Waiting for a New Economic Theory

Economic theories, for the most part, have emerged in response to particular social situations or governmental policies. For example, Francoise Quesnay’s 18th century Tableau Economique came into being in reaction to the plight of the French peasantry, excessive taxation, and government regulation that followed mercantilist teachings. Adam Smith’s “invisible hand” theory similarly appeared as a response to mercantilist restrictions. It also corresponded to the early stages of the Industrial Revolution, when inventions and innovations made England relatively prosperous. Thomas Robert Malthus’s population and glut theories emerged in the midst of the Industrial Revolution, when migration of peasants to the cities, unemployment, and poverty became rampant. Karl Marx’s version of the labor theory of value was a response to the revolutionary movements in 19th century Europe, as exemplified by the 1848 uprising and the 1871 Paris Commune. John Maynard Keynes’s “general theory” was developed in the midst of the Great Depression and was a response to the laissez faire economics and policies that prevailed at the time.

It is too early to see if the recent economic crisis?which started in the financial sector of the economy and spread to the productive side?will produce any novel theories. What we have seen so far is different economists reciting some old theories and advocating corresponding remedies.  This is exemplified by three groups of economists, ranging from the most ardent supporters of laissez faire to those who see no future for capitalism.

The free market advocates still fall back on the marginalist or “neoclassical” theories that have dominated economic teaching since the end of the 19th century (the term “neoclassical” is a misnomer, but it is widely used). This unreal, a-historical theory started not with analyzing any real economy or human behavior, but with certain concepts in mathematical physics. The marginalists’ bizarre point of departure then led to a peculiar concept of the market that the proponents of laissez faire found quite useful. A market in this theory consists of two curves, a supply curve and a demand curve. “Equilibrium price” is where these two curves meet. Left alone, all such markets will self-adjust and bring about the equilibrium price. This holds for the “labor market” as well, where the equilibrium real wage will bring about full employment. It also holds for the so-called capital market, where the interest rate is determined. Given this self-adjusting mechanism, anything that interferes with the market, such as government or central bank intervention, is considered to be undesirable. Government deficit spending merely results in higher interest rates, and monetary policy ends with price changes, particularly inflation, if the money supply increases. In either case, the “real variables,” such as the level of employment or real output of goods and services, remain intact. In this happy, serene world there is never any crisis, especially a monetary crisis. Actually, in such a world there is no need for money, since all variables are real and money is just a “veil.” Also, in this tranquil and trouble-free land there are no classes, no workers no capitalists; there are only consumers and producers, getting along happily ever after.

When the current crisis began and the capitalist world economy appeared to be on the brink of another disaster, the proponents of the neoclassical theory trembled at first. They retreated and abandoned their usual arguments concerning the glory of unfettered markets.  However, now that falling into the abyss of another depression appears less likely, they are back to the theories of leaving the market alone, reducing taxes for the captains of industry and finance and cutting spending when it comes to the working class.

At odds with these free marketeers are various shades of economists whose roots can be traced to Keynes.  Keynes clearly saw the incompatibility between the neoclassical theories and the real world, particularly during the Great Depression. He criticized certain laissez faire aspects of these theories and ultimately advocated for fiscal and monetary policies.  Yet, since he was educated in the same neoclassical school, his criticism of these theories was halfhearted and did not shake the foundation of the school. A few critical notes at the beginning of The General Theory of Employment, Interest and Money (1936) were followed by some theories that were incomplete, underdeveloped and ambiguous. The result was many possible interpretations of his theories and their ultimate subsumption under the “neoclassical synthesis,” a combination of the old-fashioned neoclassical theories, called microeconomics, and Keynesian theories, called macroeconomics. This hodgepodge of theories became, and continues to be, the regular staple of economics students.

The ambiguities and lacunae in The General Theory also allowed for very different policy prescriptions.  Take, for example, Keynes’s theory of the “multiplier,” a theory that looks at the stimulating effect of spending, particularly government expenditures, on output and employment.  The theory was ambiguous enough when Keynes borrowed it from another economist, R. F. Kahn, but Keynes added to the ambiguity by stating:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again . . . there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.

This seemed to imply that it made no difference if government spending was on useful things or wasteful things.  Actually, a number of other comments in The General Theory support this indifference. For example, just before the above passage Keynes simply stated: “Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better.” Such statements made “military Keynesianism,” or warfare, an acceptable form of economic policy.  To this day, the followers of Keynes are unclear as to whether going to war is good for the economy and a stimulant or bad for the economy and a drag. Thus, we see some individuals advocating the start of yet another war in the Middle East as a way to rescue the US economy and some opposing the wars already in progress by pointing out their overall costs and how such costs are destroying the economy.

