Economic Crisis and Crisis Theory. Paul Mattick 1974
But a great period of world history never expires as quickly as its heirs would hope and perhaps must hope if they are to be able to attack it with the necessary force.
The progressive development of the capitalist economy was from the start a process punctuated by setbacks. There were good and bad times and for this an explanation was sought. That social production was at first still dominated by agriculture made it possible to find the cause of economic distress in the inconstancy of nature. Bad harvests could be blamed for the general scarcity of goods. In addition, the low productivity of agricultural labour, in the context of a growing population, awakened the fear that the development of capitalist production would run up against natural limits, indicating the inevitability of a stationary state. Bourgeois political economy was colored by a deep pessimism, which was overcome only with the accelerating growth of capital.
Although in classical economics social relations were regarded as “natural.” this did not stop the classical theorists from explaining the distribution of income specifically in terms of these relations. And, while in classical theory the equilibrium of different interests was guaranteed by the exchange process, because the latter was regulated by the quantities of labor contained in the commodities exchanged, this character of exchange was called into question by the theory of distribution, and with it the equilibrium based on it. A purely formal consideration of exchange relationships, that is, together with the assumption of free competition, makes individual interests appear to coincide with that of society as a whole, and the economic law of the exchange of equivalents appears to ensure the system’s justice. But recognition of the class-defined distribution of the social product between rent, wages, and profit implied that the formal model of the exchange process was not a legitimate abstraction from reality.
The labor theory of value propounded by the classical economists examined the conditions of the time and their future development from the standpoint of capital and, therefore, from the standpoint of capital accumulation. With few exceptions, although with different arguments, the classical theorists hypothesized that capitalist accumulation would have definite limits that would manifest themselves in a decline of profits. According to David Ricardo, accumulation would inevitably be limited by the decreasing productivity with which the soil could be cultivated. An increasing difference between the returns from industry and agriculture would raise wage costs and lower profit rates to the benefit of rents.
This theory obviously reflected the relationship between the landowners and capitalists of Ricardo’s time and had nothing to do with developmental tendencies inherent in value production. As Marx put it, it was Ricardo’s inability to explain the developmental laws of capital on the basis of the nature of capitalism itself that caused him to flee ‘from economics into organic chemistry.” Nevertheless, Marx saw in the English economists’ concern over the decline of the rate of profit a profound understanding of the conditions of capitalist production.” What worried Ricardo, for example, was
that the rate of profit, the stimulating principle of capitalist production, the fundamental premise and driving force of accumulation, should be endangered by the development of production itself ... It comes to the surface here in a purely economic way i.e., from the bourgeois point of view, within the limitations of capitalist understanding, from the standpoint of capitalist production itself that it has its barrier, that it is relative, that it is not an absolute, but only an historical mode of production corresponding to a definite limited epoch in the development of the material requirements of production.
If the tendency of profits to fall was first explained by increasing competition and by increasing rents (in connection with population growth), it was not long before wages were also seen as conflicting with the profit requirements of accumulation. On the other hand, the extension of wage labor as a social institution suggested, to those who analyzed value in terms of labor time, questions about the origin of profit questions answered by the producers’ demand for the full proceeds of their labor. Like profit itself accumulated capital came to be understood to be accumulated unpaid labor. To refute the accusation of capitalist exploitation thus demanded abandonment of the labour theory of value. Moreover, the problem of accumulation could simply be forgotten, as earlier apprehensions appeared to be false. Accumulation did not decline but increased, and capital unmistakably dominated the whole society. Wage labor and capital now represented the fundamental antagonistic classes that determined the further metamorphoses of bourgeois economics.
The increasingly apologetic nature of economies did not, to be sure, require a conscious effort on the part of the bourgeois economists. For them, convinced as they were that the capitalist economy was the only possible one, every criticism of it was an unjustified and subjective distortion of the real facts of the matter. Apologetics appeared as objective, scientific knowledge, which no demonstrable shortcoming of the system could shake. Of course, the generalization of the capitalist economy as a model for all social systems required an ahistorical approach and the conversion of the categories of political economy into general laws of human behaviour.
As the past can only be conceptualized in terms derived from the present, for Marx also the bourgeois economy provided a key to the understanding of earlier forms of society, “but not at all in the manner of the economists, who smudge over all historical differences and see bourgeois relations in all forms of society.” There are general, abstract categories applicable more or less to all forms of society, but for the analysis of any particular system they must be given a content corresponding to that system alone. Money as a means of exchange and money as capital express different social relationships, and the means of production utilized in the past are not to be equated with capital or self-expanding value. The capitalist economy cannot be explained on the basis of abstract general categories of human behavior; the attempt to do so arises either from ignorance of real social interrelations or from the wish to escape the problems they involve.
According to Marx, the classical theory of value rested on a confusion between the natural and the economic senses of production. Taking labor as a starting point, it thought of capital as a thing, not a social relationship. However, to develop the concept of capital it is necessary to begin not with labor but with value and, precisely, with exchange value already developed in the movement of circulation.” It is on the difference between the exchange value and the use value of labor power that the existence’ and the development of capitalist society depend, a distinction that presupposes the separation of worker from the means of production. Labor itself has no value, but the commodity labor power generates, when consumed, a surplus value in addition to its own value. This surplus value divides into the various economic categories of the market economy, like price, profit, interest, and rent categories that at the same time conceal their origin as shares of surplus value.
The Marxian critique of bourgeois economics was therefore a double one. On the one hand, it consisted ii) the rigorous application of the labor theory of value to the study of capitalist development, which it analyzed in terms of the system’s own fetishistic economic categories. On the other hand, it exposed these categories as expressions of the class and exploitation relations specific to capitalist commodity production. Marx achieved what the classical economists could not namely, an explanation of capital’s growing difficulties by the contradiction, specific to capitalism, between exchange-value and use-value production. In this way he succeeded showing that the limits of capital are set by capital itself. And since the economic categories mask real class relations, the economic contradictions characteristic of capitalism are at the same time real antagonisms of interest, which can therefore be abolished by revolution.
Because it refused to observe the class conflict between labor and capital to which capitalism gave birth, classical economics saw itself as an unbiased science. It did not, however, fall into pure positivism, since at the same time, from its normative side it indulged itself in proposals for the redress of persisting or newly emerging grievances. The harmony of interests expected to characterize market society was held to be delayed by the retrograde efforts of mercantilist monopoly and monetary policy. At the same time, however, doubts arose that universal competition would be a cure-all for economic injustice. The obvious pauperization of the workers led John Stuart Mill, for instance, to suggest a modification of the economic consequences of capitalist production by a more just distribution of income, to be achieved by political means.
For Marx the relation of production to distribution was determined by the class relations of production. From this point of view Mill only shows his “fatuity” when he “considers the bourgeois relations of production as eternal, but their forms of distribution as historical, [and thereby] shows that he understands neither the one nor the other. “The normative elements of classical economics expressed only an insufficient understanding of the capitalist economy.
In general the political economy that arose along with capitalism was still the idealized representation, from the bourgeois point of view, of commodity production in which exchange enabled the possessors of the means of production to realize profits. The practical critique of political economy represented by the workers’ struggle for better living conditions remained within the same conceptual framework, seen from the workers side. The content of political economy was thus the struggle between labor and capital disguised in economic categories So long as the bourgeoisie adhered to the labor theory of value in its own way it recognized objective realities, even if it passed over in silence the fact of exploitation. By abandoning this theory it deprived itself of the possibility of objective knowledge of economic relations and relinquished to its Marxian critique the scientific investigation of bourgeois society.
