Tuesday, October 23, 2012

Neoliberalism, Marx and the 'Marginal Revolution'

Neoliberalism is a contemporary form of economic liberalism that emphasizes the efficiency of private enterprise, liberalized 'free' trade and open markets to promote globalization (a term which might also be interpreted as neo-imperialism). Neoliberals therefore seek to maximize the role of the 'private sector' in determining the political and economic priorities of the world. Neoliberalism seeks to transfer control of the economy from 'public sector' (or state) to the 'private sector' under the belief that it will produce a more efficient government and improve the economy.

The definitive statement of the concrete policies advocated by neoliberalism is often taken to be John Williamson's 'Washington Consensus', - a list of policy proposals that appeared to have gained consensus approval among the Washington-based international economic organizations such as the International Monetary Fund (IMF) and World Bank. Though apparently not Williamson's original intent, the Washington Consensus has anyway become synonymous with the ideas of neoliberal market fundamentalism.

Some claim that Chicago School economists are associated with Washington Consensus The 'Chicago school' of economics describes the neoclassical school of thought within the academic community of economists focusing around the faculty of The University of Chicago, sometimes referred to as the 'freshwater school' of economics in contrast to the 'saltwater school' based in US coastal universities, notably Harvard, MIT, and Berkeley; Chicago is considered one of the world's foremost economics departments; Milton Friedman taught there for more than three decades. A significant body of economists and policy-makers argues that what was wrong with the Washington Consensus as originally formulated by Williamson had less to do with what was included than with what was missing in it, arguing that it was an incomplete project, and that countries in Latin America and elsewhere need to move beyond 'first generation' macroeconomic and trade reforms to a stronger focus on productivity-boosting reforms and direct programs to support the poor.

How did we get to this point in economic science?

'Classical economics' is the term used for the first modern school of economics. The publication of Adam Smith's Wealth of Nations in 1776 is considered to be the birth of the school. Perhaps the central idea behind it is on the ability of the market to be self-correcting as well as being the most superior institution in allocating resources. The implicit assumption is: that all individuals maximize their economic activity. At the root of Smith's modernity, though, is his and Marx's philosophical attitude towards the object of their enquiry and the way this grasped the concept, crucial to economic theory, of value.

The so-called 'paradox of value', or the diamond–water paradox, is the apparent contradiction that, although water is more useful in terms of human survival than diamonds, diamonds command a higher price in the market; Adam Smith is the classic presenter of this paradox. To paraphrase Smith: the one may be called 'value in use' and the other, 'value in exchange', the things which have the greatest value in use often have little or no value in exchange; on the contrary, those which have the greatest value in exchange have frequently little or no value in use; nothing is more useful than water, for example, but it will purchase almost nothing; almost nothing can be gained in exchange for it, whilst a diamond has scarce any use-value; but a very great quantity of other goods may frequently be had in exchange for it. For Smith, the real price of every thing, what every thing really costs to the person who wishes to acquire it, is the toil of acquiring and making it, so Smith thereby denied a necessary relationship between price and utility, and price in this view was related to productive labor. In this he was followed by Marx. Advocates of the labor theory of value saw it as the philosophically materialist resolution of the paradox of value.

The so-called 'marginal revolution' which is based on the subjective theory of value, that is understood to have occurred in Europe, led by Carl Menger, William Stanley Jevons, and Leon Walras, gave rise to what is known as the neo-classical synthesis. As we have seen, Marx had developed and used the materialist concept of use-value versus exchange value. Use-value was classically understood to give some measure of objective material usefulness. This was later 'rebranded' in the 'marginal revolution' as 'marginal benefit', which is understood as the utility of a thing counted in terms of 'common units of value', while exchange value is given as the measure of how much one good was priced in terms of another, namely what is now called relative price. The subjective theory of value identifies value as based in the inner desires and needs of the members of a society, as opposed to value being inherent to an object that exists independently of any observer or user. Once this idealist epistemology is taken as the given grounds, it is able to refer to the units of value as subjective units. Today, the marginal utility of a good or service is seen as the utility gained (or lost) from an increase (or decrease) in the consumption of that good or service, so it is the action of subjective consumption that defines the value not the objective existence of the object. Economists therefore sometimes speak of a law of diminishing marginal utility, meaning that the first unit of consumption of a good or service yields more utility than the second and subsequent units.

