Monday, June 1, 2009

Neoclassical Economics and the Problem of Realization.

The Neoclassical School of economic theory emerged from a dissatisfaction with classical political economy and the labour theory of value. Critics of capitalism, from the Marxian tradition, had hijacked the precepts of the classical school to analyze the historical tendencies of capital accumulation and the stumbling blocks inherent within the process. In a maneuver which ostensibly undermined the Marxian conception of exploitation and therefore capitalism, the neoclassical school sought to explain economic systems in terms of markets and the arbiter of economic allocation, the price mechanism. From this focus, the neoclassical economists developed the theory of general equilibrium, under which the price mechanism (within a condition of perfect competition) is conceived of as self-regulating, self-adjusting and therefore a stabilizing apparatus. In diametrical opposition, the Marxian tradition of political economy characterizes capitalism in terms of instability, structural contradictions and disequilibrium. The current financial crisis and burgeoning recession provide the empirical material necessary to weight and contrast the contrary claims of these two competing schools on the stability of the capitalist economy.

Before a comparison with Marxian theories of capitalism is possible, the nature of neoclassical economics needs to be further delineated. In essence, neoclassical theory is a re-articulation of Adam Smith’s notion of the “invisible hand” and the self-regulating nature of markets in a “system of nature liberty”, distinguished however by the abandonment of Smith’s labour theory of value. Instead, neoclassical theory based itself upon a conceptualization of individuals and market forces augmented with the theory of marginal utility. The crucial nexus of these ideas is the neoclassical assessment of individual psychology.

The simple psychology of neoclassical economics is akin to the rational-calculations of the Machiavellian prince. The ultimate goal of the individual is the optimal satisfaction of their interests. Smith prefigured this psychological impetus when he argued that benevolence was not the prime-mover of economic production, but rather the individual’s gratification of their own interests . This selfish motivation and rational calculation underpins the neoclassical principle of marginal utility.

In contrast to the labour theory of value, the utility of a good or service was not determined by the amount of labour employed in its production, but rather from the benefit derived from the last unit purchased. Alfred Marshal noted that while wants maybe unlimited, each particular wants has a definite limit. Marginal utility diminishes with each extra addition of a product. If an individual acquires a chair, the utility of that single unit is higher then if he or she acquires ten. The first chair allows him to sit and each subsequent chair he acquires becomes less valuable given his main need for one is sufficed. The decline in marginal utility for each subsequent unit decreases the desire for another unit and is manifested in the reduced willingness to buy a given unit at prices unreflective of the decease in demand.

The relationship between supply and demand within the market is the crux of the price mechanism and the nexus which is said to converge towards equilibrium. The principle of marginal utility highlights the importance of supply and demand in determining the utility and therefore the price of a commodity. If a product is over-supplied than its marginal utility will be reduced and therefore the price will also be reduced. Conversely, if a product is under-supplied in relation to strong demand its marginal utility will be high and therefore it will command a high price on the open market. The point at which demand and supply meet is said to be the equilibrium price, but as Marshall noted the market is rarely static. For Marshall and the neoclassical school in general, the market is not stable in the sense of being motionless, but rather the market exhibits a tendency towards equilibrium. This tendency towards equilibrium is the sense in which capitalism, or the free market, is said to be stable by the neoclassical school of economics.

In sharp contrast to neoclassical economics, the Marxian school of political economy developed a conception of capitalism that asserts its fundamental structural contradictions, disequilibrium and tendency towards insatiability and crisis. For Marx and Engels, capitalism was marked by its instability and uncertainty deriving from the “constant revolutionizing of production”. This process, whereby capitalism continually renews and develops its productive capacities has been called “creative destruction” by Joseph A. Schumpeter. Whilst Schumpeter thought the basis of creative destruction was technological innovation and the search for profit by entrepreneurs, Marx emphasized push factors inherent in the process of capital accumulation and intra-capitalist conflict for the realization of surplus-value.