It would be incorrect, however, to explain the bourgeoisie’s abandonment of the labor theory of value solely by the desire to deny the fact of exploitation. To begin with, the real significance of this theory – the dual character of labor power, at once an exchange value and a use value – was not correctly understood. In addition, the labor theory had no practical importance for the bourgeoisie. In the business world we encounter not labor-time-values but the prices derived from them and established through competition. This need not have prevented the classical theorists from establishing the validity of the value theory, since their starting point was the society as a whole, and indeed they put a great deal of effort into the matter. But the solution of the theoretical difficulties connected with the labor theory of value was left to Marx. Their inability to overcome them thus surely had a role in the economists’ abandonment of the law of value.
Be that as it may, to account for profit, interest, and rent on the basis of the law of value could only make it clear that the workers produce a surplus value, in addition to the value of their labor power, which the non-producing layers of society appropriate. The idea that labor alone creates value had to be dropped if income in the form of profit, interest and rent was to be justified. This move was not only necessary but also plausible, for under capitalist conditions the workers can no more produce without capital than capital without workers. As the workers’ lack of property is the presupposition of capitalist production, so capitalist possession of property is the presupposition of the existence of a proletariat. Since labor is as necessary as capital, and people do live on the earth, we can speak of three factors of production land, labor, and capital that play equal parts in production. Thus the labor theory of value gave way, to begin with, to a theory of the determination of production costs by these three factors.
Although incompatible with the law of value, the cost-of-production theory remained an “objective” conception of value (in contrast with the later derivation of value from the subjective evaluations of consumers) in that it acknowledged the role of various putative contributions to social production and represented their value. In this theory the value of commodities was determined not only by the labor directly expended in their production but also by the conditions of production without which this labor would be impossible. Interest, often not distinguished from profit, was explained as arising from the “productivity of capital.” “Pure” profit (distinguished from interest) was explained as the payment to the entrepreneur on whose activity another portion of the total social value was supposed to depend. The cost-of-production approach, however, was unsatisfactory both from the theoretical and from the practical point of view. Moreover, the idea of property ownership as per so creative of value also was rather questionable. But the identification of the market price of labor power with its value (so that the worker seemed to be paid the full value of his labor) permitted the illusion that the gains obtained on the market were not based on exploitation. The problems of bourgeois economics seemed to disappear as soon as one ignored production and attended only to the market. This exclusive concentration on the market led to the transformation of the objective concept of value into a subjective one.
The plausible idea that the value of a commodity derives from its utility for the purchaser had also not been foreign to the classical economists. Thus Jean-Baptiste Say had already tried to explain value on the basis of utility only to come to the conclusion that the latter could not be measured. It was measurable only by the quantity of labor which a person would be willing to perform in order to purchase a commodity. For Marx, too, the exchange value of commodities presupposed their having a use value. But capitalism is based not on the exchange of products of labor for the satisfaction of individual needs but on the exchange of some use value, playing a role as exchange value, for a greater quantity of exchange value in its gold or commodity form. For such an exchange to be possible as an exchange of labor-time equivalents, there must be a commodity whose use value is greater than its exchange value in an objectively measurable sense i.e., in value terms. The commodity labor power-whose use value is labor itself – fulfils this condition. But if, like the economists, we disregard this real basis of capitalism, exchange indeed appears to serve the satisfaction of individual needs, and the valuation of commodities seems to be determined by the multiplicity of subjective human preferences.
Viewed apart from production, the price problem can be dealt with purely in terms of the market. If the supply of commodities exceeds the demand for them, their price falls; in the opposite case it rises. The movement of prices, however, cannot explain the phenomenon of price itself, as a property of products. Even if the objective concept of value is given up, some other concept of value must be maintained to say more than that prices determine prices. The “solution” to this problem was found in a move from economics to psychology. Prices, economists began to claim, are based on consumers’ individual evaluations as represented by their demand for goods. Prices are then explained by the scarcity of the goods in question relative to the demand for them. It did not take long for this subjective treatment of value, in the form of “marginal utility theory,” to become almost universally accepted within bourgeois economics.
With the marginal utility theory the idea of political economy lost its sense and was abandoned for that of “pure” economics. Marginalism was not different in method from classical economics, but it applied this method no longer to social problems but to the behavior of individuals with respect to the goods available to them and to the consequences of this behavior for the exchange process. Naturally, classical economics also concerned itself with the individual who, as homo economicus, competed with other individuals for the greatest possible gain. But this competition was thought to be a process of equilibration and ordering that adjusted production and distribution to social requirements. While this process took place as if directed by an invisible hand behind the backs of the producers, it nevertheless took place, effecting the necessary unity of private and general interest. Conversely, it could obviously not occur to the marginalists to deny the existence of society. But for them social conditions were only a means to the end of establishing the “economic relation” of the individual to the things he finds of use. They saw this relation as holding for individuals outside society as well as for each person in any and every society, so that the nature of any particular society was irrelevant.
Marginalism rested on the application to the economy of the not overly profound discovery that there can be too many good things as well as too many bad ones. In Germany it was Hermann Heinrich Gossen who first argued for this principle. At first unappreciated, it later won recognition through the popularity of the Englishman William Stanley Jevons’s independently developed concept of marginal utility. At the same time, Karl Menger founded the “Austrian School” of theoretical economics, based on the subjective value concept, to which, among others, Friedrich von Wieser and Eugen von Bohm-Bawerk belonged. Although these economists differ among themselves on details, they can be lumped together as joint founders of marginal utility theory.
Marginalism takes its departure from the needs of individuals. The evaluation of these needs is an affair of human consciousness and thus is subjective. Exchange value and use value, which take account of the scarcity or superfluity of consumer goods, are only different forms of the general phenomenon of subjective evaluation. The desire for any particular good is limited. The point, on an individual’s scale of satisfaction, at which the desire for a good is satisfied determines that good’s marginal utility and thereby its value. Since an individual’s needs are multiple, he chooses between the various goods available in such a way as to realize the maximum of marginal utility. Since some pleasures of the moment have painful consequences, he measures present satisfactions against future privations in order to minimize dissatisfaction. In the market everyone measures the value of a commodity by its marginal utility, total utility reaching its maximum when the marginal utilities of all the commodities purchased are equal.
Who does not know that human life is attended by pleasure and pain and that everyone seeks to diminish the latter and increase the former? Just like the utilitarian philosopher and social reformer Jeremy Bentham, Jevons held pleasure and its opposite to be quantifiable and calculable, thanks to which economics can be mathematically conceived and algebraically represented. But what Say had already failed to do Jevons and the other marginalists did not achieve, and the attempt to measure subjective utilities was soon abandoned. It was agreed that utilities could be compared but not measured exactly.
Bourgeois apologetics had taken on two tasks. On the one hand, it was thought essential to represent the winning of profit, interest, and rent participation in the creation of wealth. On the other, it was thought desirable to found the authority of economics on the procedures of natural science. This second desire prompted a search for general economic laws independent of time and circumstances. If such laws could be proven the existing society would thereby be legitimated and every idea of changing it refuted. Subjective value theory promised to accomplish both tasks at once. Disregarding the exchange relation peculiar to capitalism-that between the sellers and buyers of labor power it could explain the division of the social product, under whatever forms, as resulting from the needs of the exchangers themselves.
This attempt had already been anticipated in Nassau W. Senior’s view that interest and profit should be considered as recompense for the sacrifice undergone by the capitalist in his abstention from consumption in favor of capital formation. Thus the cost of capital, like the cost of labor in the sense of the pain of work could be seen as an abstention from pleasure, and profit could be put on a par with wages. Apart from these abstentions the goal of exchange was the satisfaction of the needs of the exchangers, so that everyone could only gain in exchange, since everyone obviously valued the goods or services that he received more highly than those he gave in return. The capitalist buys labor power because it means more to him than the sum of wages paid for it, and the worker sells his labor power because it means less to him than the wage received in exchange. Thus the exchange benefits both, and there can be no talk of exploitation.
