stimulus packages risk leading to inflation over a period of time. Countries frequently use such policies to help the chances of the ruling party in winning an election.

If a country refuses to allow its currency to rise, when it has high exports, such as Japan in l985 and China today, then the United States can put pressure on the country to allow their currency to appreciate. This will make their exports more expensive. China allows some appreciation, but has not allowed its currency to float on the international market. India also controls its currency, but on the other hand, the value of the Indian Rupee usually sinks rather than rises.

Liquidity is another crucial aspect of the international monetary system. International liquidity is necessary to meet balance of payments deficits when a country is in crises. Sometimes the problem involves a loan from the IMF, especially in a crisis. Reserves include gold, foreign currencies, and deposits with the IMF.

Some economists believe that the global economy should be based upon a gold standard. The Bretton Woods System was based upon “paper gold,” the US dollar. The problem with a real gold standard is that the supply of gold cannot be increased fast enough to supply adequate liquidity to the international system and so would be recessionary. Profits of major corporations would fall as they could not sell their products. Also the global economy would grow more slowly and create more poverty. The gold standard has been called “The Golden Fetters,” which means that it tends to slow down economic growth. This in itself might be good for the environment, but it is not good for the global capitalist economy. However, it would also eliminate the role of the dollar as the global hegemonic currency, militating against the interests of the United States.

Following the US economic crises in 2008 the Fed engaged in quantitative easing programs to stimulate the economy by putting more money into banks to encourage them to make loans. This was done by buying mortgage backed securities and US securities. The first program by Ben Bernanke, the Fed chief, ran from November 2008 to March 2009 and provided 1.25 trillion dollars. The second program from August 2010 to November 2010 provided another 600 billion dollars. In September 2012, the Fed began the “QE Infinity” program which provided some 85 billion dollars a month in stimulus. Each month, the Fed bought 40 billion dollars’ worth of mortgage backed securities and 45 billion dollars’ worth of US securities. This policy continued until the end of 2013 when Bernanke announced that the Fed would start cutting back the program and probably end it in 2014.  This “quantitative easing” (QE) helped to provide international liquidity, especially for big emerging markets like Brazil and Turkey. But too much liquidity will cause inflation. The European Central Bank was also engaged in quantitative easing for the Eurozone countries.

The country of seigniorage, which provides international liquidity, in this case the US, has the responsibility of maintaining the value of the currency. However, this is theoretical. The value of the dollar naturally shrinks when so many dollars are being printed. On the other hand, the global system needs the money stimulus, like heroin, flowing through its veins to keep going. This is part of the global capitalist system. The opium of the global economy. And since money is debt, the more money the more debt. When the fed slows down the amount of money being printed, this is called “tapering.” Tapering means less dollars flow to big emerging markets like India and Turkey. Tapering by The Fed will cause the currencies in emerging market countries to fall and their economies to slow down.

The Fed began its tapering policy in January 2014 by cutting ten billion dollars a month from its QE program. By September 2014, QE had been reduced to some 25 billion dollars a month and was scheduled to end by the end of 2014. But this would depend upon the economy and the new Fed chief, Janet Yelen.

Whether the Euro will take over the role of the US dollar depends to some extent on the future of US global power. The US tries very hard to ensure that the world’s “black gold,” oil, is marketed in dollars and not in Euros, which would weaken the role of the dollar. Global confidence in the dollar is crucial to the global economy.

Another possibility is that a new reserve currency, sponsored by the BRICS, perhaps the Chinese Yuan, or a new currency unit, will become a global reserve currency. Some countries, especially, Russia, strongly want to see the US dollar replaced as they believe the system allows the US to exploit the world through its monetary policies.

The Irreconcilable Trinity (The Trilemma):

According to the Mundell-Fleming Model from the l960s, there are three goals of monetary management. However, only two of these three can be achieved at any one time. This is called the irreconcilable trinity or the trilemma.

The Three goals of monetary management are:

First: Stable Exchange Rates

Second: National independence in monetary policies to maintain growth

Third: Freedom of capital movement across borders

For example, under the Bretton Woods System, there were stable exchange rates, and a degree of national independence in monetary policies, but little freedom for capital movement. This made it possible for countries to follow full-employment policies. The sector which most desires the free flow of capital is the financial sector as this is how they make much of their profits.

Export businesses, on the other hand, are primarily interested in the exchange rate. Domestic capital interests want national autonomy in macroeconomic policy making. Investors want freedom for capital movement. On the other hand, labor stands to lose by the free flow of capital out of the country. Consequently, there are several contradictions between different sectors of the economy.

Monetary Unions:

A number of monetary unions are in existence in which several countries use the same currency. In a full monetary union, the arrangement for the common use of a currency is formal and there is a common monetary policy. Monetary unions operate in an “optimal currency area.” This is a region of nations or geographical area where use of a common currency can greatly improve economic efficiency. Again, monetary unions are regional.

The following formal monetary unions were in existence in 2014.

The European Union (EU): The most extensive monetary union, of course, is the European Union. The Union came into full force in 2002. There were eighteen states using the Euro as the official currency in 2014. Also Monaco and Andorra use the Euro.

West Africa (CFA Franc): Originally set up by French colonialists in West Africa, the CFA Franc zone in West Africa is one of the oldest monetary unions. Members include Benin, Burkino Faso, Cote d’Ivoire, Guinea-Bissou, Cameroon, Central African Republic, Chad, Republic of the Congo, Equatorial Guinea, and Gabon. In 2014, one US dollar was worth around 480 CFA Francs and the daily rate of fluctuation was high.

The CFP Franc: This is a monetary union in the South Pacific. Included are French Polynesia, New Caledonia, and Wallis and Futuna.

East Caribbean Dollar: This monetary union includes Anguilla, Antigua and Barbados, Dominica, Grenada, Montserrat, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and The Grenadines.

South Africa Rand: This monetary union includes South Africa, Lesotho, Swaziland, and Namibia.

Other planned monetary unions which could be established between 2014 and 2020 include:

The Bolivarian Alternative for the Americas: This planned monetary union would unite several countries in South America, including Venezuela.

The East African Community: The common currency would be the East African Shilling.

The West African Monetary Zone: The currency would be the Eco.

The ASEAN nations plus three more: An Asian Monetary unit would be established.

The Cooperation Council for the Arab States of the Gulf or Gulf Cooperation Council. The monetary union would include the United Arab Emirates and Oman. The proposed currency was to be called the Khaleeji (Gulf).

Clearly, the only one of these monetary unions around the globe which presents any rival to the mighty US dollar as an important global currency is the European Union. The Euro may be used as foreign exchange.

As China becomes a more powerful state, the Yuan might one day come to be used as foreign exchange if the BRICS can increase their power and influence in the global economy, overcome their disagreements and unite with other big emerging economies, such as Mexico, Indonesia, and Turkey.

Hegemony and Money:

The existence of a single global hegemonic currency belonging to and issued by one state in the world reflects the structure of the global political economy since World War II. The post war global economy was structured around the three “great workhouses” of the world, the United States, Western Europe and Japan. These were to be the engines of growth of the global economy. Great Britain as the hegemon which passed the torch to the United States moved off center stage, but still played a large role as a global financial center, where vast sums of money could be traded and laundered. London retained its role as the money-laundering capital of the world. Consequently, the US dollar, the Euro, the Yen and the Pound Sterling are still the premium global currencies reflecting historical political power based upon imperial rule of these centers of power.

Today, the world has moved on. The rising BRICS, Brazil, Russia, India, China and South Africa are gaining position in relation to the old empires, but no one of them has yet become the global hegemon. That might take a global power struggle, or might come more easily as the United States global power declines. Russia is a primary force for change in the system to wean the world away from its global dependency upon the dollar as the global reserve currency. Rather than hold dollars or Euros, Russia wants a new reserve currency. The claim is that this would provide funds for global development. Clearly, Russia wishes to see the United States losing power in the international arena. It would be great for Russia if the ruble could become an international reserve currency.

Political economists wrangle over how to solve the monetary problems of the world. Under a pure gold standard, governments would lose control over monetary policy and could not make corrections in an economic crisis. Some believe that there should be a single global currency. To some extent, this would be the system that already exists, as the dollar is the de facto world reserve currency. Economists generally argue that letting the central banks and the finance ministers run the system is best. But Joseph Stiglitz says that this is a major cause of global poverty in his arguments against the policies of the IMF. In the absence of a consensus, regional arrangements, such as the one proposed by the BRICS and the Bolivarian countries in the South are beginning to emerge.

Arguments for Stable Exchange Rates:

As we saw, Keynes preferred stable exchange rates and this was implemented in the Bretton Woods System. Robert Mundell also argued in favor of more stable exchange rates. However, the global economy is not going to move back to the system of the l950s. So, regardless of the benefits, that is not going to happen. The financialization of the American economy means that most profits are made in the financial sector and this system has been globalized to a considerable extent. The prevailing free-market ideology makes it impossible to go back to a fixed exchange rate system.

First: Flexible exchange rates means that it is difficult for firms, especially small firms, to operate. The market is more volatile. If there is a local currency collapse and companies hold dollar debts, they face bankruptcy. This happens often in Turkey and other emerging market countries.

Second: There is the argument that flexible exchange rates militate against economic development in poor countries and encourage trade protectionism. This is a strong argument among the left in India. However, the left has generally lost the argument in today’s global economy. International pressures are simply too strong and the big Indian multinational corporations are strong enough to operate with flexible exchange rates.

Third: Many, especially on the left, argue that the global system of flexible exchange rates has failed. There is excessive currency and price volatility. A small drop in the value of the Turkish lira means that Turks gets hit hard at the petrol pump and in the cost of natural gas for heat and also electricity. Prices in these basic commodities are dollarized. Price rises in the dollar filter back through the economy to affect prices in general. Incomes do not rise automatically when the cost of basic commodities rise.

International capital flows are great and very destabilizing in emerging economies. Economic policies are inflationary, as prices are essentially dollarized. This increases risk and uncertainty in international trade and investment. On the other hand, as Veblen would have observed, such chaos opens up opportunities for money sharks to make their profits at the expense of others. It allows some countries to move ahead, like China, while others are sunk, when their currencies collapse.

Fourth:  Those who want fixed exchange rates say that they provide international discipline over inflationary policies.

Fifth: Fixed exchange rates reduce uncertainty in trade and investment.

Sixth: Fixed exchange rates facilitate competition based upon comparative advantage and efficient capital flows.

Seventh: If a fixed exchange rate is not feasible, then some compromise should be implemented such as pegged but adjustable rates, managed floating rates, adjustable pegs, or exchange rate target zones.

In fact, this is basically the existing system. Turkey, for example, basically has managed floating rates. However, there is only so much the central bank can do when the currency takes a nose dive downwards.

Arguments in Favor of Flexible Exchange Rates:

With international financial flows running at some one-hundred times that of trade flows there is bound to be great fluctuations in exchange rates. When the Fed announces a tapering program, currencies in developing market economies begin to drop at once. This happened in December of 2013.

First: Those who like flexible exchange rates argue that fixed exchange rates are very costly to maintain. However, it must be asked: “For whom is it costly?” Such a policy does not affect everybody in the same way.

Second: Flexible exchange rates allows currency to flow into the country or out of the country. The government must follow policies friendly to foreign capital. This means that it also serves to ensure policies that accommodate the interests of foreign capital.

Third: It is argued that flexible exchange rates are the least costly way to adjust to economic crises. When there is a balance of payments deficit, it is better to devalue the currency, rather than resort to capital controls. Of course, devaluation hurts all those who hold the local currency and are not able to shift into dollars in time to avoid the devaluation.

Fourth: It is argued that a devaluation best protects jobs and wages, the real variables in the economy. However, this must be an empirical question. It all depends upon when one’s wages might catch up with the inflation. This is not likely to be soon, as one sees in terms of devaluations in many countries.

Fifth: Flexible exchange rates make adjustments easier in a crisis. This is true, but it helps those who hold dollars and hurts those who hold the local currencies.

Sixth: Flexible exchange rates act as a cushion from the shocks from the international economy. This is true, but there is nothing to cushion the shock of losing a large part of one’s income in a devaluation. The common people take the shocks while those with hard money capital get the cushion.

Possibilities:    

First: The only real solution to the above dilemmas, short of the elimination of money altogether, would be complete monetary integration with a single global currency. This is not a possibility. Such a system would be too restrictive on small countries. Even within the Eurozone, there are major problems with using a single currency when two countries are as different economically as Germany and Greece. The monetary policies which fit Germany are not appropriate for a poorer country like Greece or Portugal without an industrial manufacturing base.

Second: An international monetary regime with floating rates against the dollar, the Euro or other global currency. The economies of large populous countries, like India or Indonesia would be too vulnerable without considerable management from the central bank.

Third: A system of regional monetary integration modeled upon the example of the European Union. So far the Euro zone with eighteen countries is the only functioning example. If strong cooperation can be achieved between the five BRICS countries in the BRICS Forum, this could be another example. The currency might be the Chinese Yuan or a currency based upon a basket of currencies. Another possibility is a reserve currency based upon the countries of the Bolivarian revolution in South America.

Fourth: The continuation of the Bretton Woods era will continue as long as the United States is still the most powerful country. If Johan Galtung is right that the American Empire will end around 2025, then it is likely that the US dollar will begin to fade as the global reserve currency. It is not at all clear that the Euro is the answer, however, given the recent financial crises in Europe.

Currently the three largest economic entities in the global economy have roughly equal GDP. These include, in 2013, the United States with some 17.1 trillion dollars GDP, the European Union with some 16.5 trillion dollars GDP and the BRICS with 16 trillion dollars GDP. If the BRICS Forum succeeds and more big emerging markets join the group, the emergence of an alternative global reserve currency seems to be a real possibility. This would simply be a reflection of the declining global power of the United States as its empire weakens.

Summary:

The Bretton Woods Monetary System was designed at the end of World War II to stabilize international money. The US dollar became the global reserve currency linked to gold. International currency flows were restricted between countries with a system of fixed but adjustable exchange rates.

Bretton Woods broke down in l971 due to dollar overhang from the Vietnam War and the over-extension of the US global empire. The global economy was fueled by inflated US dollars. The Bretton Woods Era continued, but was transformed to a system of flexible exchange rates under the guidance of central banks.

In recent years there has been a trend toward the establishment of monetary unions on a regional basis. The paradigm example is the European Union. As the US declines as a global power, ideas have emerged concerning an alternative global reserve currency. A possibility is a currency based upon a basket of the BRICS currencies and perhaps the currencies of other big emerging market countries. A return to the gold standard is not a viable option given the critical dimension of global economic growth in the twenty-first century global economy.

Key Terms:

International Monetary System

Eurodollar Market

Petrodollars

Bretton Woods System

Volatility

Financial Flows

Fixed Exchange Rates

Flexible Exchange Rates

Monetary Reserves

Pegged Currency

Crawling Peg

Adjustable Peg

Managed Float

Smithsonian Agreement

Seigniorage

Dollar Hegemony

Dollar Overhang

Special Drawing Rights

Jamaica Conference (1976)

Deregulation of Financial Markets

Reference Range System

Liquidity

Embedded System

Adjustment

Equilibrium

Plaza Conference (1985)

Gold Standard

Golden Fetters

Trilemma

Irreconcilable Trinity

Mundell-Fleming Model

European Central Bank (ECB)

US Federal Reserve (The Fed)

Bank of Japan

Welfare State

Robust Monetary Policy

Regional Monetary Integration

Fragmentation

Dollarization

The BRICS Forum

Chapter Sixteen: The International Financial System

Financial Liberalization:

A major development came about in the l970s with the financial revolution, the global liberalization of financial flows. The removal of capital controls freed up the global movement of capital. The result was the increased integration of national capital markets and the creation of a global financial system. The international financial market which emerged, however, greatly increased the instability of the international economy and increased the risk of financial crises. The interval between financial crises has been getting shorter and their impact on the global economy has been getting worse. In Mexico the l981 financial crisis resulted in a four percent drop in output. In Indonesia in 1998, output dropped by fourteen percent. In Greece in 2010, output plummeted by twenty-three percent. Between 1945 and 1975, on the other hand, the world financial system was practically crisis-free. This was mostly due to the limits on financial flows.

In the late 1970s, bankers pushed for financial liberalization. Financial flows were freed up and Eurodollars were recycled to Latin American countries as loans. The problem came with the sudden stop. When the money stopped coming, financial crises emerged. The same pattern was seen in the East Asian Financial Crisis in l997. Again this was seen in Greece, Spain and Portugal in 2010.

Liberal economists argue that the financial revolution has made the use of capital resources more efficient. This argument is disputed by those who see the global economy increasingly as a casino economy and vulnerable to financial crises.

Global financial flows have increased by leaps and bounds since the l970s. The rate of daily turnover in currency exchanges has jumped from only 15 billion US dollars in l973 to 1.2 trillion dollars in 1995 and 5.3 trillion dollars in 2013. In the l980s, financial flows were some five percent of advanced country GDP. This increased to twenty-five percent by 2008, but fell back to ten percent in 2010, after the financial crises in the United States and Europe. Financial flows had become some 100 times the volume of trade flows by 2013. Billions of dollars were being moved from one economy to another at the touch of a button. The equity and bond markets have also become global. This is an extension of the financialization of the US economy which has taken place since the l970s. Great profits are being made in the financial sector of the economy.

Historically, financial flows from Great Britain between 1880 and 1910 averaged about five percent of GNP. Before World War I, British investments funded universities and railroads, port facilities and other infrastructural projects in the United States. Financial flows from the British Empire helped to increase growth in the United States in the form of long-term investment in the late nineteenth century. Today, in contrast, international financial flows tend to be short term and highly speculative. Much of this volume of capital flow is what is known as “hot money,” capital seeking higher interest rates, or arbitrage, in the global economy. When the danger of economic crisis seems eminent, this capital can flee a country overnight, consolidating the crisis.

In this global financial casino, some countries such as Japan, China and India still maintain controls on financial flows. Turkey is more liberal than these three countries and so the Turkish Lira is more vulnerable to financial flows. The central bank can manage exchange rates in normal times, but can easily lose control with wide fluctuations in the financial markets. While Turkey has benefited from the US policy of quantitative easing (QE) between 2008 and 2014, this puts more pressure on the currency when the US eases back on this policy, as in 2014. The US began a tapering policy in early 2014 which caused emerging country currencies to drop sharply in relation to the dollar and the Euro.

Financial Crises: 

There are several conditions which are frequently associated with a financial crisis. The most vulnerable countries are in the developing world. However, not even the United States, Greece, Spain, the East Asian tigers, or other countries are immune from the increasingly volatile global financial market.

First: A high amount of government spending, in which the government builds up a large debt puts a country at risk. This frequently comes as a result of populism, or government hand-outs to the people, especially before national elections.

The United States national government has an enormous national debt of eighteen trillion dollars in late 2014, which continues to increase alarmingly. One can see the numbers rolling up and up, ever up, on the debt counter on the internet.  However, since the US has seigniorage of the world’s currency and can simply create dollars, this does not restrict the US economy as much as in other countries. This gives the US the ability to largely ignore the rules of the global economy which every other country has to obey to a considerable extent or face the consequences.

Second: A large current account deficit and lack of foreign exchange to finance this deficit means that a country will have to borrow foreign exchange from the IMF or private banks to finance the deficit if policy measures are not taken. The country could raise interest rates, for example, and try to attract more capital. However, this is often too little too late to stem the tide.

Third: The country runs out of foreign exchange and cannot pay its international debts. Again, since the country cannot print its own dollars, it will have to borrow dollars or Euros.

Fourth: A speculative and inflationary bubble due to good times. La Dolce Vita lasts while it lasts. But the good times do not roll on forever. Bubbles usually happen in the housing market in which people buy and speculate on property, often with mortgages. Household consumption and household debt increases.

Fifth: Political Instability. The government collapses or a series of governments collapse leading to uncertainties in the economy. A political scandal may bring down the government causing hot money to flee the country overnight and sending interest rates through the roof. The currency then sinks like a rock.

Sixth: Corruption and Crony Capitalism: This is typical of developing countries in which the top leaders help their friends and relatives dominate the economy, gain control of companies, and get richer and richer while corruption flourishes. While ruling elites often consider it their right to get themselves and their families rich at the expense of the country, the economy does not necessarily agree. The real condition of the economy is hidden, while government bureaucrats pay lip service to their masters and lie to the press. But it is harder to fool the market.

Seventh: A large inflow of foreign capital, followed by a sudden stop and then a sharp outflow of foreign capital (hot money) from the country due to an expected economic downturn or political crises. The currency comes under pressure, and the only possible solution is a devaluation of the local currency. Businesses with foreign debts may go bankrupt as their debt mushrooms.

Once the economy hits the bottom, a lot of businesses go bankrupt and a lot of people lose their jobs. Economies usually take about three years to recover from an economic crisis.

Hyman Minsky and the Minsky Model of Financial Crises: 

While mainstream neoclassical economists do not believe that a crisis can be caused by the workings of the capitalist system, nevertheless, someone has to explain where they come from and why they happen. In liberal economic models, decisions made in the marketplace are rational by definition. Nevertheless, Alan Greenspan could talk about “excessive exuberance.” For radicals, on the other hand, the nature of the capitalist system tends toward crises, and indeed, the normal state of capitalism is crisis. This brings us to the model of an economic crisis proposed by Hyman Minsky. The Minsky Moment or the moment of truth.

