Economics for Democratic Socialism Drexel University Spring Quarter 2009

Economics for Democratic
Drexel University
Spring Quarter 2009
• Again recall P=A+F=E+B+D+U+V-W
• Suppose U+V-W=0 and U/P is about constant.
• We have A+F=E+B+D=K+D
Employment 1
To approximate employment, use the multiplier
Actually, the multiplier for deficit spending will
depend on the proportion of tax cuts and
infrastructure projects.
with D=G-T, government spending minus tax
receipts. But we will ignore that complication.
Employment 2
Let N0 be the employment target
We can turn equation ii around:
Adjusting D to obtain the target
employment is called “fiscal policy.”
Classical View
• The classical view is that such government
policy will never be necessary (except, perhaps,
on a temporary basis).
• Adjustment of the interest rate and the real
(purchasing power) wage will bring the demand
for labor into equality with the supply.
• Lewis’ socialist view (and his ideas generally)
are quite classical in this sense.
• Unfortunately, the facts do not seem to agree.
Employment 3
To maintain target employment we have
two conventional methods.
Monetary policy
“stimulates” the economy by lowering
interest rates
may be limited by a “liquidity trap”
Certainly interest cannot go below zero
Fiscal policy
“stimulates” by government purchases of
goods and services or by tax cuts
Employment 4
Suppose that, year after year,
Then D must grow year after year.
To maintain A+F=E+B+D, A or F or both
must continue to increase every year.
This may be inconsistent.
What if people don’t want to hold increased
assets -- that is, they want to spend them instead?
Higher interest rates might persuade them -otherwise, inflation may result.
Iceland 1
• Consider, for example, Iceland.
– In Nov. 2007, unemployment was less than 1%,
inflation was a problem.
– Icelandic banks were making loads of money
borrowing and lending abroad.
– They also had a housing bubble.
– The Crown (Icelandic currency) was depreciating.
– They raised the interest rate to 13.75 to restrain
inflation and slow the depreciation.
Iceland 2
• “The nation's celebrated rags-to-riches story began in
the Nineties when free market reforms, fish quota cash
and a stock market based on stable pension funds
allowed Icelandic entrepreneurs to go out and sweep up
international credit.”
• “But, as a result of the international banking crisis, the
billionaires who own everything from West Ham United
football club to the Somerfield supermarket chain,
Hamleys toy shops and the House of Fraser, are in
trouble and the country is drowning in debt.”
– -- Huffington Post, Oct 6. 2008.
Iceland 3
• Their banking system collapsed in October, 2008. Three
of four banks in the country were nationalized.
• But no-one would buy Icelandic bonds.
• They sought aid from the IMF.
• Interest rates went up to 18% in October, and would
have been higher had they not gotten an IMF loan.
• They are now 17%.
• Unemployment more than tripled as production declined
by about 10% (projected).
• Yes. Iceland is a small country, and its
experience has been extreme. But there has been
concern that Britain and Italy could experience
similar collapses of demand for their government
bonds, and while the United States is not close to
that situation -– “It can’t happen here” are dangerous words!
Socialist Alternative 1
• Suppose instead that there is a social production sector.
Its only asset is its productive capital R. It has no
liabilities. Investment in expansion of the social
production sector comes from reinvestment of earnings
and/or tax receipts.
• The formula for employment becomes
with D=G-T+R-nR, where, again, G is government
purchases, T taxes, and nR the net income of the
social production sector available for re-investment.
Socialist Alternative 2
• Instead of expanding the government deficit in a crisis, the
socialist system could expand the sector of socialist
production, “stimulating” the economy by increasing R.
• According to Keynes, K (investment) is largely determined
by business expectations, which cannot be rational, but can
be modified by experience.
• Success in “stimulating” the economy could prove to be the
kind of experience that would lead to business optimism and
increases in K.
• Then R would be cut back, and instead government could
expand socialism by buying corporate shares, as Lewis
• Keynesian economics is our best guide to the
consequences of an economic crisis and the government
policies that may ameliorate them, in the short run.
• However, as conservatives warn, continued Keynesian
policy may lead to further and worse crises.
• A mixed socialist system would have at least one more
“degree of freedom” to stabilize the capitalist economy.