Since subjective value cannot be measured, the psychological foundation of marginal utility was soon given up, of course without abandoning the theory itself. “Utility” now referred not to the subjective evaluations themselves but to their manifestations in market demand. Utility, it was now held, concerned not so much a particular commodity as the number of commodities among which the buyer would be pleased to choose. This ordering or preference scale of the consumer’s was represented graphically by so-called indifference curves. Thus economists now distinguished between the absolute (cardinal) magnitude of utility and the relative (ordinal) utility, which was represented in the preference scale. The concept of marginal utility metamorphosed into that of the marginal rate of substitution, the rate at which the quantity of one good must increase to compensate for the diminishing quantity of another. Maximal want satisfaction could then be defined in terms of the marginal rates of substitution between all pairs of goods. In other words, the buyer would so distribute his money that all the goods he purchased were equally valuable to him, at which point his choice behavior would come to a satisfactory conclusion.
Not all marginalists were ready to give up the concept of cardinal utility, and for others the concept of ordinal utility did not go far enough, as it still referred to subjective value. Since the marginal utility could be observed only in the price, this group preferred a pure price theory which kept its distance from all value problems. Marginalism ran into another difficulty, that it was impossible to regard price as determined by the demand side alone. Without a doubt there must be production as well as consumption and supply prices as well as demand prices. In meeting this problem they moved to unite the subjective value theory with its precursor, the cost-of-production theory. This gave rise to the so-called neo-classical theory, which found its most important representative in Alfred Marshall.
Of course, in this approach production costs were defined in subjective terms, as capitalist abstention and workers’ disinclination to work. Just as marginal utility was supposed to determine demand, so behind supply was discovered the marginal propensity to work more or to defer consumption in favor of capital formation. At the same time, it was clear to Marshall that these factors determining supply and demand were not observable as such, and that the only clue to these “real” factors would be found in the actual price relations. The monetary system converted subjective valuations into prices that thus reflected “real” needs and abstentions. In the form of price the non-quantifiable subjective value would become a measurable value. Since prices were regulated by the tendency of supply and demand toward equilibrium, the relation of supply and demand would determine commodity values in the long run, if not at every moment.
For another variant of the marginal utility theory, production, as an obvious prerequisite of exchange, required no particular investigation. For Leon Walras, the founder of the “Lausanne School,” economics as a whole was nothing but a theory of commodity exchange and price determination. For him, too, value arose from the scarcity of goods in relation to wants, with marginal utility explaining the variations in the intensity of felt needs. But exactly as the individual through his choices on the market would bring his various needs into an equilibrium of want satisfaction, so exchange on the level of society as a whole would tend to a “general equilibrium” in which the total value of demanded goods and services would correspond to the total value supplied.
To be sure, the assumption of a tendency to equilibrium of supply and demand effected by exchange lay at the basis of all market theories. Walras, however, attempted to prove the validity of this assumption in the manner of the exact sciences. According to him marginal utility was not only self-evident but also measurable by the application of the principle of substitution to the commodity market as a whole, where all prices inextricably intertwined. Prices seemed to him to be inversely proportional to the quantities of commodities exchanged. Production costs were formed, in his eyes, by the wages, interest, and rents entering into them, which he considered alike as payments for productive services. All persons exchanged their productive services for consumer goods of equal value. The “reality” of the subjective values manifested in equilibrium prices was here visible in the equilibrium of the economy, and this equilibrium in turn demonstrated the validity of the subjective value concept. As value and equilibrium defined each other, the theory of value was equated to that of general equilibrium, and it sufficed to prove the theoretical possibility of the latter to prove the validity of the subjective theory of value.
Despite its dependence on circular reasoning, the idea of equilibrium applied to the economy as a whole, to parts of it, or to particular cases, remains one of the methodological principles of bourgeois economics, if only because from this discipline’s point of view, all movement in the world – not only that of the economy – tends toward equilibrium states. Of course, the Walrasian system of general equilibrium-represented by a system of simultaneous equations-was only a model and not a picture of concrete conditions. It claimed, however, the status of scientific knowledge on the ground that though the economy might depart from equilibrium, it would always tend to return to this condition. On account of the involution and complexity of the manifold intertwined economic processes, theoretical proof of the possibility of equilibrium could be furnished only by means of mathematics on a level of abstraction which, while corresponding to the theory, had lost all connection with reality.
The hypothesis that in the last analysis the consumers determine the value of commodities took no account of the social distribution of income. John Bates Clark attempted to remedy this situation through the application of marginal analysis to the factors, of production. Just as in consumption the degree of saturation determined marginal utility, so a steady increase in the supply of labor implied its decreasing marginal productivity. This marginal productivity was represented by the wage paid at the time. The identity, or equilibrium, between wage and marginal productivity could of course be disturbed, but only to re-establish itself For example, if the marginal productivity exceeded the wage, the demand for labor would increase until marginal productivity and wage again balanced. If the wage exceeded the marginal productivity, the demand for labor would go down until the identity of marginal productivity and wage was re-established. What held for wage labor would hold for all the other factors of production, so that in equilibrium all factors would share in the total iii come in proportion to their marginal productivity. In this way not only supply and demand but also the distribution of the social product were explained in terms of marginal utility (or disutility). And since every factor of production received the share of the social product corresponding to its contribution to social production, the existing distribution of income was not only economically determined but also just.
To some adepts of marginalism the inclusion of social production in the subjective value theory seemed uncalled for. To Bohm-Bawerk, for whom all production in the last analysis was only for the sake of consumption, it made no sense to make a special study of production or to speak of a dependence of income distribution on the marginal productivity of the factors of production. The production of capital was for him “indirect” production, by contrast with “direct” production, or production carried on essentially without the use of means of production. From this point of view, every production process that involved means of production would be a capitalist production process, even in a socialist economy. For Bohm-Bawerk there were only two factors of production, labor and land; he considered capital as a purely theoretical concept, not a historical one. All present goods represented means of consumption, and future goods including means of consumption appeared in the intervening time as capital goods and products of labor. Profit, of which he took account only as interest, arose not from production but from the exchange of present goods for future goods. Marginal utility decided the relative valuation of present and future goods.
According to Bohm-Bawerk interest was thus not only inevitable but also justified, as all production depended directly on the capitalists’ propensity to save, and workers, like landed proprietors depended on capitalist credit. Neither could live directly from their production, as this would require various periods of manufacture. While they were producing they had to live on products made at an earlier time. Anyone not willing or able to restrain his consumption and to save would have no claim to the interest due to the time factor. Although interest was the form in which the revenue is derived by a pro-from capital goods was paid or collected, it was a product neither of labor nor of capital but a gain due simply to the passage of time-so to speak, a gift from heaven. Interest was all the more a heavenly gift as it was equally the instrument of economic equilibrium and progress. It established the necessary equilibrium between current and future production by regulating the extension or contraction of capital investments in reference to the consumption requirements at any given time. As indirect production increased, moreover, the mass of consumption goods would grow, thereby decreasing the need for new saving for additional means of production. In this way social progress would manifest itself in a declining rate of interest.
It would not be worthwhile, however, to spend time on other exponents of the subjective value theory, just as it was hardly wrong to ignore it completely in its heyday. Marx had nothing to say about it, and for Friedrich Engels it was only a bad joke, although he thought it quite possible “that it is just as easy to build up ... [a]plausible vulgar socialism ... on the foundation of Jevons’s and Menger’s theory of use value and marginal utility.”
In fact, a section of the reformist Social Democracy did turn to ward the marginal utility theory out of the conviction that Marx’s alleged neglect of demand and its role in price formation had kept him from grasping the real interconnections of the economy. But even while the subjective value theory was gaining ground in the Social Democratic camp, it had already lost its persuasive power in the bourgeois camp and would soon be completely abandoned. Indeed, it is the rejection of the psychological conception of value by the bourgeoisie itself which renders superfluous a detailed critique of this theory.
