I. Economics as Mechanics
“Faster growth is the answer to poverty”
The current economic policies are based on the current orthodoxy reigning among economists worldwide. This view, called ‘neoclassical economics’, argues that growth will automatically spread from the current boom sectors to the backward sectors, and that all that needs to be done is to accelerate growth. The Finance Minister concluded his 2007-08 Budget speech thus: “our human and gender development indices are low not because of high growth but because growth is not high enough.... As Dr. Muhammad Yunus, the Nobel laureate, said, ‘Faster growth rate is essential for faster reduction in poverty. There is no other trick to it.’”
How is growth to be accelerated? The neoclassical economists claim that Government intervention is harmful. According to them, all that needs to be done is to ensure that nothing interferes with the incentives for individual gain. The focus should shift, then, from macro-economics to the micro-economic environment, the level at which individuals make decisions.
Thus, in the name of accelerating growth, the supporters of this approach demand that various subsidies, supports, regulations and restrictions concerning the backward sectors be removed. For example, they demand that, in agriculture, official procurement of crops be ended, restrictions on private corporate procurement and contract agriculture be removed, ceilings on land holdings be removed, new seed technology be allowed entry and patent protection be strengthened for it, restrictions on agricultural import and export be removed, restrictions on domestic trade in agricultural commodities be removed, restrictions on commodities futures markets be scrapped, and so on.
For industry, they demand that labour laws providing security to workers be relaxed, and that the remaining sectors under the public sector be privatised or ‘opened up’ to private capital. Restraints on the entry of foreign capital into various sectors should be removed. Tariffs on imports should be reduced to very low levels. Such subsidies as remain, hidden or open, should be scrapped. All such measures, they say, stifle the incentives for individuals – the incentives for investors to invest, for workers to work harder or learn new skills, for farmers to switch to growing crops for which there is demand, and for the under-employed to shift to sectors in which employment is growing.
Once all restraints are removed, they say, capital will flow to low-wage regions and under-invested sectors, and raise the productivity of labour in them, thus improving incomes of the people in those regions/sectors.
In fact, they celebrate the growth that has been taking place in the last few years as proof of their theories. The Economic Survey 2007-08 proclaims: “Faster economic growth is... translating into more inclusive growth, both in terms of employment generation and poverty reduction.” Whenever there is a sign that GDP growth is flagging, they demand that yet more neo-liberal ‘reforms’ be carried out along the above lines.
Neoclassical theory
Picture of Milton Friedman
Behind such arguments lies a certain conception of the economy and society. In the seventeenth century Isaac Newton discovered the laws of the action of forces upon material bodies, known as classical mechanics.1 Just as Newton’s mechanics spell out the laws of motion of objects, the reigning school of economics, known as neoclassical economics, imitates Newtonian mechanics to analyze human society.2 It sees each participant in the economy – each worker, peasant, big landowner, capitalist, and so on – as an independent actor. Each one acts on his/her own, striving to get the greatest possible satisfaction (termed his/her ‘utility’). Neoclassical theory claims human beings’ actions throughout history have been (and will continue to be) driven by individual, selfish gain. Yet the sum of their strivings, pushing and pulling in different directions, brings about an ‘equilibrium’, a state of balance, which yields the greatest sum of ‘utility’ possible in the given conditions. (What exactly ‘utility’ is, and how, if at all, it is to be compared, measured or added up, was never meaningfully defined.)
In this conception, every participant in the economy is, in a sense, a trader, and the forces driving the actions of all these individuals are fundamentally similar. It portrays each individual – worker, land-owner, industrialist – as possessing some resource: land, capital, or labour, which it calls ‘factors of production’. The worker hires out his labour; the landowner rents out his land; the capitalist gives the use of his capital. Each does so for a price (the price of hiring labour is wages; the price of hiring land is rent; and the price of hiring capital is the rate of interest).
That price, according to the reigning theory, is determined by supply and demand in each market. According to the proportions in which these three factors – land, labour, and capital – are available in a particular society, their prices automaticallyand simultaneouslysettle at some equilibrium which makes full use of all of them. Where capital is scarce and labour plentiful, interest rates would be high and wages low. In that case, it would be attractive to capitalists to employ less capital-intensive methods of production, that is, hire workers rather than buy machines. If any of the three resources lay idle, its price would fall till it was fully absorbed. Full employment is a central assumption of this theory.
