Equilibrium

Capitalism is a dynamic system. Marx recognised that. The philosophy of Marxism was described by the Marxist George Plekhanov as dialectical materialism. Marx took dialectics as his method from Hegel – a philosophy of perpetual movement and change through contradictions. He set as his goal in Capital to understand the laws of motion of capitalism.

Yet bourgeois economics uses as a central tool of analysis the concept of equilibrium – of capitalism in a state of rest. Equilibrium is discussed only fleetingly in Desai’s book. He mentions it in his discussion of the socialist calculation debate, which we discuss later. And yet, for anyone trained in orthodox economics, it is a notion quite difficult to shake off at a subconscious level. Here’s our evidence. Desai on post-War trends in economic theory. “Some maverick post-Keynesians argued that the world was not competitive, but full of oligopolies” [they were right –MB] “But, that said, they had no general equilibrium theory to offer.” (Marx’s Revenge p 260) So Meghnad ignores theory based on a correct understanding of the economy because it doesn’t have snazzy, if counterfactual, microfoundations. Bizarrely, Marx is tarred with the same brush. “The problem was that the Walrasian economy” (which we discuss below) “bore no relation to any actual capitalist economy, where change and uncertainty are endemic, where there are risk-takers and bankruptcies, where new products and processes are tried out all the time. This dynamic disequilibrium process was not theorised by Walras…Marx had fallen into a similar trap when he took up Ricardo’s theory of competitive equilibrium (dressed up in different terminology). Thus his disequilibrium insights hung loosely around his equilibrium of prices and values.” (ibid pp 195-6)

This is probably our fundamental disagreement with Meghnad on his interpretation of Marxist economics. We regard Marxism as essentially based on the economy in a constant state of motion and therefore in permanent disequilibrium – or rather a condition where the notion of equilibrium has no meaning.

Two concepts of equilibrium

The notion of equilibrium is a disputed one in mainstream economics. For Keynes the term had a quite neutral meaning: a situation where no force tended to produce a change. Thus the economy could be in equilibrium with full employment or with three million unemployed. Theoretically the economy can have an infinite number of equilibrium situations. Keynes wrote his major book The General Theory of Employment, Interest and Money in the 1930s, a decade when mass unemployment could quite reasonably be regarded as an equilibrium situation. Most bourgeois economists before him had been principally preoccupied in apologetics, defending capitalism with their theories. They did not aspire to reform the system which, consistent with their analysis, they regarded as perfect already. But Keynes was a practical man, intent on improving the capitalist system precisely to save it from the danger of social revolution.

Neoclassical economics and equilibrium

To the neoclassical economics establishment this neutral, realistic seeming concept of equilibrium was Keynes’ mark of apostasy. For them equilibrium was no mere state in which forces pulling in different directions counterbalanced each other, so the economy would remain where it was. It was an occult concept at the heart of economics, justifying the rule of the market, i.e. capitalism.

The first basic assumption of the neoclassical economists was that markets clear. This is another way of saying that price changes work. If you reduce the price of something low enough you will be able to sell it.

In passing, the present writer has worked in a bookshop. You cannot sell this year’s calendars and diaries in November however much you cut prices. And unsold stocks in turn disrupt continued production in the printing industry further upstream. If the shop makes too many unwise stocking decisions, that will impact on the owners’ profits. It could lead to workers being laid off. Contrary to the fantasy in economics text books, the workers will not necessarily costlessly find themselves in a new job the following day. If they end up on the dole for a time they’ll have to cut back their spending. But their spending represents demand for commodities other workers produce. Micro decisions have wider, unforeseen consequences on the rest of the economy. This is discussed further in our section on the reproduction process of capitalism.

In neoclassical economics all the above is ignored. There is only one ‘true’ equilibrium position for the economy – full employment equilibrium. In other words capitalism always uses all resources and, as we will see, it uses them efficiently! Now this is manifestly untrue.

So how do they justify a permanent state of unemployment, of unused resources, under their system? The problem, they say, is that people keep messing about with the market. ‘Market imperfections’ are the problem. Get rid of them and the market will employ all resources.

Tory leader Michael Howard was applying this argument when, still in government, he denounced Labour opposition’s modest proposal for a minimum wage as ‘a proposition of staggering economic illiteracy’. He predicted two million extra unemployed – he was only two million out in his forecast!

