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 18: Keynes Attempts To Generalize Marginalist Theory
In previous chapters, we saw that Keynes denied that the unpaid labor of the working class produced surplus value. So, how does surplus value — profit, interest, and rent — arise, according to Keynes, if the working class does not produce it?
“It is much preferable to speak of capital as having a yield over the course of its life in excess of its original cost, than as being productive,” Keynes wrote in chapter 16 of the “General Theory.” “For the only reason why an asset offers a prospect of yielding during its life services having an aggregate value greater than its initial supply price is because it is scarce; and it is kept scarce because of the competition of the rate of interest on money. If capital becomes less scarce, the excess yield will diminish, without its having become less productive—at least in the physical sense.”
To use Keynes’s terminology, the difference between the “aggregate value” and the “supply price” — the cost to the capitalist of that asset — is the surplus value that the asset yields (not produces) to its owner. But where does this surplus value that is “yielded” come from if it is not produced — if it does not arise in the sphere of production?
According to Keynes, neither the working class nor capital “produces” surplus value. Contrary to the Physiocrats or the Smith-Ricardo school, surplus value is not, according to Keynes, produced in the sphere of production. From where, then, does the surplus value come?
According to Keynes, capital “yields” a surplus value only because it is “scarce.” If capital were not scarce, there would be no surplus value.
The marginalists, including Keynes, have reverted to the views of the mercantilists and Malthus — Keynes held Malthus in especially high regard — that surplus value arises not in the sphere of production but in the sphere of circulation. In its flight from the law of labor value, marginalism negates the most outstanding achievement of the liberal classical political economists. This is the discovery that surplus value arises in production, not circulation. Therefore, according to both Keynes of the “General Theory” and classical marginalist economists, surplus value is simply the result of the scarcity of capital.
Keynes on profit and interest
Keynes broke with traditional marginalism in his view of the nature and relationship between the two different fractions of surplus value that constitute profit — the profit of enterprise and interest. Unlike Marx, who explained “interest” as simply a sub-fraction of profit, which itself is only a fraction of the surplus value produced by the unpaid labor of the working class, Keynes saw interest and profit as the “yield” of money capital and the “yield” of real capital, respectively. Real capital “yields” a profit because it is “scarce,” just like money capital “yields” its owner an interest because it, too, is “scarce.”
In contrast to Keynes, the classical marginalists claimed that capital — not just money capital — yields interest because capital is a scarce factor of production. To the classical marginalists, money capital does not have any real existence since money capital is merely the reflection of the value of scarce real capital. The pre-Keynesian marginalist held — and neoliberals still do — that the interest rate is determined by the degree of scarcity of real capital alone.
By the time he wrote the “General Theory,” Keynes had come to reject this argument. Instead, Keynes came to distinguish between the profit of the industrial and commercial capitalists — the profit earned by the entrepreneurs, to use Keynes’s preferred terminology — and the interest earned by the money capitalists — or rentiers, as Keynes called them.
The marginal efficiency of capital
Like the “classical” marginalists, Keynes generally avoided the term “profit” or “rate of profit.” Instead, he introduced a new term to distinguish the profit “earned” by the “entrepreneurs” from the “interest” appropriated by the “rentiers.”
Keynes called the profit appropriated by the industrial and commercial capitalists — or, rather, the profit they expected to appropriate — the marginal efficiency of capital. Here Keynes used the marginalist method to analyze what, in plain language, is the expected rate of profit.
Keynes reasoned like this: If an additional unit of capital is employed, the commodities that will be produced with it will, all other things remaining equal, become less scarce relative to the demand for them, causing their prices to decline. Realizing this will happen, the industrial or commercial capitalists will expect a lower profit rate on each additional unit of capital they invest. The rate of profit expected by the industrial (or commercial) capitalists on an additional — or marginal — unit of capital Keynes called the marginal efficiency of capital.