However, say the neoclassicals, if prices are kept artificially low or high by outside intervention, all factors might not be employed fully: the gears become sticky, as it were, preventing the machine of the economy from running smoothly. For example, if wages were prevented from falling to ‘equilibrium’ level by minimum wage laws, or by trade union action, capitalists would tend to buy machines that replace labour; and so some labour looking for work would remain unemployed. Thus unemployment, according to this theory, is the result of wages not being allowed to sink low enough.3
Price plays the key role in this theory. Price not only signals how much to use of each ‘factor of production’, but also how much to produce of each commodity. Every consumer, whether worker, peasant, capitalist, or landlord, whatever his/her income, is driven by the same considerations. Each consumer chooses what to spend on in a way that gives him/her the greatest possible satisfaction (‘utility’). This sends the required signal to the producer on what and how much to produce. When demand for a commodity grows, some consumers would be willing to pay more for it, and its price would rise. The higher price makes it profitable for producers to produce more of the good, and its production rises (with the increased supply, the price then falls, and further adjustments take place up and down till it settles at some equilibrium level). Again, any ‘interference’ with market forces is counter-productive: If the price of a good is kept artificially low (eg by price controls), it would deter capitalists from investing in producing that good, and hence it would remain in short supply.
This theory assumes that producers can shift their production seamlessly from one commodity to another. Each producer can adjust the quantity he/she produces. Each consumer too can shift his/her purchases from a given product to a substitute. No producer or consumer (or group of producers/consumers) can directly influence prices, since there is a large number of producers and consumers (if you price your goods higher than others, you will lose customers; if you price them lower, so will others, and you will not gain customers, but lose profits). Only when individuals increase or decrease their production or purchases do they affect prices, indirectly, by changing supply or demand. That is to say, perfect competition is assumed by the theory.
Nor could there ever be a shortage of demand in relation to production. The orthodox theory assumes that all that is left after consumption goes directly or indirectly toward investment. So the whole of income creates demand for what is produced.
The beauty of this theory is that, given the different quantities of land, capital and labour individuals possess, and their demand for different commodities, the laws of supply and demand work to deliver full employment and the maximum ‘utility’ possible for consumers in the circumstances automatically. If a change takes place in the conditions – for example, if more land, or labour, or capital, becomes available – the system automatically adjusts its mix of the three to absorb fully all of them. Like a pendulum which, when pushed, rocks back and forth but ultimately comes to rest on its own, the equilibrium, when disturbed, gets restored automatically.
Some aspects of classical theory appeal to us because they correspond to ‘commonsense’. We all know that if something becomes scarce its price goes up. And we also easily accept the notion that people are fundamentally motivated by the desire for individual gain, and that this cannot be changed; after all, is that not what we see around us every day?
The obvious fact is that this theory serves to justify capitalism. It provides a justification for profit and rent – these are presented as just the prices of hiring capital and land. (The problem of where the capitalist’s capital come from is not answered; it is assumed that he was thrifty, and saved it up.) And at any rate, whatever the distribution of wealth, unfettered capitalism is shown to maximise the use of resources of society; it maximises utility (whatever that means) in society; every participant in the economy makes individual, voluntary decisions – about how much to work, how to spend, and so on. Innate, immutable human nature (which, in its view, is greedy and selfish) is not suppressed, but harnessed; no section is oppressed, but a harmony of interests is automatically achieved. Any attempt to run counter to this system harms the interest of the whole of society.
Questioning this economic orthodoxy
With the onset of the Great Depression in 1929, certain economists (the best known among whom was Keynes) began questioning parts of the above theory. They showed how the system does not automatically create demand for the whole of production, or bring about an equilibrium in which there is full employment; rather, it spontaneously tends to break down. When for some reason capitalists do not anticipate enough demand in relation to production, they stop investing, and cut production. That in turn lowers demand further, making investment even more unattractive to them. And so the economy sinks to a level at which there is large unemployment and unused capacity.
The insight of these economists undermined the entire structure of neoclassical economics. For now it was clear prices don’t play the magic balancing role accorded to them in neoclassical theory. Contemporary capitalists don’t keep cutting prices of their products till they are able to sell all they can produce, irrespective of whether or not they make a profit. Instead, they prefer to cut production. Capitalists who are already saddled with excess capacity don’t borrow money, even if the price of capital (i.e. the rate of interest) falls to very low levels. Moreover, a fall in the ‘price of labour’ (the general level of wages), far from making investment more attractive to capitalists, reduces aggregate demand, which makes investment less attractive, dragging the economy down further. All this would suggest that in the present era the underlying tendency of capitalist economies is towards stagnation and failure to realize productive potential.