• This requires a sector of social commodity production,
and its expansion decisions must be independent of the
state of business expectations.
Capitalism and Crisis
• Marx and Schumpeter have both argued that
crises or business cycles are unavoidably a part
of capitalism, and that capitalism will cease to
– Marx argues that the crises become more serious and
ultimately destroy capitalism.
– Schumpeter argues that capitalism will be destroyed
by its successes, not by crises -- but one process
undermining capitalism is that people with higher
standards of living are not willing to accept the
uncertainty of capitalist development.
Marx’ Economics
• Marx adopts and adapts David Ricardo’s
Labor Theory of Value.
• On this basis he develops a theory of
(accounting) profit -- that profit is
• This analysis also leads him to a theory of
• A good deal of Capital also deals with this
tendency toward crises. Indeed, Marx sees
capitalism as increasingly unstable, until at last the
crises destroy capitalism and the working class,
itself a product of capitalism, takes over.
• Could Marx have been at least half right?
Capitalism as he knew it did collapse in 1929 -• But as for the part about the working class taking
over …?
Crises and Unemployment 1
• Marx didn’t really set out one clear theory of
crises. He did argue that
– With the rising organic composition of capital,
profits decline;
– The working class is “immiserized.”
– Engels writes “… violent and regularly recurring
industrial vacillations determine on the one hand the
existence of a large reserve army of unemployed
workers, …”
Crises and Unemployment 2
– And Marx, in Capital, “… subordination of labour to
capital continues in many branches of production,
and continues longer than seems at first glance
compatible with the general stage of development.
This is due to the cheapness and abundance of
disposable or unemployed wage-labourers, …”
– Critics argue, with mathematical models, that it is
not possible both for profit rates to fall and for the
working class to be worse off. But the mathematical
models do not allow for unemployment (or
Labor Theory of Value 1
“The value of a commodity, or the quantity of any
other commodity for which it will exchange,
depends on the relative quantity of labour which is
necessary for its production, and not on the greater
or less compensation which is paid for that labour.
“If I found that an ounce of gold would exchange
for … less …, I should be justified in saying that
the cause … was … the smaller quantity of labour
necessary to obtain it.”
Labor Theory of Value 2
“ …in estimating the exchangeable value of
stockings, for example, ... First, there is the labour
necessary to cultivate the land on which the raw
cotton is grown; secondly, the labour of conveying
the cotton to the country where the stockings are to be
manufactured, … thirdly, the labour of the spinner
and weaver; fourthly, a portion of the labour of the
engineer, smith, and carpenter, who erected the
buildings and machinery, by the help of which they
are made; …”
From Capital (1)
• “Cooperation ever constitutes the fundamental form of the
capitalist mode of production ….
• “The work of directing, superintending, and adjusting,
becomes one of the functions of capital, from the moment
that the labour under the control of capital becomes
• “[T]he product is the property of the capitalist and not that
of the labourer, its immediate producer. Suppose that a
capitalist pays for a day's labour-power at its value; then
the right to use that power for a day belongs to him, just as
much as the right to use any other commodity, such as a
horse that he has hired for the day.”
From Capital (2)
• “[We assume] ... that the value of a day's labour-power is
three shillings, and that six hours' labour is incorporated in
that sum; and consequently that this amount of labour is
requisite to produce the necessaries of life daily required
on an average by the labourer.
• “If now our spinner by working for one hour, can convert 1
2/3 lbs. of cotton into 1 2/3 lbs. of yarn,
• “The labourer therefore finds, in the workshop, the means
of production necessary for working, not only during six,
but during twelve hours.
• “20 lbs. of cotton will absorb 12 hours' labour and be
changed into 20 lbs. of yarn.
From Capital (3)
• ‘There is now materialised in this 20 lbs. of yarn the labour
of five days, of which four days are due to the cotton and
the lost steel of the spindle, the remaining day having been
absorbed by the cotton during the spinning process.
Expressed in gold, the labour of five days is thirty
• ‘But the sum of the values of the commodities that entered
into the process amounts to 27 shillings. … surplus-value
of 3 shillings has been created.
• ‘…the capitalist as buyer paid for each commodity, for the
cotton, the spindle and the labour-power, its full value. He
then did what is done by every purchaser of commodities;
he consumed their use-value.
