Welfare economics

The process we have tried to explain over the past few paragraphs is called partial equilibrium, because it tries to deal with forces that tend to equilibrium in a single market (industry). It is associated with the economist Marshall. At least we might give it credit for trying to set up a simplified model by which to comprehend external reality. General equilibrium in neoclassical economics is completely metaphysical and apologetic in intent. This area is sometimes called welfare economics, because it doesn’t just describe (actually, it doesn’t describe at all) but also assesses and gives a ‘scientific’ basis for judging. Its basic assumptions were set out by the economist Walras over a hundred years ago. How does equilibrium arise throughout the economy? Walras at first starts with an exchange economy. Production has already taken place. How, and what the results were, is seen as uninteresting.

Is this right? Neoclassical economics starts with people's wants. But where do they come from? The textbooks say they are just 'exogenously given'. This is economist-speak for, “Search me, gov’ – I haven’t a clue.” Actually most of our wants are provided by the possibilities for humans given by the development of the productive system. It is quite likely that medieval peasants were bored on long winter nights. It is unlikely that they sat around wishing someone would hurry up and invent television. And the idea that these days giant oligopoly firms make their money by 'giving people what they want' is quaint, but naive. On the contrary they spend vast sums making sure we will want what they give us, by manipulating people's wants through advertising and other means.

Marxist economics starts with the production of values and surplus value. Exchange and consumption are not seen as unimportant; they are seen as integral and part of a cycle where articles of production are sold and consumed either by workers and capitalists or in the production process. Consumer goods are sold to workers and consumed to keep the working class in existence. This process is called the reproduction of the human and material conditions for capitalism.

General equilibrium

For Walras all this is irrelevant. Exchange takes place. The only question is, on what terms? First he postulates an auctioneer. The auctioneer needs to work out exchange ratios and then introduce money. We will criticise this procedure a little later, but stick with his exposition for a little while. The auctioneer calls out prices at random for all the commodities in the auction….for instance ‘Ferrari – 9p, box of matches - £30,000.’ He finds to his surprise that, at these prices, there is excess demand for Ferraris and excess supply of match boxes. He then keeps adjusting prices till excess demand and excess supply have been eliminated throughout the economy. This iterative process is very similar to the adjustment process suggested by the socialists in the socialist calculation debate. Walras calls this process ‘tatonnement’, or groping towards relative prices that optimise utility (happiness). All is harmony. Ye gods, why does he adopt this procedure? This demonstration is supposed to show two things: first that general equilibrium is possible. And secondly that the prices of commodities are determined by demand conditions, by how much people want them (utility). In that sense the allocation of resources is optimal. After all, if people are prepared to pay much more for a Ferrari than a box of matches, then that’s because they must want it more (value it more).

Welfare economics really is a topsy turvey world. We have the phenomenon described by welfare theorists as ‘false trading’ (trading at non-equilibrium prices). This is real trading by real people. Because they jump the gun and don’t wait for the auctioneer to set the prices that maximise everybody’s utility (and after all the auctioneer doesn’t actually exist) they prevent an equilibrium of ‘real’ (fictional) welfare maximising prices being established.

Walras forbids us to raise two points. The people who bid for expensive things like Ferraris might have more money than those who don’t. (Isn’t this your experience?) The reason for the pattern of demand shown by the equilibrium outcome might be because of the initial distribution between rich and poor. We are not allowed to investigate this because it is ‘exogenously given’ and outside the sphere of economics. Not for Marxist economics, it’s not! We explain why the many start poor and why they stay poor under capitalism.

The second issue we can’t raise is this: isn’t it possible that Ferraris are dearer than boxes of matches? Isn’t the socially necessary labour time to make a Ferrari much greater than to produce a box of matches? But, Walras says, let’s leave production out of it and talk about a pure exchange economy.

‘Optimal’ capitalism

Markets, left to themselves, should not only make use of all resources, they should do so efficiently (wisely). Here’s how. If all markets are competitive, prices will be equal to marginal cost - that is the cost of the last unit produced. Now the demand curve for a product may be regarded as showing the benefits people regard themselves as getting from a commodity. So when supply is equal to demand in a market, that means marginal cost is equal to marginal benefit. And it can be proved (!) that this is the optimum position. In technical terms it is a Pareto optimum after the economist who devised the concept. (Vilfredo Pareto is invariably described as a liberal economist. He was also a fascist sympathiser. Mussolini made him a Senator of the Kingdom of Italy. Here is a typically drooling tribute after his death from the fascist Amoroso. “Fascism, having become victorious, extolled him in life and glorified his memory like that of a confessor of its faith.”)