Marx versus Keynes on profit and interest
According to Marx, assuming the industrial or commercial capitalists make the average rate of profit and work with their capital, these capitalists appropriate the interest on their capital plus an additional profit, the profit of enterprise. The average profit, according to Marx, consists of interest plus the profit of enterprise.
Keynes, however, because of his peculiar definition of interest, denied that entrepreneurs realize “interest” on their capital. According to Keynes, interest is the “reward” that a money capitalist—or rentier, in Keynes’s terminology—gets for not holding money.
According to Keynes, the marginal efficiency of capital — which plays the same role in Keynes’s system as the rate of profit in the classical and Marxist schools — arises due to the scarcity of real capital, and interest arises due to the scarcity of money capital. Therefore, unlike the classical marginalists, Keynes, like Marx, sharply distinguished between real and money capital.
The distinction that both Marx and Keynes made between real and money capital is incompatible with the quantity theory of money. According to that theory, changes in the quantity of money relative to the number of commodities have no effect on real wages and profits. The modern version of the quantity theory of money associated with Milton Friedman would amend this to say, no effect in the long run on real wages or real profits.
According to the traditional marginalists — including the neoliberal followers of Milton Friedman — if the quantity of money is insufficient to fully realize the value of commodities at existing prices, prices will fall to a level that will realize their values. If the total quantity of money consisted of only one dollar or one euro, for example, all the commodities produced would still be sold, though the prices of commodities would be quoted in terms of tiny fractions of a cent.
Therefore, in the long run, the quantity of money should not affect the rate of interest. At most, according to traditional marginalism, if the rate of growth in the quantity of money exceeds the rate of growth in the number of commodities, an “inflation premium” will be added to the “natural rate of interest,” which is determined in turn by the scarcity of real capital.
For example, according to Friedman, if the natural rate of interest is 3% and the expected rate of inflation is 4%, the nominal rate of interest will be 7%. But even then, the real rate of interest, that is, the actual quantity of commodities that a given interest income can buy once the effects of inflation are factored out, will not be affected. Keynes rejected this analysis.
As we saw in the preceding chapter, Keynes, in contrast to Ricardo, Marx, and marginalist supporters of the quantity theory of money, such as Milton Friedman, claimed that the level of money wages determines the level of nominal prices. Therefore, a contraction in the quantity of money will raise interest rates, according to Keynes, not lower the general price level. Only if the contraction of the money supply and the consequent rise in the rate of interest leads to mass unemployment that, in turn, drives down the level of money wages, will the general price level finally be lowered. Therefore, Keynes of the “General Theory” rejected the neutrality of money and admitted the possibility, not the inevitability, of a general overproduction of commodities.
Marx versus Keynes
Marx and Keynes are in partial agreement here, a point emphasized by the Keynesian Marxists. Both Marx and Keynes rejected the quantity theory of money, the neutrality of money that goes with it, and the consequent denial of the possibility of a “general glut” of commodities — Say’s Law. Marx and Keynes rejected the claim that a contraction in the quantity of money would lower prices and agreed that a contraction in the metallic money supply in a given country would increase the rate of interest in that country.
Conversely, they agreed that expanding the quantity of metallic money, all else remaining equal, would lower interest rates and not increase prices. Both Marx and Keynes recognized that the split between money and commodities makes general crises of overproduction possible.
Some Keynesian economists are quite cool toward the theory of comparative advantage as well. This is not surprising since, as I have demonstrated, the view that comparative advantage as opposed to absolute advantage applies in trade between nations under capitalism stands or falls — it falls — with the quantity theory of money.
How compatible are the theories of Marx and Keynes
Pointing to these very real areas of agreement, many Marxists have jumped to the conclusion that Keynes’s theories represented a significant turn in the direction of Marx. The most Keynesian Marxists have implied that the differences between Marx and Keynes are merely terminological, though they admit that, unlike Marx, Keynes failed to draw any socialist conclusions from his critique of “classical” marginalist economics.