The subjective value theory was discredited, first, by a theoretical refinement so excessive that it lost any visible connection with reality, and second, by the frank renunciation of the attempt to explain price by value. Joseph A. Schumpeter may be mentioned in connection with the first of these endeavours. From the standpoint of the Austrian School, from which he came, the value of final products, or consumer goods, depends on their marginal utility for the consumer, while the marginal utility of intermediate products, such raw materials and machinery is derived by a process of imputation from the marginal utilities of the final goods. For the consumer the various raw materials, means of production, and semifinished goods have no direct but only an indirect use value, but this is represented, through the process of imputation in the prices of the consumer goods. The same analysis was offered for commodity circulation. A distinction was made between first – order and second-order goods, the latter being those which have not yet entered into consumption and whose utility must be imputed to the marginal utility of the consumer goods. Schumpeter concluded from this that, seen theoretically, supply and demand are one and the same, so that the demand side is sufficient to state the conditions of equilibrium.
In Schumpeter’s conception of equilibrium not only were supply prices superfluous, since they could be understood in the form of demand prices, but profit and interest can be omitted as separate categories by including them under the rubric of wages. Equating production with exchange, Schumpeter saw no need to deal with utility or its opposite. He replaced the psychological concept of value with a logic of choices, since even the subjective concept allowed one to say no more than that a person, with given tastes and income, is guided in his purchases by the given prices. Schumpeter had no interest in investigating the fundamental factors which determine consumer choices but took them as the given starting point for economic analysis. The logic of choice was sufficient for the mathematics of equilibrium, which on this abstract level admittedly had no real significance. Nevertheless', the “pure theory” was supposed to be a means to the understanding of reality and to stand in the same relation to it as theoretical mechanics to practical engineering. In any case, “pure theory” was a valuable pursuit in itself because it was interesting in its own right and satisfied human curiosity.
Among others it was notably Gustav Cassel who strove for the abolition of the marginal utility theory because of its vicious circularity. Although the theory was supposed to explain prices, prices were made use of in the explanation of marginal utilities. As business is transacted in terms of measurable quantities, money and prices, in Cassel’s view the analysis of those transactions required nothing but price concepts, so that economics had no need of any theory of value. On the assumption that economic relationships are determined by a general “scarcity,” Cassel saw the task of economics as the optimal adaptation of people’s various wants to the insufficient means available for their satisfaction.
The derivation of prices from the scarcity of goods can of course only explain one price by another and leaves the question of what lies behind prices unanswered. Bourgeois economics, however, sees no need to pose this question. It has therefore abandoned the original doctrine of marginal utility, as it can make do without it and is able to return to it, when necessary, with the assertion that in the final analysis prices express consumers’ subjective evaluations. Indeed, it came to be said that modern economic theory became an objective science just because it is based on the subjective. According to Ludwig von Mises, people’s needs are observable in their behavior, which requires no deeper investigation; they are to be taken as they are given. Since the marginal utility theory was finally boiled down to an identification of the economic realm with the domain of the price mechanism, the various attempts to substitute psychologically grounded marginal utilities for the objective value theory must be considered to have failed. They led only, to the elimination of the value problem from bourgeois economics.
Although the concept of marginal utility was abandoned, marginal analysis remained generally accepted by bourgeois economists. According to Joan Robinson, this showed that even metaphysical concepts, which are strictly speaking nonsense, have made a contribution to science. “ As an instrument of analysis the principle of the “margin” is no more than a generalization of Ricardo's idea of differential rent. Ricardo believed the price of agricultural products to depend on the yield of the least fertile soil; mutatis mutandis, the Ricardian law of diminishing returns is supposed to hold for industry just as for every other sort of economic activity and to determine prices and their fluctuations. The individual am ranges his purchases, on the basis of the given prices, in such a way as to obtain the maximum satisfaction available with his income; in the same way, since all individuals follow this “rational” or “economic” principle, the interdependence of prices produces a general price configuration in which supply and demand are balanced. When the total demand is equal to the total supply, all prices are equilibrium prices; conversely, application of the economic principle (or marginal principle) leads to prices which represent a general equilibrium. Thus “pure theory” was anchored by the all-embracing marginal principle, on which the price theory in all its detail was built.
It is not worth the consumer’s effort in daily life to “optimize” the distribution of his expenditures by the application of marginal calculation apart from the question of whether he is in a position to do so. In the behavior of the capitalist entrepreneur as well, marginal calculation does not play the role assigned to it by the economists. To be sure, the latter admit that their theoretical reflections do not picture the world as it really is. But they are supposed to be close enough to reality to have practical validity over and above their value as scientific knowledge. The fact that entrepreneurs transact their affairs without troubling themselves about the calculation procedures of theoretical economics does not prevent the theorists from finding confirmation of their theories in practical economic life.
Of course, this requires translation of “ideas from the businessman’s language into that of the economists, and vice versa.” This would reveal that the theoretical “explanation of an action must often include steps of reasoning which the acting individual himself does not consciously perform... . [T]he construction of a pattern for the analytical description of a process is not the same thing as the actual process in daily life; and we should not expect to find in daily life the definite numerical estimates that are part of the scientific pattern.” While it is conceded that the behavior of consumers and businessmen also displays “uneconomic” elements, both must on the whole operate rationally, that is, strive for maximum gain at minimum cost. Entrepreneurs must consider the proportional relations between their production and the existing demand, and between their production and the capital invested and the wages paid out, as well as make choices with respect to means of production and raw materials. In brief, they must proceed in accordance with the principle of the marginal rate of substitution. According to this principle the economic optimum is reached at the point where further alterations in the combinations of the multiple factors of production would yield no additional profit, the marginal rate of costs then coinciding with that of benefits.
What we have here is thus not so much a matter of economics as a more precise than normal calculation of expenses and receipts. But at the same time, this method of calculation is viewed as the basic principle of all economic phenomena, since it establishes a common denominator for all exchange relations by means of the simple identification of value and price. In this way it eliminates a major defect of the classical theory of value. Although they founded their theory on an explanation of the phenomenon of value in terms of social labor time, the classical economists had nonetheless spoken in the same breath of individual market prices. Since they saw the true content of political economy as lying in the question of the class distribution of the social product, they struggled to show how individual prices are determined by social value relations. With the appearance of subjective value and “pure price theory,” the realm of economic questions was reduced to that of exchange, and the problems posed by the classical theory, like those of the relation between value and price and of distribution, could thereby be ignored. Now the marginalists saw distribution, just as the classical economists had seen production, as regulated – whatever the outcome of the process by the price system. The problem of distribution ceased to exist as a topic for theoretical economics. It was integrated into the general problem of price formation, since the different forms of revenue were treated as prices of factors of production. Since all prices are functionally related to each other, the solution of the general price problem already includes the solution of the problem of distribution.
In this way all questions about the economy were to be dealt with in terms of one principle. This principle had the form of a calculus that could pass for neutral with respect to any particular economic viewpoint. In the eyes of its advocates, marginal analysis and the concept of equilibrium derived from it gave economics, for the first time, a positive, scientific character. The marginalist calculus, however, rested on no more than the old illusion, inherited from the classical theorists, of the possibility of an equilibrium of supply and demand and the possibility of price formation as governed by this equilibrium. The very nature of the mathematization of economics on the basis of marginal analysis led to the conception of equilibrium in terms of a static model. Since the capitalist economy in fact knows no steady state, static equilibrium models could not be confirmed by reality; and the mathematical expressions, while undeniably exact, “related not to the content of economic knowledge but to the technique of mathematical operations.”
In contrast to Marx, for whom the assumption of a static condition (in his terminology, simple reproduction) was only a methodological device to exhibit the necessary dynamic of the capitalist system, bourgeois economics saw its static model of the economy as furnishing “scientific” support for the hypothesis of a tendency toward equilibrium. The endless playing around with such equilibrium models gave rise to the conviction among theoretical economists that this mental expedient is a prerequisite for economic analysis, even though they admit that the actual economy is never in perfect equilibrium. Just as every machine can be in need of repair, the equilibrium of the economic system can be disturbed by internal or external shocks. In either case only equilibrium analysis permits identification of the reasons for the disturbances and allows for the discovery of the factors needed to re-establish equilibrium.