The concept of marginal utility played a defining conceptual role in the (so-called) marginal revolution of the late 19th century that led to the replacement of the labor theory of value of Adam Smith and Karl Marx by neoclassical value theory in which the relative prices of goods and services are thought to be simultaneously determined by marginal rates of substitution in consumption and marginal rates of transformation in production, which are apparently equal in 'economic equilibrium'. This neo-classical formulation had also been formalized by Alfred Marshall. However, it was the concept of the general equilibrium of Walras that helped solidify the research in economic science as a mathematical and deductive enterprise, the essence of which is still defined as neo-classical and makes up what is currently found in mainstream economics textbooks today. The key implication is usually that what is new (revolutionary) here is the scientific rigor, i.e. that Marx specifically is not supposed to have. In actual fact this rigor is precisely what is missing in this fudge and mystification of use value and exchange value through the concept of the marginal, which serves to obscure its idealist philosophical roots.

Macroeconomics in its modern form began with the publication of John Maynard Keynes's General Theory of Employment, Interest and Money in 1936. Keynes projected an aggregated framework to explain macroeconomic behavior, leading us to the current distinction between micro and macroeconomics. According to Keynesian theory, some individually-rational microeconomic-level actions—if taken collectively by a large proportion of individuals and firms—can lead to inefficient amassed macroeconomic outcomes, wherein the economy operates below its potential output and growth rate. Such a situation had previously been referred to by classical economists as a general glut, which in Marx is described as overproduction. Keynesian economics argues that private sector decisions sometimes lead to these inefficient macroeconomic outcomes and, therefore, advocates interventionist policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the 'business cycle'. Of special importance in Keynes' theories was his explanation of economic behavior as also being led by 'animal spirits'. In this sense, it limited the role for the so-called rational (maximizing) agent. In fact, this foundational ideology of a division of the rational ('angelic') and the irrational ('bestial') in the human subject seems to underpin the whole of modern post Smithian-Marxian economics, as well as the accepted division of macro from microeconomic theory. It avoids confronting the concept and existence of contradiction in the economic system by founding any antagonism ultimately in innate human attributes; although this underlying thesis is rarely invoked as such (it could sound racist), it is nevertheless always implied.

The neo-classical school dominated the field up until the event of the Great Depression. When the Great Depression struck, classical economists (other than Marx), had difficulty explaining how goods could go unsold and workers could be left unemployed, thus with Keynes's publication, certain of its assumptions were rejected. Keynes argued the solution to the Great Depression was to stimulate the economy ('inducement to invest') through a combination of two approaches: a reduction in interest rates and government investment in infrastructure; the theory has it that investment by government injects income, which results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so on and so forth. The initial stimulation is seen as beginning a concatenation of events, whose total increase in economic activity is a multiple of the original investment; it does not explain why the situation arises in the first place, i.e. why the investments that have taken place always/already in the economy are not producing this effect, or the answer is left simply as a fault of policy. The Post-World War II period saw the widespread implementation of Keynesian economic policy in the United States and Western European countries. Its dominance in the field by the 1970s was best reflected by the controversial statement attributed to ex-President Richard Nixon and economist Milton Friedman: "We are all Keynesians now."

A central conclusion of Keynesian economics is that, in some situations, no strong automatic mechanism moves output and employment towards full employment levels. This conclusion conflicts with economic approaches that assume a strong general tendency towards 'equilibrium'. In the 'neoclassical synthesis', which combines Keynesian macro concepts with a micro foundation, the conditions of general equilibrium allow for price adjustment to eventually achieve this goal. General equilibrium theory seeks to explain the behavior of supply, demand, and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium. What here seems to have been omitted is the political as such, politics is subordinated to a technical and instrumental understanding of the problem, and (for instance) an effect, prices, are treated as a cause, or as both cause and effect of its own function. Generally speaking any material foundations or groundings are lost.

With microeconomics, macroeconomics is now one of the two most general fields in economics; the fact that macroeconomics is 'smaller' than economics seems to render the terms faintly ridiculous, notwithstanding. Macroeconomics (from Greek prefix "makros-" meaning "large" + "economics") is the branch of modern economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy. Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indices to understand how the whole economy functions. They develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance. In contrast, microeconomics is primarily focused on the actions of individual agents, such as firms and consumers, and how their behavior 'determines' prices and quantities in specific markets.