A Pareto optimum is a situation where nobody can be made better off without somebody else becoming worse off. In the words of the moral philosopher Pangloss in Voltaire’s Candide, ‘all is for the best in the best of all possible worlds.’

Some criticisms

The real capitalist economy can never approximate to the idealized model in the economic text books. This is because of unavoidable ‘market imperfections’, such as:

· Monopoly (and oligopoly). There is an inevitable tendency towards monopoly and oligopoly in some industries because of scale economies and other reasons. If it is cheaper to produce each unit as we produce more units (and, after all, that is what modern machinery makes possible), then the first firms that gear up for large scale production will destroy the competition. So the industry will be dominated by one, or a few, large firms. That is the reason US car production has been dominated by only three giant firms – Ford, General Motors and Chrysler for nearly a century. But then the firm or firms will be operating in a monopoly or oligopoly market and will be in a position to raise prices above marginal costs. But if large scale production is more efficient, they might still be able to undercut small producers, even while exploiting consumers. If we’re going to get a monopoly anyway, then better to have a publicly run, publicly accountable monopoly where any excess profits are used to defray the general expenses of the state.

For Marxists all real competition within capitalism is imperfect competition, not the fantasy of a fair fight on a ‘level playing field’.

· Natural monopoly. The extreme case of monopoly is natural monopoly, where even some welfare economists recognize the best solution is public ownership. Natural monopoly occurs where the efficiency gains of a single supplier catering for everyone are so obvious, that any competitor trying to enter the industry would be blown out of the water. Examples may include the provision of electricity, gas and water, sewage disposal, railways and telephone lines. Quite a lot, in fact!

· Externalities. Positive externalities. Education of others may make the country (and me) better off. So I can be better off even if I don’t receive the education. Then it would be quite reasonable to charge me, by way of the tax system, to pay my way for education as a general benefit. If only the people who got educated paid for education, there would be less of it around and we would all be poorer.

Negative externalities. Pollution may damage everyone in the vicinity of a polluting factory. This time the costs are off-balance sheet (In the last paragraph it was the benefits). So pollution is a negative externality. Such costs and benefits are not calculable by welfare economics. This can have perverse results, results which are very costly for ‘society’, for the rest of us, but not for the capitalist firm The firm belches out smoke and pollutes our air. It does so because this is cheaper than attatching a filter. The firm doesn’t have to pay the costs of hospitalisation and early death of workers with lung and respiratory illness caused by pollution. And once it’s in the air, you can’t ‘choose’ not to ‘consume’ the pollution. Paradoxically this affects the ‘consumer sovereignty’ of everyone. Even a millionaire in Mexico City can’t buy clean air, despite the fact that the pollution poisoning his lungs is the source of his profits.

If you think about it, externalities are so pervasive that they make welfare ‘optima’ extremely problematic. Economics starts with the assumption that the only beneficiary of a good is the consumer. In fact others may be affected positively or negatively. But markets measure the costs and benefits for the individual, not to society as a whole.

· Public goods. The case of public goods, and commodities with some public goods characteristics is like the extreme form of an externality. Public goods benefit everybody, whether they pay or not. The classic textbook example is a lighthouse. A public park is another. A radio programme is a third. You cannot stop people taking advantage of the light from the lighthouse. In any case why should you? It doesn’t cost any more to light the way for two ships than it does for one. But capitalism, left to itself, cannot make money out of goods it cannot charge for. So making lighthouses universally available for free means taking them out of market provision. That is often the only way such facilities, that benefit everyone, will come into existence.

The point about these market imperfections is that they distort the signals given by prices as to the welfare benefits of equilibrium. They are not taken account of in the cash calculation. And they are so pervasive that they make any claim that equilibrium is optimal laughable.

Note that in any case the Pareto optimum position does not mean that everyone is equally well off. It may mean that no succour can be given to the starving without inconveniencing the gluttonous millionaire. Socialists may think this a funny sort of optimum. The Pareto optimum specifically abstracts from the distribution of income, which is ‘exogenously given.’ This fine phrase means we do not enquire into where the rich got their start in life.

Why are the many poor?

Marxist economics answers the question ‘how did the many start poor?’ with an analysis of primitive accumulation, the historical process of the dispossession of the toilers from the means of production and creation of a propertyless working class. We then go on to explain capitalist production as the production not just of commodities, but also of rich and poor. Reproduction is the reproduction not just of factories and offices, but of the capitalists who own them and the workers who labour in them. And accumulation of capital doesn’t just mean capital getting bigger; it means capitalists getting richer at our expense and a widening gulf between the classes.