The idea of the equilibrium of supply and demand, imposed on the market through competition, has thus remained a common theme of bourgeois economics from the time of Adam Smith and Jean-Baptiste Say to the present, however the foundations of this hypothesis have been transformed and however unrealistic they have meanwhile become. The question that neo-classical theory set itself was not how the price system really functions, but how it would function if the world were as the economists have imagined it. This theory required the equilibrium principle in order to see the price system as the regulator of the economy, and it required the amalgam of the pure price system in order to be able to pass off the actual state of affairs as rational and therefore immune to attack. But this all added up to no more than a new version of Adam Smith’s “invisible hand” in mathematical formulas, together with Say’s conviction that every supply brings with it an equivalent demand.
Neo-classical theory not only remained at the level of bourgeois economic science’s first results but fell far short of it, since the equilibrium approach makes it impossible to investigate the real dynamic of capital, the accumulation process. ‘The freeze-frame image of static equilibrium did not allow predictions about the process of development. While the fact of economic change of course could not be overlooked, it was treated as self explanatory, Since they could not abandon the static equilibrium conception without declaring their own theoretical bankruptcy, the market theorists limited themselves, in dealing with development, to “comparative statics:” the features of one non-existent equilibrium were compared with those of a later non-existent equilibrium, in the hope thereby of registering economic changes in the actual world. But since there is no profit or any other sort of surplus in the neo-classical equilibrium, there can be no expanded reproduction of the system. To the extent that it nonetheless occurs, it falls outside the framework of theoretical economics.
In contrast, the classical economists had directed their attention to the accumulation of capital, the growth of national wealth. Their theories of distribution started from the necessity of accumulation and inquired what factors would favor or hinder accumulation. The profit economy was for them the condition sine qua non of accumulation. The pursuit of profit thereby served the community because on it depended the improvement of living conditions through increasing production and productivity. Market problems were subordinated to those of accumulation and governed by the law of supply and demand. Under the conditions of general competition, exchange was considered to be a process regulating the economy in the framework of continuous social development.
This self-regulating and therefore crisis-free economy of classical theory confronted a refractory reality. The accumulation of capital took place not as a smoothly continuing process but as one interrupted periodically, since the beginning of the nineteenth century, by profound crises. How were these crises, clearly contradicting the dominant economic theory, to be explained? Although the classical economists, especially Ricardo, concentrated on the accumulation of capital, at the same time, they shared Say’s conviction that the market economy is a self equilibrating system in which every supply will find an equivalent demand. According to Say every person produces with the intention either to consume his product or to sell it in order to acquire other commodities for his own consumption. As this holds for all producers, production must naturally be balanced by consumption. If all individual supplies and demands match, social equilibrium results. This state can of course be disturbed from time to time by an oversupply of a particular commodity or an insufficient demand for another. But the price changes produced by such partial disequilibration lead to the restoration of equilibrium. Apart from such disturbances in particular markets there can be no general overproduction, any more than accumulation can overstep society’s propensity to consume.
Thus the classical economists’ theories of accumulation were combined with a static conception of equilibrium that obliged them to explain disturbances of the system’s equilibrium by reference to factors outside the system. The fact of crises of general overproduction led J. C. L. Sismonde de Sismondi to renounce classical theory and soon to reject the laissez-faire system as a whole. In his opinion it was exactly the general competition, based on nothing but prices, which, instead of resulting in equilibrium and general welfare, opened the way to the misery of overproduction. The anarchy of capitalist production, the passion for exchange value without consideration of social needs, gave rise to production in excess of effective demand and therefore to periodic crises. The underconsumption resulting from the unequal distribution of income was the cause of overproduction and the accompanying drive toward foreign markets. Sismondi was thus the founder of the theory, still widespread today, of underconsumption as the cause of capitalist crisis.
Among many others it was notably John A. Hobson who applied Sismondi’s theory to developed capitalism and related it to imperialism. In Hobson’s view, anticipating that later elaborated by Keynes, the demand for consumer goods, and with it the rate of capital expansion, falls as a result of unequal distribution and the increasing accumulation of capital. Since consumption cannot keep step with production, there are periodic crises, since part of the accumulating profits can no longer be profitably invested and fore lies fallow. Only the reduction of overproduction in depression makes possible a new beginning of the expansion process, which will lead again in time to overproduction and idle capital. Overproduction resulting from insufficient consumption also explains the need for foreign markets that characterizes imperialism and imperialistic competition. Hobson, however, was of the opinion that this state of affairs could be remedied by reformist government interventions in the economic mechanisms to strengthen consumer demand; in this respect he remained an ideological prisoner of the capitalist economy.
What should be clear here is that it was necessary to abandon the classical and then the neo-classical theories in order to come to grips with the reality of the economy. Viewed from a perspective defined by the allegedly self-regulating market mechanism, the actual economic processes were incomprehensible; this pushed Sismondi and Hobson to renounce the market-oriented theory. To deal with the capitalist crisis, as with social conditions generally, was also to reject traditional economic conceptions, to develop theories closer to reality, though without questioning capitalist property relations this is possible only to a limited degree. Attempts in this direction were conditioned not only by the dominant theory’s flagrant conflict with reality but also by the impact of capitalist competition on the development opportunities of backward countries. This accounts, on the one hand, for the empiricism of the historical school and, on the other, for the evolutionary perspective of institutionalism, both of which opposed the theories developed by the classical economists. In the process of capitalist accumulation, the advantage of those who come first represents the disadvantage of those they have left behind. Thus free trade appeared as an English privilege and monopoly that made the industrialization of less developed lands more difficult and the misery of their “take-off” appear unbearable. In the struggle against monopolistic competition, the principle of laissez-faire had to be abandoned and with it the theories of classical economics. This was not, as Rosa Luxemburg supposed, a “protest of bourgeois society against the knowledge of its own laws” but an attempt to use political means to reach a stage of development to which the ideology of free trade would be appropriate. It was only after they experienced the effects of the international competitive struggle that the economically weaker countries escaped the influence of English political economy and developed an ideology suited to state intervention and protective tariffs. That the historical school which flowered briefly in Germany only expressed the particular needs of competitively weak countries was already visible in the contradiction implicit in its doctrine: that it recommended in the national context what it condemned in the international.
To be sure, the adherents of the historical school of political economy endeavored to demonstrate that a distribution of income regulated exclusively by the market would lead to the pauperisation of the workers and would thereby call the existence of bourgeois society itself into question an apprehension seemingly corroborated by the rise of an independent labor movement. The remedy for pauperization was simply a more rapid and more orderly development of capitalism. In this way the historical school combined a nationally oriented economic policy with the social policy known as Kathedersozialismus (academic socialism), an ideology which rejected the abstractions of classical theory with the aim not of transcending them completely but of adapting them through historical criticism to particular national interests.
In the eyes of the historical school, economic knowledge was much more than a deductively established understanding of the market mechanism. It included also the inductive discovery of the historically determined, nationally specific, and extraeconomic aspects of the social totality and its development, so that assertions about the content of political economy were held to presuppose extensive historical research. Things did not progress beyond the level of research, however, since the continuing homogenization of the economies of the West, which accompanied the capitalization of this part of the world, also dedifferentiated economic theory, and the historical school lost its influence. It left behind the need it had awakened for an unprejudiced investigation of the empirically given phenomena of the economy, which finally precipitated in business-cycle research.
Although the economy remained afflicted by crisis and cyclical fluctuations, bourgeois economics still had no theory of crisis as an inherent aspect of the capitalist system but explained economic fluctuations in terms of events external to the economy. Jevons went so far as to connect crisis with extraterrestrial natural phenomena. He discovered that the periodic appearance of sunspots coincided with the outbreak of economic crisis. Supposedly the sunspots adversely affected the weather and with it agricultural production, whose decline led to a general crisis. Of course, this theory did not win many supporters. Although the weather certainly has some influence on the economy, crises have begun in periods of good weather, and a significant correlation between the weather and sunspots cannot be established.