If the differences between Marx and Keynes are merely terminological, it should be possible to integrate Keynes’s entire system into Marxism. All we would need is a dictionary to translate the different terms. But is this really the case?
Fundamental differences between Keynes and Marx
Indeed, even leaving aside the fact that Keynes did not draw any socialist conclusions from his work, the differences between Marx and Keynes are much more than terminological. They involve the most fundamental question in all economic science — the origins and nature of surplus value.
In addition, they involve the very nature of value, money, and price. Why do products of labor under certain historically determined conditions of production take the form of commodities at all? What determines the magnitude of the value of a given commodity? What is the meaning of the word value? Marx and Keynes gave radically different answers to these basic questions.
For example, take the economic category of “money,” which plays a far more critical role for both Marx and Keynes than for traditional marginalists. As we have seen in earlier chapters dealing with the theory of money, metallic money, token money, and credit money are, according to Marx, governed by quite different laws.
However, Keynes — much like Milton Friedman — applied the same laws to all three forms of money. According to Keynes and Friedman, whether money takes the form of gold coins, banknotes convertible into gold, or paper money, changes in the quantity of money will have the same effect. To Friedman, an expansion of the quantity of money, everything else remaining equal, will, over time, simply affect nominal prices and wages. To Keynes, in contrast, unless “full employment” already exists, an expansion in the quantity of money will lower interest rates, increase production and employment, as well as the market.
To be fair to Friedman, he did distinguish between what he called “high-powered money” — hard cash — that can be used to form bank reserves that enable the banking system to increase the quantity of bank money — deposits that can be transferred by check or electronic means to make purchases and payments through the system of fractional reserve banking. Friedman disliked the whole system of fractional reserve banking for this very reason since it undermined the ability of the “monetary authority” to determine the rate of growth of the quantity of money. However, he tended towards the view that, because of the great inherent stability that he claimed characterized the capitalist system, a “monetary authority” that has a monopoly on the creation of “high-powered money” should still be able to control the rate of growth of the money supply as a whole.
But to Friedman, it makes no difference whether the “high-powered” money that serves as a reserve behind bank money consists of full-weight gold coins and bars, convertible into gold banknotes, or legal tender paper money issued by a monetary authority. According to Friedman, gold only functions as money when it is coined and circulates as currency.
The neoliberal followers of Milton Friedman, therefore, wrongly apply the laws that govern token money — paper money — to metallic money. Keynes and his followers make the reverse error, wrongly applying the laws that govern metallic money to token money. Keynes believed that an increased issue of paper money by the “monetaryauthority” is exactly the equivalent of a rise in gold production or an influx gold from abroad.
Where Marx agrees with Friedman
When it comes to the effects of an increase in the quantity of token money issued by a monetary authority, Marx was closer to Milton Friedman than Keynes. Marx and Friedman agree that if the monetary authority doubles the quantity of the token money it issues, the quantity of metallic money and commodities remains unchanged, doubling nominal prices and wages, but otherwise, it has no effect. According to both Marx and Friedman, the doubling of wages would reflect the doubling of prices, not cause the doubling of prices.
However, Marx would be closer to Keynes regarding the effects of an increase in the quantity of metallic money. While Friedman would see this as just as inflationary as an increase in the quantity of paper money, Marx would agree with Keynes that an increase in the quantity of metallic money, all other things remaining equal, will bring about a fall in the rate of interest, not higher prices, and form a basis for the actual extension of the market which brings with it higher production and employment.
Keynes saw a rise in money wages as inflationary because they raised the “prime costs,” which, according to Keynes, govern prices. But Marx did not agree. Since Friedman believed that inflation was always caused by an excessive expansion in the quantity of money relative to commodities, he, like Marx, did not believe that higher wages were inflationary.