Minsky’s Theory of Economic Crisis:

First: There is a displacement or external shock to the economy. This must be something large, such as the start of a war, a bumper crop or a crop failure, or the innovation and diffusion of a new technology. For example, the so-called dot-com revolution in the internet in the l990s.

Second: Profits increase in at least one important area, resulting in an investment boom.

Third: The expansion of credit greatly increases the money supply. Credit expands both in business and in family purchases and consumption.

Fourth: The expansion of the economy continues until it reaches a “euphoria stage.” This results in a “bubble economy.” More investors rush into the profitable areas of the economy.

Fifth: At some point in this expansion, some investors get cold feet and decide that the expansion is about to top out. They take their profits and get out of the market. They put their money in less risky investments.

Sixth: More businessmen begin to feel that the expansion is over and start to get out. This continues until it reaches a panic stage.  The panic may be set off with the collapse of a major bank, such as the Lehman Brothers Bank collapse in the US, a corporate bankruptcy or other such event.

Seventh: Major Bankruptcies increase.

Eighth: Finally, the bubble bursts. Panic sets in seriously. There is a credit crunch. There is a liquidity trap with firms holding onto their cash. A recession or depression follows. Economic output drops sharply from five percent up to twenty-five percent or more.

Ninth: Eventually, the economy recovers and returns to equilibrium. The average time is around three years. Some players in the market emerge much richer. Many more lose most of what they had. Consumers’ standard of living decreases. For some, who are always poor, it does not make much difference. They are always in a financial crisis, no matter what happens in the economy.

Such a crisis is also called a “Minsky Moment.”

Mainstream Economists and the Minsky Model:

Mainstream economists reject the Minsky Model outright. They say that there can be no general model of an economic crisis. Every economic crisis has its particular features. Minsky’s model is based upon the idea that the crisis is generated by speculation in the market. Milton Friedman argued that there is no such thing as “speculation.” This sounds very much like an argument from the Austrian School.

For Minsky, on the other hand, euphoria, irrationality and financial crises are all just normal parts of capitalism. History shows that financial mania can be caused by “mob psychology” or a “herd mentality.” Charles Kindleberger, for example, agrees with Minsky that financial crises are an inherent feature of international capitalism.

Economic Crises:

An economic crisis is a complex event and it is true that they are different. However, they share a general pattern. Something serious has to happen to affect the currency. Four real world events happened as below.

The Mexican Peso Crisis (December 1994):

A new President, Ernesto Zedillo had just been elected. Carlos Salinas de Gortari was the outgoing President. Zedillo moved quickly to change economic policy.

First, Zedillo reversed the tight money controls. That is, he brought financial liberalization. Salinas’s policies while in office had strained the finances with government debt.

Second, Salinas used populism to stimulate the economy just before the election, but this policy was unsustainable due the weak economy.

Third, a low interest rate led to risky domestic loans. The quality of loans fell.

Fourth, the armed rebellion in Chiapas broke out during l994 just before the election.

Fifth, the Chiapas revolution or revolt by the poor helped cause foreign investment to drop.

Sixth. high government spending during l985-1993 had led to high inflation.

Seventh, the price of oil dropped making it more difficult for the government to pay its high debts. The current account deficit increased as it was difficult to finance the debts.

Eighth, Salinas then issued bonds to finance the debt.

Ninth, one of the presidential candidates, Luis Donaldo Colosio was assassinated in l994 just before the election.

Tenth, the current account deficit rose with dollars flowing out of the country.

On December 1, 1994, Zedillo took office. The Mexican Peso was four to a dollar. It then quickly crashed to seven to a dollar. The United States bought pesos to help out and provided Mexico with a fifty billion US dollar loan but the damage had been done. The country recovered from the crises by about 1997. This is the normal time that it takes a country to recover from a financial crisis on average.

The Asian Financial Crisis (1997):

This was the worst economic collapse since the l930s in East Asia. The countries most affected by this crisis were Thailand, Indonesia, and South Korea. However, all of the countries in Asia were affected to some degree. It was feared that it could lead to a world-wide crisis without quick action.

First, the crisis started in Thailand in July of l997. The Thai baht was allowed

to float in the market due to a lack of foreign exchange. Thailand was short of US dollars.

Second, there was a real estate bubble. There was also financial over-extension with too many loans.

Third, Thailand had a high foreign debt and was effectively bankrupt.

Fourth, the crisis then spread to all of Southeast Asia. The Japanese yen declined. Stock markets fell. Private debt rose.

Fifth, Hong Kong, Malaysia, Laos, and the Philippines were also hurt. Less affected were China, Taiwan, Singapore and Vietnam.

Sixth, the IMF launched a bail-out package of 40 billion US dollars for Thailand, South Korea and Indonesia.

Seventh, on 21 May 1998, Suharto was forced to resign as President of Indonesia after thirty years in power. There was massive crony capitalism as Suharto had divided up the economy among his close relatives.

Eighth, growth in the Philippines dropped to zero.

Ninth, by 1999, the recovery was beginning. So again, the crisis lasted about three years.

Causes of the Asian Financial Crisis:

First, there was a lot of hot money in the Asian economies. Foreign capital flowed in and then there was a sudden stop. Paul Krugman had written that there was no economic miracle in these countries. He noted that productivity was not high and the technology was mainly owned by foreign countries. But there was a high capital inflow of short-term finance due to high interest rates (arbitrage). This money was not invested in the real economy.

Second, prices had risen sharply for several years. This had created a bubble, especially in the housing market.

Third, there had been a high economic growth-rate, said to be the East Asian “economic miracle.” This growth rate was due more to the Asian developmentalist state-guided model than free-market capitalism.

Fourth, Thailand had an asset bubble in housing, stocks and other commodities.

Fifth, there was rampant crony capitalism in Malaysia and Indonesia under authoritarian regimes.

Sixth, the development money flowed to those in power under this model of crony capitalism.

Seventh, the countries were running high current account deficits. Once started, there was a domino effect as the debt defaults in one country led to defaults in other countries and affected the whole region.

Following the crisis, there was a debate about whether the crisis was caused by the new system of global financial liberalization or the strong role of the state in Asian economies. Joseph Stiglitz and Chalmers Johnson argued that the Asian model of state-led growth could not have caused the crisis. The state developmentalist model had a solid record since the l950s. No one imagined the onset of the crisis as the economies seemed to be sound. However, the governments seemed to be the logical place to put the blame. This was the view of free-market economists. Those critical of financial liberalization and leftists said that the crisis was due to allowing the free flow of global financial capital, roaming the world for short-term profits. They were inclined to argue that financial liberalization was the root cause, because this system had made the international financial system unstable and said that this unstable international financial market could bring down even strong economies under certain circumstances.

The Turkish Financial Crisis (February 2001):

First, Turkey was under an IMF structural adjustment program (SAP). The Turkish Lira was pegged to the dollar but adjustable by a crawling peg.

Second, in February 2001, the currency crashed by thirty percent, a sharp devaluation.

Third, the Turkish banking system was under political control and badly needed reform.

Fourth, there was much hot money and much corruption in the country.

Fifth, in November, before the crises, the Turkish banks experienced liquidity problems. There was a general loss of confidence in both the political and economic systems.

Sixth, the Turkish Central Bank responded by printing money massively, violating its own rules.

Seventh, some six billion US dollars flowed out of the country almost overnight. This raised the current account deficit.

Eighth, Turkey got an 11.5 billion US dollar loan from the IMF as an emergency package to bail out the sinking economy.

Ninth, meanwhile privatization was forced upon the country and the sale of state economic enterprises proceeded.

Tenth, interest rates rose sharply in early 2001.

Eleventh, on February 19, 2001, Ahmet Necder Sezer, the Turkish President, and Prime Minister Bulent Ecevit, had a fight over corruption.

Twelfth, the Turkish lira collapsed from the peg on February 21. The Turkish Lira was floated under lack of confidence in the Government.

Thirteenth, Prime Minister, Bulent Ecevit brought in Kemal Dervis, a former World Bank official, to reorganize the Turkish banking system and carry out reforms. The Turkish economy recovered after the banks were reformed and recapitalized.

In December 2013, Turkey was starting to feel some of the effects of rapid growth over the past decade, as the Fed began its tapering program, to cut back on quantitative easing. At the same time pressure was put on the currencies of India, Brazil, Russia and several other big emerging markets. When global economies are fragile, the actions of the Fed can be felt around the world at once.

Case Study: The US Financial Crisis (2007-2008):

The US financial crisis began in July 2007 when two Bear Stearns hedge funds collapsed. They had invested in mortgage-backed securities. The Fed began to flood the financial sector with hundreds of billions of dollars. By April 2009, the Fed had committed around $8.5 trillion dollars to salvaging the US financial system.

On September 18, 2008, Senator Chris Dodd announced that the US was just days away from a complete financial meltdown without a huge US Government bailout. A bill for $700 billion for the bail-out was quickly written but initially failed to pass in the US House of Representatives. The financial community was shocked at the rebuff. A few days later with sharp warnings by President George W. Bush and the Secretary of the Treasury Henry Paulson, the package for the banks was pushed through Congress. Some called it a financial coup d’ etat.

This money would buy toxic assets, that is, worthless assets, also called “toxic waste.” There was a lot of anger among the American people about the bailout and financial panic spread. This was similar to what Hyman Minsky’s theory of a crisis predicted. Stocks fell sharply. The Fed responded by pumping more dollars into the economy and the Government announced that it would buy more toxic assets. It became a buyer of last resort. The Fed would buy all commercial paper, up to $1.3 trillion, if necessary. Commercial paper is loans issued by corporations to other businesses.

Nevertheless, the system went into a liquidity trap. This happens when banks and businesses will not loan money to other banks and businesses because they do not trust that it can be paid back. They hoard money. Interest rates fell to near zero. This is what Keynes called the “propensity to hoard.”  This included cash and Treasury bills. The “Financial Ice Age” had started. There was no lending between banks and businesses.

The G-7 countries announced that they would partially nationalize the banks. They would do this by buying shares and so injecting money into the banks. They expanded deposit insurance. The US Government would guarantee $1.5 trillion debt to be issued by banks. The cost of the bailout package came to $2.5 trillion by the time of the Lehman Brothers Bank Collapse.

Funds were also committed to bail out Fannie Mae, Freddie Mac, the Wall Street Firm Bear Sterns and American International Group (AIG). The total bailout at that point was estimated at $5.1 trillion.

The contraction of the economy continued. Auto companies, Ford, Chrysler and General Motors, got a $25 billion bailout, with more low interest loans promised later. Some 600,000 to 700,000 jobs were lost in December 2008 and January 2009 as the crises began to hit the real economy.

There were two major theories about the crisis. First is the Milton Friedman, Ben Bernanke, monetarist theory, that it was a liquidity crisis. Secondly, the Monthly Review School argued that it was a structural crisis of capitalism.

According to monetarist theory, the crisis could be solved by just pouring a lot more money into the banks and the financial sector. Ben Bernanke, who became the Fed Chair, and was a monetarist, had said that one could just fly over the country and drop money from a helicopter to solve the crisis. After this he was called “helicopter Ben.”

The second theory from Monthly Review would mean that financial sector debt would have to be squeezed out of the system before the markets could recover and get back to production in the real economy. It was a structural crisis.

By the end of 2008, most banks were insolvent. They could not pay their debts because all their assets had been wiped out by the declining values of the loans which they owned. It was clear that many of these loans could not be paid back. Several bank mergers quickly took place. JP Morgan Chase bought Washington Mutual and Bear Stearns. Bank of America bought Country Wide and Merrill Lynch. Wells Fargo bought Wachovia Bank.

Banks became more monopolistic and the US Government purchased more shares to help liquidate the loans and get the banks back to solvency. At the same time, people lost jobs and were unable to pay their debts.

The Great Depression and the Lender of Last resort:

The confidence in the system is underwritten by the Government, as the “lender of last resort.”

For Bernanke, it was just a liquidity crisis which could be fixed by pumping massive money into the economy. You just fly over and drop money (helicopter Ben). Bernanke had argued that economists had figured out how to keep a depression from ever happening again. He thought the Federal Reserve could always reflate the economy by pumping in more dollars. When the interest rate gets down to near zero, the Fed can buy government securities to pump money into the economy. This was quantitative easing which is just another name for printing dollars.

So Bernanke argued that the Fed only had to look at monetary factors and not at the real economy. Nothing was done until the housing bubble burst in 2007. Then money was pumped into the economy massively.

The Financial explosion and implosion:

The are two parts to the economy: The real economy (base) and the financial superstructure. The US economy had started to generate most of its profits from the financial superstructure, rather than the underlying real economy. The Monthly Review School (Harry Magdoff and Paul Sweezy) had always argued that the normal state of the underlying capitalist economy was stagnation. They argued that the root problem when the bubble burst was not the mortgage problem but the real economy.

Most profits were being made in speculation in the financial sector of the economy with ever expanding debt. This increased from 1.5 trillion in 1970 to almost 48 trillion in 2007. And private debt had skyrocketed relative to national income from the l960s. This stimulated the economy, boosted economic growth, and provided large financial profits, but was not sustainable. There was a large gap between the financial superstructure of the economy and the underlying real economy, where surplus value is generated. The profit from speculation in the superstructure is just an advance on the exploitation of surplus value in future, but the gap had become too large.

The US financial system was a giant casino with leveraging debts thirty to one. It was bound to collapse unless the system kept expanding indefinitely, which could never happen. This was a contradiction associated with speculative bubbles.

When the bubble finally burst, the economy could not recover until the debt was liquidated, written off, or more likely taken over by the tax payers. It became a “debt overhang.” However, some economists had started to believe in the theory of the “New Economy” and thought that with enough financial management tools such a crisis could be prevented from ever happening again. Alan Greenspan, the former Fed Chief, said that he was absolutely shocked that the bank crises happened so quickly.

Paul Sweeney and Harry Mag doff in their book, Monopoly Capital, had pointed out that the US economy could absorb excess capital through government spending on the military, advertising, new innovations and so on and this would promote economic growth. However, these enterprises were never enough to get the economy out of the essential problem of stagnation. The normal state of a capitalist economy, in their view is stagnation. Financialization of the economy became necessary to provide the necessary growth. However, this was speculative and ran the risk of financial crisis and collapse.

The real stimulus to demand in the US economy, in this view, was the growth of debt. Credit cards, mortgages, student loans and so on kept piling up higher and higher to keep the economy going. Government spending, national, state and local and so on, was also increasingly based on debt. This was going on in other economies as well.

According to the Monthly Review School, some $1.2 trillion of excess profits had been made by financial speculation. They argued that this must be squeezed out of the system by “mean reversion.” The long-term trend in financial markets must return to a mean projection or trend line of normal profit, according to this theory. This $1.2 trillion of excess profits would have to be wiped out before the system returned to the long term trend in growth.

The system would need to undergo a major economic downturn to return to the normal growth.

The attempt to solve the normal stagnation problem by pumping up paper profits in the financial sector had failed.

After World War II, the US was in a special situation and was able to stimulate the economy. US prosperity benefited from savings from the war period, automobilization, people moving to suburbia, increasing consumption, housing developments, the interstate highway system, the glass, steel and rubber industries, the rebuilding of the Japanese and European economies, the Cold War arms race, advertising, TV expansion, insurance, and the US dollar. This was the “golden age” of American capitalism. However, this ended with the recovery of Japan, East Asia and Europe. US GDP fell from about six percent during the war to 2.6 percent. With economic stagnation, came financialization and neoliberalism. It was financial Keynesianism and produced asset bubbles which were subject to bursting.

A new class war set in. Real wages fell as profits rose largely in the financial sector. Labor costs were pushed down. Wages peaked in the US in l972 at about $9 dollars an hour. They had fallen to $8.24 in 2006. There was a massive redistribution of income upwards and greater inequality. This increased during the Reagan years in the l980s. Those at the top got richer while most got poorer.

But household consumption rose, not through greater wages, but as a result in the rise in equity values in houses. But this also meant that household debt increased on new mortgages from forty percent of GDP in l960 to 100 percent of GDP by the l990s. People borrowed money on the value of their house in order to keep consuming. They were told that their house was a bank and that they owned their own bank. An increasing number of house owners owed more on their house than it was worth. They were “under water.”

At the same time, there was less investment in the real economy and so less capital formation. In the dot-com revolution in the l990s, this was not seen as important. Investment was expanding through speculative financial instruments. More and more, profits had nothing to do with production as most production was sent offshore to Mexico and China. Stagnation in the domestic economy was certain to remain.

The economic slow-down in the US spread the crisis to the rest of the world, first to Europe. There would be slow growth and high unemployment around the world as a result of the US crisis. The economy of Iceland melted down where the banks had invested in speculation abroad under a right-wing government for years. Iceland refused to pay and defaulted on the loan.

The cost of bailing out the rich was put on the backs of the poor. People were angry. Rather than to create jobs, the government used monetarism or quantitative easing. This kept the economy afloat, but did not serve to create jobs as was done after the great depression in the l930s. The government could have spent up to 13.5 percent of GDP to put people back to work.

Instead, the monetarist solution was to return to business as usual and the same kind of financial speculative system. The critics argued that it was not a sustainable system and just created more wealth for the rich and inequality.

The Dynamics of the Mortgage Crisis in the US: Monopoly Finance Capitalism

The housing bubble was crucial to US capitalism because this was providing much of the income for spending in the last few years, with job creation weak. Higher interest rates could generate stagnation, leading to defaults and foreclosures. There was a rapid growth of hedge funds and credit derivatives. The panic spread after the collapse of the sub-prime mortgage market in July 2007 and all sectors were affected. Adjustable rate mortgages, commercial paper (unsecured short-term corporate debt), insured bonds, commercial mortgages, corporate bonds, auto loans, credit card debt, student loans are all forms of money that are traded on the markets on an international scale. This financial unwinding soon reached the real economy resulting in falling employment, weakening consumption and investment, and decreasing production and profit.  

By February 28, 2008 the US growth rate had fallen to zero. The recession had begun.

Over the last four decades, there had been a shift from production under Fordism to finance with a rapid growth in financial profit.

The Five Phases of the bubble and the Minksy Model:

The housing bubble expanded to trigger the crisis. Capital flowed into the housing market causing hyper-speculation. The five phases include a novel offering, credit expansion, speculative mania, distress, and crash/panic.

First, the novel offering was the “collateralized debt obligation” (CDO). The collateral is the house for which the mortgage loan was made. The cash from these loans, after pooling them, was a basis for more loans to generate “mortgage backed securities.” These mortgage backed securities were repackaged in the form of “Collateralized Mortgage Obligations (CMO). They were packaged so that they were a mix of low-risk, middle-risk and high-risk (subprime) mortgages. The ones with more risk were “junk bonds.” They were rated according to risk of default. Some were investment grade. And banks were allowed to invest in them. Mixing sub-prime with other mortgages would make almost all of them into “safe bets,” theoretically. They were also insured by bond agencies. Some were even AAA rated. All this vastly expanded the market for mortgage lending. So people with poor credit histories could get mortgage loans.

These new securities could be sold through new global financial markets. Structured Investment Vehicles (SIVs) were set up to hold CDOs .These were virtual banks. They drew on the commercial paper market for short term funds to buy the mortgages. Short-term funds were borrowed to invest in long-term securities. Credit default swaps were made with banks. This meant that the SIVs made quarterly payments to banks, like Bank of America. In return banks promised to make a large payment if the SIVs found their assets declining and their credit drying up. This would prevent them from being forced into default. This left the banks exposed to risks that they had tried to transfer elsewhere.

The second phase was credit expansion. Credit is required to feed the asset bubble. The Fed lowered the interest rate to one percent in June 2003, so interest was very low. Mortgages expanded. House prices increased. But jobs paid low salaries. Many loans for houses were adjustable rate mortgages. Low “teaser” interest rates were given to begin with that would go up in three to five years. This made the homes affordable as long as one’s income held out and increased. People believed house prices would continue to rise. A huge rise from $56 billion in loans in 2000 mushroomed to $508 billion in 2005.

The third phase is speculative mania. In this phase there is a rapid rise in debt and a rapid decrease in its quality. It is assumed that house prices will continue to rise. It is Ponzi finance or hyper-speculation. The debt is not based on income streams but merely on what the value of the assets may be in future. CDOs increasingly took this toxic form. Real estate speculators got into the business. Mortgages were used for consumption. Mortgage borrowing increased by $1.1 trillion between October 2005 and December 2005. Total mortgage debt went up to $8.6 trillion, which was equal to seventy percent of the US GDP.

The fourth phase is distress. Something caused the speculative bubble to be pricked. In 2006, interest rates rose. Housing prices declined in California, Arizona and Florida. Mortgage payments ratcheted up at the same time. Credit debt swaps increased globally by forty-nine percent, to cover $42.5 trillion in debt, in the first half of 2007.