New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis on the neoclassical framework; specifically, it emphasizes the importance of supposedly rigorous foundations based on microeconomics. Macroeconomics descended from the hitherto divided fields of business cycle theory and monetary theory. The quantity theory of money was particularly influential prior to World War II. It took many forms including the version based on the work of Irving Fisher. His work on the quantity theory of money inaugurated the school of economic thought known as monetarism. Both Milton Friedman and James Tobin called Fisher "the greatest economist the United States has ever produced." New classical macroeconomics strives to provide neoclassical microeconomic foundations for macroeconomic analysis; this is in contrast with its rival, the new Keynesian school that uses microfoundations such as 'price stickiness' and imperfect competition to generate macroeconomic models similar to earlier, Keynesian ones.

Problems arose in the Keynesian theory in the 1970s and early 1980s with the onset of 'stagflation'. Stagflation is a situation in which the inflation rate is high and the economic growth rate slows down but unemployment also remains high. The reasons for this were and are often placed upon factors such as oil. The decade of the 1970s saw rising oil prices caused by an OPEC oil embargo on the United States. This oil embargo ostensibly caused both high inflation and a steep economic downturn that in turn generated high unemployment. However, the question arises: what caused the high oil prices in the first place? Is the price of oil an extra economic factor, or totally political? And what was the politics based on which here apparently 'caused' the higher price of oil, if not economic factors? Keynesians were perplexed by the outbreak of stagflation because the original concept of the Phillips curve ruled out concurrent high inflation and high unemployment. The Phillips curve is a historical apparent inverse relationship between the rate of unemployment and the rate of inflation in an economy. Put simply, the lower the unemployment in an economy, the higher the rate of inflation should be. The new classical school emerged in the 1970s as a response to this failure of Keynesian economics to explain stagflation.

During the 1970s in the United States and several other industrialized countries, the Phillips curve concept and analysis became less popular. The new classical and monetarist criticisms led by Robert Lucas, Jr. and Milton Friedman respectively forced the rethinking of Keynesian economics. In particular, Lucas made the 'Lucas critique' that cast doubt on the Keynesian model. The Lucas critique suggested that if we want to predict the effect of a policy experiment, we should model the 'deep parameters' that govern individual behavior, because only such deep models can avoid merely aggregating previous policy; only then can we predict what individuals will do, taking into account the change in policy, and then aggregate the individual decisions to calculate the macroeconomic effects of the policy change. His idea of deep, though, only meant relating to preferences, technology and resource constraints and not a deeper theoretical model in the sense of its philosophical foundations (such as the theory of value). This nevertheless strengthened the case for macro models to be based on microeconomics.

Milton Friedman (July 31, 1912 - November 16, 2006) had already proposed before the phenomenon of stagflation that the Phillips curve did not exist and would fail. On this basis he theorized the existence of a 'natural rate of unemployment' that contradicted the then accepted relationship between inflation and unemployment rate, and this became a concept fundamental to monetarist economics, on which also worked Lucas Papademos (who was to become the 'technocratic' prime minister of Greece during the 2011-12 years of the crisis,; in January 2012 he warned that workers would have to accept cuts in income for a default to be avoided, he also told business and labor leaders that the 'troika'—the European Union, the IMF and the European Central Bank—was looking for Greece to take steps to open up so-called closed professions, as well as adjustments to the minimum wage, abolition of Christmas and summer vacation 'bonuses' and automatic wage increases) and Franco Modigliani. As far as many economists were concerned, the Phillips curve had little or no theoretical basis anyway. Critics like Friedman argued that the Phillips curve could not be a fundamental characteristic of economic general equilibrium because it showed a correlation between a real economic variable (the unemployment rate) and an only nominal economic variable (the inflation rate). Their counter-analysis was that government macroeconomic policy (primarily monetary policy) was being driven by a low unemployment target and that this caused expectations of inflation to change, so that steadily accelerating inflation rather than reduced unemployment was the result.

