A Marxist Guide to Capitalist Crises
“A Marxist Guide to Capitalist Crises,” an eBook created from the key posts on the Critique of Crisis Theory blog, is currently in production. We’ll be sharing the completed chapters between our regular postings.
Chapter 16: Keynes on the ‘Classical’ Marginalist Economists
In the second chapter of his “General Theory of Employment, Interest, and Money,” Keynes summarizes the theories of the “classical economists.” Keynes uses the same terminology that Marx uses and indeed borrowed the terminology from Marx. However, Keynes referred to the “classics” of marginalism, or rather, he lumped together the marginalists with the classical economists in Marx’s sense of the term.
To Marx, the classical economists were those pre-1830 bourgeois economists who lived in a time when the contradiction between the capitalists and the working classes was still underdeveloped. Therefore, bourgeois economists could still analyze the laws of capitalist production scientifically rather than merely apologetically.
Keynes’s “classical economists” were the “classics” of marginalism, especially Keynes’s teacher Alfred Marshall. In his critique of the “classical” marginalist doctrine, Keynes did not dump neoclassical marginalism and return to anything like classical economics in the Marxist sense. Instead, he gave neoclassical marginalism a facelift so it would no longer be in such obvious contradiction with capitalist reality, especially the reality of the Depression years of the 1930s. Keynes aimed to develop a form of marginalism that could explain the existence of persistent mass unemployment under capitalism.
Keynes’s modified marginalism was designed to serve two purposes: First, he hoped to halt the spread of Marxist ideas among students of economics and other members of the young intelligentsia that was occurring under the impact of the Depression. This more plausible version of marginalism, Keynes hoped, would help turn the newly radicalized young intellectuals back towards a “safe” bourgeois version of economics. Second, Keynes’s revised marginalism would also justify massive government deficit spending, which he believed was necessary to combat the Depression in a way that “classical” marginalism did not.
Keynes’s critique of the marginalist theory of wages and prices
In Chapter 2 of the “General Theory,” Keynes presented the postulates of the liberal marginalist economists. These postulates are still defended today by neoliberal economists. All the following quotes are from Chapter 2 of Keynes’s “General Theory.”
The first, and perhaps the most important, postulate of traditional marginalism is this: “The wage is equal to the marginal product of labour. That is to say, the wage of an employed person is equal to the value which would be lost if employment were to be reduced by one unit (after deducting any other costs that this reduction of output would avoid); subject, however, to the qualification that the equality may be disturbed, in accordance with certain principles, if competition and markets are imperfect.”
This postulate holds that the worker’s wage is equal to the marginal product of the worker’s labor under conditions of “perfect competition” — no trade unions, no minimum wage laws, and no social insurance. It assumes that the capitalists do not exploit the workers. According to marginalism, when a new worker is hired, production will rise by a certain amount. The extra production is the marginal product produced by workers of that particular skill.
As more workers of that particular skill are hired, the value of the worker’s marginal product will decline for two reasons: First, the more workers that are hired, the amount of capital — in Marxist terminology, constant capital — remaining unchanged, the lower will be the extra amount of production — marginal product — in physical use value terms. Second, the products produced with the help of the newly hired workers become less scarce relative to subjective human needs, all things remaining equal, and therefore less valuable
On the other hand, the more workers of a given skill that are hired, the stronger the demand for labor and the higher the wage will be. This process continues until the value added by the last worker hired equals that worker’s wage. According to the marginalists, equilibrium is reached at this point. In equilibrium, therefore, each worker, through their labor, produces a quantity of value that is exactly equal to the value of their wages.
How the marginalist economists used mathematics to ‘refute’ Marx
This “postulate” boils down to the statement that the source of surplus value is not the unpaid labor of the working class, since the worker’s wage is equal to the value that the worker produces. What mathematical proof do the marginalists provide that this is indeed the case? Furthermore, what exactly is the meaning of the word postulate?
Postulate” is a mathematical term. In mathematics, a subject with which Keynes was very familiar, “postulate” has a precise meaning. It is defined by the CliffNotes “Postulates and Theorems” web page as “a statement that is assumed true without proof.”
Therefore, we see how the mathematical marginalist economists refuted Marx’s explanation of surplus value. They merely assumed without proof that surplus value is not produced by the working class.
The second “postulate” is that “the utility of the wage when a given volume of labor is employed is equal to the marginal disutility of that amount of employment.” The marginalists assume that no worker wants to work at all. Performing labor for a capitalist boss is a definite “disutility” from the worker’s point of view. On the other hand, the money that workers obtain in exchange for their “labor” enables them to buy commodities that have a definite utility. Indeed, without the “utility” provided by the wage, which the worker can only obtain by selling his or her “labor,” the worker could not live at all.