However, the situation of underdeveloped economies, like India’s, has a further dimension. The manner in which production is organised – the social and economic order under which production takes place – itself does not permit even an approach to full employment.4
The Indian economy has been deregulated over the last 15 years, labour laws have been given a de facto burial, and various sectors have been opened up to, or handed over to, private capital. If the prevailing economic theory were correct, one ought to have witnessed a more even spread of income growth and a steady rise in employment.
Instead, the gap between the growth rates of different regions has grown; the gap between the growth rates of different sectors of the economy too has grown; the rate of employment growth has slowed, resulting in massive growth of unemployment; and employment in the organised sector, where wages and conditions meet some minimum norms, is actually falling. Inequality in incomes and wealth has grown. And the bulk of the workforce remains in agriculture, the sector that is stagnant or retrogressing.
Thus the currently prevailing economic theory does not help us to understand the current state of affairs – boom on one side, and destitution and retrogression on the other. So this orthodox theory cannot help us change it, either. In fact, such change is the main concern of the vast majority of people.
The view of classical political economy
Picture of David Ricardo
Before the rise of neoclassical economics in the late 19th century, the dominant stream was what is now called ‘classical political economy’. Its founders, stalwarts of the capitalist system, are now cited in textbooks for those aspects of their thinking which were later adopted by neoclassical economics. Adam Smith is cited for his belief that each person had a propensity to trade; that in the pursuit of selfish gain each person would advance the common good, “as if led by an invisible hand”; and that State intervention could only harm the natural harmony of social interests that arose from free competition. David Ricardo is cited for his theory showing how trade between two countries benefited both. However, important questions explored by them were cast aside by neoclassical economics.
In the work of Smith and Ricardo, the participants in the economy do not appear as independent, atomistic actors, but as classes – workers, landowners, capitalists – characterised by their roles in relation to production. They tried to work out the principles by which income created in the course of production is distributed among these three classes in the form of wages, rent, and profit.
The discipline of political economy developed in a period of rapid change – the era of the rise of capitalism in Europe. Thus Smith and Ricardo were interested to find the driving force of development. They located it in the production of a surplus over the consumption of the labourer, and the accumulation of the surplus in the form of the growth of productive capacity.
In the course of their investigations, it emerged that the interests of the three classes (workers, landowners, capitalists) are in conflict: The surplus over the consumption of the labourers is distributed among the other two classes (i.e., landowners and capitalists). Of course, in their view, the capitalist’s share of the surplus, i.e., profit, benefits society: for it goes toward accumulation, expanding the productive capacity – unlike the landlord’s share. Smith termed various sections other than labourers and capitalists as “unproductive” (he included among “unproductive labourers” the king, the armed forces, churchmen and lawyers). Ricardo was concerned with preventing a rise in either wages or rents, which would lead to a decline in profit and thus development. Thus, in their approach, struggle between classes played an important role in shaping economic processes.
Marx developed aspects from Smith and Ricardo’s thought, while rejecting other aspects, in creating a comprehensive and consistent analytic system. His work marks the culmination of classical political economy. At the same time, he introduced aspects which went far beyond its frame.
Historical approach
Neoclassical theory sees the economy as a snapshot – in which supply and demand in all markets simultaneously and instantly arrive at equilibrium. Each successive change is a new snapshot, a new equilibrium. By contrast, Marx viewed the economy and society as a process. This approach allowed him to analyse development in the economy. It follows from this approach that in order to understand the present, we must trace the process back – that is, look at history.
Picture of Karl Marx
In Marx’s historical approach, classes in each society are stamped by their specific history. It is the character and strength of the contending classes that not only shape society itself, but determine that society’s place in the world economy. Only armed with this approach can we understand the vast diversities of the world: how some countries developed first, and colonised or otherwise dominated others; or how some countries today have developed so highly, while the bulk of them, containing the vast majority of the world’s population, remain underdeveloped and in misery.
The source of wealth
Neoclassical theory, as we saw, begins and ends with the market. Classical political economy too gave great importance to the role of market forces and the operation of supply and demand; but its account centred on the sphere of production. Drawing on the analysis of his predecessors, but taking it further, Marx showed that the whole of ‘civilized society’ rests on the surplus created by the working people in the course of production. The manner in which that surplus is generated, the level of the surplus, how it is distributed among different classes, how much of the surplus is accumulated (i.e., re-invested), and in what manner it is accumulated – these give us the key to understanding the economy.
