Chapter 1 : 
Bourgeois Economics
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Author : Paul Mattick

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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
labor, 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 labor 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 behavior.

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 – fulfills 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 reestablish 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
reestablished. 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
endeavors. 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 reestablish
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 pauperization 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 reestablished 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 partizans 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
judgments 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 capitalizing 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 disorganization 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 hyenas” 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 specialties 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.


     From : Marxists.org

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     Chapter 1 -- Added : March 03, 2021

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