The Views of Ricardo, Mill, Marx, and Keynes on the Long-run Dynamics of the Capitalist System
Ricardo considered an economy that consisted of workers, landowners, and capitalists. The workers earned wages in exchange for their labor, whereas the landowners leased their land to farmers. The capitalist s invested their capital, paid workers, and earned profits. Ricardo’s analysis of the dynamics of capitalism indicates that real wages can fluctuate in the short-run (Hunt and Lautzenheiser 96). However, in the long-run Malthusian law prevents wages from rising above the subsistence level. Thus, the production of agricultural output such as corn will have to be increased in order to develop industry and to reduce unemployment. In a closed economy, the farmers will have to cultivate the land of low quality in order to increase employment. However, the price of the output must increase so that the cultivation of the low-quality land can be profitable. Similarly, owners of the fertile land will charge high rent for their land.
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As the rent continues to rise and wages remain constant, capitalists’ profits will begin to fall. Consequently, the capitalists will not have any incentive to increase their investments. At this stage, the economy will be at a steady-state (Hunt and Lautzenheiser 102). The new land will be required to sustain production and economic growth. Alternative, highly productive farming methods can be employed on the best lands to improve efficiency and productivity.
John Stuart Mill
According to Mill, the accumulation of wealth is not boundless. Mill argues that achieving a stationary state is the ultimate goal of the process of wealth accumulation. The stationary state is characterized by freedom from “the imperatives of economic necessity and the freedom to develop as a human being” (Hunt and Lautzenheiser 115). In this regard, having limits in economic production is crucial to the achievement of human ends. According to Mill, the expansion of economic production is a relevant objective in underdeveloped rather than developed countries. The main economic problem in developed countries is distribution.
Mill believed that uncontrolled production in the capitalist system merely leads to increased accumulation of wealth, rather than improving the standards of living. For instance, he states that increased use of machinery in production would ultimately abridge labor, thereby increasing unemployment (Hunt and Lautzenheiser 117). Similarly, Mill argued that increased use of machinery in the capitalist system had enabled most manufacturers to increase their earnings. By contrast, most workers continue to live “the same life of drudgery and imprisonment despite the use of machinery in the capitalist system” (Hunt and Lautzenheiser 118).
In sum, Mill argues that extreme capitalism that is characterized by endless accumulation is unsustainable because the world has limited resources. Thus, production in the capitalist system should be regulated to prevent its destructive effects and to enhance the achievement of human ends in the long-run.
Marx had a pessimistic view of the capitalist system, which he expected to collapse in the long-run. Marx perceived capitalism as a system characterized by “a reserve army of the unemployed, falling rate of profit, business crises, increasing concentration of industry into fewer firms, and increasing misery within the proletariat” (Hunt and Lautzenheiser 121). According to Marx, the supply of labor often exceeded its demand, thereby reducing wages and maintaining positive surplus value and profits. The supply of labor exceeds demand because of the increased use of machines in production.
Although Marx acknowledged the potential of capitalism to increase material wealth, he believed that the system had inherent contradictions that would eventually lead to its collapse. In particular, the capitalist system is characterized by the intense competition that forces capitalists to improve their efficiency. This involves increasing investments in machinery and reducing expenditure on labor. Thus, workers’ earnings and purchasing power will reduce, thereby reducing demand for the capitalists’ products. In this regard, the reduction in demand will reduce the profits earned by the capitalists (Hunt and Lautzenheiser 124). Moreover, the increase in the misery of the workers will eventually lead to a revolution against the capitalists. Marx believed that capitalists focused on profit maximization rather than satisfying needs. They produce the goods and services that the rich can afford rather than the goods needed by the poor. These contradictions ultimately lead to the collapse of the capitalist system, and the society will embrace socialism.
Liberal economists believed that government intervention was not necessary to move the business cycle from depression to recovery in a capitalist system. They believed that the capitalist system would recover from the recession on its own since recovery often followed the recession. However, the experience of the great depression in the 1930s disapproved the notion that the capitalist system was capable of recovering from depression on its own.
Keynes argued that capitalism could be saved through government intervention. In this regard, the government is expected to run a budget deficit to compensate for the reduction in expenditure in the private sector. As a result, unemployment will be replaced by full employment. Keynes believed that recession could be prevented through “increased deficit spending by the government-backed up by interest rate cuts by the central bank” (Hunt and Lautzenheiser 245). If inflation increased, the government could respond by balancing its budget or reducing its deficits.
According to Keynes, the lack of demand during depression can be permanent, thereby causing stagflation. He argued that the rate of profit would tend to reduce as the world’s capital stock increased. Consequently, investments and consumption would decrease. In this regard, the collapse of capitalism can be prevented if the government increases its spending to stimulate private investments, as well as implementing fiscal policies that encourage consumption (Keynes).