Crucially, classical political economy located the source of society’s wealth in human beings’ interaction with nature in the form of labour.6 The wealth of a nation is measured by how productive its labour is, and what proportion of its labour force is employed in productive labour. Whereas in the currently dominant theory, the wealth of a nation is measured by how much capital a country has accumulated and production per unit of capital. By this measure, a nation grows wealthy by carrying out large investments and using the latest technology, even if this involves keeping a large proportion of its labour force unemployed or under-employed or engaged in work that does not yield it a subsistence. The approach of classical political economy implies that such a deployment of the labour force is a suppression of the nation’s potential wealth.
In neoclassical theory, markets operate on their own; State intervention is represented only as a harmful phenomenon, preventing the markets from ‘clearing’ and arriving at equilibrium.7 And the use of coercion is missing in its account; indeed, it claims there is no need of coercion in a free market; in a free market, by definition, exchange must be of equivalents.
By contrast, Marx and his followers pointed out that under exploitative societies before capitalism, such as slave society and feudalism, extra-economic coercion was a necessary part of surplus extraction: slaves and serfs toiled for the ruling classes of their times because laws, traditions and armed force compelled them to do so. No doubt, in capitalist society it is principally economic coercion that compels the worker to labour (he/she needs to labour in order to eat); but the use of organised force, and its highest form, the State, is essential to the operation of the social and economic order. If the workers set their hands on the capitalist’s private property (which after all has been created by the workers’ labour), they face the armed force of the State. (Indeed, they face it even when trying to reduce the extent of surplus-extraction by fighting for higher wages and better conditions of labour – for example, the use of police against striking workers.) All this can be understood in the Marxist framework. And even the State’s own economic activity – its taxes, its expenditures and subsidies, its production of goods and services – can be understood with the class analysis of Marxism.
Study of the social-economic formation
Finally, neoclassical theory does not take note of the distinct social and economic relations within different societies; it merely talks of ‘advanced’ and ‘backward’ economies. In its view, the difference between the two is merely quantitative: the backward economy has less capital (for example, less industry). As the backward economy develops, it will eventually reach the condition of the advanced economies today. They believe that contact (in the form of free trade and investment) between the advanced and backward economies accelerates the development of the latter, benefiting both in the process. The increasing wealth of one economy (or of a class within an economy) will eventually percolate to the rest; there is no relation between the wealth of some and the poverty of the rest.
Evidently, in such a framework it is impossible to understand why some countries took the trouble to colonise others, and why, centuries later, the gulf between the colonisers and the once-colonised persists in various forms. By contrast, Marx uncovered the character of different stages of social development, and further looked at the specific historical path each society has travelled. Later Marxists extended this to understand the phenomena of colonialism and its development into latter-day imperialism. With the Marxist approach, we can understand how social institutions like caste, race, and gender developed, and in turn their role in shaping particular patterns of economic development. In sum, Marxism does not make a separation between economics and sociology: both are aspects of study of the social-economic formation.
Amid the confusing processes we are now witnessing in the Indian economy, the neoclassical approach cannot explain the strange pattern of growth we are witnessing today. We all the more need the class, surplus-based and historical approach of political economy.
Indeed, in order to understand the historical process by which the Indian economy has developed, we need to look, by contrast, at the process by which capitalism developed in Europe. Though this is a lengthy detour, the reason for our taking it will become evident when we return to look at Indian society.
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Notes:
1. It was later superseded by quantum mechanics. (back)
2. See Krishna Bharadwaj, On Some Questions of Method in the Analysis of Social Change, 1980. (back)
3. As wages sink, not only would capitalists hire more workers, but some workers would no longer find wages attractive compensation for the pain of working, and would voluntarily choose ‘leisure’ over work. (back)
4. What the government terms the ‘unemployment rate’ in India refers only to open unemployment. A much larger number of persons are under-employed – they do not have enough work, and whatever they occupy themselves with does not generate enough for their subsistence. And a large number of persons suffer disguised unemployment: they are not counted as unemployed because they are not looking for jobs, though they would be looking if they had any hope of getting a job. These two categories are larger than the official figure of unemployed. The total of the three categories – unemployed, underemployed, and disguised unemployed – is larger than the figure of those we can properly consider employed. (back)
5. We are not describing here Marx’s entire system, merely a few aspects relevant for this article. (back)
6. Nature is “the primary source of all instruments and subjects of labour”, that which labour works with and upon. (back)
7. For example, by enacting a minimum wage law which prevents wages from sinking low enough to be attractive to capitalists to start hiring. (back)
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