The fifth phase is crash and panic. There was a rapid selling off of assets in a “flight to quality.” Investors wanted liquidity. First two Bear-Stearns hedge funds collapsed in July 2007. They held $10 billion in mortgage backed securities. They lost almost all their value. Banks in Europe and Asia were also exposed to toxic assets. A credit crunch began as banks did not know the extent of their exposure. The commercial paper market was hit, which was the source of funds for the SIVs.

September 2007, Northern Rock Bank failed and was bailed out. There was a run on the bank.

Bond insurers began to fail because they underwrote the credit default swaps on mortgage-backed securities. Financial panic spread. No one could be sure what investments were toxic.

There was a stampede into US Treasury bills. In January 2008, the system had reached the panic stage. The Fed poured money into the system. Consumer spending was hit. The governments in the US and Europe were left to bail the capitalists out.

It was a crisis of the stagnation of capitalism, according to Monthly Review. In the US, capacity utilization was around eighty-five percent in the l960s. It fell to eighty percent between l972 and 2007. Big companies had a “mountain of cash,” at least $600 billion, but investment declined. So the capital went into the financial sector. The FIRE sector included finance, insurance, and real estate. This is the non-productive sector or the economy. The main stimulus to the economy, other than finance, had been military spending.

It was stagnation that led the financialization of the economy. On the other hand, others argued  that it was the other way around. Financialization had led to stagnation by crowding out other investments. However, this theory is rejected by the Monthly Review School. They said there were real opportunities for investment outside the financial sector. It is a structural crisis of capitalism itself which is the real problem.

Recent Trends in International Financial Flows:

US Quantitative Easing by the Fed:  Quantitative Easing is another name for printing money and increasing the money supply in the economy. Some of this money finds its way into emerging economies and boosts economic growth. However, these financial flows can come to a sudden stop and then flow out, leading to a financial crisis.

However, the US Government only gets the money from the Fed by borrowing it, that is, by buying bonds. The Fed, the national bank of the United States, which creates dollars, is not owned by the people but by the private banks. It costs about seven cents to make every US dollar.

Financial Flows in percentage of GDP in Advance Countries: In the 1980s financial flows were five percent of advanced country GDP. This increased to twenty-five percent in 2008. By 2010, financial flows declined to ten percent of advanced country GDP due to the US financial crisis.

Financial flows in Emerging Countries: In the l980s, financial flows were two and a half percent of the GDP of emerging countries. In 2008, financial flows increased to twelve percent, but fell back to seven and a half percent in 2010 due to the US economic crisis.

In emerging market countries, large inflows of foreign capital support large housing markets, big shopping centers, and so on. It tends to make government borrowing easy. Also consumer credit is increased. It also encourages corporate leveraging. These inflows can greatly increase when the Fed and the European Central Bank are engaged in quantitative easing programs such as the period from 2008 up to 2014.

Financial Outflows from Developing Countries: In 2000 financial outflows from developing countries was some 295 billion US dollars. In 2013, this increased to 1800 billion US dollars.

Forex Trading: The volume of Forex trading is about 100 times greater than international trade flows today. This means that the rate of currency exchange in global markets is largely determined by currency flows. Daily Forex Trading in 2014 was 5.3 trillion US dollars per day or 1825 trillion US dollars per year. Trade Flows were 18.3 trillion US dollars per year. These figures were expected to increase.

Forex Trading by Countries in 2013: In the USA, forex trading was 860 Billion US dollars per day. In the UK forex trading was two trillion US dollars per day. In Japan forex trading was 283 Billion US dollars per day. Clearly, London lives up to its reputation as the money-laundering capital of the world.

Global Foreign Direct Investment in 2013: Foreign direct investment was between 1.1 trillion and 1.5 trillion US dollars per year. Some 700 billion US dollars went to developing economies. Some 561 billion US dollars went to developed economies.

Derivatives in the Global Economy: As of June 2007 there were 516 trillion US dollars in derivatives. Much of this value was wiped out, however, by the 2008 US financial crisis.

US Quantitative Easing (printing money): The Fed has been pumping some 85 billion dollars per month into the US economy from September 2012 through 2013. This is 1.02 trillion dollars per year. This followed other quantitative easing periods to get the economy back to health.

European Quantitative Easing (QE): The European Central Bank created some 1.5 trillion dollars in 2013. (LTRO Liquidity Injection Policy)

Regulating the International Financial System:

A number of scholars have stated that the international financial system is the weakest link in the global financial system. Among these are Charles Kindleberger, Susan Strange and James Tobin. Various measures have been proposed to strengthen the system.

The Tobin Tax: James Tobin proposed that a small tax be placed upon international financial flows. This would provide a fund which could be used to bail out economies which experienced financial crises. The tax has never been implemented, however.

George Soros is a financial speculator who made huge profits on speculating on foreign currencies. He wanted a “lender of last resort.” A lender of last resort is a source of loans for a country which experiences a financial crisis. People like George Soros can do a lot to help them along. So someone should come along and pick up the pieces of the economy after George and the other money traders have taken their profits and left the mess behind.

The IMF has traditionally played the role of lender of last resort. However, even the IMF may not be capable of dealing with the need for funds in the contemporary global economy. In the case of the United States economic crises in 2008, it would have been impossible for the IMF to come up with the funds to bail out the US. This had to fall to the US taxpayers, and quantitative easing by the Fed. The US Government bailout at the end of 2008 was more than 800 billion dollars to prop up the banks. The total package was much greater. The US Government bought a lot of essentially worthless paper assets to keep banks and other companies from bankruptcy, which were considered “too big to fail.” But at the same time, several million families lost their homes in foreclosures of their mortgages. They were too small to save.

In the case of countries in the European Union, such as Greece, Spain and Portugal, a combination of funding has come from the IMF and the largest banks of Europe. Sometimes the poor just have to make sacrifices so that the rich can go on having their easy and plush lifestyle. At least in today’s global economy.

A lender of last resort raises the issue of “moral hazard.” The argument is that the existence of a lender of last resort can result in a moral hazard. This is because if a country knows that it can be bailed out in the event of a financial crisis, it will follow risky policies. However, the danger to the global economy of the collapse of a large country or area means that in practice, countries must be bailed out to stabilize the system. There is great fear of financial contagion.

Economists do not agree on what can be done. It reminds one of the old joke: “If one laid all economists end to end, they would all be pointing in different directions.”

Financial Crises and Austerity:

Under the neoliberal policies of today’s global political economy, financial crises are being dealt with by imposing austerity on countries. For neo-Keynesians, like Paul Krugman, this is exactly the wrong medicine and is likely to kill the patient. Krugman has blamed much of the volatility in the global political economy upon these wrong policies in Western countries.

A pattern has emerged in the global economy of swinging from bubbles to depression. Most of the blame is not in emerging market countries like India, Russia, Hungary, South Africa and Turkey. The austerity policies in Europe and America being urged by extreme political conservatives, depresses economic growth in Western countries. There is too much savings and not enough investment to stimulate growth in the world economy. Excess capital flows to emerging economies to take advantage of higher interest rates, but when there is a sudden stop, an economic crisis is triggered.

Summary:

Thorstein Veblen would surely have been amused. Since the l970s, the bankers and money traders have greatly increased their profits in the global financial sector by destabilizing the global financial system. This is exactly what he predicted as the role of businessmen. When they wreck the economy it opens up opportunities to increase their profits.

Following formal rational economic models, economists generally believe that it is just the opposite. That the new system of financial liberalization ensures that capital is used in the most efficient way. When there is an economic crisis, however, the big firms get bailed out while it is the common people who lose their savings, pay higher for everything they need to live, and lose their jobs.

In such a situation, emerging countries owe it to their citizens to take some precautions to curb speculation in the financial sector for profits. Much of these profits are secreted away in Swiss bank accounts or offshore tax havens. All of this goes under the rubric of corporate ethics.

The 1970s were marked by a revolution in the international financial system. Financial flows were liberalized, greatly increasing the volatility in the global political economy. Massive financial flows have come to largely control the exchange rates of big emerging market countries and have contributed to the risk of financial crises in these countries. This development reflects the extension of the financialization of the US economy globally. Recent financial crises include the Mexican Peso Crisis, the Asian Financial Crisis, and the Turkish Economic Crisis. The largest and most serious financial crisis was the 2007-2008 US financial crisis which spread to Europe and still affected the global economy in 2014.

Monetarists believe that the US financial crisis was the result of a liquidity crisis which could have easily been remedied by an appropriate Fed monetary policy. Marxists scholars at the Monthly Review School in New York, on the other hand, argued that the crisis was caused by a structural crisis of capitalism. They argue that it was due to the tendency of mature capitalist economies to fall into economic stagnation.

The Minsky model of an economic crisis is based upon the observation that a speculative bubble can emerge leading to an economic crisis. This is particularly true in the financial sector of the economy. The United States and Europe have dealt with the financial crises through monetarist policies of quantitative easing and austerity, rather than Keynesian job creation programs. This seems to be the wrong way to solve the crisis, in terms of global economic growth. This policy has been criticized by neo-Keynesian economists such as Paul Krugman and Joseph Stiglitz. World economic growth slowed considerably to only 2.1 percent in 2012.

Key Terms:

Financial Liberalization

Capital Flows

Speculative Capital

Home Bias

Casino Economy

Hedge Funds

Hyman Minsky

Minsky Model

Minsky Moment

Financial Instability Theory

East Asian Financial Crises

Mexican Financial Crises

Turkish Financial Crises

Tobin Tax

James Tobin

New International Financial Architecture

Moral Hazard

Lender of Last Resort

Basle Accord (1988)

Volker Shock

Paul Volker

Irrational Exuberance

Mob Psychology

Speculation

Euphoria Stage

Bubble Economy

Herd Mentality

Sudden Stop

Hedge Funds

Mortgage-backed securities

The Federal Reserve

Ben Bernanke (Fed Reserve Chairman)

Henry Paulson (former Treasury Secretary)

“Toxic Assets”

Buyer of last resort

Lender of Last Resort

Liquidity trap

“Propensity to Hoard”

Treasury Bills

“Financial Ice Age”

Fannie Mae

Freddie Mac

deposit insurance

liquidity crises

Solvency crises

Structural crises

Mergers

“debt deflation”

Hyman Minsky

Financial instability hypothesis

Speculative bubbles

Debt overhang

The New Economy

Mean reversion

The Stagnation Problem

Financialization

Financial Keynesianism

Collateralized Debt Obligation (CDO)

Collateralized Mortgage Obligation (CMO)

Subprime Mortgage

Structural Adjustment Vehicle (SIV)

Credit-Default Swaps

Novel Offering

Quantitative Easing

Tapering Policy

Mean Reversion

 

Chapter Seventeen: The Multinational Corporation and the Global Economy

“What is good for General Motors is good for the Country.” US Secretary of State, “Engine Charlie” Wilson. (1953-1957)

To a great extent, the global economy is run by the multinational corporations. They are more powerful than all but a handful of governments. They function as virtual parliaments and control people’s lives around the globe even though they are not democratic organizations. The mode of operation of the world’s corporations is new, but they have historical roots in the beginnings of colonialism. Firms like the British East India Company founded in 1600 and the Dutch East India Company founded in 1602 were the forerunners of today’s multinational corporations.

Profile of MNCs Today:

The top 1000 multinational corporations account for eighty percent of world industrial output. They produce twenty-five percent of the world’s gross output. With revenues of 228 billion US dollars, ExxonMobil is ranked twenty first among world economies. Of the 100 largest economic entities in the world, fifty-three are MNCs and these are wealthier than 120 nation states.

The number of MNCs has mushroomed. In 1990, there were some 3000 MNCs. The number in 2014 has surpassed 63,000 with 821,000 subsidiaries. They employ 90 million people, including 20 million in developing countries. The country with the most MNCs is not the Unites States, England, or Japan. Denmark is the home location for some 9356 MNCs. Germany is second. However, 93 of the top 100 MNCs are located in the United States, Europe or Japan.

America’s domination has changed greatly, however. In 1962, sixty percent of the top 500 MNCs were American. In l999, only 36 percent were American.

In contrast to popular belief, most MNCs are not huge companies. Most of them employ less than 250 people. The United States has some 3390 MNCs, while there are 7460 in South Korea and 4334 in Japan.

The Study of Multinational Corporations:

Mainstream economic theories do not deal with multinational corporations as a separate entity. They are primarily studied by business economists, political economists, and radical political economists. From the perspective of mainstream economists, a firm’s behavior is controlled by the market whether it operates in the domestic or the international arena. Following the principle of the Mundell Equivalency, economists generally argue that foreign direct investment in multinational corporations is equivalent to the flow of trade in the real world. It means that trade and investment are perfect substitutes for each other.

Those political economists who stress the strategic behavior of multinational corporations point out that many multinational corporations are oligopolies. They function in very imperfect markets and have various relationships with the governments of the countries where they operate. Corporations can benefit from many strategies including tax breaks, using offshore havens to conceal their profits, and using transfer pricing to avoid paying taxes. They routinely seek countries where they do not have to worry about restrictive labor and environmental laws. Theories relevant to understanding the nature of multinational corporations include strategic trade theory (STT), industrial organization theory, technological advances through R & D, and the control of assets, such as trade-marks and particularly technologies.

The Product Cycle Theory (Raymond Vernon):

Raymond Vernon argued in his book, Sovereignty at Bay (1971), that every product follows a life-cycle from innovation to maturity to eventual decline and obsolescence. Initially, American products have an advantage internationally since US firms have excelled in R & D. This has not always been true in relation to Japanese firms, however. Another advantage enjoyed by American firms is the large domestic market.

In the first phase, the products are produced in the United States and exported to foreign markets. Once production techniques are established and standardized, firms export the means of production and produce the product abroad. Not only can the American firms flood the market, they can better compete with foreign imitators which begin to enter the market. This serves to preempt the competition. The goal of the firm is to maintain a monopoly in the market for the particular product.

Vernon’s theory was useful in explaining the behavior of American multinational corporations in the l960s between the US and Western Europe. American firms could not penetrate the Japanese market as easily, so the theory mainly applied to Europe. By the end of the l960s, Europe had recovered economically, as had Japan, and the US began to lose some of its advantage in the international market. European and Japanese firms began to compete with American firms and take over the markets by the mid l960s. The Japanese were also able to produce superior quality products which began to become popular in the US market. First in electronics, cameras and so on, and later in automobiles, the Japanese took over the American market to a great extent.

John Dunning and the Eclectic Theory of the Reading School:

John Dunning studied business strategy at the University of Reading in England. Dunning stressed several important factors in international business behavior. First, multinational corporations rely upon the development of technology to establish their place in the market. Secondly, MNCs organize themselves on a global basis in order to minimize the costs of production and distribution. Third, the location of the firm, ownership, and brand name are important to give the firm an advantage in the market. If one could buy any car they wanted, perhaps most would go for a Mercedes. Part of the appeal is simply the name, although few cars can come up to the sophisticated technology. This allows firms to extract high rents, that is, higher prices. Fourth, successful MNCs try to monopolize specific technology as long as possible. Fifth, internalization includes establishing branches in other countries. Sixth, as oligopolies, they seek to keep technology out of the hands of rival firms. Seventh, new branches can take advantage of cheap labor, and lack of labor unions, such as Daimler Benz locating in the south of the United States. With financial liberalization, it is easier for firms to move capital to new countries and leap over trade barriers. Management extends across borders to a world-wide scale.

Michael Porter’s Strategic Theory: 

In his book, Comparative Advantage of Nations (1990), Michael Porter argued that multinational corporations engage in strategic management. They establish a “value chain of activities” all the way from extraction, in the case of oil and minerals, to production and marketing. The firm uses a strategy to plan which activities it will pursue and in which countries it will locate around the globe. This is a theory of strategic management. The firm chooses the optimal location for each activity around the globe. This is a true transnational strategy and gives the firm great advantage over domestic firms. HP produces some of its printers in Vietnam, perhaps because the labor is so cheap, and Hanoi is next to a convenient sea port.

Marxist or Radical Theories (Stephen Hymer):  

There is a huge body of work on multinational corporations by Marxist writers. One of the early writers was Stephen Hymer.  Hymer challenged the conventional wisdom of economists that there was no significant difference between foreign direct investment (FDI) and portfolio investment in the l960s. For Hymer, FDI was part of a strategy to control the markets. Firms wanted to control production in foreign countries. This was a strategy to help firms control their monopolistic advantage.

Hymer’s work was ignored by mainstream economists because he was a Marxist. However, later business economists came to see that he was right. Organizational theorists came to the same conclusion as Hymer, although they were not Marxists.

Hymer said that monopoly capitalism is driven by two fundamental laws:

First, firms attempt to increase the size of the firm in the core and the periphery. Second, is the law of uneven development. Firms have considerable power in the global market. So they can exploit countries around the world to their advantage. It is relatively easy for the countries in the rich north to exploit less developed countries in the South. Much work has been done along this line by William Tabb, Harry Magdoff, Paul Sweezy and others at the Monthly Review School. They too, however, have largely been ignored by the mainstream. They were never likely to win the Nobel Prize.

Multinational Corporations: Benefits and their Downsides

Benefits of MNCs are said to include paying increasing tax revenues, providing employment, providing needed goods and services, and bringing in capital, technology and management skills.

On the negative side, Noam Chomsky has referred to MNCs as totalitarian organizations which increasingly control the global economy. Their leaders increasingly control people’s lives, even though they are not elected. MNCs are accused of enabling cultural imperialism. Some eighty percent of all recorded music is sold by just six MNCs. There are huge media corporations such as that owned by Rupert Murdoch. MNCs sometimes bring unwanted ideas and images to countries and have a powerful effect, either positive or negative, depending upon one’s point of view. MNCs have also been accused of promoting unhealthy diets with fast-food outlets. McDonalds has more than 29,000 hamburger restaurants in 120 countries.

MNCs also often threaten democracy. They can skew politics with political contributions, bribery and influence peddling. They repatriate profits from countries around the world, rather than invest them locally. In this way, they contribute to global inequality.

Intrafirm Trade:

We see that much of what goes as global trade is actually just transfers between divisions of the same MNC. In the United States, forty-six percent of imports are transfers between related parties. Some seven-forty percent of imports from Japan are intrafirm. On the other hand, only two percent of goods from Bangladesh are intrafirm. In the case of US imports of autos and medical equipment, seventy percent is intrafirm. The percentage of trade which is intrafirm also increases with increasing concentration of capital.

Transfer Pricing Between Divisions of MNCs:

Transfer pricing is the major tool used by MNCs for tax avoidance. Transfer pricing can be used to lower profits in high-tax countries and increase profits in countries where taxes are low or zero. The latter indicates tax havens. Between divisions of an MNC, prices may be set so as to allocate worldwide profits to low tax countries. In this way a large amount of taxes may be avoided.

Rules for transfer pricing are based upon the “arms-length principle.” This means essentially that prices should be the same as if the company was selling to an outside party. However, there are many techniques which may be used to avoid taxes. Legally, tax authorities may adjust prices, but often it is not easy to determine the correct price.

This mechanism allows corporations to shift much of their profits to tax havens and avoid taxes. It is estimated that sixty percent of capital flight from Africa is through improper transfer pricing. This sort of capital flight from the developing world is estimated to be ten times the size of aid received by these countries. According to the African Union, at lease thirty percent of the GDP of sub-Saharan has been moved to off-shore tax havens.

An International Regime for MNCs and Foreign Direct Investment:

There is no international agreement governing MNCs and FDI. Various attempts have been made to establish freedom for MNCs to operate and make profits in any country of the world. This agenda is primarily being pursued through the World Trade Organization dispute settlement bodies.

The Multilateral Agreement on Investment (MAI) was a draft agreement negotiated between members of the Organization for Economic Cooperation and Development (OECD) between 1995 and l998 on international investment. It was launched in May 1995 and negotiated in secret. In March l997, a draft of the agreement was leaked. NGOs and developing countries launched a campaign of criticism of the draft agreement because it would largely prevent countries from regulating foreign companies. Due to this pressure, the negotiations were suspended in April 1998 and France withdrew from the negotiations in October. The negotiations were then canceled on December 3, 1998. However, similar measures to serve the interests of corporate investors and prevent their regulation are being established under the World Trade Organization.

Other elements desired by MNCs in an international agreement on FDI include the right of establishment, national treatment, and nondiscrimination. The “right of establishment” means that the firms of any nation would have the right to invest anywhere in the world. National treatment means that national governments must treat subsidiaries of foreign firms as if they were their own firms. Nondiscrimination means that countries must not discriminate against foreign subsidiaries. The firms of every nation must be treated the same. For example, the US would not be able to prevent companies based in an Arab country from purchasing companies and operating in the United States. The same rules would apply to all countries in the agreement.

However, most countries would insist on areas of restrictions for the purposes of national security. For example an alarm was raised in the United States when it became known that the George W. Bush Administration planned to sell several US port facilities to a company from an Arab country. Also there is the question of whether a country could protect its cultural possessions from foreign encroachment. For example, the French have insisted that their wine industry stay in the hands of French. National security is another area of large concern. It is not likely that the US is going to agree to sell military drones to any country whatsoever.

The question arises in relation to US restrictions on American firms doing business with certain regimes such as Iran, Cuba, and North Korea, which are considered political enemies. Also the question of whether developing countries should be able to put restrictions upon powerful MNCs arises.