Where Marx and Friedman do not agree
Unlike Marx, however, Friedman would oppose a rise in money wages, not because he thought it would be inflationary but because he would claim it would increase unemployment. Eager to safeguard his reputation as the darling of the business world, it is hard to imagine the old University of Chicago professor ever supporting a wage hike in any real-world situation.
Marx, in contrast, as the champion of the working class, supported demands for higher wages by the workers. He also explained that the real liberation of the workers could not be achieved by raising wages — which can only reduce the rate of surplus value or at least prevent its increase. Liberation is won by abolishing the wage system — capitalism.
No Friedmanite-Marxists
No Marxist, trade unionist, or left winger that I know of ever claimed that Milton Friedman’s “anti-Keynesian counterrevolution” was a move toward Marx on the part of the academic bourgeois economists, though as we have shown, there are points where Marx is closer to Friedman than he is to Keynes.
Just because Marx and Keynes agree on some questions does not demonstrate that the views of the two economists are close enough to create a consistent “Keynesian-Marxism,” just like the fact that some points of agreement between Marx and Friedman do not make possible a logically consistent “Friedmanite-Marxist” school.
Keynes on the effects of changes in the rates of profit and interest on production and employment
The “classical” marginalists claimed that when the economy is in “equilibrium,” profit of enterprise will disappear, leaving only interest. They argued that if there were branches of industry where profits exceeded interest, the industrial capitalists would invest in those areas as part of their ceaseless drive to maximize profits. They would expand their production in those areas until prices dropped and the profits, as opposed to interest, vanished.
Assuming that there is “free competition, especially in the labor market,” the only possible economic equilibrium, according to this view, would be an equilibrium of full employment, with the industrial and commercial capitalists earning only “interest.” For many years before he wrote the “General Theory,” Keynes’s view was the same.
Keynes breaks with classical marginalism
However, Keynes was bothered by the obvious contradiction between the reality of mass unemployment in Britain during the 1920s and 1930s and the great “discovery” of the marginalists that the capitalist economy could only be at equilibrium when it was at “full employment” — leaving aside the effects of labor unions and social legislation.
In his “General Theory,” Keynes held that the economy tends toward an equilibrium where the rate of interest equals the marginal efficiency of capital — that is, in terms of algebra, the marginal efficiency of capital = rate of interest. Or in plain language, where the interest rate equals the expected profit rate. Industrial capitalists, in their never-ending search for profit, will cease to expand production at the point where they expect that a further investment of capital will yield only the rate of interest.
In Keynesian economics, as production increases — all else remaining equal — commodities become less scarce, causing their prices to fall, reducing the rate of profit on additional units of capital applied to production. The marginal efficiency of capital falls as production increases. However, the industrial capitalists will keep increasing production, despite the prospects of a falling rate of return, as long as the expected rate of profit exceeds the prevailing rate of interest.
However, this process will halt the moment the rate of profit yielded by additional units of capital invested in industry is expected by the industrial capitalists to yield a return less than the rate of interest. At that point, the economy has reached an equilibrium where the rate of interest and the marginal efficiency of capital are equal.
Here Keynes makes his break with traditional marginalism. According to Keynes, the point of equilibrium where the expected rate of profit equals the rate of interest may or may not coincide with “full employment.” In Keynes, unlike “classical” marginalism, the rate of interest is determined independently of the rate of profit on real capital. As we have seen, the rate of interest is determined in the Keynesian system by the relative scarcity of money relative to the demand for money — what Keynes called liquidity preference.
Keynes held that no mechanism in a capitalist economy automatically ensures that the point where the rate of interest is equal to the marginal efficiency of capital corresponds to full employment. According to Keynes, the rate of interest and the marginal efficiency of capital could equalize at a level corresponding to mass unemployment.
In practice, Keynes assumed that the level of employment would fluctuate around this equilibrium point, just like in classical economics and Marx, market prices fluctuate around the prices of production of individual commodities.