From Capital (4)
• “… the labour-process may continue beyond the time
necessary to reproduce and incorporate in the product a
mere equivalent for the value of the labour-power. Instead
of the six hours that are sufficient for the latter purpose, the
process may continue for twelve hours. The action of
labour-power, therefore, not only reproduces its own value,
but produces value over and above it. This surplus-value is
the difference between the value of the product and the
value of the elements consumed in the formation of that
product, in other words, of the means of production and the
From Capital (5)
• “The capital C is made up of … the sum of money
c laid out upon the means of production, and …
the sum of money v expended upon the labourpower;… At first then, C = c + v: for example….
When the process of production is finished, we get
a commodity whose value = (c + v) + s, where s is
the surplus-value; … The original capital has now
changed from C to C', from £500 to £590. The
difference is s or a surplus value of £90,…”
The Composition of Capital
• c is the money value of raw materials (and of machinery
used up), the “constant capital.”
• v is the wage bill, the “variable capital”
• C=c+v is the “capital” laid out to begin production
• v/c is the “composition of capital.”
• In Capital, v. 1, Marx makes the simplifying assumption
that the composition of capital is the same in every
• In v. 3 he reconsiders that assumption.
Profit 1
• The value of the day’s product is more than
c+v, and the difference is s, the surplus value.
The value is c+v+s
• For Marx in volume 1, the rate of profit is
• This reflects the simplifying assumption that
constant capital (machinery et. al.) is used up
during the “period of production.” In later
volumes Marx corrects for that.
• The simple version will do for our purposes.
Some Problems 1
• In volume 3, Marx discovered a problem with this
approach. Indeed it was a problem with all classical
• The rate of profit, s/(c+v) would depend on the organic
composition of capital, v/c, and that composition would
differ from industry to industry.
• However, all classical economists (including Marx)
postulated the equalization of rates of profit as a result of
• This postulate now seems to conflict with the labor
theory of value.
Some Problems 2
• Marx suggested that the rate of profit would depend on
the surplus value and composition of capital in the
economy as a whole.
• There were mathematical complexities in this that were
not resolved until the 20th century.
• Another problem is: what do we mean by the labor cost
of labor?
• For a Marxist approach, it is NOT subsistence.
• A Japanese Marxist, Okishio, proposed a common
solution to both problems in 1961.
Modern Labor Theory 1
• Actual prices (values) proportional to embodied
labor time plus a profit mark-up.
• The cost of labor depends on the conventional
standard of living of the working class.
• It is the labor cost of producing the goods and
services that comprise that conventional
standard of living
• It is, in other words, a “cost of living” index in
labor value terms.
Modern Labor Theory 2
• The mark-up depends on surplus value and
invested capital in the economy as a whole.
• For the individual capitalist, however, profit
will still depend on surplus value and the
composition of capital in his operation.
Decreasing Rate of Profit 1
• According to Marx, the rate of profit tends to decrease.
• In the search for higher profits, businessmen introduce
new techniques with more constant capital, that is,
• Therefore, the organic composition of capital, v/c, rises.
• In the profit rate, s/(c+v), the denominator rises.
• Initially, for an individual firm, s rises more, increasing
Decreasing Rate of Profit 2
• However, other capitalists imitate the innovation,
reducing the value (socially necessary labor time) of the
• (This is closely related to Schumpeter’s idea that profits
arise only transitorily, as a result of innovation, and to
the neoclassical idea that the normal rate of “economic
profit” is zero.)
• As firms throughout the economy increase their c, the
overall c in the entire economy rises, without overall
increase in the surplus (since labor values decline), so
that the normal profit rate -- the mark-up -- tends
Profits and Crises
• For Marx, the declining rate of profit is a key factor
leading to crises.
• In their attempts to keep the profit rate up, businessmen
adopt more and more risky and complicated business
• Inevitably, some of these fail, and dominoes begin to
• Since production is more and more “socialized” -- largescale, capital-intensive and interdependent -- the fallingdominoes results are more and more far-reaching.
• Marx argues that as the profits fall, the working class is
“immiserized” -- made more miserable.
• Simply -- to try to keep profits up, capitalists would find
ways to push the conventional standard of living of the
working class down.
• Some modern economists have argued that this is
mathematically impossible -- that falling profits must be
associated with rising wages.