“That is to say,” Keynes explains, “the real wage of an employed person is that which is just sufficient (in the estimation of the employed persons themselves) to induce the volume of labour actually employed to be forthcoming; subject to the qualification that the equality for each individual unit of labour may be disturbed by a combination between employable units analogous to the imperfections of competition which qualify the first postulate.” Keynes continues, “Disutility must be here understood to cover every kind of reason which might lead a man, or a body of men, to withhold their labour rather than accept a wage which had to them a utility below a certain minimum.”
Therefore, according to the “classical marginalists,” the worker does a kind of unconscious mathematical calculation. As long as the utility of the wage exceeds the “disutility” to the worker of working for the boss, the worker continues to work. At some point, however, the worker will decide that the disutility of working for the boss exceeds the utility provided by the extra wages the worker could earn if they continued to work. At that point, the worker says, Enough is enough, and clocks out.
It is just as well for our economists that this statement is a postulate and therefore does not need to be proved. Anybody who has ever had a job under the capitalist system will immediately see that this “postulate” is completely divorced from reality. Suppose a worker who has read the marginalist economists explained to their boss that they had reached a point where the marginal disutility of their labor equals their wage for the day. Following the postulate used by professional economists, they are clocking out.
If he is mathematically educated, the boss might explain that economists do not have to prove this postulate since a postulate is a statement in mathematics that does not have to be proved. However, I, your boss, will disprove this particular postulate used by the economists for you. If you clock out now, you are fired. There are many other people out there who would be more than willing to take your job.
The second “postulate” of the classical economists is disproven whenever a boss schedules “forced overtime.” Even at “time and a half,” the worker would often be more than willing to give up the overtime, but cannot do so because if they refuse the overtime, they will be fired. That is why it is called “forced overtime.”
Perhaps the professors who taught at Oxford or Cambridge who discovered this “postulate” might have been in a position to refuse to teach more than, say, two hours a week. In late 19th-century Britain, almost all professors were recruited from ruling-class families who drew a large income from the rents on their families’ landed property and interest and dividends on their families’ investments.
After two hours of teaching the spoiled brats that constituted the rising generation of the ruling class the rudiments of marginalist economics, our professors would naturally prefer leisure for the rest of the week over continued teaching. Perhaps these professional economists who taught at such great institutions as Cambridge and Oxford did not realize that their conditions of employment were not the same as those of the workers who labored in the mills, mines, and fields. Unlike most professional economists, real workers had no other source of income except their wages. This postulate of marginalism, however, does provide an interesting illustration of Marx’s materialist theory of ideology. Being does indeed determine consciousness.
Using these two postulates of marginalism — both at odds with reality — the marginalists construct their “proof” that, assuming “free competition” prevails in the labor market, the only kind of unemployment that can exist is either frictional or voluntary. If a worker quits a job, it might take them a few days to find another one to their liking. Such a situation is an example of “frictional unemployment.”
The other type of possible unemployment is voluntary. For example, I might be able to find a job that will pay $500 a week. But I make the following calculation. While I certainly would like the commodities that I could obtain if I had an extra income of $500 a week, the utility that I would obtain from these commodities is less than the disutility of getting up in the morning and working for eight hours. I, therefore, choose leisure over work.
Indeed, voluntary unemployment was a growing phenomenon among the ruling class in Britain in the period when marginalist economics was being developed. The last quarter of the 19th century witnessed the transition from industrial capitalism based on free competition to monopoly capitalism, or imperialism. Members of the capitalist class were increasingly withdrawing from the active direction of their businesses — leaving it to hired managers — and becoming transformed into mere collectors of interest and dividends. Increasingly, these members of the ruling class were indeed choosing “leisure” over any extra income they might have been able to earn directing businesses; as members of parliament; or serving in the upper reaches of the military, civil service, or the church or as professors or other similar occupations that might do honor to a “gentleman.”
However demoralizing the growth of this kind of mass idleness among the members of the ruling class was, it did represent the free voluntary choice of the individuals concerned. Idleness among the working class was a different matter altogether. Unlike the idle capitalists and landowners, idleness among the working class meant poverty. Few workers would voluntarily choose the extreme poverty that the unemployed experienced in late 19th-century England rather than hold a job. Basing itself on these two absurd postulates, marginalism “proved” that long-term mass unemployment among the working class — except perhaps in unionized industries — was simply impossible.