Another example of an attempt of the US Government to impose its domestic laws on other countries was seen in the Helms-Burton Act. This law punished foreign firms, for example from Europe, which did business with Cuba. But it is the US which has political problems with Cuba and not the European countries.

Lacking an international agreement, the dispute settlement facility of the World Trade Organization has begun to deal with these issues. In some cases, national legislatures can be overridden by this body. This is another example of how the MNCs in practice threaten democracy around the world.

Case Study: The Largest Private Multinational Corporation in the US, ExxonMobil:

ExxonMobil became the largest private corporation in the United States after the merger of Exxon with Mobil in l998. It is also the most profitable company with huge annual profits in the range of thirty billion dollars. The company is responsible for the Exxon Valdez oil spill in Alaska in l989. The BP Deepwater Horizon oil spill in the Gulf of Mexico in 2010 was much larger. The BP oil spill dumped twenty times more oil in the environment than the Exxon Valdez accident but by this time, people were getting used to seeing the environment polluted by the oil giants.

ExxonMobil is a company which Americans love to hate, but which is at the very heart of the American system of capitalism and global power. ExxonMobil operates globally in some 200 countries.

The ExxonMobil oil spill that dumped a quarter of a million barrels of oil into Prince William Sound stamped major oil corporations as reckless despoilers of the environment in the American psyche. It was a landmark event that would not soon be forgotten by Americans, seeing wildlife drenched and drowning in sticky black oil. In contrast, the ExxonMobil pipeline leak that dumped four times as much oil in Eastern Nigeria just ten days after the Deepwater Horizon production platform burned and sank, was hardly reported. It would not figure highly in the American press, nor cause the corporation a major headache. ExxonMobil conducts operations in the United States and around the globe. As the largest American corporation ExxonMobil generates some thirty billion dollars of profit a year.

The actually existing system of global capitalism is a threat to the global environment. This system is deeply institutionalized and this current era of ecological stress is going to continue long into the future. Global warming is likely to become a more serious problem.

ExxonMobil is a great corporation, a model of excellence, in terms of the criteria of business schools across the world. It is the purpose of every business school to train individuals to emulate this behavior. Those who work for ExxonMobil are generally serious and hard-working people. They deserve credit for excellence in their line of work in the pursuit of efficiency and maximizing the return on employed capital. Many of them genuinely believe in what they are doing and ground their pursuit of profit in the Judeo-Christian tradition of their upbringing. Many of them were Boy Scouts, which teaches a strict sense of discipline and morality.

What really happened that night when the huge tanker with one and a quarter barrels of oil ran aground off the coast of Alaska? A fifth of the load leaked into Prince William Sound, creating massive ecological damage. The captain of the ship had been drinking and left the bridge saying he needed to take care of some paperwork. It was a wake-up call for Exxon. The company tightened up its operations and emphasized safety. The Operations Integrity Management System (OIMS) emphasized discipline and accountability. The company was inflexible, focused upon performance, and driven by numbers. A culture of discipline ruled. And the bottom line was financial performance.

ExxonMobil is a corporate state within the American state, operating under secrecy, forcefully protecting itself from competition and lawsuits. It is geared to breaking all records in terms of profits. The company produced one and a half billion barrels of oil and gas each year and sold 50 billion gallons of petrol worldwide.

A senior Exxon executive was kidnapped and killed in 1992 after which the company moved to politically conservative Irving, Texas from Manhattan.

The company under Lee Raymond was exceptionally profitable when oil prices were high and also when they were low. Operating in 200 countries with some 80,000 employees, of which only two percent were Americans, it was also a powerful political actor that could act against the interests of the US Government. But the corporation was seen as lacking human factors. It was set aside from even other major oil corporations in this respect. And there was no attempt to adapt to the concerns of environmentalists after the l970s. This only changed marginally when Rex Tillerson took over from Raymond.  Middle and upper managers of the firm could expect to become millionaires over their long career.

For Lee Raymond, the focus was on ROCE, return on capital employed, which was around twenty-two percent a year. Globally, ExxonMobil had to deal with increasing resource nationalism. Many countries, including those in the Middle East, seized back oil fields from Western companies. This happened in Saudi Arabia too. By the 1990s, almost all the oil in the Middle East was off limits to private corporate ownership.

A major concern of companies was the need to replace their booked oil reserves each year. Otherwise, their stock values would suffer and they risked falling into liquidation. One problem was that ExxonMobil owned a large amount of the tar sands in Canada, which contained oil. Technically, these could not be counted as booked reserves, according to the rules of the US Securities and Exchange Commission. The company counted them anyway in their reports to stock owners to enhance the value of their stock.

Interestingly, most Americans do not even know where their oil comes from. Surely, to some extent this is a function of the severe depoliticization that is endemic in America. Americans think that most oil used in the United States comes from Saudi Arabia. Actually, Canada, Mexico and Venezuela supply more oil.

ExxonMobil had another problem: too much cash. This reached eighty-one billion dollars in l998. When Exxon merged with Mobil, the company cut 20,000 jobs and reduced operating costs by $8 billion. It became the largest corporation in the United States with $228 billion in revenue the first year. This is more than the GDP of Norway. Only 20 states in the world have a larger GNP. It ranks forty-fifth among the top economic entities of the world.

While Americans generally have a domestic view, the transnational corporation has a global view to making profit quite independent of the US Government. The Washington office of the corporation is a sort of embassy. It engages in much lobbying of Congress.

Lobbying takes place through the American Petroleum Institute as well as through the efforts of other company staff on Capitol Hill and the White House. Votes are tracked and the money handed out for political campaigns according to who votes in the interests of the corporation.

The corporation is so powerful, that it generally wants the US Government to stay out of its affairs. But for serious help, the company can turn to the White House. The Chairman could simply pick up the phone and talk to Vice President, Dick Cheney during the George W. Bush Presidency.

The corporation typically opposes all government regulation and fears the spread of European ideas, particularly curbs on carbon emissions and the precautionary principle of passing laws to preserve the environment. Researchers were paid to write papers which sowed confusion among the public about global warming. The polls show that it worked, with a majority of Americans believing that global warming was not happening. Still there came a point, when a change in policy was called for, after the departure of Lee Raymond. This did not go so far as to admit that there was actual man-made global warming. It was largely a public relations exercise.

Raymond even advised the Chinese to resist Washington’s attempt to get them to lower greenhouse gas emissions. The corporation formed a Global Climate Coalition, a front group to block climate change legislation in the US, and spent some eight million dollars on research.

The company faced major problems in getting the gas and oil out in such places as Indonesia, West Africa, Chad, Nigeria, Equatorial Guinea, Russia, Venezuela and Iraq. The company faced the difficulty of extracting gas and oil where local populations can become hostile and attack. One case happened in the province of Aceh in Indonesia. The Free Aceh Movement (The Gerakan Aceh Merdeka or GAM) carried out violence against the company. Indonesian Government troops from the TNI (Tentara Nasional Indonesia) patrolled the LNG plant and were paid by ExxonMobil. They carried out many human rights violations.

During the Clinton Administration, there was an effort to address this issue with the launching of the Voluntary Principles on Security and Human Rights. Many corporations signed up, but Lee Raymond refused. He said that ExxonMobil had its own principles. Of course, every effort was being made to avoid lawsuits. When the company lost, it appealed. Company executives feared that they would be sued for the brutality carried out in Aceh. They were, in Washington, DC, and fought bitterly against compensation for those wronged. The Bush Administration was on the verge of listing the GAM leaders as terrorists.

In Equatorial Guinea, ExxonMobil operates in the offshore Zafro and Alba Oil Fields. The country was seen as “politically toxic.” The US government distanced itself from dealings and the US Embassy was closed down for some time. The dictator, Teodoro Obiang Nguema, came to power and controlled the economy through his family. The corporation did not consider that the way the country was being run was their concern. They were there to get the oil and make money. They followed Dick Cheney who once said that companies had to go where the oil was and not where there were good governments. The good Lord did not see fit to put the oil in places that were safe and well governed.

President Obiang visited Washington, on various shopping trips and fell in love with the impressive façade of the Riggs Bank in Washington. He decided to deposit his country’s oil money there. There were soon some $200 million in the account with an additional $20 million expected monthly. Eventually, the President persuaded the George W. Bush Government to open a new US Embassy in the country. But the windfall for the bank soon resulted in trouble with the government, when unaccountable amounts of money were disappearing.

In southern Chad, a pipeline was built to carry ExxonMobil oil overland to the west coast of Africa. Chad is a terribly poor country, twice the size of Texas with a literacy rate of less than fifty percent. Idriss Deby had come to power and ran the country with his relatives and cronies. He later ran into trouble with the World Bank over the lack of social spending.

One reason why ExxonMobil did not worry greatly about what local governments did was the “stability clause” in its contracts, such as in Chad. This device grandfathers in provisions for the company that no future government could change in the future. This might even mean that social spending by the government could be illegal under the clause if it cost the corporation money. This meant that Exxon ruled over its own affairs in the country, effectively stripping Chad of sovereignty. Exxon’s profits in Chad in l988 reached 5.3 billion dollars.

To address the “resource curse,” of oil-rich weak states like Chad, the World Bank had been made a partner to the deal. The Government would be required to spend a certain portion of its oil revenues on education, health and social welfare. This constituted a double standard, of course, as states such as Saudi Arabia were free to spend the money as they desired. For ExxonMobil, their interests were largely confined to the oil and regional political stability.

After 9-11, twenty-five percent of American oil imports were coming from West Africa so terrorism was also a concern.

When George W. Bush entered the White House in 2001, global warming was becoming a larger concern to environmentalists. The Bush Government was top heavy with Texas oil men who were not going to address the issue of carbon emissions. Vice President Cheney’s model was primarily to get the oil men together and let them write their own policies. To ward off potential danger coming from the scientific community, ExxonMobil funded their own research on global warming with an energy project at Stanford University along with General Electric and Toyota. One hundred million dollars of the $225 million came from ExxonMobil.

For Greenpeace, big oil seemed the perfect target in 2001. ExxonMobil’s position was that there was no such thing as global warming. The company wanted to prevent any legislation requiring caps on carbon emissions. So ExxonMobil funded skepticism, to increase doubt in the public mind. ExxonMobil funded right wing groups such as the CATO Institute for Public Policy Research and the American Enterprise Institute. A US Senator from Oklahoma, James Inhofe, called the idea of man-made global warming a “hoax.” Behind the scenes, in fact, ExxonMobil not only believed in global warming but was trying to use it to gain insight into oil exploration.

Lee Raymond would demonstrate no flexibility on the issue of global warming as long as he led the company. He doubted the scientific validity of public opinion surveys. In any event, he saw no reason to allow public opinion to drive decision making. The public was naturally skeptical of big oil and big corporations in general. There was a strong perception that the company was “hostile to social responsibility” as charged by Human Rights Watch. But there was also the perception that when the company decided to do something, it did it well.

The company tended to sneer at the efforts of BP to engage in green washing with its sun and flower symbols on petrol stations. This kind of stuff was not for ExxonMobil. ExxonMobil was seen as having an authoritarian top-down culture and was most popular in only one country, Singapore.

Even with all their money, knowledge, and expertise, a company like ExxonMobil could sometimes get it wrong. Lee Raymond decided that it was futile to try to predict the future price of oil. This depended too much upon unforeseen global events, wars and political instability. On the other hand, the company should be able to predict trends in supply and production. But in the case of natural gas, the company failed.

ExxonMobil operated Qatar’s North Field where they owned an estimated 800 trillion cubic feet of natural gas. They built a production facility to produce Liquified Natural Gas (LNG). The company’s projections were that the gas production in the United States had peaked. This would turn out to be wrong with new technology to extract gas from rock formations in a few years.

With resource nationalism, acquiring booked reserves was getting more difficult. The only possible places in the world were Russia, Iran, Iraq and Saudi Arabia. The Texas oil men in the George W. Bush Government had their eye on Iraq. Some, who knew little about the country, even dreamed of the privatization of oil in the country.

The American and British governments claimed that the invasion and occupation of Iraq was not about oil. One saw the same sort of blanket denials on both sides of the Atlantic. Defense Secretary Donald Rumsfeld scoffed that the war had “literally nothing to do with oil.” However, the concern of oil corporations with keeping up their booked reserves in order to keep their stock prices high was a detail which was hidden from the public. Iraq surely seemed to be an exciting opportunity in this aspect if the US could carry out its plans to totally make over the laws of the entire country. For people in the Bush Government, the invasion of Iraq seemed to be a cost effective way to “expand booked oil reserves.” If oil companies could use the country to bank reserves, their profits would greatly benefit, even if they did not pump a drop of oil. As it turned out, it was not so easy, and resource nationalism asserted itself in Iraq after the war. The US could not even push the country into passing an oil law, with dire threats. Nevertheless, even with all the legal uncertainty, the oil firms rushed in. The Kurdish Regional Government in Northern Iraq was friendly to foreign companies and ExxonMobil signed deals, which Baghdad saw as illegal. The company found plenty of reserves to book. A deal was also signed between Turkey and ExxonMobil to explore for oil in northern Iraq.

There were cross-cutting interests and contradictions. Some neoconservatives in the Bush Administration wanted to get Iraq out of OPEC, increase production, and cheapen the price of oil with Iraqi oil. This would benefit the US economy, provide cheaper oil for the vast needs of the US military machine, and help the balance of payments. For the oil majors, like ExxonMobil, they were enjoying windfall profit because of high oil prices.

Philip Carroll, who had run Shell-USA, was sent to Iraq to restructure the oil industry. As an oil man, he was aware that privatization was a pipe dream of those at AEI that could not work. He thought that Iraqis could be sent to the US for training in the oil industry. Ironically, due to the sanctions and the war, most of Iraq’s expert technicians had left the country long ago.

For Lee Raymond at ExxonMobil, with his eyes turned to profit, the entire world was a unified oil market. Let the market work on a global basis and keep banking the profits. This was not the way oil was viewed in China and Russia. Access to oil was a part of national power and these countries did not want to depend totally upon foreign oil. For the Russian President, Vladimir Putin, Russia would use its oil and gas to control and punish other countries. ExxonMobil was set to clash with Russia over this approach.

Oil executives and politicians in the United States did not understand Putin’s thinking on oil. Again, it was resource nationalism, state power, and Putin would use it to preserve and expand Russian state power. He was not just pumping oil into the global market, as ExxonMobil saw it, rather as a corporate business empire independent of the state. Exxon was fully prepared to go against the interests of the United States for profits and did not hesitate to do so. Their bottom line was profits and not the United States of America.

Russia was no longer a communist country. The country had huge oil and gas reserves. George W. Bush and his oil men brought Putin to the Texas ranch and began to envision US-Russian cooperation on oil. Russia might be a place where American companies could book huge reserves if things worked out. But they were not dealing with a banana republic.

Previously, under President Boris Yeltsin, the Sakhalin 1 project had been signed with Russia, which was a production sharing agreement, and allowed for foreign ownership of oil in the ground. This was what the Texas oil men, including ExxonMobil were looking for.

Rex Tillerson went to Moscow in 2002 to try to make a deal. BP was also interested. The Russian oligarch Mikhail Khodorkovsky wanted to sell part of Yukos to a western firm for cash. He had by then amassed an $8 billion fortune and donated a million dollars to the Library of Congress. But Khodorkovsky was coming into conflict with Putin. The Russian President was consolidating his power through bringing old KGB conservatives back into the government. They did not have a free market view of the world. Putin was not going to see Russia sold off to the Americans and British.

Khodorkovsky would only sell a quarter of the company. Perhaps that was as much as he could get by with, given Putin’s objections. This would not have interested ExxonMobil, however, whose executives wanted nothing except a controlling interest. Putin met Lee Raymond and disliked his rough and overbearing ways.

On October 25, 2003, Khodorkovsky was arrested and charged with income tax evasion, forgery, theft, and other crimes. Putin was also threatened by his trying to buy allies in the Duma. This sort of thing would have been business as usual in the United States of America. The ExxonMobil deal with Russia fell through.

In Russia, companies were subordinate to the state. In the US, it was just the opposite. It would have been difficult for Putin to have understood this.

For ExxonMobil, oil and gas were here to stay, at least up until 2030. They were realists about changing the world. They did not believe in the possibility of transforming other nations. The stuff of the neoconservative’s naive dreams in the Middle East was now lying in dust. Their business was to pump oil and bank the profits. They saw the world, to some extent like Chuck Hagel, who became US Secretary of Defense.

ExxonMobile’s vision of the future, up until at least 2030, sees global energy demand growing by thirty-five percent. There is nothing in the cards that is going to prevent this. By 2005, the world’s 6.4 billion people consumed 245 million barrels of oil, equivalent energy, including natural gas, coal, hydropower, nuclear, biomass, wind, and solar sources. The global population is projected to reach eight billion by 2030 with an average three percent economic growth per year until then.

The poor countries of the world are going to burn more fossil fuels as they industrialize and use more autos. ExxonMobil saw no end in sight to the rise in demand for oil and gas. It was not going to be in the interests of governments to take the needed action to limit global warming.

In the last year of Lee Raymond’s leadership, the company made $36 billion dollars in profits. The value of shares was $360 billion dollars with $68 billion dollars paid out in dividends between 1993 and 2005. The company had 83,700 employees and 2.5 million share holders. When Lee Raymond retired, he was given a $400 million retirement package.

The company was heavily into politics. The ExxonMobil Political Action Committee distributed $700,000 to those politicians who voted their way every two years. But only five percent of this money was going to Democrats. It was eleven percent when Obama ran in 2008. It was simple. Under the Key Vote System, members of Congress were ranked according to the favorable votes they cast. There were no Democrats who ranked higher than fifty percent. So they got little or none of the money that went to the pro-business Republicans.

ExxonMobil also came into conflict with Hugo Chavez in Venezuela and pulled out of the country for a second time. Chavez wanted more royalties for the oil for social spending, but ExxonMobil would not go back on its contracts, which largely stripped the host country of sovereignty over its own oil.

Problems in Nigeria involved the kidnapping of ex patriot workers and the theft of oil, assisted by the local navy.

In the United States, the company fought battles against the regulation of plastic toys and President Barack Obama’s threats to impose a windfall profits tax on the company.

Developments in the oil industry continued. Particularly important was the extraction of oil from the tar sands in Canada, of which ExxonMobil was a major owner and producer. The other major development was producing rock gas from hydraulic fracturing. These developments meant that the US would get more of its gas from domestic sources and more of its oil from Canada. These processes are severely environmentally damaging.

These developments greatly increased the estimates of how much oil and gas was available outside of the Middle East, Russia and Venezuela. The down side was that greenhouse gas production was going to continue producing more global warming. The concept of peak oil became more elusive with these developments. There seems to be plenty of oil, gas, and coal for a number of decades into the future.

The lack of political will to reduce carbon emissions was bound to produce a heavy toll on the earth and society in future. The US was clearly behind the curve in enacting a carbon tax. Americans were not concerned with global warming, partly due to ExxonMobil propaganda. India and China would not reduce emissions as they used more energy, along with the other big emerging markets of the world.

Summary:

Multinational corporations are a global empire in themselves. They control global resources and wield great economic and political power. Their leaders are not elected. The top 1000 MNCs account for eighty percent of the world’s industrial output. The biggest MNCs have economies larger than all but a few nation states. Of the largest 100 economic entities in the world, fifty three are MNCs. These corporations are wealthier than 120 nation states.

While America’s domination of MNCs has declined, the power of the top MNCs is still concentrated in the United States, Europe and Japan, reflecting the post-war economic structure and global economic and political power. Today the strategic behavior of MNCs in their global operations is important to understand. They structure their operations to maximize profits and minimize taxes and obligations to the states and people where they operate.

In the l960s, Marxist scholars set the pace for later generations of business economists in understanding the behavior of MNCs. ExxonMobil is a paradigm example of the global corporation. It owes its loyalty not to the United States but to the company and profits for shareholders. Profits are the bottom line while MNCs ignore ecological damage and fight environmentalists and the interests of society with the inordinate power they wield.

Key Terms:

Charlie Wilson

Mundell Equivalency

Strategic Behavior

Appropriability

Internalization

Strategic Trade Theory

Raymond Vernon

Product Cycle

John Dunning

The Reading School

Michael Porter

Strategic theory

Strategic Management

Stephen Hymer

Uneven Development

State-Centric Approach

Transfer Prices

Intercorporate Alliances

Regionalization

Kenichi Ohmae

The Borderless World

The Triad

Samir Amin

International Regime

Rights of Establishment

National Treatment

Non-Discrimination

Helms-Burton Act

British East India Company

Dutch East India Company

Return of Capital Employed

Securities and Exchange Commission

Global View

Lobbying

Carbon Tax

Global Warming

Voluntary Principles on Security and Human Rights

Stability Clause

Greenwashing

Peak Oil

 

Chapter Eighteen: The Neoliberal Revolution and New Political Economy

The Basis of Capitalism

While theoretically the classical political economists promised universal prosperity, based upon capitalism, the actual history of capitalism has been a different story. It has been observed that the basis for the operation of capitalism is a source of free labor. Without a ready supply of workers with no prospect of making a living without selling their labor power, capitalism could not exist. Workers would not be found to man the factories and businesses and run the system.