The Responses of Keynes, Kalecki, and Friedman to the Problem of Full Employment
According to Keynes, full employment can be achieved through feasible government policies. Keynes noted that it is impossible to determine the full employment level of output that must be produced in order to employ the unemployed. Consequently, the focus of fiscal policy should shift from stimulating growth to direct provision of wages through public works programs (Hunt and Lautzenheiser 315).
Keynes believed that the private sector was not capable of creating full employment since it is the main cause of unemployment. In the capitalist system, full employment cannot be achieved since employers can pay wages that are too low to reduce unemployment (Hunt and Lautzenheiser 316). Similarly, employers will not have an incentive to hire more workers if they expect low profits. According to Keynes, achieving full employment through the private sector has two problems.
First, there is a disconnect between stimulating aggregate demand and increasing employment. Keynes asserts that the rate of employment and aggregate demand is not effectively connected despite the relationship that exists between them. In particular, aggregate demand is a determinant of employment. However, the private factors that influence aggregate demand are characterized by high uncertainty (Hunt and Lautzenheiser, 317). Thus, it is not possible to guarantee a sufficient increase in aggregate demand in order to achieve full employment.
Second, creating jobs through fiscal stimulus programs is not effective due to its inequitable distributional effects. Keynes argued that “the size of fiscal stimulus is irrelevant to eliminating unemployment” (Hunt and Lautzenheiser 319). Specifically, policies such as reduction of taxes and interest rates have no influence on the uncertainties that prevent job creation in the private sector. According to Keynes, the policies that are often implemented to increase aggregate income do not address the problem of distributing stimuli in the economy since unemployment varies across the country. For instance, the stimuli attributed to fiscal and monetary policies often benefit consumers of durable goods rather than the unemployed. In this regard, Keynes argues that full employment can only be achieved if the government creates jobs through public works projects.
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According to Kalecki, full employment can be achieved in the capitalist system through government spending. If the “government undertakes public investment or subsidizes mass consumption, and if this expenditure is financed by borrowing and not taxation, effective demand may be increased up to a point where full employment is achieved” (Kalecki 1-9). In order to finance the expenditure, the “government pays its suppliers in government securities” (Kalecki 1-9). The government securities in circulation at any given time will be equivalent to the goods and services purchased by the government. According to Kalecki, the central bank is often capable of maintaining a specific level of interest rate irrespective of the level of government borrowing.
Kalecki was aware of the fact that increased government spending was likely to increase inflation. Thus, he argued that the increase in demand as a result of government expenditure should be considered as a normal increase in demand. If there is adequate stock of factors of production, an increase in demand should be addressed through an increase in production (Kalecki 1-9). However, the prices are likely to rise in order to ration the limited supply if demand continues to rise after the full employment of available resources.
Kalecki argued that the government is not capable of maintaining full employment due to the resistance of the captains of the industry. The captains will oppose the government if the public expenditure does not favor their interest (Kalecki 1-9). An overlap between public expenditure and private expenditure will also cause opposition to the government. In this case, the government will be opposed because the overlap in spending will impair profitability in the private sector, which in turn offsets the positive effects of public spending on employment. Kalecki also argued that business leaders would oppose full employment because sacking employees will no longer be an effective disciplinary action. Workers will not be concerned about being sacked if they are able to find jobs easily.
Keynesians believed that full employment could be achieved through an increase in the money supply. However, the expansion of the money supply was expected to cause inflation after full employment was reached. Thus, the main concern of monetary policy authorities was to determine the optimal level of money supply expansion (Hunt and Lautzenheiser 342). In response to this concern, William Phillips developed the Phillips Curve analysis to help economists to make a tradeoff between inflation and unemployment. According to Phillips, unemployment had a negative relationship with inflation. However, Friedman argued that monetary policy loses its effectiveness as businessmen refine their prediction of the expected level of monetary expansion. In this regard, both unemployment and inflation would rise, thereby causing stagflation.
According to Friedman, full employment cannot be reached through monetary policy. Specifically, monetary policy is ineffective because it results in a significant increase in inflation before full employment is achieved. Thus, Friedman believed that targeting the lowest rate of unemployment was more practical than struggling to achieve full employment using a monetary policy (Hunt and Lautzenheiser 346). Friedman referred to the lowest rate of unemployment as the natural rate. The natural rate of unemployment is desirable because it can be achieved without a significant increase in inflation. However, determining the natural rate of unemployment that should be targeted is often difficult.
Say’s law states that “the production of goods creates its own demand” (Hunt and Lautzenheiser 387). The gist of this premise is that businessmen are always interested in selling all the goods that they produce. The production process generates income for the workers (salaries) and profits for the owners of capital. In this regard, the production of goods creates wealth for both workers and businessmen. Consequently, effective demand for the produced goods will always exist. According to Say, hoarding money is irrational since inflation can reduce its value.