It was this “proof” that only voluntary and frictional unemployment could exist in a capitalist economy that Keynes challenged. After the experience of the mass unemployment of the 1920s, followed by the even higher unemployment after 1929 of the Depression, Keynes realized something was wrong with the marginalist “proof.” But where did the “proof” go wrong?
The diehards of economic liberalism, especially the leaders of the Austrian school of marginalist economists such as Friedrich von Hayek and Ludwig von Mises, supported in England by Lionel Robbins, insisted that the way out of the slump was through massive wage cuts.
According to these economists, if the capitalists hired the unemployed workers at the prevailing level of wages, the workers’ labor would produce far less value than the value of the wages the bosses would be paying them. The workers would exploit the poor capitalists! In a free society, the capitalists would not put up with that. Economists of the Hayek, Mises, and Robbins schools claimed the only way out was through major wage cuts. Once wages dropped to a level that corresponded to the actual value that the workers’ labor was capable of producing, mass unemployment would disappear.
What was standing in the way, Hayek, Mises, and Robbins claimed, was the power of the trade unions and “socialist” government policies that were either encouraging mass “voluntary” idleness on the part of the working class or keeping wages so high that the capitalists could not afford to hire them at the prevailing wage levels.
In his “General Theory,” Keynes rejected the claim that cutting nominal wages would eliminate unemployment. The bosses, during the Depression years, certainly knew how to take advantage of the mass unemployment. There was no lack of wage cuts. Yet contrary to the predictions of Hayek, Mises, Robbins, and their supporters, there was no sign that full employment was being restored. On the contrary.
Keynes, by no means, completely disagreed with Hayek and Company. He shared their basic marginalist assumptions. But Keynes’s marginalism was more pragmatic and flexible in the British manner, as opposed to the rigid dogmatism of the “Austrians.” Keynes agreed with the Austrians that “real wages” must be cut to restore “full employment.”
However, he argued that cutting money wages was not the same thing as cutting real wages. Instead, according to Keynes, it was real wages that must be cut to restore full employment. “Whilst workers will usually resist a reduction of money-wages,” Keynes explained, “it is not their practice to withdraw their labor whenever there is a rise in the price of wage-goods.”
Keynes almost certainly was greatly influenced by the General Strike of 1926, the greatest social and political crisis in recent British history. How could he not have been? The General Strike occurred less than a decade after Russia’s October Revolution of 1917. Could something similar happen in Britain? This was, of course, the ultimate nightmare of all members of the British ruling class, Keynes included.
Back in the mid-1920s, the chancellor of the exchequer, Britain’s finance minister, Winston Churchill, in the face of considerable opposition within the British ruling class, including Keynes, moved to restore the convertibility of the British pound into gold at the old exchange rate. Since the pound had fallen about 10 percent since the suspension of gold convertibility in 1914, that amounted to a revaluation of the pound by about 9 percent against both gold and the U.S. dollar. (Unlike the pound, the U.S. dollar had not been devalued against gold due to World War I.)
The effect of this currency revaluation was to raise the price of labor power in terms of gold and the dollar by about 9 percent. The bosses, especially in the declining British coal mining industry, responded by attempting to lower the wages in revalued pounds by about 9 percent to wipe out the effects of the pound’s revaluation. The struggle against these wage cuts in terms of revalued British pounds led straight to the great General Strike of 1926.
But what would have happened if the pound had been devalued instead of a revaluation? Suppose the pound devaluation was such that the prices of commodities that the British workers consumed to reproduce their labor power rose by 10 percent in terms of pounds while nominal pound wages had remained unchanged. Real wages would have fallen about 9 percent. Would the response of the workers have been so strong? Would the General Strike of 1926 have occurred anyway?
Keynes suspected the answer would be no. Therefore, he concluded, it is always better to avoid cutting nominal money wages, which the trade unions and workers will strongly resist. Instead, Keynes implied that the government should pursue policies encouraging the cost of living to rise. This will lower the living standard of the workers in a way that will be less obvious to them and, therefore, he hoped, avoid any repetition of the “unpleasantness” of 1926 that had brought the continued rule of Keynes’s beloved capitalist class into question.