Marxists understood this by going back to the “rosy dawn” of capitalism. The birth of capitalism was brought about to a considerable extent by the enclosure movement in England. The English population in the traditional village did not find it necessary to sell their labor power to make a living. The products in the market were made by local craftsmen and most made their living though subsistence agriculture. Once the land was enclosed, the peasants were forced into the city where they lived in poverty and were forced to sell their labor power for a living.

As industrial capitalism developed in England and the continent, and later in the United States, workers with great struggle were able to use the democratic tools to gradually improve their lot and gain higher real wages and worker benefits and improve their lives. Nevertheless, this progress militated against the profits of businesses over time. However, as technology developed, more productivity could be gained from the worker. This process was greatly accelerated by the emergence of the assembly line which could control the pace of work through the working day.

There was ever the search for cheaper labor which encouraged investment abroad. Today in the areas of the world where the workers have gained rights and benefits, they increasingly find themselves out of work as their jobs are exported to cheap labor countries. These are often slave labor countries, such as China, India, and Bangladesh. More labor can be squeezed out of the worker for less pay. If wages rise in China, capitalists seek labor in India and Bangladesh. Profits are often based upon the availability of cheap labor.

New Political Economy:

New political economy is the contemporary ideology of neoliberalism that has basically become the system of capitalism prevailing around the globe. New Political economy overlaps with and is based upon rational choice theories, public choice theories, and collective choice. It says that rational political and social choices result in irrational economic outcomes. The bottom line is that it tends to deny democracy. Democracy is seen as problematical for the capitalist economy. If one wants to have a healthy capitalist economy, one must curb much of the worker’s democracy.

The political system can simply be run by elites and technocrats rather than decided in a democratic way. It can be seen how this system has been in operation in several countries of Europe. By the same token, the bankers and businessmen are allowed to run the economic system in the United States. The bankers cause a collapse of the system but get their bonuses anyway. This is seen as economically rational. When people seek to save their houses this is seen as irrational.

Today New Political Economy is the mainstream academic approach, based upon methodological individualism and a market approach. It serves as the basis for Structural Adjustment Packages (SAPS) of the World Bank, such as privatization and cutting back on social welfare programs, education, health and government employment. New Political Economy turns traditional American political science theory on its head. Interest groups are seen as bad for society. They are generally seen as “special interest groups.” However, they do not include big business and corporate heads that are seen to have a right to run the government. “Special interests” generally is a code-word which refers to labor unions, minorities, women, environmentalists, students and people in general, rather than big business.

Borrowing from Anthony Downs and the Chicago School of Economics and also from the Virginia School of Public Choice, New Political Economy (NPE) sees all decisions as individual decisions made on the basis of maximizing utility. It is said that this methodological individualism can be used to understand every institution in society. While individuals make decisions, self-interest applies to groups as well, borrowing from the work of Mancur Olson on group behavior.

Central to NPE is the concept of “rent seeking.” This happens when individuals and groups seek to gain utility at the expense of the market and economic growth. Or they gain at the expense of the accumulation of capital from a Marxist perspective. An individual would rather have a free ride than pay taxes unless the costs are greater than paying taxes. This theory works better in small groups where interests are nearly the same. In larger groups interests are more diverse or heterogeneous.

Groups form distributional coalitions and engage in political activity to achieve their goals, such as lobbying, forming coalitions, and taking legal and illegal actions. Traditional neoclassical economics and political interest group theory from David Truman, believed that such activity led to utility maximization and social welfare. It was also seen as the heart of American political democracy. People struggled to make things better for themselves in the political arena. Public choice theorists like Mancur Olson disagreed and turned interest group theory on its head. Olson said that rational political activity, in other words democracy, leads to an irrational result. It also distorts the market, makes prices higher, and hurts the economy. That is, democracy results in a negative outcome for society.

Interest groups force the government to pass laws which help them only. This is “rent seeking.” For example, farmers engage in a lobby to get subsidies on prices of their crops from the government. This tends to make prices higher for everyone. Groups in society try to capture the largest possible share of national income at the cost of the majority. Most people do not fight against this as the cost to each individual is small. In New Political Economy, the question is never asked whether the demands of such coalitional distributions (special interest groups) are in the public interest.

Public choice theorists argue that labor unions are a negative coalitional distribution because when they lobby for higher wages they keep wages too high. This hurts consumers and creates unemployment. If wages are left to the market, then wages will fall to their natural price and more people will have jobs, according to this theory. For Olson, all subsidies and shelters should be eliminated, including social security benefits to those retired. Distributional coalitions harm society, except in the cases where positive distributional coalitions engage in productive investment and grow the economy. That is, business groups are treated favorably but political action by the people is seen as a problem. They should leave both politics and the economy to technicians and the market, which can get along just fine without interference from the people.

Traditional American political theory on interest groups has been turned upside down by the New Political Economy. Traditionally interest group activity was seen as democratic input from the people. There was competition in the political market place for policies. The policies which emerged would then be compromises and quite moderate, rather than radical. New Political Economy says that interest groups are an impediment to the interests of society. In general, these interests seem to be those of the capitalist elites.

Labor unions are especially targeted by NPE as the worst of the rent seekers, as they are seen as responsible for the “stickiness of wages,” which means that they keep wages too high. They say that this means that many young people are kept from getting jobs. They say that it also causes inflation because wages cannot fall under the union contracts.

When interest groups, whether labor unions, farmers, teachers, students, or environmentalists, engage in politics it hurts the economy. Social welfare is seen as wasting capital. Voting is also seen as a useless and futile exercise. This is because voters are rationally ignorant. The cost of informing themselves of the issues is too high and the worth of one vote is much less than the cost of gaining enough information to vote rationally. It is relatively easy for political parties to just tell people how they should vote, even when it goes against their own interests.

In many third world societies, civil society is much less developed than in Western countries. The state has relative autonomy and can act in authoritarian ways. Neoliberal policies can usually be imposed with a minimum of resistance. Or if there is resistance it can be crushed relatively easily through the brutality of the police or the military.

Rent Seeking Behavior:

New Political Economy argues that losses caused by the rent seeking of special interest groups is very high. According to Arnold Harberger, however, it is only 0.5 percent. Mancur Olson, Ann Krueger and Jagdish Bhagwati have argued that losses are high and that these lost resources could be better used elsewhere.

New Political Economy holds that rent-seeking is different from rent creation. Rent seeking diverts resources to unproductive areas. Jagdish Bhagwati speaks of directly unproductive profit-seeking activities (DUPs) such as tariffs, monopolies and smuggling. Types of rent-seeking include preparing for government positions, where much of what is learned to pass a civil service examination is not relevant to the job. Under privatization the jobs could just be sold and traded and become more efficient. Therefore, privatization is said to reduce rent-seeking. Also if one uses technocrats to run government, they can be isolated from interest groups. That is, they can be protected from democratic political pressures. Other ways of reducing rent-seeking is military coups, revolution, invasion and war.

Justifiable Coalitions:

However, NPE holds that there are also justifiable distributional coalitions. For example, those who want to implement structural adjustment programs are justified. Those who would benefit might be large firms producing for export. It is also argued that SAPs could benefit the rural masses by allowing agricultural prices to be determined by the market. It is argued that the urban bias in developmentalist countries tends to exploit the countryside.

Also for NPE, the state is not a neutral force, as in pluralism, but rather the vehicle for implementing new agendas such as neoliberalism and privatization that goes along with structural adjustment programs. The state may need to be authoritarian to carry out reforms and democracy is not an issue. According to Anthony Downs, state elites generally have no ideological principles and are mostly interested in staying in power. State officials are the enemy and can do no right. They encourage DUP activities that make the economy less efficient. “The state is the fountain of privileges of all sorts,” they say.

State bureaucrats are dangerous for the economy, according to NPE. Bureaucrats and the state are not neutral, but are also engaged in rational utility maximizing that feather their own nests and distort the economy. They care nothing about the country and the welfare of the people. They are generally involved in crony capitalism, kickbacks, and corruption. The preferred state for NPE is an authoritarian one, because more democratic states encourage consumption, populism, and so on. What is needed is investment to promote economic growth.

Since civil society is not very well developed in developing states, an authoritarian government can be effective in crushing democratic interest groups, such as trade unions seeking higher wages, industrial interests seeking import controls, urban interests seeking price controls on food, and farmers seeking government subsidies in agriculture. It takes a strong authoritarian regime to control these political groups. Democracy and government bureaucrats are major enemies. Implementation of neoliberalism is painful for most, and so a strong government is needed to withstand the unpopularity. It takes an autocracy. Seymour Martin Lipsett has said that authoritarian regimes can help sustain the drive toward growth and cut public expenditures by suppressing civil liberties. NPE clearly rejects democratization. It is also thought that the duty of the universities is not to socialization students to practice democracy, but to encourage them to support the rule of society by elites.

Enter the Technocrats: 

The next step is to bring in the technocrats. Let the streets go wild with chaos and riots. Who cares? The technocrats will make their decisions calmly behind closed doors isolated from the winds of politics. This process has been seen in many countries around the world in recent years, not just Brazil and Argentina, but in Greece and Turkey. The bureaucratic technocratic elites care nothing about interest groups. They will just meet pepper spray and go to jail, if they survive the police beatings in the street. The bureaucrats are backed by the World Bank and the IMF.

NPE also prefers a strong executive who can ignore pressures from elsewhere, such as the legislature. They would like to give the finance department control over government spending, letting technocrats run the economy. The secret of NPE is that liberal neoclassical economics requires an illiberal authoritarian government to be successful. Politically, it is not liberal at all.

Also NPE prefers the “big-bang” approach to reform. Reforms should be implemented quickly in the “honeymoon period” of the government to preempt the opposition which is emerging. However, along with this shock treatment, it is important that foreign capital flow into the country quickly. Otherwise, the brutal reforms could precipitate a coup or bring about a revolution.

From the perspective of the IMF and World Bank, it is important that the programs appear to come from the politicians, rather than from the outside. The government can use sweeteners to gain support while the pain is being administered. These can take the form of a “safety net,” retraining of workers laid off, loans from Western governments, and increased funding for health and education. These are often more for appearance than substance and are frequently on a token basis.

The ruling political regime will proceed to put all the blame for the pain on the previous government and plead that the harsh measures are not their desire but are unavoidable. Reforms can be carried out more easily after a deep financial crisis as the government can argue that policies must change. The government can more quickly orient the economy to the outside world and bring in foreign capital. Labor legislation can be dismantled, state factories closed, and exchange rates floated on the market. Everything, including democracy, must be cleared away so that the market can work. This, in a nutshell, is New Political Economy.         

The Neoliberal Era:

By the l970s, a new model had begun to emerge. Large corporations were becoming multinational corporations operating in many countries around the world. They began to use a global strategy of production to maximize profits on a world-wide basis. The US began a program of deindustrialization, whereby factories in the US were dismantled and the production sent to cheap labor countries, usually in Asia. In this way, corporations could escape domestic regulatory laws and greatly increase their profits. This began the era of intensified globalization. At the same time, exporting jobs and importing cheap goods from Asian countries created greater levels of unemployment and inequality. Real wages fell and most people became poorer and less secure in their jobs. Further, the nature of work changed from full time jobs with benefits to more part time and temporary jobs. Corporations were benefiting at the expense of the working class, which included most of the people in the United States.

The economic crisis produced was also predictable, as the country shifted from manufacturing production to an economy in which most profits were being made from the financial sector. With fewer jobs that paid less, families had to borrow more money to live, usually putting the debt on their credit cards. Household debt continued to grow as household incomes shrank.

The era of globalization or neoliberalism also caused problems in many other countries around the world. First as populations grew, global growth slowed from more than four percent earlier to around two and a half percent annually. Neoliberalism is not liberal, in fact. To put it in a nutshell, it uses the state to help big business rather than the people. It is a sort of social welfare program for big capital and the free market for the people.

The most notable proof of this was the bail out of the big banks in the US financial crises in 2008 and later in Europe. Some three million Americans were allowed to lose their homes through foreclosures when they could not pay their mortgages. The government did very little and in most cases nothing to help these families stay in their homes. It was said that the banks were too big to fail. By the same token, the common people were too little to save. And the bankers were too important to jail.

On a global basis, the spread of neoliberalism around the world is resulting in an unsustainable global economy in the twenty-first century.

Critique of New Political Economy:

First, the perspective on democracy: Rational Choice theory rejects democracy outright. It says that democracy is impossible to achieve. Therefore society must be directed by an oligarchy.  It is doubtful if this is a viable model for global development and political stability in the age of broadening information and education. The people demand a voice in politics.

Second, the utility maximization assumption: Rational Choice theorists have sometimes had to admit that rational utility maximization does not explain all human behavior. Even in a selfish society, it does not explain such things as cooperation, ethnicity, and nationalism.

Third, perspectives on voting:  If voting is not rational, it is hard to explain why so many people vote, far more than half in most countries.

Fourth, the myth of the disinterested technocrat:  NPE assumes that bureaucrats selfishly feather their own nests, yet believe that technocrats, who are also bureaucrats, can see beyond their own self-interests. It is unlikely the World Bank is going to find such honest and efficient authoritarian regimes. The most typical situation in oligarchies is crony capitalism with corruption and kickbacks to the technocrats.

Fifth, the disparaging of all politicians: Not all politicians are corrupt and rent-seeking. Some have an idea of the public good, which does not exist in NPE. If NPE sets up regimes that have no political base of support, it will be difficult if not impossible for authoritarian regimes to isolate themselves from the political pressures of society.

Sixth, private rent-seeking: Privatization can do nothing about private rent seeking by businesses and other groups. Egypt, Tunisia, Morocco, and Turkey show that privatization does not root out rent-seeking.

Seventh, democracy and development: Is democracy incompatible with development? Authoritarianism does not necessarily lead to development. No strong empirical evidence has been found linking regime type to policy performance. Political pluralism might lead to faster growth.

Eighth, the elimination of politics: Politics is the principle means to resolve disputes. It is not possible to eliminate politics from society.

Ninth, the limits of the market: State policy extends beyond the market to nation building, national cohesion and foreign policies. History, culture, and tradition are important.

Tenth, market failure: Rational Choice theorists only talk about political failure. But markets fail too in producing externalities in society, waste and pollution, inequality, financial crises, housing crises, and famines.

Eleventh, the concept of political markets: Public policies are not produced by supply and demand. Policies do not change just because there is a demand.

Twelfth, New Political Economy is ahistorical: NPE says that principles are universal, regardless of the historical, social, cultural, and political context. Whether a country was ruled under colonialism, like India, or never ruled like Japan and Turkey, history and culture influence public policies. There is a strong state tradition in Turkey, unlike in the US.

Thirteenth, the lack of a social dimension: For NPE, there is no such thing as society. It is said that the best macroeconomic policy is a good microeconomic policy. That is, getting the prices right. But classical economists, such as Adam Smith, David Ricardo and Karl Marx, dealt with the social division of the national product. Capitalism tends to create ever greater inequality in society.

Fourteenth, the public good and Pareto Optimality: Rational Choice Theory substitutes Pareto Optimality for the Public Good. But Pareto Optimality can exist where there is great inequality and exploitation in society. Yet redistribution is not an option under Pareto Optimality. Nothing can be done about inequality, which Pareto considered to be a natural part of society.

Fifteenth, the Developmentalist Economics contradiction: If Japan and other East Asian economies had followed the NPE model of relying upon the market they would probably never have developed into powerful exporting countries. Import Substitution Industrialization has been successful in many countries, including India and Turkey in early phases of industrialization.

Sixteenth, traditional institutions and infrastructure:  Modernization Theory laid down prerequisites for development. But NPE does not worry about the lack of infrastructure and feudal institutions which are a restraint upon development. In India, Brazil, Egypt, and China, import substitution industrialization built up consumer industries as a basis for further phases of industrialization.

Seventeenth, The State and Development:  The state can intervene to promote higher and more equitable growth, not just rent-seeking. For East Asia, including China, this was the case. There are multiple paths to growth.

Summary:

New Political Economy is the ideology of global corporate capitalism today. Based upon public choice theory, it rejects democracy and claims that economic growth can best be promoted by restricting political participation and allowing technocrats to rule under authoritarian regimes. Capitalist profits and accumulation of capital are the underlying objective.

This contemporary agenda, promoted by conservative economists, political scientists, and bankers has led to slow global economic growth and greater global inequality. It replaces the social good with Pareto Optimality to serve the interests of international capital.

Key Terms:

Neoclassical Economics

New Political Economy

Anthony Downs

An Economic Theory of Democracy (1957)

Interest Group Theory

Pluralism

Structural Adjustment Package (SAP)

Distributional Coalitions

Rent-Seeking Behavior

Rent Creation

Welfare Maximizing

Mancur Olson

Jagdish Bhagwati

Directly Unproductive Profit-Seeking Activity (DUP)

Justifiable Coalition

Seymour Martin Lipsett

Big Bank Approach

Macroeconomic Policy

Microeconomic Policy

Chapter Nineteen: The Global Economy Today

The GDP of the global economy in 2013 was 74.9 trillion US dollars (also called Gross World Product). This is 101.93 trillion US dollars in purchasing power parity (PPP). The global population had grown to 7.095 billion.   There were only nine countries with a GDP of over 2 trillion US dollars. These were the USA, China, Japan, Germany, France, the UK, Brazil, Russia, and Italy. However, in terms of purchasing power parity (PPP), India would be included.

By historical standards, the world economy was seen to be limping along at the slow annual economic growth rate of 2.1 percent. The days of six percent growth had ended when neoliberalism began in the l980s. After the recent era of globalization under corporate neoliberalism, world growth rates slowed to some three percent. But recent growth had slumped even further. This was of some concern to the leaders of the G-20 group of nations, although their expectations were not very high. In February 2014 they declared that they would work to increase global GDP by some two trillion dollars in the coming year. However, this was a quite modest goal. The IMF predicted that the world economy would grow by about 3.7 percent in 2014, or by 2.7 trillion dollars. However, no one could be sure if this could be accomplished.

The world economy had been in a slump since the financial crises in the United States in 2008 and the spread of the crises to Europe. In Western Europe, there was no economic growth at all in 2013, except in Germany where growth was just one half of one percent. Eastern Europe also had only a tiny growth rate of one percent. Even Asian economic growth had slowed to 3.9 percent for the year.

Some economists, like Paul Krugman, believed that part of this was due to wrong economic policies in Western countries. For example, austerity policies to cut government spending and debt in the United States and Western Europe had resulted in record unemployment in Europe. This meant that disposable income was less and less consumption affected other regions of the world. There was little investment in Eastern Europe so there was little growth.

At the same time, economic growth slowed in the engine of growth in Asia, China. The Japanese economy had been stagnant for some twenty years. The Indian economy also slowed down just as the current account deficit was rising. At the same time, the Federal Reserve in the United States began a tapering program to cut back on its program of quantitative easing. This led to the fall in the value of currencies in developing countries such as India, Turkey, and Argentina.

The global standard of living was hurt with the rise of food prices, even while the global economy slumped. The real price rises are generally not reflected in official inflation figures. Much of the world’s population of 7.1 billion would be paying more for food, while their real incomes were shrinking.

The IMF projected that in 2014 China would lead economic growth and contribute about a quarter of the increase in global GDP. Today, China was the world’s great workhouse.

Global exports were $12.4 trillion US dollars. And derivatives valued at $601 trillion US dollars.

On the other hand, the absolute number of people living in poverty was increasing. About one billion people lived in slums and this number was growing.

 

 

 

 

 

 

 

The Global Leaders:

1. USA 16.8 Trillion
2. China 9.24 Trillion
3. Japan 4.90 Trillion
4. Germany 3.63 Trillion
5. France 2.73 Trillion
6. United Kingdom 2.52 Trillion
7. Brazil 2.24 Trillion
8. Russia 2.09 Trillion
9. Italy 2.07 Trillion
10. India 1.87 Trillion
11. Canada 1.82 Trillion
12. Australia 1.56 Trillion
13. Spain 1.35 Trillion
14. South Korea 1.30 Trillion
15. Mexico 1.26 Trillion
16. Indonesia 868  Billion
17. Turkey 820  Billion
18. Netherlands 800  Billion
19. Saudi Arabia 745  Billion
20. Switzerland 650  Billion

 

Figure 4: Nominal GDP for the top twenty nations in 2013 (US Dollars)

Source: World Bank

In 2012, the GDP of the state of California in the United States was about equal to the GDP in India. The GDP of Turkey was about equal to the GDP of the city of Los Angeles.