Schumpeter, in contrast, attempted to explain the economic development resulting from the trade cycle and the cycle itself by reference to the nature of the capitalist system. Familiar with Marx’s theory, he was aware that all fundamental progress depends on the development of the social forces of production. But for Schumpeter the agents of new productive forces were the particularly energetic entrepreneurs who by their genius broke through custom-bound, monotonously repeated economic processes. He developed a kind of heroic theory of business fluctuations, seeing in them the dynamic of the capitalist system.
To this end, however, he made use of two different theories corresponding to two psychologically differentiated types of people. In the general equilibrium of “pure theory” there was no development. This corresponded to the fact that in the real world the majority of mankind was too sluggish and lazy in spirit to oppose the monotony of the static state. As we have already seen, in equilibrium there is no profit, the appearance of which indicates perturbation of the system, which will again be overcome by the counter-movements it provokes. So the problem is posed: how can situation that knows no development give rise to development?
Here Schumpeter had the advantage that he, as earlier an adept of the historical school, had not forgotten that economics did not need to be confined to the abstractions of supply-demand equilibrium. To account for its dynamic the capitalist system must also be considered from the historical and sociological points of view. But in the framework of economic theory he would consider only the special mechanism that would transform the static to a dynamic model. This mechanism he embodied in a type of person who, tormented or blessed by creative unrest, breaks by self-willed activity through the cycle of static equilibrium. This type, the innovative entrepreneur, always on the lookout for new industrial, scientific, business, and organizational projects that would quantitatively and qualitatively alter existing productivity and production, destroys the consumer-governed economic equilibrium in such a way that it can be re-established only on a new, higher level. This spontaneous, accidental, but ever recurring process produces the business cycle, at once creative and destructive, in which the dynamic of the capitalist system is played out. While certainly regrettable, it is unavoidable that adaptation to changing circumstances involves costs and misery. These disadvantages, however, Schumpeter thought could be mitigated with better economic forecasts and government interventions. In any case, in his view the inherent dynamic of the capitalist system was of greater importance than the problem of economic equilibrium with which bourgeois economics had almost exclusively occupied itself.
Even if it was only in his imagination that Schumpeter’s theory was relevant to the laws of capitalist development, this theory was nonetheless symptomatic of the profound uneasiness of bourgeois theoreticians about cyclical fluctuations and crisis periods, which were becoming more serious as accumulation progressed. The theory of a self-regulating price mechanism made the crisis phenomenon an unsolvable riddle. Schumpeter’s attempt to find a solution in the repeated violation of equilibrium conditions by a special kind of person was no explanation but only a confession that the equilibrium tendency attributed to the market was not to be found in the real world. As we have seen, this had already been recognized by the earliest economic critics of capitalism, like Sismondi and Hobson. But the simple statement that the theoretical harmony of supply and demand, production and consumption, was refuted by reality was in the end reduced to a mere description of obvious states of affairs, which in itself provides no explanation of the laws of motion peculiar to capital.
Unsolvable by the dominant economic theory, the problem of the nature of capitalist crisis could nevertheless not be ignored. Attempts were made to deal with it by empirical methods. This approach had been anticipated by the establishment of private institutions for the study of the business cycle with the aim of turning cyclical fluctuations to commercial account. From this arose a special branch of economic science, concerned exclusively with business-cycle research, which grew with the systematic multiplication of private and public data collection. Wishing to describe the course of economic events as it unfolds in reality, cycle research “made use of ‘pure theory’ only as an elementary theory.”
This rather minor concession to neo-classical economics was already an exaggeration, as business-cycle research could develop only in direct opposition to “elementary” economic theory. This theory dealt, as we have seen, only with the static equilibrium state, in which the course of economic events brings no change in the data. Such a stationary equilibrium was precisely excluded from the domain of cycle theory, as the latter dealt with the continuous transformation of the economy. While in the “elementary theory” deviations from equilibrium only led to the reestablishment of equilibrium, business-cycle theory did not deal with transient irregularities but attempted to lay bare the laws of motion of capital and to explain the phenomena of crisis. Success in this attempt would mean the construction of a dynamic theory of capitalist development transcending the static conception.
It goes without saying that the theory of capitalist development and its laws of motion long since formulated by Marx was intentionally neglected. The “unbiased” methods of the historical school were supposed to confer on business-cycle research the “objectivity” indispensable for knowledge of the actual process of economic events. In historical surveys of the changing market conditions and their oscillations, researchers attempted, on the basis of relevant statistics and with the aid of mathematical methods such as correlation coefficients, to trace the rhythm of economic life in order to determine its driving forces and internal relations. Of course, purely empirical research can yield no more than data; the facts, once determined, still require an explanation. For this a theory is required that would not only describe the business cycle but would also make it intelligible. But none of what seem to be dynamic theories of the business cycle investigates the causes of cyclical changes; instead, these changes form their point of departure and are taken as given. In these circumstances the business-cycle theories remain mere descriptions of the economic dynamic without exposing the nature of the dynamic itself.
The diversity of economic phenomena seemingly indicated a plurality of causes for the cyclical fluctuations and prompted the construction of various theories which, though confronting the same facts, distinguished themselves from each other by the emphasis laid particularly on one or another aspect of the whole process. Distinctions were made between economic and non economic, endogenous and exogenous factors responsible for the business cycle, while some opted for a combination of both to elucidate the rhythm of the economy. Sometimes money and credit questions, at other times technical matters, market discrepancies, investment problems, or psychological factors were pushed into the foreground and declared the decisive element of the whole movement. Starting from these various viewpoints, people sought the causes of crisis and depression in the events of the preceding period of prosperity and its decline or looked for means and ways to move from crisis to a new upswing.
The aim of business-cycle research was not a methodical and more exact description of the cyclical fluctuations observable in any case but the discovery of some way to intervene for the alleviation of crisis situations and for the “normalization” of the C changing economic processes with the aim of evening out the harsh alternation of boom and crisis. Cycle diagnosis was to lead, on the one hand, to the formulation of a prognosis facilitating the adaptation of economic activity to a given trend of economic development and, on the other, to the attempt to stabilize the economy over the longer term through a cyclical policy counteracting the automatic course of the cycle. Business-cycle theory thus saw itself as an applied science whose forecasts, even if they remained abstract, still permitted the drawing of analogical conclusions of possibly practical significance.
Of course, cycle theory did not call the social order into question and therefore remained from the start limited to the investigation of market phenomena. Not the essence of capitalism but its appearance formed the domain of business-cycle research and served as the basis for the various theories in which it clothed itself. According to the cycle theorists it is the obscurity of the developed market economy and the ignorance or misunderstanding of economic conditions that are the causes of the disproportional economic development in which the business cycle manifests itself. Consumption lags behind production, credit expansion leads to over investment, profits decline due to an unjustified expansion of production, so that at a certain point, the point of crisis, the economy swings in the other direction. Then investments lag behind savings, the saturated market finds no effective demand, capital values are destroyed, production decreases rapidly, and unemployment gains ground. The crisis and the period of depression that develops out of it make a clean sweep of the excesses of the period of expansion until the requisite economic proportions are restored, making possible a new upswing, which of course will in its turn meet its high point and collapse into a new crisis.
This represented an accurate picture of the economic events produced by capitalism’s tendency to crisis, but it did not explain this tendency itself The cyclical movements appeared in this view to be departures from a normal course of affairs which without them would run smoothly. We see here the presence, in the minds of the business-cycle theorists, of the equilibrium mechanism of “pure theory,” a mechanism which to be sure can work only by way of irregularities, so that the proportionalities necessary for the “normal” course of the economy must be established through the ups and downs of the cycle. The business cycle was seen as the actual form of the equilibrium tendency of the market mechanism. It evidently followed that an exact knowledge of the factors responsible for the deviations from the norm could open the way to the conscious use of economic instruments to alleviate or eliminate the harmful sides of the cycle.