Keynes feared that lowering money wages would not lower real wages
In addition to opposing cuts in nominal wages, because they provoked the trade unions and the working class, Keynes also argued that cutting nominal wages was simply ineffective when it came to lowering the workers’ standard of living:
“Moreover, the contention that the unemployment which characterizes a depression is due to a refusal by labour to accept a reduction of money-wages is not clearly supported by the facts. It is not very plausible to assert that unemployment in the United States in 1932 was due either to labour obstinately refusing to accept a reduction of money-wages or to its obstinately demanding a real wage beyond what the productivity of the economic machine was capable of furnishing. Wide variations are experienced in the volume of employment without any apparent change either in the minimum real demands of labour or in its productivity. Labour is not more truculent in the depression than in the boom—far from it. Nor is its physical productivity less. These facts from experience are a prima facie ground for questioning the adequacy of the classical analysis.”
Following the logic of the classical marginalist analysis, why would the value that the workers’ labor produced suddenly collapse in the early 1930s, causing their wages to exceed that value? In terms of “physical productivity,” as Keynes put it, or in terms of use value, as the classical economists and Marx would put it, the workers’ labor was capable of producing more than ever.
Indeed, the decade of the 1920s, which preceded the Depression, saw an extraordinarily rapid increase in the productivity of labor in the United States as electricity finally drove out steam as the main motive power in industry. Yet the United States was hit hardest and longest by the Depression and experienced the most persistent and highest levels of mass unemployment among the imperialist nations.
Great Depression or ‘Great Vacation’?
According to the classical marginalists, in the United States during the terrible year of 1932, the unemployed were “choosing leisure” rather than accepting wages representing the value their labor was producing. Indeed, one wag even suggested that if the marginalist analysis is correct, the Great Depression should be renamed the “Great Vacation.”
Indeed, this is not far from Milton Friedman’s analysis of the Depression. If the Depression was not simply a “Great Vacation,” it was at least a “Great Misunderstanding.” According to Friedman, real wages had risen due to the fall in prices brought on by a contraction of the money supply. Therefore, when the Fed allowed the money supply to contract by one-third, the workers received a huge wage increase in real terms that was only partially counteracted by cuts in their nominal wages. The workers, not realizing how much the cost of living had fallen, were withholding their labor because they wrongly interpreted cuts in money wages as reductions in real wages.
One obvious problem with this “analysis” is that if it were true, workers should have been quitting their jobs in large numbers as the bosses moved to cut money wages rather than being laid off as they were in reality. The implication of the “classical marginalist theory,” defended by the neoliberal Friedman, was that once the workers got sufficiently bored with the “Great Vacation” and began to realize just how much cheaper everything was, they would gladly return to work at lower money wages — but the same real wage — and “full employment” would return.
By recognizing that the Great Depression was no “Great Vacation,” Keynes was making a point that was obvious to every worker, indeed to virtually every member of the lay public who was not a trained professional economist. But Keynes was very much a trained professional economist of the marginalist school. How, then, could he square the marginalist analysis with the facts that were so obvious to everybody except for marginalist economists?
Keynes did this by appealing to an even older economic fallacy than marginalism. This fallacy is the claim that the level of money wages determines the general price level. This view holds that all things remaining equal, if wages go up, prices go up as well, leaving real wages unchanged. Conversely, if wages go down, so will the general price level, also leaving real wages unchanged.
In the past, this argument had been used to “demonstrate” the futility of trade union activity. The argument was that if the unions succeeded in winning higher money wages, the workers would gain nothing from it because the bosses would pass on the extra costs in the form of higher prices.
“The classical theory,” Keynes wrote, “assumes that it is always open to labor to reduce its real wage by accepting a reduction in its money-wage. The postulate that there is a tendency for the real wage to come to equality with the marginal disutility of labor clearly presumes that labor itself is in a position to decide the real wage for which it works, though not the quantity of employment forthcoming at this wage.”
In other words, the marginalists assumed that if there is serious unemployment, the workers will accept lower wages, resulting in lower money and real wages. The “classical marginalists” claimed this would lead to a speedy restoration of “full employment.”
“Now the assumption that the general level of real wages depends on the money-wage bargains between the employers and the workers is not obviously true,” Keynes wrote. “Indeed it is strange that so little attempt should have been made to prove or to refute it. For it is far from being consistent with the general tenor of the classical theory, which has taught us to believe that prices are governed by marginal prime cost in terms of money and that money-wages largely govern marginal prime cost.”
According to economists of the Friedman type, even the stupidity of the Federal Reserve System in “allowing” or even “causing” the one-third drop in the U.S. money supply between 1929 and 1933 would not have been enough to cause the Depression. The stupidity of the Fed had to be backed up by the stupidity of the workers in not understanding the difference between a fall in real wages and a mere fall in money wages.