 

European Union 18.4   Trillion 23.7 %
1. United States 17.41 Trillion 22.4 %
2. China 10.35 Trillion 13.3 %
3. Japan 4.76  Trillion 6.1 %
4. Germany 3.82  Trillion 4.9 %
5. France 2.90  Trillion 3.7 %
6. United Kingdom 2.85  Trillion 3.7 %
7. Brazil 2.24  Trillion 2.9 %
8. Italy 2.13 Trillion 2.7 %
9. Russia 2.06 Trillion 2.7 %
10. India 2.05 Trillion 2.6 %
World (2013) 74.7 Trillion 100 %

 

Figure 5: 2014 Estimates of GDP (Nominal)

Source: IMF World Economic Outlook Databases (WEO)

 

World 101.93 Trillion
European Union 17.57    Trillion
1. United States 16.76    Trillion
2. China 16.15    Trillion
3. India 6.77      Trillion
4. Japan 4.67      Trillion
5. Germany 3.51      Trillion
6. Russia 3.49      Trillion
7. Brazil 3.01      Trillion
8. France 2.53      Trillion
9. Indonesia 2.39      Trillion
10. United Kingdom 2.32      Trillion
11. Mexico 2.06      Trillion
12. Italy 2.03      Trillion
13. South Korea 1.69      Trillion
14. Saudi Arabia 1.55      Trillion
15. Canada 1.52      Trillion
16. Spain 1.49      Trillion
17. Turkey 1.44      Trillion
18. Iran 1.24      Trillion
19. Australia 1.05      Trillion
20. Nigeria 972       Billion

 

Figure 6: GDP in Purchasing Price Parity (PPP) 2013

Source: IMF

 

1. China 17.6 Trillion
2. United States 17.4 Trillion
3. India 7.27 Trillion
4. Japan 4.79 Trillion
5. Germany 3.62 Trillion
6. Russia 3.65 Trillion
7. Brazil 3.07 Trillion
8. France 2.58 Trillion
9. Indonesia 2.55 Trillion
10. United Kingdom 2.43 Trillion
11. Mexico 2.14 Trillion
12 Italy 2.06 Trillion

 

 

Figure 7: GDP Purchasing Power Parity (PPP) Estimates for 2014

Source: IMF

For the first time, China was number one in the world in GDP measured in PPP according to estimates released by the IMF in October 2014.

The G-8:

The G-8 was previously known as the leading group of “industrialized countries.” In 2014, they had about half the worlds’ nominal GDP and 36 percent of World GDP (according to purchasing power parity). Russia was added to the G-7 in 1998 to make the group the G-8. However, in 2014, the G-8 was being replaced by the G-20 as the main economic council of wealthy nations. The reason is that China and India should now be included in the industrialized countries according to either their nominal GDP or GDP (according to PPP).

The G-8 included Canada, France, Germany, Italy, Japan, Russia, the UK, and the United States.

The G-20:

The G-20 countries have about 85 percent of global GDP.

Countries in G-20: Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, South Korea, Russia, Saudi Arabia, South Africa, Turkey, the United States and the European Union. In other words there are 43 countries in the G-20 when the European Union is includud. The G-20 had 85 percent of world industrial output in 2014.

The BRICS: Brazil, Russia, India, China and South Africa

The BRICS have large fast-growing economies and an influence on regional and global affairs. All five are members of the G-20. Together they had a population of three billion people with a GDP of 16.04 trillion US dollars in 2013. They had 4 trillion US dollars in foreign reserves. Exports were 256 billion US dollars in 2012. The main trading partners were China, the USA and Argentina.

The Brazilian Economy:

Brazil was the seventh largest economy in the world in 2013 with a GDP of 2.25 trillion US dollars. Some 21.4 percent of the population of 190 million was below the poverty level. The country had 378 billion US dollars in foreign currency reserves.

The Russian Economy:

In 2013, Russia had the eighth largest economy in the world and was classified as a “developing country.” Its GDP was 2.03 trillion US dollars in 2012. There were 11.2 percent of the people below the poverty line. Exports reached 543 billion US dollars in 2012. Foreign currency reserves were 561 billion US dollars.

The Indian Economy:

India had the tenth largest economy in the world in terms of nominal GDP of 1.87 trillion US dollars in 2012. However in terms of GDP (PPP), India was the third largest economy in the world. Economic growth was about five percent, but the number below the poverty line was 22 percent. The country had an average gross salary of 1580 US dollars per year. India had a huge work force of 498 million people, which included child laborers. The country had 47 billion US dollars in Foreign Direct Investment (FDI) and foreign exchange reserves of 292 billion US dollars.

The Chinese Economy:

China ranked second in world in GDP at 9.24 Trillion US dollars in 2013.

Average salary: $457 per month.

Exports: $2.2 trillion. The main export market is the US (17 percent). Hong Kong was second with 16 percent. China had $116 Billion FDI stock. Gross external debt us $694 billion. China had $3.44 trillion in Forex (March 2013).

The South African Economy:

According to the IMF, South Africa was the thirty-third largest economy in the world in 2013 with a nominal GDP of 351 billion US dollars. It was included in the BRICS group of countries as it was the top country on the African continent with 24 percent of Africa’s GDP. About 31 percent of the people were below the poverty line with a quarter of all people living on less than $1.25 a day. South Africa had a labor force of 18 million. Exports reached 101 billion US dollars. The main trade partners were China, the USA, Germany and Japan. The country had 55 billion US dollars in foreign exchange.

In 2011, the BRICS Forum was formed, an international organization of the members. By 2014 arrangements for a new development bank was planned. This would set up a $100 billion fund to stabilize currency markets. However it might take up to five years to create the bank. There remained some disputes between members, including territorial issues between India and China. There is also a disagreement among members over UN Security Council reform.

In 2014, some seventy-five percent of the world’s currency reserves were in the East. The BRICS countries held $4.4 trillion in export earnings. The BRICS were subsidizing the US economy by holding US dollars. Some countries, particularly Russia wanted an alternative reserve currency, other than the US dollar.

Developing Countries:

The International Statistical Institute defines a developing country as one with gross per capital national income of less than $11,905. This included 139 countries in 2013.

Least Developed Countries (LDCs):

Least developed countries are countries which lack socioeconomic development and have a low human development index. The three criteria for least developed countries include poverty, lack of human resources and economic vulnerability. LDCs have a gross national income (GNI) per capita of less that US $992 as of 2012. Human resources are weak in terms of nutrition, health, education, and adult literacy. They also demonstrate economic vulnerability based upon the instability of agricultural production, the instability of exports of goods and services, merchandise export concentration, the handicap of smallness, and a significant proportion of the population affected by natural disasters. These criteria are set by the Committee for Development Policy of the UN Economic and Social Council (ECOSOC). There were 50 LDCs in 2014, including 34 in Africa, 10 in Asia, five in Australia and the Pacific, and one in the Caribbean. LDCs included some 880 million people or about 12 percent of the global population.

The Shanghai Cooperation Organization (SCO):

By 2013, emerging markets accounted for more than half of world GDP on purchasing power parity (PPP). Clearly, the world wealth was shifting to the East, including China, India, and Southeast Asia.

The Shanghai Cooperation Organization was founded in 2001 in Shanghai by the leaders of China, Kazakhstan, Kyrgyzstan, Russia, Tajikistan, and Uzbekistan. These countries had one-quarter of the world’s population. They intended to launch large scale projects in transport, energy, telecommunications, and military cooperation. They were involved in setting up a new banking system. These arrangements tend to undermine the role of the USA and the US dollar in the global economy.

A Picture from Life’s Other Side:

At the center of the global economy, the US economy seemed to be way out in front of everyone else in 2014. This could be deceptive, however, when one looks at what was happening to the people. Officially, economic growth was 2.8 percent annually in 2013, but this seemed to exaggerate the true figure. Five years after the US financial crisis, the economy had yet to recover. Consumer confidence was low. The labor market was weak and hundreds of thousands of people had simply given up finding employment.

The trend toward hiring people on a part time and contingent basis with no benefits continued. Two-thirds of jobs opening up were part time or temporary positions. Wages were stagnant and in some cases falling. Much of consumer spending was on credit cards. At the same time, the top ten percent were doing well. The stock market and bond markets had surged to record levels while the economy remained stagnant.

Veterans returning from the wars in Afghanistan and Iraq faced high levels of unemployment as well as post-traumatic stress and homelessness. Since the year 2000, there had been at least 6000 traumatic amputations from IEDs and other accidents. One million had mental health disorders and there were 22 veteran suicides happening every day according to the Department of Veterans Affairs. There were more suicides than soldiers killed in war in 2013.

At the same time, while corporate profits soared, food stamps were being cut. The Fed was printing 75 billion dollars a month in quantitative easing to stimulate the economy in 2013 while the rich put money in overseas banks. Under the previous five years under President Obama, ninety-five percent of new income had gone to the rich. Corporations were using a practice called “pass throughs” or pseudo-legal partnership structures to avoid corporate taxes. Since profits were being passed through to shareholders, they did not have to pay corporate taxes. They could make huge profits and avoid taxes. One example was Richard Kinder who made 376 million dollars in dividends in one year. Some 63 percent of corporate profits in 2008 were pass throughs. Private equity firms were also making big profits with the Fed policy of providing cheap money.

Many big corporations paid no taxes at all or got rebates by using accounting techniques, such as Wells Fargo Bank, Boeing, Verizon, and General Electric. At least 280 billion in tax revenues was saved by using overseas tax havens. Apple made 74 billion dollars in profits and declared their profits in Ireland to save on taxes. Such corporate practices were starving public services of funds as politicians protected the corporations.

Stress due to poverty and unemployment, financial stress, among ordinary Americans was leading to health problems for many. Some 68 percent of people now had to depend upon private pension plans, which made corporations money and did not provide for a good retirement. Twenty-four million Americans were receiving food stamps, but the $78 billion budget was being cut back so that the Government provided only $1.40 for each meal, instead of $1.50. The food stamp budget was equal to the investment earnings of the 20 richest Americans.

In one year corporate profits doubled while millions of jobs were lost. Taxes were cut for corporations. Americans were becoming less healthy partly due to financial stress. Some 45,000 Americans were dying in a year for lack of health insurance and one out of five adults had mental illness. Under the Obama health plan, people had to buy health insurance from a private company. However, even this was an improvement over the past. The suicide rate in America had increased since 2008. More people were dying of suicides than in auto accidents.

The neoliberal economic policies that the US worked to implement around the world were creating greater poverty in America. Officially, 15 percent, or 46.5 million Americans were living in poverty. In 2012, the poverty line was considered to be an income of $23, 050 yearly for a family of four. Many had fallen into deep poverty, which is half of this amount. At the same time, the United States had the highest GDP on the globe.

The World Bank is continuously launching and running programs to end world poverty. Still, the absolute number of people in poverty is at an all-time high. This is in spite of the figures given about how many people are being “lifted out of poverty” every year under neoliberal development.

In the United States in 2010, there were ten million millionaires. In 2014, the United States had 492 billionaires. But world median income was only $1040.

Some of the facts in 2014 are as follows. Some twenty percent of the global population, or 1.2 billion people, lived below the poverty line of one dollar and twenty-five cents per day. ($1.25 per day) Some 3.25 billion people lived on less than two dollars ($2) per day. This was about half of the world’s population. Some 1.3 billion people had no electricity. Another 2.5 billion had no safe sanitation. There were 783 million with no safe drinking water. And three billion used wood, coal, or dung for cooking and heating.

The World Bank officials said that they wanted to reduce this poverty to three percent by 2030. They said that this could be done through rapid growth for some forty percent of the population in developing and transitional countries. China was seen as one of the few successes in poverty alleviation. But perhaps it was being achieved through a sort of slave-labor capitalism. The World Bank said that China had rescued 680 million people from poverty since l981. They said that extreme poverty had fallen from 84 percent to ten percent. They did not see the Mao era of a mixed economy and import substitution industrialization as contributing significantly to the development of China.

The World Bank said that through the private sector China would be green, with more environmental protection. But, on the other hand, the World Bank was almost seventy years old and pushing private sector growth all this time had not yet eliminated poverty.

The disparity between the richest and poorest nations had greatly increased, which seems to be a feature of modernization and progress. In 1820, the richest nation was about three times wealthier than the poorest. In l998, the richest nation was 74 times as rich as the poorest.

More people were living in cities. About half the world’s population lived in cities in 2014 and with urbanization there were more than 500 cities with over a million people. A billion people or one-seventh of the global population lived in slums. In the next twenty years, two billion more would be added to urban populations. Ninety percent of this urban growth was happening in developing countries and cities had 70 percent of global GDP.

Urban population living in slums included 174 million in China; 110 million in India; 46 million in Brazil; 45 million in Nigeria; 30 million in Bangladesh; and 12 million in Mexico. The absolute number of people living in slums was also rising, while at the same time developing countries like China and India claimed to be raising millions out of poverty. Half of the people in South Asian cities lacked sanitation facilities. It is no wonder that many side streets smell of urine a short distance from the city center in Delhi.

On the other hand, the richest 8.3 million people in the world had 31 trillion US dollars in wealth. This was $3,735,000 per person. Clearly a large amount of global wealth was hidden in offshore tax havens.

The Global Underground Economy:

It is necessary to dive beneath the surface to get a better idea of the real global economy. A huge amount of wealth is not in the official statistics. This is the underground economy.

There are at least five specific underground economies.

One: Criminal Drugs

Two: The illegal Economy

Three: The Unreported Economy

Four: The Unrecorded Economy

Five: The World’s Fastest Growing Economy: The Informal Sector

Each of these sectors was very large and required a separate study. The most important here is the informal economy. The informal economy generated some ten trillion US dollars in GDP globally, but did not appear in the official statistics. This means that if it was a country, it would be the second largest economy in the world. This is the part of the economy that is off the books, not monitored and not reported in GDP and employment statistics. There are both good and bad sides to this. In some ways, one can say that this is the real free economy, the real “free market,” if there is such a thing. It is perhaps the closest thing to Adam Smith’s classical idea of laissez faire that one finds in the global economy and the world’s governments do not even know what is going on there, for the most part. It was outside of the view and control of governments.

Robert Neuwirth, a journalist, has researched and written on this part of the global economy. It is known as “System D” from the French word “debrouillard” which means resourceful or making do with what one has. He reports that half the world’s workers, some 1.8 billion, were working in System D, off the books, in 2011. They were paid in cash and reported no income and paid no taxes. System D produces many types of machinery, mobile telephones, computers, foods, and many other items and these are transported around the world. Many are produced in China and slipped into other countries past the eyes of customs officials using various devious techniques to slip them into countries undetected.

This economy is huge and increasing so much that the OECD estimates that by 2020, two-thirds of the world’s workers will be off the books. In that sense, the world economy is truly moving toward a laissez faire economy. This economy is completely outside of trade agreements, labor laws, copyright agreements, product safety regulations, environmental regulations, and pollution laws. Anything goes. It spreads even high technology around the world at prices that even the poor can afford. They cannot afford to buy the same items legally through MNCs observing intellectual property rights. Most in the world cannot afford software prices charged by Microsoft and other companies, but they can get cheap bootlegged copies. They can get music and films and books, all bootlegged in the informal economy. Simply, the informal economy gives opportunities to the poor, which are not provided by the formal economy, both in terms of jobs and in terms of trade and business, entrepreneurship.

The informal economy does much of the recycling in developing countries. These people do not set out to be environmentalists, but they do more for the environment than most environmentalists. Also trash pickup and many public services, including inexpensive lunches to millions of office workers in cities like Delhi, Bombay and Calcutta are provided. This part of the global economy is so large that by 2014, eighty-five percent of new employment opportunities were in the informal economy. Also sixty to eighty percent of informal workers were women.

The informal economy is also an efficient system of distribution of products, many of which are produced by big corporations in the formal economy. The big companies like Procter and Gamble have developed a way to get their products into the thousands of small unlicensed stores. Food companies can use the same techniques.

The informal economy even works in the Unites States, as it is ten to twenty percent of the US economy. In India, it is estimated at twenty to thirty percent of the economy and in Turkey thirty to forty percent. In Russia forty to fifty percent of the economy is in the informal sector and in some African countries, it reaches sixty percent. The informal economy also provides a safety net when the formal sector is hit by a financial crisis. In Greece it was thirty percent of the economy which saved many in the economic crisis.

The unreported economy is also very large. Edgar Feige has estimated that twenty-five percent of income in the United States is unreported, resulting in an income tax loss to the government of 500 billion US dollars.

Offshore Tax Havens:

It has been estimated that half the world’s capital flows through offshore tax havens. The main venues are Switzerland and the Cayman Islands. Others include Jersey, Guernsey and the Isle of Man. According to the IMF, between 600 billion and 1.5 trillion US dollars illicit money was being laundered annually. This was two to five percent of global output. Up to 500 billion dollars drug money may be laundered off shore in a year, more than the income of the world’s poorest twenty percent. There are also links between offshore banks and standard banks.

Another estimate is that one-third of the wealth of high net worth individuals is hidden offshore. This is some six trillion dollars out of 17.5 trillion. Some 6.3 trillion pounds sterling is owned by the richest 92,000 individuals, or 0.001 percent of the population. Over thirty percent of the net profits of MNCs may be hidden offshore. The estimate of the amount hidden offshore is between 13 and 20 million pounds sterling. Another estimate says 32 trillion US dollars. Some three trillion dollars is in deposits in tax haven banks and the rest in securities held by international business companies and trusts. Swiss banks have an estimated thirty-five percent of the world’s private institutional funds worth three trillion Swiss Francs. The Cayman Islands have 1.9 trillion US dollars in deposits.  Some 1.2 percent or the population has a quarter of the world’s wealth.

Where is the money? Edgar Feige has tried to figure out where the money is. It seems that the location of 85 percent of the US currency supply is unknown. Currency in circulation in 2010 was some 920 billion US dollars. This is 2950 dollars for everyone in the US. A lot of it is abroad. The illicit drug industry was estimated to be 300 to 400 billion dollars a year and the US was the biggest market in the world for illegal drugs. There was also a global illegal market in oil. Other prominent global illicit industries included human trafficking, and prostitution.

It was estimated that a huge amount of black money from India was hidden in Swiss bank accounts, but it was not possible to know the amount.

That’s the way the global cookie crumbles. Some get the goodies and some get the crumbs, like the sparrows in the road.

 

Chapter Twenty: Conclusion: Global Political Economy

The great dialectical struggle over which ideological system of thought would control the world economy and the world’s wealth has been seen in the history of economic thought since the classical period of political economy. It is a matter of the division of the spoils between capital and labor. This historical dynamic has produced the world as it exists today. A critical dimension includes increasing inequality both globally and domestically. Another critical dimension is the ecological one with increasing environmental destruction. The struggle goes on and no one has a crystal ball to tell what the future holds. It is the task of political economy to attempt to understand the complex nature of the global political economy. Attempting to predict the future is a more risky enterprise. Political economists have made many such attempts but have generally not been successful.

We have seen since the seventeenth century the evolution of economic thought has resulted in two great camps. One says that the world as it exists is natural and approved by God. The market and capital are neutral. Inequality is also said to be natural and reflect an equilibrium or Pareto Optimality.

The other perspective is a denaturalization of the world. The world is not natural but rather man-made, a product of history. The first, mainstream economics, has served as an example of an ideology to underwrite the capitalist system even going so far as to say that there is only one possible system of economics. There is no alternative (TINA). The idea comes from Herbert Spencer, but was popularized famously by British Prime Minister Margaret Thatcher.

Today, after the failure of socialist societies to provide their promised benefits, the capitalist ideology has strengthened and essentially rules the global political economy. Since the l970s, the myths of classical political economy, such as laissez faire, have been reinforced. The Austrian School trend in the market and public choice theories in the area of public policy have largely taken over. This has produced a new condition in the world since the middle of the twentieth century. The open global economy generally serves the interests of international capital and the financial sector at the expense of the working classes around the world.

More than half of the world’s people live in conditions in which Jack London called “The People of the Abyss.” Dispossessed. At the same time, they produce the wealth for those who do not have to work. The world precariat, those who barely survive on the edge of existence, and do not know from where their next meal is coming, is increasing. The global ruling ideology is neoliberalism. It is based upon running the world by a technocratic elite and the bankers that serve the interests of global capital. This ideology has become the ruling ideology as even those at the bottom tend to buy into it with effective right-wing propaganda. The world’s leaders talk about democracy but generally do not give the masses a voice. Democracy has been rejected outright by the rational choice theorists. The majority of the people must survive in the underground informal economy just to live and breathe. The underground informal economy, it seems, is the real free market and the underbelly of the global class struggle. The official economy is a monopoly capitalist economy controlled by oligopolistic global corporations.

The Physiocrats saw the rural life as natural and productive of wealth. They promoted agricultural interests and an anti-urban agrarian ideology similar to the Jeffersonian ideal in America. Their ideas were largely pre-capitalist. The eighteenth century saw the beginning of industrial capitalism and the extension of colonialism by European powers. The industrial revolution based upon enclosure, disfranchisement, and colonialism produced wealth for the rising capitalist class in England. Adam Smith and David Ricardo constructed an ideology of free market capitalism. However this approach showed that the wealth and profits of capitalism came from the exploitation of labor.

Two streams of critique emerged in the nineteenth century: the utopian socialists and the scientific socialists. The utopian socialists wanted to use the emerging technology, the means of production, to construct an ideal society. The emergence of science and technology would serve the interests of the whole society and the public good.

With the emergence of industrial capitalism, the proletariat struggled just to live. And many did not live very long, as the brutal exploitation of early factory work meant death at a fairly young age. Marx and Engels explored their condition in England. This provided a critique and platform for the working class in the middle of the nineteenth century. These thinkers set out to shed light upon “the laws of motion of modern capitalist society.” They built upon the insights into capitalism by Adam Smith and David Ricardo, showing that profits came from the exploitation of labor. Their work became a powerful tool for the working classes in the historical struggle for a living wage.