According to this view the capitalist economy is characterized by both static and dynamic tendencies, of which the latter condition the former. It follows from this that “pure theory,” the static equilibrium approach, ought to be subordinated to the bus-mess-cycle theories, since it applies to a situation that arises only momentarily, as a point of transition toward the perpetually changing conditions, and that could therefore yield no information about the real position of the economy and the direction in which it was moving. Although the partisans of the theory of general equilibrium claimed only that it was an abstract representation of the price system without direct correspondence to real economic processes, they nevertheless insisted on its heuristic value for the study of economic relationships. From their point of view even business-cycle movements could be considered as proof of the factual existence of equilibrium tendencies, since the departure from an equilibrium state taken as a norm is finally followed by a restoration of equilibrium. Whatever brings them about, these deviations will in turn be annulled through the system’s own equilibrium mechanism, so that equilibrium theory cannot be denied the front rank among economic theories.
Some bourgeois economists went so far as to deny the very existence of the business cycle. For example, Irving Fisher found no justification for speaking of a business cycle, as the term referred to nothing but the record of economic activity at a level above or below the average. The supposition that these phenomena were characterized by a definite periodicity and that this opened a way to the making of economic predictions was untenable so long as the economy was governed by changing price relations. In Fisher’s view it was more important to show how the economy would function if there were no cyclical deviations so as to understand the character of these disturbances and to counteract them where possible. In the end a division of labor developed within economic science that preserved the equilibrium approach for the “pure” theorists and left the field of business-cycle analysis to the more empirically oriented economists.
Aside from the fact that there exists no unbiased empirical research, it is also worth noting, as W. C. Mitchell was led to see by his own experience, that two observers can interpret and utilize the same empirical material quite differently. Accordingly, all statistical investigations must be looked at with a skeptical eye, a requirement that of course is often forgotten, since simply as a result of being published, numbers and tables acquire an authority that in reality they do not deserve Oscar Morgenstern has pointed out that the statistics relevant to the amplitude, the interactions, and the historical correspondences of cyclical waves are completely uncertain, although this flaw is for the most part ignored. The accepted data are not free from error and the judgements made on their basis are open to doubt.
Despite the acknowledged deficiencies of statistical techniques and the conflicting interpretations of the data, the results obtained by this kind of research do reveal the cyclical movement of capitalist development. But this only confirmed what was already obvious from the qualitative side. The series of crisis years – 1815, 1825, 1836, 1847, 1857, 1866 – suggested the existence of a ten-year cycle, although it could not be established why the industrial cycle had this particular rhythm. Later crises and the data worked up from past crises pointed to a less pronounced regularity in the onset of crisis periods, which in any case had different effects in different countries. Of course, it could also be shown that with the passage of time the phenomena of crisis took on an evermore international and uniform character. The more exact analysis of statistical time series yielded both smaller cyclical movements within the two phases of the business cycle and so-called long waves encompassing shorter wave movements. The second of these put business-cycle fluctuations into the context of an underlying trend the “long wave” or “secular trend,” with a wavelength estimated, depending on the calculation, at either twenty-five or fifty years.
All these cases represented different uses and interpretations of statistical time series, which by themselves could lead only to provisional statements of probability. The “long wave” theory has nevertheless maintained its power to fascinate until today, since on the one hand it allows the bourgeoisie to sink the irrefutable Marxian law of crisis in a mysterious, epochal wave motion of economic life, and on the other hand it gives the critics of bourgeois society an opportunity to adhere to the inevitability of crises despite their changing periodicity. But the statistical data themselves offer no explanation for the “long waves,” since the hypotheses are lacking that alone could lead to their interpretation.
From these bewildering descriptions of various types of cycles neither can short-run predictions be made nor long-range policy be defined, as every cycle has its particular character and accordingly calls for measures tailored to it, and hence not decidable in advance, with equally incalculable consequences. Although a cycle policy in the broad sense is a practical impossibility simply because of the private interests that govern society, it was nonetheless attempted to make the overall trend of business perceptible to the general public by means of so-called business barometers, in the hope thereby of influencing the economy in a beneficial way. The disappointing results of this attempt put an end to it, and business-cycle research remained a field within economic history.
Various theories of capitalist crisis, aiming in their results at the confirmation of preconceived ideas, had already been suggested without reference to cycle research. Some took the hypothetical equilibrium as their point of departure, only to show how it was violated in reality. The economy could expand free of crisis only if all its elements develop at the same time, something which, unfortunately, is never the en Se. The balancing mechanism does not operate directly but manifests itself only when the various deviations from the necessary proportionality reach their limits. The demand for commodities cannot be discovered in advance, for example, and production and its volume therefore cannot be adjusted to it. So production exceeds demand, which leads to declining profits, bringing the expansion process to a halt and releasing the crisis. This process is accentuated by the credit system, since low discount rates stimulate new investments, which then affect the whole economy to a point at which the extension of credit comes up against the limits of bank reserves and with this comes to an end. The resulting rise in interest rates leads to deflation, which also grips the whole economy and introduces a period of depression. The reduction of demand relative to production and capital accumulation arises either subjectively, from the decreasing marginal utility of the increasing quantity of consumer goods, or objectively, from the shrinking consumption of the working population as determined by the wage system.
In opposition to such views the adherents of “pure theory,” who not only started in their reasoning from equilibrium but remained there, insisted that the crisis situation should be blamed not on the system but on arbitrary disregard for or interference I with its regulatory functions. They took their stand on the absolute validity of Say’s law of the market and consequently found it self-evident that when more is consumed, less will be invested, and when more is invested, less can be consumed. In either case the equilibrium of production and consumption remains intact. Of course, to err is human and can lead to bad investments; the consequences of such errors, however, disappear of themselves as entrepreneurs adapt to the changed market conditions. There is no point in racking one’s brain over the crisis since the price mechanism also makes it possible to overcome whatever distortions of the economy may appear. That these distortions can end up having very far-reaching effects in one or another phase of the cycle is a reflection less of the nature or the system than of the psychological properties of human beings. Although objective changes engender cyclical movement in the economy, saying this leaves unanswered the question:
why is this movement first pushed so far in one direction, only to be later reversed? Why does it lead to an incorrect relationship between consumption and production over time, instead of a permanent, one-time change in this relationship? This question can only be answered in a non artificial way by a “psychological” theory.
The course of economic affairs can only be said to be dynamic “when we find, on the highest level of theoretical abstraction as well as in reality no tendency toward the establishment of a static equilibrium.” The assumption that there is such a tendency in the construction of theories, whether they denied or recognized the tendency to crisis as well, ruled out from the start any real insight into the dynamic of the capitalist system. Such theories must always be in contradiction with reality, despite the greatest efforts to escape this. The futility of trying to comprehend capitalist development with the methods of classical and neo-classical theory led in the bourgeois camp itself to a sharp critique of these theories and to new attempts to approach the laws of development by other paths.
According to Smith and Ricardo, the ultimate basis of economics was human nature, particularly the propensity to exchange, by which man is differentiated from animals. The division of labor, classes, the market, and the accumulation of capital were seen as natural phenomena that neither could be nor should be changed. Moreover, the political economy developed in England took up the ideas of the French physiocrats, notably the assumption that a smooth-running economy is in the nature of things, and that everything will turn out for the best if this natural order of things is undisturbed. The physiocrats’ theme song, laissez faire, became a moral element in the classical theory. While this moral principle was exchanged –to some extent already by Ricardo and after him even more widely – for conceptions borrowed from Malthus and Darwin, the capitalist mode of production nevertheless continued to pass for a nature-given order.