Equilibrium and the future

Equilibrium is conceived by neoclassical economists as instantaneous, not a process working itself out in real time. General equilibrium, in its nineteenth century form, received a body blow a hundred years later in the work of Arrow and Debreu. Their papers were uncompromising and hard. But, they said, for welfare economics to mean anything, it not only needs a complete set of present markets, it also has to have a full set of future markets to cover every possibility. But this requires a complete knowledge of the future, which is impossible. We cannot possibly do justice to the Arrow-Debreu development of welfare economics. We are just alerting the reader that it is the existence of economic activity in real time that has once again scuppered neoclassical equilibrium. Arrow admits, “A complete equilibrium system requires markets for all contingencies in all future periods. Such a system could not exist.” (from Rationality of the self and others in the economic system p 393) Time is money, they say, and money is the link in time between past, present and future for all economic activity. As Frank Hahn comments on the equilibrium theory as a whole, “The most serious challenge that the existence of money poses to the theorist is this: the best developed model of the economy cannot find room for it. The best developed is of course the Arrow-Debreu version of Walrasian general equilibrium. A world in which all conceivable contracts are possible neither needs nor wants intrinsically worthless money.” (Money and Inflation p 1).

Money is necessary because we live in real time. But that’s where we all live! We later deal with the Cambridge capital controversy. This debate was really a dialogue of the deaf between equilibrium theorists and those who realised capitalism is an inherently dynamic system. Joan Robinson, the left wing Keynesian economist, was anxious to turn the debate into a wholesale assault on the notion of equilibrium. “The real source of trouble is the confusion between comparisons of equilibrium positions and the history of a process of accumulation. We might suppose that we can take a number of still photographs of economies each in stationary equilibrium…This is an allowable thought experiment. But it is not allowable to flip the stills through a projector to obtain a moving picture of a process of accumulation.” She characterised the debate as “history versus equilibrium.”

Capitalist dynamics, not equilibrium

Marxism is the analysis of capitalism as a dynamic system. Marx sets out to find ‘the laws of motion of the capitalist economy’, not its laws of stasis. His basic finding is that capitalism accumulates - brutally, inexorably. If equilibrium states exist at all, they are instantly destroyed. For Marx an economic law is a force pulling in a certain direction, not a proposition which is instantly and always true. Tendencies, such as the tendency for the formation of an economy-wide rate of profit exist only as forces lying below the surface of things. The creation of a single profit rate is never an accomplished fact, only a tendency. It comes into approximate existence only through capitalists relentlessly trying to get a higher profit than the average. Capitalism also has a contradictory tendency to destroy and devalorise capital, to shake up sectors of production and subject them to permanent technological revolution.

Money and economic dynamism

And why did Walras drag in this obviously fictitious auctioneer to do his dirty work for him? Walras, in the manner of neoclassical economists, can’t just assume money. He needs to explain why it has to be invented to smooth exchanges. In fact his explanation is no explanation at all.

Here’s Frank Hahn again, a neoclassical economist who was drawn into the controversies with the monetarists. “Monetary theory cannot simply be grafted on to Walrasian theory with minor modifications. Money is an outward sign that the economy is not adequately described by the pristine construction of Arrow and Debreu.” (On monetary theory p1)

For Marxists, money is not something to be invented – at least in the way the wheel or the computer was invented. It emerges out of the exchange process. In the first chapter of Capital Volume I, Marx deals with the commodity as a unity of use value and exchange value. Then, as one commodity is exchanged for another, the use value of one expresses itself as the exchange value of another. Already one commodity is functioning as a means of exchange. As exchange ceases to be an isolated act (twenty yards of linen equals one coat) and becomes general, then one commodity will evolve into a universal equivalent. From universal equivalent money becomes a general means of circulation. All the functions of money evolve from exchange as it becomes generalised.

Money is an indication of the dynamic character of capitalist relations. It functions not only as a means of present exchange but also as a means of future payment. In so doing it provides a link between the present and the future (as some post-Keynesian economists have recognised). Modern capitalism is characterised by chains of payment stretched out in real time. The severance of a single link in the chain can have catastrophic consequences for the system as a whole. It can provide a painful reminder to the capitalists that what they see as private labour is actually social labour - part of a global division of labour, an edifice erected entirely by private monetary transactions.

Marx was one of the first to explore the implications of the intertemporal existence of money and its consequences for the system.