Antonio Negri and Michael Hardt have argued that the central nexus of Marx’s analysis of the necessarily expansionary character of capital is the “quantitative relationship between worker as producer and power as consumer of commodities”. Marxian theory fundamentally asserts the asymmetry of class relations between the bourgeoisie and proletariat. This is manifest in production and consumption. In order to accumulate capital and realize a profit the capitalist must extract surplus-value and complete the capital circuit by selling the product of production. Surplus-value is only realized if the price of the commodity outstrips the cost of production. Labour-power is but one component of the cost of production, but it falls upon the working-classes to buy and consume commodities that cost more than their wages to sustain capitalist profit and capital accumulation. Therefore, there is a structural disequilibrium between production and consumption within the process of capital accumulation.

The problem of realization in the guise of under-consumption is but one of a multiple of Marxian theories of capitalism’s instability and crisis. David Laibman outlined five different forms of capitalist crisis, whilst Simon Clarke has argued that there are no comprehensive “Marxist” theories of crisis. However, it is clear that the Marxian conception of Capitalism’s inherent instability is at obvious variance with the general theory of equilibrium and school of neoclassical economics. The reasons for the divergence between Marxian and neoclassical school of thought are manifold: ideological inflection, scope of inquiry and methodological approach all markedly different.

Methodologically, the neoclassical school is grounded in abstract modeling, while Marxian conceptualization are often more sociological and historical in their prejudices. Marxists and Neo-Marxists have often criticized the ahistorical and abstract nature of neoclassical theories and moreover asserting that it does not reflect actual economic conditions. Milton Freidman has argued in turn that it is not the assumptions of a model that are important, but rather its significance rests in the accuracy of its predictions. The current financial crisis and global recession provides a basis for the evaluation of each school upon the stability of capitalism.

The major proximal cause of the current financial crisis and credit crunch was the sub-prime crisis of early 2007. Interest rate increases caused an increased rate of defaults upon subprime mortgages. In turn, this lead to the collapse of many mortgage brokerages and banks faced with overwhelming bad assets. Of course, a spark without a powder keg is a non-event – an interest rate increase was not the course of the financial collapse –the roots of the financial crisis lay much deeper. Ultimately, the financial crisis is the result of a credit glut caused by structural imbalances in the world-economy and unsound banking practices designed to profit from an excess of cheap credit. For neoclassical economics in the proper sense, the current financial crisis is merely a severe market correction. Mortgage backed assets and collateralized debt obligations were over-priced by the market and firms which over-valuated their worth. From this point of view, there is really no crisis in purely economic terms, but a market correction. Marxian economics, which its focus upon the structural imbalances would see the current turbulence within the world-economy as validation of their general paradigm. Debt played a central role in the current crisis, and this can be construed as deriving from capitalisms fundamental asymmetry and instability. In order to propel the growth and capital accumulation of the years preceding the crisis, debt was acquired by many house holds and individual to bridge the gap between their livelihoods and the price of commodities. The problem of realization, therefore, is at the forefront of the current goal financial crisis.

The current financial crisis seemly give credence to Marxian claims about the instability of process of capital accumulation. Neoclassical economics give no explanation of crisis in terms of its endogenous character; this is because neoclassical economics limits itself to the analysis of price-mechanisms and the importance of supply and demand for market equilibriums. The financial crisis in view of this school is not a crisis, but rather a market correction. Neoclassical economics presents a rather myopic view of social dynamics given the limited basis of its analysis. Marxian political economy on the other hand seeks to understand economic instability in terms of inherent structural imbalance. This does not necessarily imply that capitalism’s collapses is inevitable, but does contradict the notion that free markets tend toward equilibrium. Both schools of thought have valuable insights to offer on the nature of markets and capitalism, but the Marxian analysis is better suited to understanding economic instability and crisis.

Written by Mathew Toll.


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