In economics, 'adaptive' expectations means that people form their expectations about what will happen in the future based on what has happened in the past. For example, if inflation has been higher than expected in the past, people would revise their expectations for the future. Chicago macroeconomic theory, as above rejected Keynesianism in favor of monetarism until the mid-1970s, when it turned to new classical macroeconomics based on the concept of rational expectations. Rational expectations is a hypothesis in economics which holds that agents' predictions of the future value of economically relevant variables are not systematically wrong in that all errors are random. Equivalently, this is to say that agents' expectations equal true statistical expected values. An alternative formulation is that rational expectations are model-consistent expectations, in that the agents inside the model assume the model's predictions are valid. Since most macroeconomic models today study decisions over many periods, the expectations of workers, consumers and firms about future economic conditions are an essential part of the model. How to model these expectations has long been controversial, and it is well known that the macroeconomic predictions of the model may differ depending on the assumptions made about expectations (e.g. see Cobweb model).

To assume rational expectations in this view is to assume that agents' expectations may be individually wrong, but are correct on average. In other words, although the future is not fully predictable, agents' expectations are assumed not to be systematically biased and use all relevant information in forming expectations of economic variables. This way of modeling expectations was originally proposed by John F. Muth (1961) and later became influential when it was used by Robert E. Lucas Jr. and others. Modeling expectations is crucial to all models which study how a large number of individuals, firms and organizations make choices under uncertainty. For example, negotiations between workers and firms will be influenced by the expected level of inflation, and the value of a share of stock is dependent on the expected future income from that stock.

Rational expectations theory is the basis for the 'efficient market hypothesis' (efficient market theory). If a security's price does not reflect all the information about it, then there exist 'unexploited profit opportunities': someone can buy (or sell) the security to make a profit, thus driving the price toward equilibrium. In the strongest versions of these theories, where all profit opportunities have been exploited, all prices in financial markets are deemed 'correct' and reflect market fundamentals (such as future streams of profits and dividends). Each financial investment is as good as any other, while a security's price reflects all information about its intrinsic value.

The idea behind the natural rate hypothesis put forward by Friedman was that any given labor market structure must involve a certain amount of unemployment, including 'frictional' unemployment associated with individuals changing jobs and possibly classical unemployment described as arising from real wages being held above the market-clearing level by minimum wage laws, trade unions or other labor market institutions. Unexpected inflation might allow unemployment to fall below the 'natural rate' by temporarily depressing real wages, but this effect would dissipate once the expectations about inflation were corrected. Only with continuously accelerating inflation could rates of unemployment below the 'natural rate' be maintained. The resulting prescription was that government economic policy (or at least monetary policy) should not be influenced by any level of unemployment below a critical level, the so-called 'natural rate'.

The analysis supporting the natural rate hypothesis proved controversial, because empirical evidence suggested that the 'natural rate' varied over time in ways that could not easily be explained by changes in labor market structures. And the analysis is especially problematic if the Phillips curve displays 'hysteresis', that is, if episodes of high unemployment raise the rate. This could happen, for example, if unemployed workers lose skills so that employers prefer to bid up of the wages of existing workers when demand increases, rather than hiring the unemployed. As a result of such problems the 'natural rate' terminology was largely dropped in favor of the NAIRU (Non-Accelerating Inflation Rate of Unemployment) , which referred to a rate of unemployment below which inflation would accelerate, but did not imply a commitment to any particular theoretical explanation, or a prediction that the rate would be stable over time. In short, the conceptual basis of the concept was left fallow, undecided, and ambiguous. There is no theoretical basis for predicting the NAIRU. The NAIRU theory was mainly intended as an argument against active Keynesian demand management and in favor of free markets (at least on the macroeconomic level).