Say’s law

Earlier economic thinkers, including Ricardo, had accepted a theorem known as Say’s law. This purported to show that a general crisis of capitalism was impossible. Say’s law can be summed up as ‘every seller brings his own buyer to market’. In effect Say was treating the economy as a giant swap shop, where products you didn’t want are exchanged for things you did want. This is actually quite similar to Walras’ approach. Marx on the other hand knew that the transaction from commodity to money (C-M) was analytically distinct from that of money to commodity (M-C). And it could be separated in time too. Marx explained how this happens in the real world where commodities are exchanged for money. The holders of money do not need to instantaneously exchanging their newly acquired money for commodities. But if the sellers sit on their money, then they are depriving some other commodity holder of the possibility of realising the product of their labour. So that seller is not bringing another buyer to market with him. Money after all functions as a store of value. Thus the possibility of a general crisis is posed. Why this possibility should turn into a reality is explained by Marx’s theory of crisis. Say’s law is dealt with in Theories of Surplus Value Vol II on p 500. Since “purchase and sale…”, explains Marx, “belong together, the independence of the two correlated aspects can only show itself forcibly, as a destructive process. It is just the crisis in which they assert their unity, the unity of the different aspects. The independence which these two linked and complementary phases assume in relation to each other is forcibly destroyed.” Nearly a century later, Keynes made similar points, without having read Marx. Say’s law is waved aloft by bourgeois economists to demonstrate how capitalism cannot produce crisis in times of boom, and quietly forgotten when the bad times return.

Is money neutral?

Money is not neutral in relationship to something separate called the real economy. That money is ‘neutral’ was the monetarist position justifying the horrible experiment on the British economy in the 1980s (and earlier after 1973 by the torturer Pinochet in Chile). The monetarist position from their theory was, ‘cut the money supply and nothing will happen to the real economy’. Employment levels would not be affected. After all we would always have full utilisation of resources under capitalism. These absurdities were shown for what they are, nonsense, but useful nonsense for the rich and powerful. Just to take the most obvious objection: cutting the money supply means real interest rates will rise. This will have an effect on the real economy, all right. Ask an improvident householder, up to their ears in debt. Ask a businessman who needs to borrow to stop his business going under. Whether money is ‘neutral’ or has real effects on the economy is a contended issue between Keynesians and other realists (who believe it is not neutral) and the neoclassical ideologues.

The non-neutrality of money is also an affront to the essentially timeless nature of neoclassical equilibria. For traditional neoclassical economists money is a ‘veil’. Draw aside the veil and you can examine the reality beneath. For us Marxists there is no objective reality separate from the ‘veil’ of money. The veil is part of the reality. Is money capital? Or is machinery and means of production real capital? Both these are only forms of appearance of capital as it circulates. Capital is in essence a relationship between people.

For post-Ricardian economists, on the contrary, money is a ‘numeraire’. In this they are following in the footsteps of the master. Ricardo began his analysis of the role of money in the same manner as Marx. “To begin with, Ricardo determines the value of gold and silver like the value of all other commodities, by the quantity of labour time materialised in them…When Ricardo suddenly interrupts the smooth progress of his exposition and adopts the opposite point of view, he does so in order to deal with the international movement of the precious metals and this complicates the problem by introducing extraneous concepts.” (Contribution to a Critique of Political Economy pp 170-171)

Marx then shows how, starting from the same assumptions as himself, Ricardo is diverted by the problems of the balance of payments into advancing what we would nowadays call a quantity theory of money. This theory suggests that money is just pumped out by the government. If the money supply doubles, the only effect is that each unit of currency buys half as much of the national product as before. Money is thus seen as an ‘add-on’ to the substrate of the ‘real economy’.

“(Ricardo) does not grasp the connection of this labour with money or that it must assume the form of money. Hence he completely fails to grasp the connection between the determination of the exchange value of the commodity by labour time and the fact that the development of commodities necessarily leads to the formation of money. Hence his erroneous theory of money.” (Theories of Surplus Value Vol II p164) This is extremely important when we come to deal with the so-called transformation problem. The school of post-Ricardians has foisted Ricardo’s concept of money on to Marx’s analysis.

For Marxists money is an indication that the economy is not a set of simultaneous equations. Money transactions introduce the notion of time into economics. Real time is the mortal enemy of static equilibria. It means that economic transactions, always in money, are messy and never settle into predictable patterns. This is an essential part of our criticism of the post-Ricardian ‘solution’ to the so-called transformation problem (see that section). Marxist economics is in essence dialectical, non-equilibrium economics.