With Social Darwinism we see the bourgeoisie at the high point of its self-understanding. It had no more need of illusions about the character of society. The class struggle was confused with the general struggle for existence, with which all progress is patently connected. For the Social Darwinists every individual person is in competition with every other person, and this competitive struggle has nothing to do with the particular social relations of capitalising but expresses the operation within the economic realm of a law of nature. If one person is more successful than another, this is because they have had different social opportunities but because of their differing individual aptitudes. If one can abstract from class divisions, one might as well abstract from the relations of production in which they manifest themselves.
As a theory of evolution Darwinism implied a slow but continuous transformation of nature, society, and mankind. Accordingly, the present state of society must also be regarded as transitory and hence as a process that could not be comprehended by means of the statics of “pure” or orthodox theory. According to Thorstein Veblen, the founder of the American “institutionalist” school, orthodox theory’s neglect of development and its treatment of social relationships in isolation from any but abstract economic aspects prohibited any real insight into socio-economic reality. The transformations of society are to be seen, according to Veblen, in the changes of its institutions, by which he meant the culturally developed customs or habits of thought and feeling that he thought determine the way and manner in which people satisfy their vital needs. Cultural development is a slow but uninterrupted process of small but cumulative changes that results in new customs and new social relations.
The current result of this general process of development and the accumulation of experience is, according to Veblen, a set of customs or institutions whose expression we see in the machine process of production and in capitalist entrepreneurship. Although they developed simultaneously, these institutions are in conflict: the aim of the first is goods production, that of the second, money making. While industry represents the material basis of modern civilization, this civilization is controlled not by industry but by businessmen. From this arises all the absurdities of the economy and its crises.
The profit motive that dominates the economy conditions both its rise and its decline. Profits arise from the difference between the cost prices and the market prices realized. The value of an enterprise, however, is estimated by reference not to the profits it actually earns but to expected future profits. The nominal capital value differs from the actual capital value, but it is the former that determines the credit worthiness of the enterprise. Competition compels the increase of productivity, the expansion of the enterprises, and therefore of their borrowings, which affect future profitability. So long as there is enough money to be borrowed and the prosperity engendered by expansion holds, the growing sum of capital value represents no problem. Otherwise, however, a divergence arises between the inflated capital values and their actual profits that leads to a process of liquidation and the depression to which this gives rise.
Thus prosperity bears the seeds of its own demise. Productivity and production increase as profits grow in tandem along with credit and the accompanying price increases, until the extension of credit comes up against its own limits and those imposed by the contraction of profits. As loan capital becomes scarce and interest rates rise, the earlier relationship between the profits expected and the capital invested on this basis changes, compelling a deflationary revision of capital values. To this are added the causes of sinking profitability resulting from production itself, such as rising wages, a decreasing intensity of labor, and the spreading disorganisation of the enterprises, which arises from the hectic character of the boom.
Though Veblen’s description of the course of the business cycle does not differ from those given by others, he does however relate it to the conflict between production and capitalist production. He sees that it is only because the aim of production is the in crease of capital rather than the satisfaction of human needs that the lamentable conditions of capitalist society, and the crises characterized by overproduction and underconsumption, arise. Unlike other observers, Veblen saw crises not as phenomena determined by equilibrium relations and representing nothing but temporary deviations from the norm, but as the normal condition of capitalist society as soon as it has attained a certain maturity. From the crisis cycle of an earlier period arose the chronic crisis of developed capitalism, which could be eliminated only by a transformation of the social system.
Since there exist no static state and no economic equilibrium, it cannot be expected, according to Veblen, that the capitalist system will develop continuously despite or by means of its cyclical fluctuations. The system as such contains no equilibration mechanism. During the money-and-credit society’s period of ascendance, the periodicity of crisis had nothing to do with the system itself but was most likely due to external circumstances. The divergence between capitalism and profitability could still for a while be controlled by extra systemic means, such as monetary inflation or an enlarged and cheapened gold production and the price increases bound up with this. The crises that periodically arose were for the most part commercial crises, quite different from the crises of industrial society. With the development of the latter, the contradiction between the exigencies of capital and the profits attainable cannot be even momentarily overcome. From this arises the chronic crisis condition.
According to Veblen it is of the essence of machine production, and the continually increasing productivity that goes with it, that under competitive conditions prices fall and the profit of a given capital declines. The maintenance of profits requires the enlargement of the individual capitals. Thus a sort of race begins between capital expansion and the tendency of profits to fall, which of course only the latter can win. As capital values and the attainable profits increasingly diverge, an attempt to combat this is first made through trustification and monopolization. Monopolization, however, gives rise to monopolistic competition and a new start to the race. The need for profitable prices is then met by an extraordinary growth of unprofitable consumption a production of waste; but this encounters impassable barriers. [he end result is a situation that can only be described as one of chronic crisis. Veblen believed that this no longer surmountable crisis already existed and accordingly, that a general breakdown of society could be avoided only by the replacement of the economic system (as a money-and-credit system) by another system of production.
This new system would be the existing system of production without its capitalist perversions. It was for Veblen already anticipated iii the widening split between ownership and management and in a growing consciousness that industrial production can progress without the capitalist institutions parasitic on it. The increasing sabotage of industrial development by the decay of profit production (together with the growing significance of technology and machine production) would destroy antiquated customs and allow new ones to arise that were better suited to industrial production and to further social development.
As it became a branch of bourgeois economics, institutionalism, despite its critical moments, lost much of the consistency to be found in Veblen’s work. If Veblen (like Adam Smith) could in the last analysis only trace the ruin of capital back to the effects of increasing competition, his aversion to capitalist civilization extended to all its aspects. The critique made by his followers, in contrast, arose more from anxiety about the threatening end of capitalist society than from a desire for new social relations. For them the irresponsible behavior of the powerful “profit hyaenas” drove the system to collapse; thus “Institutionalism is a call to action, an SOS to save a sinking world.” Conscious intervention in economic processes was necessary if a way out of the spreading misery was to be found. Orthodox theory offered no handle on a solution to the mounting social problems and conflicts. Here institutionalism wished to be of help by suggesting a set of reform measures, pointing in the direction of a planned economy, that would overcome the defects of competitive capitalism.
With this to offer, institutionalism could win no extensive or lasting influence and was seen as a curiosity, capable only of serving, in a modified form as an ideological foundation for temporary government interventions in crisis situations. It played all the greater role in various reform movements, particularly in the English Fabian Society. Orthodox theory subdivided into numerous specialities subordinated to ‘pure theory"-controlled the field of theoretical economics, offering a rapidly growing number of academics the opportunity to make a relatively good living. The purely ideological function of theoretical economics was also evidenced by the growth of business schools, dedicated to the practical life of business, which remained undisturbed by theoretical economics.
As an ideological apologia for the capitalist system, theoretical economics found itself more and more embarrassed thanks to its increasingly obvious irrelevance to real economic affairs Since it could not approach this reality without renouncing itself it took the opposite road to greater abstraction in order to be able to escape every confrontation with reality It now no longer investigated merely the economy but a principle of rationality, purportedly relevant to all human action, which adapts scarce means to alternative ends in order to achieve the best possible result. Economics concentrated, in this conception,
on a particular aspect of behavior, the form imposed by the influence of scarcity. It follows from this, therefore, that insofar as it presents this aspect, any kind of human behavior falls within the scope of economic generalizations. We do not say that the production of potatoes is economic activity and the production of philosophy is not. We say rather that, insofar as either kind of activity involves the relinquishment of other desired alternatives, it has its economic aspect. There are no limitations on the subject-matter of Economic Science save this.
This extension of economics to every subject matter as a principle of rationality was at the same time its reduction to a purely analytical procedure, which prohibited it from saying anything at all about the economic system itself. Thus economic crisis, too, lay outside the sphere of interest of economics, and it required a worldwide crisis, shaking the globe for years, to overcome this lack of interest.