Friedman was an economic advisor to conservative President Ronald Reagan, and his political philosophy extolled the virtues of a free market economic system with minimal intervention. In his 1962 book Capitalism and Freedom, he advocated policies such as a volunteer military, freely floating exchange rates, abolition of medical licenses, a negative income tax, and education vouchers. His ideas concerning monetary policy, taxation, privatization and deregulation influenced government policies, especially during the 1980s, and his monetary theory influenced the Federal Reserve's response to the current global financial crisis (2008-12). The advent of the global financial crisis in 2008 caused some resurgence in Keynesian thought and the Chicago school came under attack and has been at least partly blamed for the growing income inequality in the United States. Economist Brad DeLong of the University of California, Berkeley for instance says the Chicago School has experienced an 'intellectual collapse', while Nobel laureate Paul Krugman of Princeton University, said that recent comments from Chicago school economists were "the product of a Dark Age of macroeconomics in which hard-won knowledge has been forgotten." Critics also charged that the school's belief in human rationality contributed to bubbles such as seen in the financial crisis, and that the school's trust in markets to self-regulate has offered no aid to the economy in the wake of the crisis. The 'new Keynesian' view of the backlash rests on microeconomic models that indicate that nominal wages and prices are 'sticky', i.e. do not change easily or quickly with changes in supply and demand, so that quantity adjustment prevails. According to Paul Krugman, "while I regard the evidence for such stickiness as overwhelming, the assumption of at least temporarily rigid nominal prices is one of those things that works beautifully in practice but very badly in theory." This integration is further spurred by the work of other economists that questions rational decision-making in a perfect information environment as a necessity for micro-economic theory. Imperfect decision-making such as that investigated by Joseph Stiglitz underlines the importance of the management of risk in the economy. Notwithstanding, over time, many macroeconomists have returned to the IS-LM model and the Phillips curve as a first approximation of how an economy works. New versions of the Phillips curve, such as the 'Triangle Model', allow for stagflation, since the curve can shift due to supply shocks or changes in built-in inflation. In the 1990s, the original ideas of 'full employment' had been modified by the NAIRU doctrine. NAIRU advocates suggest restraint in combating unemployment, in case accelerating inflation should result. However, it is unclear exactly what the value of the NAIRU should be—or whether it even exists.

What seems obvious to any reader of Marx is that the effort in modern economics is to avoid looking at contradictions in the capitalist mode of production and how these contradictions enter into the ideology of the economy, the illusions about what the economy is doing and how it is working. Both the Keynesian and Friedmanite economic theories tackle significant problems and proffer solutions to actual economic strife, but they do so one-sidedly so that they are still unable to explain significant factors commonly occurring in the economy: high unemployment while high inflation (stagflation) for Keynes, and now, the collapse of neoliberal economics in the same kind of crisis. Neither form of the perfect market exists in which their respective theories would make sense, yet also putting them together in their positivist (a priori pre-Marxian) synthesis provides no way out. Many other commentators have suggested going back to basics and to the concept of value to look for answers. To look at one, specifically, there are the arguments of Ecological Economics: for this understanding the primary example of the concept of value in neo-classical economics is 'market value', or 'willingness to pay', which is the principal method of accounting used in 'receiver-type' theories, where the receiver (the 'interpreter of the world') determines the value. By contrast, in Ecological Economics value theory is separated into two types: 'donor-type' value and 'receiver-type' value. Ecological economists tend to believe that 'real wealth' needs a donor-determined value as a measure of what things were needed to make an item or generate a service (H.T. Odum 1996). Marx's and the Smithian labor theory of value and the 'Energy' concept is in this interpretation 'donor-type' value theories. Energy theorists, agreeing perhaps with Marx's concept of labor power, believe that this conception of value has relevance to all of philosophy, economics, sociology and psychology as well as Environmental Science (something which Marx was of course aware of long ago).

It is worth noting finally again how these ideas of value are inevitably epistemological (theory of knowledge) definitions and these definitions have inevitable political overtones. The two great camps of philosophy are materialist and idealist. In short, materialism holds that matter exists independently of thought, while idealism takes the contrary view. Marx and Smith's concept of value in their economic theory is philosophically speaking materialist in its theory of knowledge: In this, it is not the receiver's understanding and subjective valuation on the market which determines value, or the movements of the market itself, which would only explain the market by the market and therefore be tautological, but the independent properties of the entity combined with human labor power. Marx (in Volume I of Capital) distinguishes the value of a commodity into its use-value (utility) and exchange (market) value, both of which (aside from naturally occurring use values) are produced through the labor process by labor power, human effort or energy. This division is a theoretical distinction however, and not an absolute epistemological division. A characteristic of modern economics is to take exchange value as the dominant side, to extend its dominance to include dominance over use value, and then to regard this as the actual manifestation of the truth of philosophical idealism, of abstraction and the mind over matter, which in all other respects is the dominance of capital over labor, or as Marx says the dominance of dead labor over living.

Gary Tedman

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