His argument was that a minimum wage was bound to be above the market clearing rate. If wages are left to find their own level (fall), then eventually everyone will get a job. In the terms used by economics textbooks, the demand curve for ‘labour’ slopes down. If something is cheaper then you are likely to buy more of it, and capitalists feel the same about hiring workers. To use more textbook terminology, the supply curve for labour slopes up. If wages are higher, more workers will want a job.

At the price when supply is equal to demand, all workers willing to work at the ‘market rate’ will get a job. There will be ‘full employment’. In the same way it is ‘assumed’ calendars and diaries will always be sold at the end of the year if the seller drops the price enough - even though nobody wants them. Note that Howard is restating the discredited interwar ‘Treasury view’ that informed the 1931 National Government’s policies of cuts in wages and benefits. The manifestly wrong but politically convenient conclusions of Howard and the interwar Tories are propped up by the theory of equilibrium economics.

Supply and demand in orthodox economics

Neoclassical economics is based on a few metaphysical propositions. Commodities are said to be valued not by how much socially necessary labour time it takes to produce them but by how much people want them (utility). Joan Robinson, a left wing academic economist has commented, “The whole point of utility was to justify laissez faire.” As we know the Marxist view is that a commodity has both use value and exchange value. Use value is a precondition of a commodity having value, but it does not determine that value. But for modern bourgeois economics value is determined by what is called marginal utility. The assumption is made that the individual likes crispy crème doughnuts. One doughnut is nice. Two doughnuts are nicer than one but not twice as nice. In other words doughnuts, like everything else, are subject to declining marginal utility. If one were to try to measure how much an individual liked the first, second and third doughnuts to pass their lips  ‑ how on earth would we do this? In practice all we can measure is how much they are prepared to pay ‑ and draw it on a diagram, we would have a descending line.

Now let us look at supply conditions. If a capitalist has a factory with a set labour force of 100 workers and employs an extra one we can assume production will rise. But productivity (measured as production divided by the work force) will go down. This is taught to millions of students throughout the world as an undoubted axiom of economics. It is nothing of the sort. Modern workplaces are usually designed to be staffed by a particular number of workers with a range of particular skills. Economists have spent over a century ‘explaining’ the declining marginal productivity of labour in the workplace. If they spent five minutes walking round and surveying workplaces, they would see factories are not designed to deliver declining marginal productivity. Actually they tend to have a degree of built-in overcapacity to deal with rushes. This would suggest an increase in output would be associated with a decline in average costs. In any case the idea that employers can just lob homogenous ‘units of labour’ at a situation and see what happens is ludicrously unrealistic.

However it is assumed in neoclassical economics that, at some stage, declining marginal productivity will set in. This will make it more difficult to produce the next unit of output than the last one, and so it will cost more. So the firm’s supply curve will slope up. Add up all the firms’ supply curves and, Bob’s your uncle, you have an upward sloping industry supply curve. Superimpose the supply curve on the demand curve diagram and equilibrium will be found where the lines cross, where supply is equal to demand.

So the demand curve can be seen as an indicator of the benefits and the supply curve gives us an idea of the costs. Where supply is equal to demand on a diagram (equilibrium) then marginal cost is equal to marginal benefit. ‘Marginal’ means the last unit demanded and supplied. Costs are assumed to be increasing and benefits going down. Equilibrium gives the quantity of the good that maximises net benefits. Isn’t that wonderful?

Is there any truth in this? Even on its own terms equilibrium is episodic. The demand for beer, ice creams and umbrellas (to name but three items) fluctuates daily with the weather. The marketing department of a firm are not confronted with a nice pair of curves on a chart, but at best a range of data showing demand and supply conditions at different dates which they interpret as best they can. Nobody has tried to sell BMX bikes at 75p or £30,000 even as a thought experiment, so the range of readings is narrow and confused.

In the case of supply, we do not have any necessary reason to assume that increases in output are inevitably associated with increased costs per unit of output (caused by declining marginal productivity) even in the short run. Certainly in the long run an increase in demand for a product will call forth an increase in supply as capitalists respond to price and profit signals. There is no evidence whatsoever for rising prices in the long run.

The reason is simple. Though supply and demand constantly cause confusion like waves on the surface of the sea, values (around which day to day prices fluctuate) are determined by socially necessary labour time. Supply is determined, in other words, by cost conditions in the longer term. There is no necessary reason why costs should rise as output increases.

In conventional economic terms, Marxist economics posits a horizontal long run supply curve. Prices are determined by costs which are constant in the long run and dictated by the prevailing technology, while the amount produced is demand determined.

(to be continued...)