In the capitalist system, Say’s law is characterized by six propositions. First, the “total factor payments received for producing a given volume of output are necessarily sufficient to purchase that volume of output” (Hunt and Lautzenheiser 391). Specifically, production creates the means to purchase the produced goods. Second, there are no Keynesian leakages because individuals save money that is only enough to meet their investments and transaction needs in the present period. In this regard, purchasing power will not reduce in any sector of the economy.
Third, investment is “considered as an internal transfer rather than a reduction of aggregate demand” (Hunt and Lautzenheiser 396). Fourth, demand and supply will always be equal in real terms. This equilibrium holds because individuals produce only the amount of goods that enable them to access other goods. Fifth, the level of aggregate output increases with the rise in savings. Finally, disequilibrium can only exist if the produced goods fail to match consumers’ preferences. Thus, disequilibrium in the economy is not an indication of excess output. Say’s the law has often been criticized based on the extent to which these propositions are valid.
Critique of Say’s Law by Keynes and Malthus
According to Keynes, Say’s law implied that the economy must always achieve full employment. Although Say’s law indicates that there are no obstacles to achieving full employment, practical experience showed that full employment is not always achieved. Thus, Keynes concluded that the law advanced by Say does not hold because of the insufficiency of aggregate demand. The lack of aggregate demand was attributed to the disequilibrium between savings and investments (Keynes 209-223).
Keynes believed that resources are not always fully employed in the economy. He considered full employment as a random occurrence. Thus, full employment can only be achieved if “by accident or design, current investments provide an amount of demand just equal to the excess of the aggregate supply price of the output resulting from full employment” (Hunt and Lautzenheiser 214). Unlike Say, Keynes considered savings and investments as different and unequal activities.
Keynes also disagreed with Say’s perspective that hoarding money was irrational. According to Keynes, both consumers and investors are likely to hoard large sums of money if they are worried about future changes in the economy. In this context, the consumers would have a high liquidity preference, whereas investors would reduce their investments (Keynes 209-223). Thus, savings and investments will not be equal, thereby causing the economic decline. In this context, Say’s law does not hold since the economy is facing the paradox of thrift. In particular, supply will exceed demand if consumers and investors focus on saving rather than spending.
Keynes also criticized Say’s perception of equilibrium. He asserted that equilibrium is a state in which aggregate supply and demand are equal. Thus, equilibrium does not entail a balance between the goods produced and consumed, as Say argued. Say presented the equilibrium as an identity, whereas Keynes considered it a random occurrence. Say believed that an exogenous shock would cause disequilibrium in the economy. By contrast, Keynes argued that an exogenous shock would be required to restore equilibrium rather than to create an imbalance.
In the theory of the general glut, Malthus criticized Say’s claim that supply will always equal demand. Say’s an analysis of the production system was based on the assumption that all profits were invested, whereas all wages were consumed (Hunt and Lautzenheiser 218). The rent received by landowners could be consumed or saved. Thus, Malthus argued that if landowners’ income is not fully consumed (part of it is saved), the demand for consumer goods will be less than their supply (there will be a general glut).
Malthus was aware of the fact that investments led to the expansion of output capacity, thereby increasing the supply of goods. In this context, the supply of goods in the current period will exceed the demand for consumption, which is determined by the income earned in the previous period. The glut will persist if consumption in the next period does not increase exogenously or the prices of goods fail to reduce (Hunt and Lautzenheiser 219). As a result, the capitalists will reduce their investments, which in turn reduces rent and labor incomes. This will further reduce consumption and the general glut in the subsequent production periods.
In order to prevent the glut, Malthus argues that the proportion of landowners’ income that is consumed should be increased in response to the expansion of the output capacity. The increase in landowners’ consumption will slow down the expansion of the output capacity by reducing savings (Hunt and Lautzenheiser 221). In addition, it will compensate for the expected reduction of workers’ consumption of capital goods. Thus, supply will equal demand. Generally, Malthus’ argument for the existence of a general glut is likely to hold only in the short-run. In the long-run, excess production will result in a reduction of entrepreneurs’ profits. Consequently, savings and investment will decline, thereby reducing output capacity.
Hunt, Eric and Mark Lautzenheiser. History of Economic Thought: A Critical Perspective. New York: M.E Sharpe, 2011. Print.
Kalecki, Michael. “Political Aspects of Full Employment.” Political Quarterly 1.1(1943): 1-9. Print.
Keynes, John. The End of Laissez-faire. Ludwig von Mises Institute, 31 Sept. 1926. Web. 15 Dec. 2013.
Keynes, John. “The General Theory of Employment.” Quarterly Journal of Economics 51.2 (1937): 209-223. Print.