The classical capitalist ideology was forced to shift gears as the theory of surplus value was apparently too revealing. Adam Smith and David Ricardo had clearly exposed the exploitation of labor in capitalist production as the source of profit. The marginalist school emerged. This provided the ideological basis for neoclassical economics. The veil was thrown over the capitalist productive process. Historical reality was obscured, partly by obscure mathematical formulas. The neoclassical approach tended to hide the nature of capitalist exploitation beneath vague concepts and mathematical equations. Presented as economic science, it also hid the fact that it was an ideology of capital. Perhaps it was smoke and mirrors, a way to pull the wool over the eyes of society and defeat the efforts of the working classes for decent wages. The various schools of thought which emerged in the nineteenth century to repair the damage done by the deep insight of Karl Marx into capitalism in the Grundrisse and Capital were consolidated in the work of Alfred Marshall at the end of the nineteenth century. It was to be a water tight proof that capitalism was moral and ethical and that society was in equilibrium. God is in his heaven and all is right with the world. It was all explained by supply and demand, Marshall’s cross. This has become the mainstream approach to economics ever since.

In the late 1920s, a critical problem arose in the system. The internal contradictions were bringing the system down. The system was modified by Keynesianism when neoclassical economic theory could not account for how the real economy worked in the great depression. John Maynard Keynes criticized economists for teaching wrong doctrines to students rather than facing the truth. Economics was political. It was being used as an ideology. With insights from the classical political economists, Keynes devised an approach which would save the capitalist system from itself while providing for the public good. The system must divide a portion of the spoils with the working class. This would be more of a stakeholder approach, rather than harsh class struggle from above for maximum profits. The working class would be cut into the system for a greater share of the spoils. At least for a period of time.

The problem was that the owners of wealth were not willing to share the spoils. The world had been divided up under an imperialist system. For profits, capital needed an open world economy for markets and resources. Those with capital were interested in profits. They fell back on classical ideology for an open world economy which would serve the interests of capital over the interests of the working class. A controlled economy was more compatible with the interests of labor.

After World War II, the Bretton Woods Monetary system put some controls upon capital but the interests of capital won out over the interests of labor. The US pushed for an open global political economy. This was to come about fully only in the l970s, with the strengthening of conservative economics and the attack upon Keynes. It was as Joseph Schumpeter had seen, namely that the capitalist class would not tolerate the gains of the working classes. So it was a struggle from above to remove controls on capital on a global basis. However, the system did not become socialist, as Schumpeter feared. The capitalists were winning with the help of the Nobel Laureates at the University of Chicago.

By the l970s, the US was faced with competition from Western Europe and Japan. The Bretton Woods Monetary System had collapsed, but the dollar was still the global currency. American capitalism, along with European and Japanese capitalism, were oligopolistic systems of political economy. They began to spread and operate on a global basis with strategic management. It became rational for the capitalist class to deconstruct the industrial state in the United States. The deindustrialization of America was carried out. Most industrial jobs shifted overseas. Under the ideology of conservative economists this was said to be good for everybody. Another shift in the ideology was in order.

The ideology of the new political economy based upon public choice theory began to emerge. For the justification for the new phase of global rule, it had to be explained why the stockholders would rule and why there was no need for the stakeholders to be included. It had to be explained why democracy could be simply be dismissed. It came to be said that the problem with democracy and grass-roots interest groups were that they were in conflict with capitalism. The interests of the global population everywhere were in conflict with the interests of capital. The Public Choice school set about to construct an ideology which explained why democracy and political participation on the part of the people must be rejected and society run by technocrats. Getting a share of the spoils was “rent seeking” and this went against the interests of capital. It simply wasted capital. The traditional pluralist theory of American democracy, based on interest group theory, had to be modified.

Marginal utility theory of the nineteenth century was extended beyond economics to every phase of society. It was said that economic methodological individualism could be used to explain all of human behavior by the rational choice theorists. The ideology began to take over all of social science. This pushed both economics and politics to the right.

The liberal doctrines and marginal utility theory had provided an ideology of capitalism. Globally, it was an imperialist political and economic order. The United States, Europe and Japan ruled the world after the war.

After World War II, the US set up a new world order. Theories of trade and development followed traditional liberal doctrines. But these theories did not describe the real world. Multinational corporations arose protected by states to control the economy. America was a global empire, Europe a sub-empire, along with Japan. Samir Amin called this collective imperialism.

By the l970s, American capitalism had stagnated. Greater profits could be made abroad. So the deindustrialization of the US began. This was a dialectic that led to development in some areas, such as China and the big emerging markets, while the American empire declined. America fought wars for the control of markets and resources and for the control of oil in Afghanistan and Iraq, but the empire was declining.

Financialization of the US economy proceeded as manufacturing jobs were exported. Multinational corporations gained great political power. Public choice ideology took hold to roll back Keynesianism. The defense industry preferred military Keynesianism which generated greater profits. The new political economy became the ideology of neoliberalism. The result has been greater struggle and increasing inequality both in the US and in the wider world.

Today, the picture is complex, but clearly, the financial elites have taken over the global economy. They have imposed their ideology on global development to slow economic growth through the structural adjustment programs of the IMF. The official institutions, particularly, the World Trade Organization, serve their interests.

The idea of global development with social dimensions providing for social welfare, the public good and democracy, has largely been lost. Since public choice theory says that democracy does not work and is impossible, it is logical to let technocrats control the economy. This is the new political economy. Since democracy holds back capitalist profits and wastes capital it is not desirable.

Lost sight of as well is the critical dimension of ecological destruction.

In the underground economy, System D, we see the precariat struggling to make a living. If lucky, they work in sweat shops, garbage dumps, ship recycling, and polluting industries. They are street sellers and drug smugglers. The rise of religious politics, in part, may be a result of this struggle that alienates a large section of the society. Socialism failed, but liberal democracies have also failed to meet most people’s needs. The system results in a colossal waste of human resources, human brains and human talent. Western youth sometimes turn against the system and become militants.

The world is becoming increasingly turbulent. The existing system is not serving at least three-quarters of humanity. Today the global political economy is exceedingly complex. It will continue to be a challenge to political economists to understand what is happening. It is an even bigger challenge to change the world for the better for the people. First one must understand as much as possible. Global political economy is a matter of lifting the veil on the real world.

 

Biographical Sketches

Amin, Samir (1931-): Egyptian Marxist political economist. Author of many books including The Liberal Virus (2004). Worked in Dependency and World Systems Theory. Critical of US imperial policies and neoliberalism.

Aristotle (384-322): Greek Philosopher. His economic ideas are discussed in The Politics. Perhaps he influenced Marx.

Arrighi, Giovanni (1937-2009): Italian scholar of Political Economy and Sociology. Collaborated with Immanuel Wallerstein at the Fernand Braudel Center at SUNY Binghampton. Worked on World Systems Analysis. Influenced by Adam Smith, Max Weber, Karl Marx, Antonio Gramsci, Karl Polanyi and Joseph Schumpeter. Major works: The Long Twentieth Century: Money, Power, and The Origins of Our Times (1994) and Chaos and Governance in the Modern World System (1999).

Arrow, Kenneth (1921-):Became famous for his impossibility theorem. Contributed to rational choice theory. He said essentially that social decision making is not rational. It is impossible to derive a social group choice from individual preferences. In an election, the rules determine who wins. No matter what the rules, there will be some unintended result. This casts doubt upon the possibility of democracy.

Bagchi, Amiya Kumar (1936): Indian Political Economist. Student of economic history and development. Author of Perilous Passage: Mankind and the Global Ascendency of Capital (2005).

Baran, Paul (1909-1964): American Marxist economist. Stanford University professor. Famous for his book, The Political Economy of Growth (1957).

Becker, Gary (1930-2014): University of Chicago economist. Contributed to rational choice theory. Claimed that all forms of human behavior can be explained by economic theory including decisions about who to marry, whether to have children, whether to rob a bank, or become a dealer in drugs. Claimed that there was no racial discrimination in America. Won a Nobel Prize.

Bentham, Jeremy (1748-1832): British philosopher and economist. Developed a philosophy of utilitarianism. The fundamental principle was: “It is the greatest happiness of the greatest number that is the measure of right and wrong.” In economics, he focused on monetary expansion as a means of helping to create full employment. He also worked on legal reform designing a prison building called the Panopticon. This concept influenced the French philosopher Michel Foucault.

Bernanke, Ben (1953-) American Economist, Chairman of the US Federal Reserve Board 2006-2013. Professor at Princeton University. Wrote on Monetary theory. Influenced by Milton Friedman. Became known as “helicopter Ben” by critics after quoting a statement made by Friedman about using a helicopter to drop money into the economy to fight deflation. Bernanke thought that adequate liquidity could have saved the US from the Great Depression of the l930s.

Bernstein, Eduard (1850-1932): A German Social Democrat. Bernstein was the founder of evolutionary socialism and revisionism. Bernstein believed that socialism could be achieved through peaceful means. Workers would win democratic rights through the democratic parliamentary process. With better social conditions, there would be less motivation for a revolution.

Bhagwati, Jagdish (1934- ): Indian-American economist. Taught at Columbia University in the field of international trade. A Liberal scholar pushing the notion of globalization and free trade. Worked with Amartya Sen and Indian Prime Minister Manmohan Singh. Work: In Defense of Globalization (2004) and many other books.

Blanc, Louis (1811-1882): French politician, historian, and socialist. Advocated cooperatives to guarantee employment for the urban poor with equal wages. An actor in the Revolution of 1848.

Blanqui, Louis Auguste (1805-1881): French socialist and revolutionary. Elected President of the Paris Commune. Wanted a just distribution of wealth carried out by a temporary dictatorship.

Bohm-Bawerk, Eugen von (1851-1914): An Austrian economist and disciple of Carl Menger. He published Capital and Interest in three volumes (1884, 1889). He criticized the exploitation theory of Karl Marx and influenced Joseph Schumpeter and Ludwig von Mises. He rebutted the labor theory of value of Marx. Wrote that “capitalists do not exploit workers; they accommodate workers by providing them with income well in advance of the revenue from the output they helped to produce.” 

Braudel, Fernand (1902-1985): French Historian of the Annales School. Precursor of World Systems Theory. Studied long historical waves of capitalist development in the Mediterranean and Europe. Famous for the books: The Mediterranean, Civilization and Capitalism, and Identity of France. 

Buchanan, James M. (1919-2013): American economist. Founder of the Virginia School of Political Economy and Public Choice Theory. Awarded Nobel Prize in l986. Said to be founder of “New Political Economy.”

Bukharin, Nikolai (1888-1938) A member of the Bolshevik Party in Russia. Participated in the Bolshevik Revolution in 1917. Leader of the right wing of the Party in the 1920s. Thought that the peasants should be allowed to get rich because they supplied food to the cities. Purged in the l930s by Joseph Stalin. Executed in the Purge Trials in 1938.

Cardoso, Fernando Henrique (1931-): Sociologist, professor, politician, President of Brazil (1995-2003). Worked on Dependency Theory. Author of Dependency and Development in Latin America (with Enzo Faletto) 1979.

Darwin, Charles (1809-1882): English naturalist and geologist. Contributed to evolutionary theory. Wrote: The Evolution of the Species (1859).

Downs, Anthony (1930- ): American Economist. Influenced Public Choice School. Famous for An Economic Theory of Democracy (l957). Since most voters have incomplete information, they resort to economic voting in an irrational way.

Engels, Friedrich (1820-1895): German social scientist, author, political theorist and philosopher. Engels worked with Marx on developing Marxist theory and edited Marx’s unfinished works after Marx died in 1883. Engels met Marx in 1842 in Germany and later in Paris and London. Major works include: The Condition of the Working Class in England (1844), The Communist Manifesto (with Marx, 1848), and Socialism: Utopian and Scientific (1880).

Faletto, Enzo (1935-2003): Chilean economist. Taught at University of Chile. Worked on Dependency Theory and development and underdevelopment in Latin America.

Fanon, Frantz (1925-1961): French Creole psychiatrist, philosopher and revolutionary. Made post-colonial studies. Best known for The Wretched of the Earth (1961). Studied the psychopathology of colonialism.

Foster, John Bellamy (1953-): Editor of the American independent Socialist journal, Monthly Review. Wrote many books focusing upon Marxist political economy, capitalism, economic crises, and the ecological crises. Author of many articles in Monthly Review journal.

Fourier, Charles (1772-1837): French philosopher and utopian socialist. Coined the word “feminism.” People would live in socialist communities called a phalanx. He set up several socialist communities in the USA. 

Frank, Andre Gunder (1912-2005): German-American economic historian and sociologist. Promoted Dependency Theory and World Systems Theory. Used Marxian concepts in political economy. Wrote many books on underdevelopment.

Friedman, Milton (1912-2006): American economists. Leader of Chicago School at University of Chicago. Awarded Nobel Prize (1976). A monetarist who challenged Keynesianism. Influential conservative economist.

Fukuyama, Francis (1952- ): American political scientist. A neoconservative who first supported George W. Bush and later changed his mind. During the George W. Bush Administration, he abandoned his neoconservatism.  His main thesis was that liberal democracy and the free market was the final form of human government. Wrote: The End of History and the Last Man (1992).

Furtado, Celso (1920-2004): Brazilian economist. Worked on development, underdevelopment, and poverty. An economic  structuralist. Inspired by Keynesianism and dependency theory. He was exiled with the military coup in l964.

Galbraith, John Kenneth (1908-2006): Canadian-American economist and diplomat. A Keynesian and institutionalist. Taught at Harvard University. US Ambassador to India. Wrote almost 50 books. Criticized the power of large corporations over consumers. Noted that economic ideas have inordinate stability, even when they are wrong.

George, Henry (1839-1914): An American writer and political economist. He was the strongest proponent of the “single tax,” the land value tax. Most important work is: Progress and Poverty (1879). He said that people should own what they create, but that everything found in nature, including land, belongs to all humanity. George criticized the railroad and mining interests, corrupt politicians, land speculators, and labor contractors. He thought the high price of land was the cause of poverty. He thought that a land tax was the only tax needed for public expenditure.

Godwin, William (1756-1836): English political philosopher. Anarchist and utilitarian. Advocated the peaceful overthrow of political, economic, social and religious institutions. Wrote: An Enquiry Concerning Political Justice. Engaged in a debate with Thomas Malthus over the issue of population.

Greenspan, Alan (1926-): American economist. Chairman of the US Federal Reserve (1987-2006). Supported Social Security privatization and tax cuts. Loved to write his memoirs in the bathtub.

Hamilton, Alexander (1757-1804): American founding father. He was chief of staff to General George Washington. He became the leader of the Federalist Party. He helped to put down a tax revolt by western farmers known as the Whiskey Revolt. The farmers opposed a tax on whiskey. He supported tariffs on imports to protect American industries. One of the main proponents to organize a constitutional convention to write a new constitution to replace the Articles of Confederation. He was killed in a duel with Aaron Burr.

Harberger, Arnold C. (1924- ): University of Chicago Professor (1953-1982). He headed the Chile Project of the US Government to establish free market economics in Chile, Argentina and other Latin American countries. Many of his students became Chicago Boys in Chile and Argentina. Established the technique of “Shock Treatment.” An economic adviser to many Latin American nations, including Chile under Augusto Pinochet.

Hayek, Friedrich (1899-1992): Austrian-British economist and philosopher. Defended classical liberalism. Awarded Nobel Prize in l974. Worked on the theory of money. Wrote: The Road to Serfdom (1944).

Hilferding, Rudolf (1877-1941): An Austrian-born Marxist economist who developed the theory of organized capitalism. Hilferding published his most influential work in l910, Finance Capital. Hilferding believed that the concentration of capital in the industrial, mercantile, and banking sectors of the economy was a key factor in the transformation of capitalism into socialism in future. As capitalists came to rely upon the state as a narrow ruling class, it would be relatively straight forward for the working class to take over the state and initiate socialism, once the forces of production were sufficiently developed.

Hobsbawm, Eric (1917-2012): British Marxist historian. Studied the rise of industrial capitalism, socialism and nationalism. Coined the term: “The Long Nineteenth Century.”

Hobson, John A. (1858-1940): John Hobson was an English economist and critic of imperialism. He is best known for his 1902 book, Imperialism: A Study. Hobson believed that imperialism was the result of the forces of expanding capitalism. Over-saving and underconsumption set in causing a maldistribution of income. Capitalists, finding no profitable investments for their capital in the domestic economy, exported their capital abroad to make higher profits. He believed that the solution to this was the redistribution of wealth through taxation and the nationalization of monopolies. Hobson’s work was a major influence on Vladimir Lenin’s theory of imperialism.

Hume, David (1711-1776): Scottish philosopher, historian, and economist. An empiricist. Hume argued against innate ideas. His economic works include ideas on the balance of trade. He said that protectionism to promote trade was counterproductive, since exports caused the value of the currency to rise. Hume said that there is no natural right to property. Wrote: A Treatise of Human Nature (1739) and An Enquiry Concerning Human Understanding (1748). 

Huntington, Samuel (1927-2008): A conservative American political scientist. Advocated the strategic hamlet program in Vietnam to depopulate areas and push peasants into the cities to help prevent revolution. Became famous for his thesis of the clash of civilizations. He said that after the collapse of the Soviet Union, the main cleavage in international politics would not be between ideologies, but between cultures. It seemed to justify the US wars in the Middle East. He also saw the danger of a “crises of democracy” in developing counties as countries developed. Wrote: Political Order in Changing Societies (1968); The Third Wave: Democratization in the Late Twentieth Century (1991); and The Clash of Civilizations and the Remaking of the World Order (1996).

Jaures, Jean (1859-1914): Jaures was the leader of the French Socialist Party. He tried to prevent the outbreak of World War I. He was assassinated at the outbreak of the war.

Jevons, William Stanley (1835-1882): British economist. Part of the marginalist revolution. Originator of mathematical methods in economics. Developed marginal utility theory of value. Famous for Jevon’s Paradox which states that an increase in the efficiency of use of a resource will tend to increase the rate of consumption of that resource rather than lead to less consumption.

Kalecki, Michal (1899-1970): Polish economist and Keynesian. Integrated Marxist class analysis with oligopoly theory. Predicted that the Keynesian Revolution would not endure.

Kautsky, Karl (1854-1938): German social democrat. An orthodox Marxist who wrote on imperialism. He criticized the Bolshevik Revolution as a coup. Said that imperialism was not a necessary form of capitalist development, in contrast to Lenin and Rosa Luxemburg who believed imperialism was necessary to capitalist development.

Keynes, John Maynard (1883-1946): British economist and professor. Developed the theory for Keynesian economics. Best known works: The Economic Consequences of the Peace (1919) and The General Theory of Employment, Interest and Money (1936). The most influential economist of the twentieth century.

Khaldun, Ibn (1332-1406): Arab historian and philosopher. Considered to be a founding father of sociology. Also wrote on economics. His most famous work is The Muqaddimah. He developed a theory of history of the successive regimes in the Maghreb. He saw history as evolving in cycles from primitive life among desert tribes to civilized life in cities. Analyzed society primarily on the basis of material conditions.

Kondratiev, Nikolai (1892-1938): Russian economist. Worked in agricultural economics. The Deputy  Minister of Supply in the government of Alexander Kerensky in 1917. He founded a research institute in Moscow in l920. He worked on the Five Year Plans of the Soviet Government and developed a theory of long economic cycles of fifty years. A proponent of Vladimir Lenin’s New Economic Policy (NEP).

Krugman, Paul (1953- ): American economist and professor at Princeton University and the London School of Economics. Author of many books on economics, he has worked on trade theory and New Economic Geography. Also a columnist for the New York Times. A liberal in terms of politics.

Laffer, Arthur B (1940- ): American economist who became famous for the Laffer Curve during the Reagan Administration (1981-1989). The argument is that there is some tax rate between zero and one-hundred percent that will maximize tax revenues to the government. Laffer argued that the current tax rate was above the optimum percent. Laffer did not claim originality for the theory, citing Ibn Khaldun and John Maynard Keynes as sources. A conservative and libertarian advocating supply side economics.

Lange, Oskar (1904-1965): Polish economist and diplomat. Developed a market model of socialism using market tools and economic planning. Prices would be adjusted according to supply and demand.

Lenin, Vladimir (1870-1924): Bolshevik and the first leader of the Soviet Union after the Bolshevik Revolution in l917. Contributed to theories on imperialism and capitalism. Famous for the theory of democratic centralism and the idea that professional revolutionaries or a vanguard must lead a revolution. He warned against making Josef Stalin the leader of the Soviet Union in his last will and testament.

Locke, John (1632-1704): An English philosopher and economist. His book, Two Treatises on Government laid out the ideology of liberal government in 1690. His contributions to economic thinking included the argument that men acquired property, including land, through a natural process when they mixed their labor with land and other elements of nature. This was a sort of labor theory of property. He argued that in nature man could appropriate as much provisions as he could use before it spoiled. Once money was invented, a substance which did not spoil, it legitimized unlimited property. Locke’s ideas provided an ideology which legitimized the emerging system of industrial capitalism.