In addition, the silences in The General Theory allowed for the simultaneous existence of different types of Keynesian economists.  Even though all such economists agree on the need for fiscal and monetary policy, they do not agree on the limit of such policies and the exact method of pursuing them.  For example, liberal Keynesians?such as the “Post-Keynesians” who try to distance themselves from the neoclassical teachings?and conservative Keynesians?such as the “New Keynesians” who are quite eclectic in their theories?are often at odds with one another as to how high the deficit can go or what steps the Federal Reserve System should take.  They also disagree over such matters as how much regulation the financial sector of the economy needs. Yet, the squabbles between different types of Keynesians are quarrels within the family.  All Keynesians, similar to Keynes, believe in saving capitalism from itself; reform, and not revolution, is their aim.

This brings us to the Marxist economists who, when it comes to solving the ills of the capitalist society, believe in revolution and not just reform.  For these economists a little more or a little less deficit spending, or tinkering with the money supply, will not solve the long-term problems of capitalism, particularly when it comes to the current worldwide economic crisis. Neither would the financial woes of the capitalist economy be solved by more regulation.

In their arguments, most Marxist economists fall back on Marx’s mature writings, particularly his Capital, the first volume of which was published in 1867.  Setting aside the fact that Marx’s economic project was never finished and that his labor theory of value has always been the subject of controversy, Marx’s work is one of the few economic writings that actually tries to address the issue of economic crises.  In Capital there are two major theories of crisis, one cyclical and another secular. The first deals with disproportionality or imbalances between different sectors of the economy, that is, between the sectors that produce “capital goods” and “consumer goods.” Marx’s second theory deals with the tendency for the rate of profit to fall over the long haul. However, neither of these theories explains the current economic crisis.  It is, of course, true that in Marx’s theory of capitalist economy money plays a central role in production and could therefore cause crisis at various moments. But, there is no detailed and comprehensive theory of money and credit in his theory that would enable us to deal with modern monetary problems.

Of course, one should not expect theories that were developed in the middle of the 19th century to explain unique economic crises in the 21st century. This is particularly true if one believes, as any good Marxist economist should, that capitalism continuously evolves and poses new problems.  Thus, any theory trying to explain an evolving economy must itself evolve and grow. That, however, does not appear to be the case when it comes to Marxian economics. Very little has changed in this field since Marx wrote his Capital, as is evident from various books that have been recently published by Marxist economists, as well as the discussions and debates that are going on between these economists.

There is another major problem with the application of Marx’s theory to the recent economic crisis. Given the period in which it was written, Marx’s Capital was not about reform, but was about revolution, a socialist revolution. The work was meant to sound the death knell of “capitalist private property,” the expropriation of “expropriators.” And the sound was supposed to be heard in the most advanced capitalist country, where forces of production had grown so much that they were no longer compatible with the relations of production. Presumably, this would have been England, where the workers would have established the first socialist economy.  What a socialist economy might look like, however, was never delineated by Marx beyond a short and vague sketch in the Gotha Program written in 1875. Such a revolution never happened, and a socialist society was never established (setting aside, of course, the Russian Revolution of 1917, when in a relatively less developed country some revolutionary intellectuals, in the name of workers, came to power and presumably established “state capitalism”).

Nearly a century and a half later, there is no sign of workers’ uprisings in any part of the globe, particularly in advanced capitalist countries. We also have no idea, beyond that discussed in the Gotha Program, what a socialist society might look like.  Thus, waiting for the working class to rise, put an end to a chronically sick social system, and establish a new order does not appear to be feasible in the near future, unless one has a strong set of religious beliefs, as some “Marxists” do.

What is to be done? Should we leave the markets alone, as marginalist economists argue, even though we know that their two-curve markets have never existed and, historically, when markets were left alone they always fell into crisis? Or should we rely on increasing budget deficit and easy money policy to get us out of the present economic conundrum, as Keynesians advocate? In the latter case, which Keynesians should we listen to and why, knowing full well that none of the renowned Keynesians of our time predicted the 2008 crisis that brought the US economy to the brink of depression? Or should we wait and hope for workers’ uprisings to end the ills of the capitalist economy once and for all, as some Marxist economists are still hoping for, even though there are no signs of such uprisings anywhere in the world?

It seems that none of the prevailing economic theories provide a viable option for understanding and dealing with the current economic woes. Looking back at the history of economic thought and emergence of new theories at particular historical conjunctions, one can only hope that the current worldwide economic slump will generate new ways of thinking and new theories.

SASAN FAYAZMANESH is Professor Emeritus of Economics at California State University, Fresno. He is the author of Money and Exchange: Folktales and Reality (Routledge, 2006). He can be reached at: sasan.fayazmanesh@gmail.com.

The above essay was prompted by a conversation at a dinner party. The author was asked by some non-economist friends what he thought of the recent economic crisis and policy prescriptions. A short and simple verbal answer was hard to come by, particularly when one is busy eating and drinking.




Sasan Fayazmanesh is Professor Emeritus of Economics at California State University, Fresno, and is the author of Containing Iran: Obama’s Policy of “Tough Diplomacy.” He can be reached at: sasan.fayazmanesh@gmail.com.