• However, this overlooks unemployment, the “industrial
reserve army.”
Standard of Living
• In fact, labor standards of living have
risen in the twentieth century, in more
developed countries.
• But not always.
• In the last third of the 20th century, in the
USA, median wage income did not rise
Labor Theory and
• Recall the Keynesian “45°” model of
unemployment. I am going to translate it
into labor theory terms. Fair warning:
this has not been published and so cannot
be regarded as a scholarly discussion.
Labor Value Expenditures
• Let Y be the labor cost of a unit of labor, i.e. of the
goods and services that make up the conventional
standard of living.
• Let N be the number employed.
• Assume “workers spend what they get.”
• Then working class consumption, in labor value terms,
is YN.
• Aggregate surplus value is N(1-Y)
• Given the state of long-term expectations, the capitalist
class demands new capital goods with aggregate labor
value T.
Labor Demanded 1
• For now, assume also that capitalists
consume nothing -- they are accumulation
• Total labor value of goods and services
demanded is T+YN.
• That must also be the total labor
employed, i.e. N= T+YN
Labor Demanded 2
The Result of a New Technology
Lump of Labor
• Economists sometimes criticize others for committing
the “lump of labor” fallacy.
• The fallacy is that somehow there is just a “lump” of
labor demand that has to be divided among available
• Perhaps there is, though -- the labor cost of producing a
conventional standard of living of labor.
• In any case: the “technological unemployment” we see
here could be offset by an increase in the labor standard
of living, but that is against the interest of capitalists,
who will be doing their best to push it down.
• For a Marxist, then, the development of
capitalism tends always to bring about a falling
rate of profit and rising unemployment.
• Forces from outside capitalism -- such as
government, war, labor unions and strikes,
cultural and political upheavals -- can offset
these tendencies.
• This offsetting may -- or may not -- create new
space for continuing capitalism.
From the Manifesto, again
• “The conditions of bourgeois society are too narrow to
comprise the wealth created by them. And how does the
bourgeoisie get over these crises? On the one hand, by
enforced destruction of a mass of productive forces; on the
other, by the conquest of new markets, and by the more
thorough exploitation of the old ones. That is to say, by
paving the way for more extensive and more destructive
crises, and by diminishing the means whereby crises are
• “But not only has the bourgeoisie forged the weapons that
bring death to itself; it has also called into existence the
men who are to wield those weapons – the modern
working class – the proletarians.”
Seeds of Destruction
• Thus capitalism, through its drive for profits and
accumulation, sows the seeds of its own
destruction, according to Marx.
• Schumpeter agreed, but for different reasons.
• Schumpeter’s economic theory, influenced by
Austrian economics, differs in important details.
• He claims that capitalism will be destroyed “by
its own success.
Destroyed by Success 1
• Successful innovation, raising standards of
living, leads to more risk aversion.
– Capitalism is inherently risky.
• Successful innovation leads to bigger
companies, monopoly.
– Capitalism without competition loses its dynamic
Destroyed by Success 2
• Capitalism encourages rationalization.
– Bureaucracy becomes more efficient and the
unpredictable nature of capitalism less tolerable.
• Innovation becomes “routinized.”
– Capitalist leadership is no longer needed nor useful.
Destroyed by Failure
• Writing in the 1970’s, John Kenneth Galbraith argued that
some capitalist companies had become “too big to fail.”
• He proposed that the socialism that would emerge from
American Capitalism would be the “socialism of the
weak” -- that some companies and industries would have
to be organized by government in order to survive.
• He probably DIDN’T expect that to be automobiles and
Wall Street -- but -• Like Marx and Smith, he considered corporations as
implicitly socialist organizations, and envisioned
“socialization” as the appointment of executives and
boards by government.
A Variety of Points of View
• Marx, we recall, was radically opposed to capitalism.
• Schumpeter favored capitalism, though he preferred to
leave government in the hands of the aristocracy.
• Galbraith was a liberal, skeptical about capitalism but
not committed to oppose it.
• Keynesian analysis is helpful in understanding the
impacts of crisis, but these writers help us to understand
the causes of crises and their tendency to transform
This is the way the world ends
This is the way the world ends
This is the way the world ends
Not with a bang but a whimper.