Luxemburg, Rosa (1871-1919): A Polish Marxist and political economist. She was murdered by a member of a right-wing German paramilitary group, the Freikorps. She attacked militarism and imperialism. She was not enthusiastic about the Bolshevik Revolution, believing that it would turn into a dictatorship.

Marcuse, Herbert (1898-1979): German philosopher, sociologist, political theorist, and a member of the Frankfurt School. He worked on The Economic and Philosophical Manuscripts of 1844 of Karl Marx.  He wrote about the dehumanizing effects of capitalism and modern technology.  Most well-known books are Eros and Civilization (1955) and One Dimensional Man (1964).

Magdoff, Harry (1913-2006): American socialist writer. He worked for the US Government in the Franklin D. Roosevelt Administration. Later he became the co-editor of Monthly Review journal. Wrote many books on US Imperialism and on financial crises with Paul M. Sweezy.

Malthus, Thomas Robert (1766-1834): English cleric, scholar, political economist. Became famous for his arguments on population in his book: An Essay on The Principle of Population (1798).  Predicted that population growth would outstrip the ability to produce food bringing a Malthusian catastrophe. Misery and vice would suppress the population. His book was part of an argument with Rousseau about the future improvement of society. He became professor of political economy at East India Company College.

Marshall, Alfred (1842-1924): Primary founder of Neoclassical Economics with his textbook: Principles of Economics (1890). Cambridge University professor.  He developed famous supply and demand curve and developed  marginal utility theory.

Marx, Karl (1818-1883): German philosopher and political economist. Most famous for his three volume work, Capital (Volume I, 1867;Volume II, 1885; Volume III, 1894). Marx used Hegel’s philosophy to develop the dialectical materialist theory of history along with Friedrich Engels. This theory was published in The German Ideology (1845)  Marx’s early work on economics began with the Economic and Philosophical Manuscripts of 1844. Marx wrote his outline for Capital, The Grundrisse, in 1856-1857, published later. Marx continued to work on Capital until his death, but never finished the three volumes. These were edited by Engels after Marx’s death and published. Theories of Surplus Value (three volumes, 1862) critiques the work classical political economists, including Adam Smith. Stated that he was not a Marxist. Marx laid the foundation for the continuing radical critique of capitalism to the present time. Marxism may refer to a method of understanding society and history rather than an ideology.     

Menger, Carl (1840-1921): Founder of the Austrian School of Economics. Contributed to marginal utility theory. He opposed Adam Smith and David Ricardo on their cost-based labor theory of value. He helped develop a theory of marginal utility which argues that price is determined at the margin. Books include: Principles of Economics (1871) and The Theory of Capital (1888). He also wrote on monetary theory.

Mill, John Stuart (1806-1873): English philosopher, political economist and civil servant. He was raised as a precocious child being tutored by his father, James Mill, and Robert Thomas Bentham. He also knew David Ricardo, a friend of his father, and met Jean-Baptiste Say and Henri Saint Simon in Paris at a young age. Highly influential thinker of the nineteenth century. A proponent of Utilitarianism. Defended the freedom if the individual from the state. Called for the right of women to vote in Parliament. Wrote: The Principles of Political Economy (1848),  On Liberty (1859, and Utilitarianism (1863).

Minsky, Hyman (1919-1996): An American economist and professor. A post-Keynesian, he studied financial crises. He studied under Joseph Schumpeter and Wassily Leontief. He developed a theory of financial crises and the concept of the “Minsky Moment.” He wrote: “A fundamental characteristic of our economy is that the financial system swings between robustness and fragility and these swings are an integral part of the process that generates business cycles.” He emphasized the dangers of speculative bubbles in asset prices.  Works: Can “It” happen again (1982), John Maynard Keynes (1975, and Stabilizing An Unstable Economy (2008).

Mises, Ludwig von (1881-1973): Philosopher, Austrian School economist, sociologist and classical liberal. Moved from Europe to the United States in 1940. Became a professor at New York University (1945-1969). Developed his theory of praxeology. In Vienna, he was influenced by Carl Menger and Bohm-Bawerk. Wrote The Theory of Money and Capital (1912), Socialism (1922), and The AntiCapitalist Mentality (1956). He influenced James Buchanan, Milton Friedman, Friedrich Hayek, Lionel Robbins and Joseph Schumpeter. Von Mises stated that anti-capitalist sentiment is rooted in envy. He praised Ayn Rand.

More, Sir Thomas (1478-1535): English philosopher, author, statesman, Renaissance humanist, Councilor to Henry VIII. Wrote Utopia (1516). Utopia addressed the problems of the land due to the enclosures of common lands. Enclosures brought poverty and starvation due to lack of access to land because of sheep farming. There was a system of socialism where there was no private property and people requested what they needed from storehouses. Everyone must farm for two years and learn a trade. It was a welfare state with free hospitals. Thomas More was tried for treason, convicted and beheaded.

Mun, Thomas (1571-1641): A seventeenth Century British merchant economist. He was a mercantilist and a director of the East India Company. He said that a country becomes wealthy by making more money and produce than it spends. Mun preached the virtues of surplus trade.

Myrdal, Gunnar (1898-1987): Swedish economist and social democrat. Studied race relations in the United States, unemployment and poverty. Wrote the four volume work on Asian development, Asian Drama. Developed the idea of cumulative causation which helped to explain the cycle of poverty seen in rural Asia. He was critical of mainstream economists who often hid a political agenda under what seemed to be objective social science.

Olson, Mancur (1932-1998): American economist and social scientist. Contributed to conservative Public Choice theory. Studied institutional economics and collective action. Challenged the logic of interest group theory and saw such groups as damaging to economic growth. Wrote: The Logic of Collective Action (1965) and The Rise and Decline of Nations (1982). When groups such as cotton farmers, steel producers and labor unions form lobbies and engage in rent seeking, they hurt economic growth. Such unproductive distributional coalitions lead to the economic decline of nations. 

Owen, Robert (1771-1858): The founder of utopian socialism and the cooperative movement. Utilitarian. Famous for setting up New Lanark Mill to give mill workers a better life with physical, moral and social progress. Several communities were set up in the United States based upon Owen’s ideas.

Pareto, Vilfredo (1848-1923): Italian engineer, sociologist, economist, and political scientist. He studied income distribution and derived the notion of Pareto efficiency. He said income follows a Pareto distribution. For example, 80 percent of the land is owned by 20 percent of the people as a general rule in any human society in any age and country. Derived the notion of circulation of elites. Said “History is a graveyard of aristocracies.” Said that democracy is a fraud. He advocated free trade and believed like Walras that economics is a mathematical science. As part of the neoclassical revolution, he said that “good” cannot be measured. Utility is just preference ordering. The concept of Pareto Optimality says that a system enjoys maximum economic satisfaction when no one can be made better off without making someone else worse off. Pareto succeeded Leon Walras in the chair of political economy at the University of Lausanne in l893. He influenced Talcott Parsons at Harvard University. Wrote: The Mind of Society (1935). Advisor to Mussolini. Opposed worker strikes and may have favored fascism.

Parsons, Talcott (1902-1979): American sociologist. Studied at London School of Economics and the University of Heidelberg.  Taught at Harvard University 1927-1973. Developed the concept of action theory based upon voluntarism. Influenced by Emile Durkheim and Vilfredo Pareto. At Harvard worked with Joseph Schumpeter, Wassily Leontief, and Paul Sweezy. Wrote many books on sociology.

Pigou, Arthur C. (1877-1959): English economist, taught at the University of Cambridge, succeeding Alfred Marshall. Worked on welfare economics, unemployment and public finance. Invented the concept of externality which could be corrected with a Pigovian tax, such as a carbon tax on pollution. Wrote: The Economics of Welfare (1920) and The Theory of Unemployment (1933).

Polanyi, Karl Paul (l886-1964): Hungarian economic historian, political economist and social philosopher. Wrote: The Great Transformation (1944). Worked on the Enclosure Movement.

Prebisch, Raul (1901-1986): Argentine economist who contributed to the development of Dependency Theory. He was the President of the Central Bank of Argentina. He became the director general of the Economic Commission for Latin America (1948)  Dependency theory is based upon the Singer-Prebisch Thesis. This thesis reexamines the comparative advantage theory of David Ricardo. The international arena is seen to be divided between a center, such as the US or Western Europe, and a periphery, such as Latin American countries. While the center produces manufactured goods, the periphery produces agricultural products. 

Proudhon, Pierre-Joseph (1809-1865):  French anarchist, socialist, and political economist. Said “property is theft.” Advocated worker’s self-management and libertarian socialism. Developed a philosophy of Mutualism. Wrote: The System of Economic Contradictions on the Philosophy of Misery (1846).

Quesnay, Francois (1694-1774): French economist, Physiocrat and surgeon. Believed all national wealth came from the productivity of the soil and the ability of the natural environment to renew itself. Praised rural life over life in the city. He attempted to understand the economy in a systematic way. His economic table showed the distribution among the productive classes, proprietors and cultivators of land and the unproductive classes, the manufacturers and merchants. He praised Chinese constitutional despotism. Wrote: The Economic Table (1758).

Rand, Ayn (1905-1982): American novelist, philosopher, playwright. Developed a philosophical system called Objectivism. Promoted limited government and laissez faire capitalism. Emphasized individual rights and property rights. Ethical egoism or rational self-interest is the guiding moral principle. She rejected all forms of religion. Said that all knowledge is sense perception. Probably influenced Alan Greenspan. Wrote: The Fountainhead (1943) and Atlas Shrugged (1957).

Riker, William H. (19201993): American Political Scientist. The godfather of rational choice theory as applied to political science. An elitist, who believed that politics should be run by elites who manipulate the system through rhetoric and structuring institutions so that they can “win.” Elections are seen as meaningless. Used economic rational utility theory to understand politics. Wrote: The Art of Political Manipulation (1986).

Robinson, Joan (1903-1983): Post Keynesian economist. She worked on monetary economics and other economic theories. Taught at Cambridge University. Influenced Manmohan Singh, who became the Prime Minister of India. Wrote: The Economics of Imperfect Competition (1933), An Essay on Marxian Economics (1942) and The Accumulation of Capital (1956). Wrote many other books, some on China.

Rodney, Walter (1942-1980): Guyanese historian and political activist. Wrote: How Europe Underdeveloped Africa (1972). Assassinated by a car bomb.

Russell, Bertrand (1872-1970): British philosopher, logician, historian, social critic and aristocrat. An anti-imperialist. Believed religion is harmful to people. Wrote many books.

Sachs, Jeffrey (1954-): American economist. Professor at Columbia University. Became an adviser to Eastern European governments after the transition to market economies. Advocate of shock therapy to reform statist economies. Adviser to Bolivia, Poland, Slovenia, Estonia, and Russia. Worked on economic development, environmental sustainability, poverty alleviation, and debt cancellation. Stated that there is no solution to global warming and environmental degradation under current pattern of development in 2013. Said poor countries are caught in a poverty trap and cannot escape without foreign aid. Works include: The End of Poverty (2005) and The Price of Civilization (2011).

Saint-Simon, Claude Henry de Rouvroy, Comte de (1760-1825): An aristocrat and early French utopian socialist. He influenced Marxism, positivism, and sociology. His influence is seen in Karl Marx, Auguste Comte and Emile Durkheim. He thought industrialists would lead society using technocratic socialism. This would eliminate poverty. Science should control society, not religion. He saw “the hand of greed” as the avarice of human beings, controlling society. Socialism would be possible only when this is eradicated through education. His works have been published in 47 volumes.

Samuelson, Paul A. (1915-2009):  American economist. Nobel prize winner. He has been called the “Father of Modern Economics.” A key figure in the development of neoclassical economics, particularly the neoclassical synthesis, which combines Keynesian and neoclassical principles. He taught at the Massachusetts Institute of Technology (MIT), along with Robert M. Solow, Joseph E. Stiglitz, and Paul Krugman. Wrote the best- selling economics textbook of all times, Economics: An Introductory Analysis (1948), which has sold more than four million copies in many editions. Also: Foundations of Economic Analysis. (1947)

Say, Jean-Baptiste (1767-1832): French economist and businessman. Classical liberal views and an advocate of free trade and competition. Known for “Say’s Law.” It was not his original idea, however. The law says that “inherent in supply is the wherewithal for its own consumption.” This was criticized by John Maynard Keynes. John Kenneth Galbraith said that Say’s law is the most distinguished example of the stability of economic ideas, including when they are wrong.

Schumpeter, Joseph (1883-1950): Austrian American economist and political scientist. Coined the concept “creative destruction,” which described the continuous evolution of capitalism. Predicted capitalism would be destroyed by the emergence of social democracy. He influenced Milton Friedman, Paul Samuelson and others. He opposed Keynesianism. Studied business cycles. He said that capitalism would collapse, not from a revolution, but as a result of internal conflicts within capitalist society. The success of capitalism would lead to a form of corporatism and the rise of values hostile to capitalism, particularly among intellectuals. The intellectual climate necessary to entrepreneurship will be lost. A sort of laborism will be established and social democrats will come to rule society. These restrictions on business will come to destroy capitalism. Best known work: Capitalism, Socialism and Democracy (1942).

 Sedgewick, Henry (1838-1900): English utilitarian philosopher and economist. Founded Newham College for women at Cambridge (1875). He said no man should act so as to destroy his own happiness. He influenced Alfred Marshall.

Sen, Amartya (1933- ): An Indian economist who won the Nobel Prize. He contributed to welfare economics, social choice theory, and economic and social justice. He worked on the economic and political cause of famines. Sen showed that it is not just a lack of food which causes famines but a lack of equitable distribution of food. The Bengal Famine was caused by an economic boom in the cities that raised prices and starved millions of peasants in the countryside. Also wrote on why there are one-hundred million missing woman in Asia. Works: Poverty and Famines: An Essay on Entitlement and Deprivation (1981) and The Idea of Justice (2009).

Singer, Hans. (1910-2006): German development economist known for the Singer-Prebisch Thesis. This states that the terms of trade militate against the producers of primary products, so that the benefits of free trade go to the countries which produce manufactured products. He worked at the United Nations Economics Department on international trade. Taught at Sussex University, producing 30 books.

Soros, George (1930- ): Hungarian-American businessman, investor, money-trader. He made one billion US dollars in 1992 in the Black Wednesday United Kingdom Currency crises. Soros sold over ten billion pounds Sterling after which the sterling crashed out of the exchange rate mechanism, earning Soros a huge profit. Soros was implicated in helping to trigger the Asian financial crises. A liberal. Runs Soros Fund Management, a currency trading company. As a philanthropist he has given some eight billion dollars to causes such as human rights, public health and education. He funded the European Central University in Budapest. In 2009, Soros said that the world’s financial system had collapsed and was effectively on life support. He donated 23.5 million dollars to defeat George W. Bush in the 2004 Presidential campaign, but failed. He has written several books

Smith, Adam (1723-1790): Scottish moral philosopher and political economist. Famous for his image of “the invisible hand.” Smith argues that when one pursues their own interests, they contribute to the general interest of society and promote the public good without knowing it. He warns against a conspiracy of businessmen against the public who attempt to form a monopoly and raise prices. He also warned against a business-dominated political system where businessmen come to unduly influence politics and legislation. He said that the interests of manufacturers and tradesmen are often opposite to that of the public. His support of laissez faire economics has probably been exaggerated as he saw the necessity of government regulation. Two major works: The Theory of Moral Sentiments (1759) and An Inquiry into the Nature and Causes of the Wealth of Nations (1776).

Spencer, Herbert (1820-1903): English philosopher, biologist, anthropologist, sociologist. Liberal political theorist. Coined the terms “Survival of the Fittest” and “There is no alternative.” Said all socialism is slavery. Had a great influence on many writers. Works: Principles of Biology (1864).   

Sraffa, Piero (1898-1983): Italian economist. Close friend of Antonio Gramsci. He was brought to Cambridge University by Keynes. Criticized Alfred Marshall’s work. Founded the neo-Ricardian School of Economics. He reconstructed Ricardo’s theory of surplus value. He demonstrated flaws in the marginalist value theory. Constructed a major challenge to the neoclassical theory of value.  Major work: Production of Commodities by Means of Commodities” (1960).

Stiglitz, Joseph (1943- ): American economist. Won Nobel Prize, 2001. He worked for the World Bank. He criticized free market economists, the IMF and the World Bank. Said markets are efficient only under exceptional circumstances. Wrote: Globalization and its Discontents (2002); Making Globalization Work (2006); The Price of Inequality (2012).

Strange, Susan (1923-1998): British scholar of international relations and political economy. She taught at the London School of Economics. She said one cannot understand how the world works without an understanding of international financial markets. Markets create great uncertainty and risk in the international arena. Wrote: Casino Capitalism (1986); The Retreat of the State (1996); States and Markets (1988).

Summers, Lawrence (1954- ): American economist. Professor at Harvard University. Worked at World Bank and in the US Government at the US Treasury Department as Undersecretary under the Clinton Administration. Worked on public finance, labor economics, economic history and development economics. Said that toxic waste should be dumped in low-wage African countries.

Sweezy, Paul M. (1910-2004): Giant of American leftist political economists. Reconstructed Marxist political economy. Founder, editor of Monthly Review journal. Called the Dean of American Marxists. Wrote: The Theory of Capitalist Development (1942). Said modern capitalism is characterized by monopoly, stagnation, and financialization. Influenced many leftist political economists, such as John Bellamy Foster.

Swift, Jonathan (1667-1745): Anglo-Irish satirist and essayist. His satirical works have meaning for political economy as he addressed the economic and political ills of society. In A Modest Proposal, he satirically suggests that the poor in Ireland sell their young children to the rich as food. What he is really suggesting is that most of the problem could be solved by other policies, such as taxing absentee landlords, home manufacture of goods, a rejection of foreign luxury goods, moderation in consumption and less fighting among political factions. Works: Gulliver’s Travels (1726), A Modest Proposal (1729) and many others.

Thompson. E.P. (1924-1993): British historian, writer, socialist. An intellectual of the Communist Party in Great Britain. He remained a Marxist after leaving the party. Part of the New Left in Britain and a socialist humanist. Wrote: The Making of the English Working Class (1963) and William Morris: Romantic to Revolutionary (1976).

Tobin, James (1918-2002): American economist. Taught at Harvard University. Served on the Board of Governors of the Federal Reserve System. A Keynesian who advocated government intervention. Won Nobel Prize in l981. He wanted a tax on foreign exchange called the Tobin Tax. This would serve to reduce speculation in the international currency markets.

Truman, David B. (1913-2003): American political scientist. Wrote on interest groups and pluralism. Professor at Columbia University. Best known work: The Governmental Process: Political Interests and Public Opinion (1951).

Tullock, Gordon (1922- ): American economist. Major figure in Public Choice Theory associated with the Virginia school of economics. He developed a theory of rent seeking, which happens when a monopolistic firm uses its financial position to lobby politicians in order to create new legislation to increase their profits. This results in a moral hazard which does not serve the public interest. Wrote: The Calculus of Consent (with James Buchanan, 1962), Private Wants, Public Means (1970), and many other books.  

Turgot, Anne-Robert-Jacques (1727-1781): supporter of private property in land and individualism. An economic liberal. Supported the ideas of Quesnay that land is the only source of wealth. Carried out tax reform, reducing the tax on land. Wrote the first complete statement on the idea of progress, A Philosophical Review of the Successive Advances of the Human Mind (1750). Best known work: Reflections on the Formation and Distribution of Wealth (1769).   

Veblen, Thorstein (1857-1929): American economist and sociologist. Most famous for A Theory of the Leisure Class. Saw capitalism as a modern form of barbarism. War is highly praised. Conspicuous consumption and conspicuous waste are integral to the feudal nature of modern capitalism. Said the modern economy must be run by engineers, not businessmen. Businessmen try to wreck the system to increase profits.

Volcker, Paul (1927- ): American economist. Chairman of the US Federal Reserve 1979-1987. Chairman of the Economic Recovery Advisory Board under President Barack Obama, 2009-2011. He played a role in President Richard Nixon’s decision to suspend gold convertibility on August 15, 1971, leading to the collapse of the Bretton Woods System. Famous for the Volcker Shock in 1981, when he raised interest rates to 21 percent to slow down inflation. This hurt developing countries.  

Wallerstein, Immanuel (1930- ): American Sociologist, historical social scientist, and world systems analyst. He is famous for his world-systems theory. Influenced by Karl Marx, Fernand Braudel, and Franz Fanon. Most known work: The Modern World-System (Four Volumes, 1974, 1980, 1989, 2011).

Walras, Marie-Espirit-Leon (1834-1910): French mathematical economist. He formulated the marginal theory of value. Helped develop general equilibrium theory. Advocated the nationalization of the land which he thought would support the nation. Became professor of political economy at the University of Laussanne and founded the Laussanne School of Economics. A leader of the marginalist revolution, along with William Stanley Jevons and Carl Menger.

Williams, Raymond (1921-1988): Welsh academic, novelist, and critic. Influential figure in the New Left in Britain. Wrote on politics, culture, mass media, and cultural studies with a materialist approach. Wrote many novels. Wrote: Culture and Society (1958) and The Long Revolution (1961).

 

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