But Keynes was arguing that workers are not so stupid. Even if the workers fully “understand” that real wages must be reduced so that they can again get work, they will not be able to lower their real wages as opposed to money wages. According to Keynes, the more money wages fall, the more prices fall. The workers are thus powerless to lower their real wages. To lower their real wages so they can return to work, Keynes was implying that workers need the assistance of an inflationary policy on the part of the government and central bank.
The claim that “prime costs” — which are supposed to come down to wage costs — govern the general price level is not a marginalist notion but a return to a false idea of Adam Smith that Ricardo later refuted. Smith used the theory of labor value in places, but in a far less consistent way than Ricardo.
Essentially, Smith assumed that commodities would exchange in proportion to the labor socially necessary to produce them under conditions of simple commodity production, where the separation between wages and profits did not yet exist. But once capitalist production came into existence, it was the equalization of the rate of profit that drove capitalist production.
Capital is constantly flowing from industries where the rate of profit is below the average to industries where the rate of profit is above the average. Therefore, according to Smith, under capitalist production proper, the value of commodities — what Smith called “natural price” — is not proportional to the quantity of labor socially necessary to produce them. Then what determines the value of commodities under profit-driven capitalist production?
Smith believed that “constant capital,” to use Marx’s later terminology, could be reduced ultimately to variable capital. Smith argued that commodities necessary to produce a given commodity other than labor (power) are produced with both constant and variable capital. In turn, the commodities that produced these commodities other than labor power are produced with both constant and variable capital. Therefore, Smith claimed, if you go back far enough, all capital consists of variable capital alone. All capital is therefore reduced to wages! A fine theory indeed.
Smith concluded that the value of a commodity is reducible to the three forms of income — or revenue — of capitalist society — wages, profits, and rents. Therefore, Smith reasoned, if wages rise, the values and, thus, the prices of commodities must also rise.
Keynes, in the passage quoted, is replacing the vulgar theory of marginalism with an older vulgar theory. Changes in wages, Keynes insisted, govern changes in prices.
I should make clear here that even if the quantity theory of money is invalid, which it indeed is, this does not mean that the claim advanced by Keynes that changes in wages determine changes in prices is true. This claim will be examined in the next chapter.
Was Keynes really a friend of the working class?
During the first deflationary years of the Great Depression, compared to the economists of the Austrian school and other marginalist economists, Keynes appeared more friendly to the working class. The trade unions and the working class were resisting cuts in their wages, and Keynes, for his own reasons, also opposed cuts in nominal wages.
The workers were trying, to the extent it was possible, to defend their standard of living under the extremely unfavorable conditions of the early years of the Great Depression. On the other hand, Keynes opposed the cuts in nominal wages partly because he believed they were ineffective in lowering real wages.
However, in the inflationary years that were to follow, Keynesian economists came to the aid of the supporters of “wage moderation” on the part of the trade unions. During the “Great Inflation” of the 1970s, Keynesian economists, backed up by the bourgeois media, constantly talked about the “wage-price spiral.” Higher wages were raising the “cost of production” — shades of Adam Smith’s old theory — and therefore were driving up prices. The Keynesian economists called this alleged process “cost-push” inflation, which they distinguished from “demand-pull” inflation.
Keynesian economists, therefore, urged the trade unions to practice wage moderation and were delighted when Republican President Richard Nixon imposed wage-price controls that were mostly wage controls in practice.
The Keynesian economists, who had proclaimed victory over the “business cycle” in the 1960s, claimed that prosperity could be maintained by so-called expansionary policies — large budget deficits financed by massive borrowing by the government combined with rapid increases in the quantity of token money by the central banks — without inflation rising to “intolerable” levels if only the trade unions maintained wage moderation.
Unfortunately, the unions, especially in the United States, followed the advice of their mostly Keynesian and Keynesian-influenced economic advisers and went along with the wage moderation program. The result? Inflation continued to accelerate, and the U.S. economy went through the back-to-back monster recessions of 1974-75 and 1979-82.
Both the inflation rate and the official unemployment rate eventually rose into the double digits. As for real wages, measured on an hourly basis, they have never returned to the levels that prevailed in 1973, shortly after the controls were imposed, despite the considerable growth in labor productivity over the last quarter of a century.
The failure of the trade unions to resist wage controls greatly weakened them, not only economically but politically. This weakening of the trade unions made possible the reaction of the Reagan-Thatcher years and the long reign of “neoliberalism” that followed.
A Critique of Crisis Theory 