Keynes on the industrial cycle
Keynes reasoned that sometimes production and employment would be below the equilibrium point where the marginal efficiency of capital and the rate of interest are equal. In this case, the industrial capitalists expect that the additional capital investment will yield a rate of profit greater than the interest rate. Under this type of disequilibrium, industrial production and employment in the economy are increasing. This corresponds to the rising phase of the “trade cycle.”
At some point, however, as production increases and prices and profits start to fall, the marginal efficiency of capital will fall below the prevailing rate of interest. The industrial capitalists will then start to reduce production and lay off workers. The economy enters the downward, or recession, phase of the industrial cycle, or trade cycle, as Keynes called it. If, according to Keynes of the “General Theory,” the equilibrium level of production — the point where the marginal efficiency of capital is equal to the rate of interest — corresponds to mass unemployment, the level of unemployment across “the trade cycle” will be high with much “involuntary unemployment,” such as it was in Britain during the 1920s and 1930s.
In contrast, the traditional marginalist position that Keynes was breaking with in the “General Theory” held that since the only possible capitalist economic equilibrium was “full employment,” any rise in unemployment caused by a recession would be short-lived since, by definition, any level of unemployment except “full employment” represents a disequilibrium. Therefore, the conclusion was that if a recession did occur, the capitalist economy would always rapidly return to full employment without any government intervention. At most, the central bank — Bank of England — would only need to lower its (re)discount rate to restore “full employment” quickly.
Starting with the “General Theory,” Keynes, in contrast, held that the economic equilibrium could just as well be reached at levels of mass unemployment. In such a situation, which he certainly believed was the case when he wrote the “General Theory,” Keynes believed that — barring appropriate action by the government — mass unemployment could persist — with cyclical fluctuations — indefinitely.
According to Keynes, the traditional marginalist claim that assuming free competition, especially in the labor market, the capitalist economy would constantly return to “full employment” after a recession was true only in the special case where the level of employment and production that equates the rate of interest with the (expected) rate of profit happened by chance to coincide with “full employment.” Therefore, according to Keynes, the “classical” marginalists made the mistake of confusing what was only a special case — where economic equilibrium happened by chance to coincide with “full employment” — with the many real-world situations where equilibrium coincided instead with mass unemployment.
According to Keynes, the marginalist classics correctly analyzed the “special case” where the rate of interest equals the rate of profit at “full employment.” Their only mistake was their failure to realize that this was only a special case. Keynes aimed to complete marginalist theory by analyzing the cases where the rate of interest equals the rate of profit at other than “full employment.” If the equalization of the rate of interest and profit occurs at a point where there is a considerable amount of “involuntary” unemployment, which Keynes believed was becoming more and more the norm, the intervention of the state would be necessary to ensure a “reasonable approximation to full employment.”
Keynes’s conservative conclusions
Therefore, according to Keynes, there was nothing fundamentally wrong with marginalist economics, or indeed the capitalist society it champions. The only necessary thing was to analyze not only the “special case” where economic equilibrium happened to coincide with “full employment” but the other cases where it did not as well. Once this was done, it would become evident that there was an important role for government to play in ensuring that economic equilibrium does coincide with “full employment.” It is this conclusion of Keynes that makes him so popular with progressives and even some Marxists. His conservatism stemmed from the fact that he was confident that full employment could be achieved within his beloved existing order of society — the system of capitalist class rule and exploitation.
Keynes remained a marginalist
The great 20th-century physicist Albert Einstein did not break with his special theory of relativity — which applied to the special case where acceleration is absent — when he expanded it to take into account cases where acceleration is present. Einstein’s generalization of his theory of relativity is known as the general theory of relativity.
Einstein could generalize his special theory of relativity into the general theory because the special theory, at least within a broad domain, corresponds to physical reality. In contrast, Keynes’s attempt to generalize neoclassical marginalist economics to situations where equilibrium coincides with less than full employment is based on a set of postulates that are in basic conflict with the economic and social reality of the capitalist system.
A Critique of Crisis Theory 