Three Great Economists
A look back over economic history has taught us something about capitalism, the social system with which economics is mainly concerned. But we have not yet gained a sense of what economics itself is about. Perhaps we can see, however, that economics is mainly "about" capitalism that it is an effort to explain how a society knit together by the market rather than by tradition or command, powered by a restive technology rather than by inertia, could hang together, how it would work.
There is no better way of grasping this basic purpose of economics than to look at the work of three great economists-Adam Smith, Karl Marx, and John Maynard Keynes. The three names raise blood pressures differently, depending on whether one is a conservative, a radical, or a liberal. That's a matter for a different kind of book than this one. We want to explain what Smith, Marx, and Keynes saw when they looked at capitalism, for their visions still define the field of economics for everyone, right and left alike.
ADAM SMITH (1723-1790)
Adam Smith is the patron saint of our discipline and a figure of towering intellectual stature. His fame resides in his masterpiece, which everyone has heard of and almost no one has read, The Wealth of Nations, published in 1776, the year of the Declaration of Independence. All things considered, it is not easy to say which document is of greater historic importance. The Declaration sounded a new call for society dedicated to "Life, Liberty, and the pursuit of Happiness." The Wealth explained how such a society worked.
Here Smith begins by addressing a perplexing question. The actors in the market, as we know, are all driven by the desire to make money for themselves-to "better their condition:' as Smith puts it. The problem is obvious. How does a market society prevent self-interested, profit-hungry individuals from holding up their fellow citizens for ransom? How can a socially workable arrangement arise from such a dangerously unsocial motivation as self-betterment?
The answer introduces us to a central mechanism of a market system, the mechanism of competition. Each person out for self-betterment, with no thought of others, is faced with a host of similarly motivated persons. As a result, each market actor, in buying or selling, is forced to meet the prices offered by competitors.
In the kind of competition that Smith assumes, a manufacturer who tries to charge more than other manufacturers will not be able to find any buyers. A job seeker who asks more than the going wage will not be able to find work. And an employer who tries to pay less than competitors pay will not find workers to fill the jobs. In this way, the market mechanism imposes a discipline on its participants- buyers must bid against other buyers and therefore cannot gang up against sellers. Sellers must contend against other sellers and therefore cannot impose their will on buyers.
But the market has a second, equally important function. Smith shows that the market will arrange for the production of the goods that society wants, in the quantities society wants-without anyone ever issuing an order of any kind. Suppose that consumers want more pots and fewer pans than are being turned out. The public will buy up the existing stock of pots, and as a result their prices will rise. Contrariwise, the pan business will be dull; as pan makers try to get rid of their inventories, pan prices will fall.
Now a restorative force comes into play. As pot prices rise, so will profits in the pot business; and as pan prices fall, so will profits in that business. Once again, the drive for self-betterment will go to work. Employers in the favored pot business will seek to expand, hiring more factors of production more workers, more space, more capital equipment; and employers in the disfavored pan business will reduce their use of the factors of production, letting workers go, giving up leases on space, cutting down on their capital investment.
Hence the output of pots will rise and that of pans will fall. And this is what the public wanted in the first place. The pressures of the marketplace direct the selfish activities of individuals as if by an Invisible Hand (to use Smith's wonderful phrase) into socially responsible paths. Thus the workings of the competitive system transmute self-regarding behavior into socially useful outcomes. The Invisible Hand- the words that describe the overall process-keeps society on track, assuring that it produces the goods and services it needs.
Smith's demonstration of how a market performs this extraordinary feat has never ceased to be of interest. Much of economics, as we shall see in closer detail later, is concerned with scrutinizing carefully how the Invisible Hand works. Not that it always does work. There are areas of economic life where the does not exert its influence at all. In every market system, for instance, tradition continues to play a role in nonmarket methods of remuneration such as tipping. So, too, command is always in evidence within businesses, for example in hiring or firing, or in the exercise of government powers such as taxation. Further, the market system has no way of providing certain public goods that cannot be privately marketed, such as national defense or public law and order. Smith knew about these and recognized that such goods would have to be supplied by the government. Then, too, the market does not always meet the ethical or aesthetic criteria of society, or it may produce goods that are profitable to make but harmful to consume. We shall look into these problems in due course. At this juncture, however, we had better stand in considerable awe of Smith's basic insight, for he showed his generation and all succeeding ones that a market system is a powerful force for orderly social provisioning.
He also showed that it was self-regulating. The beautiful consequence of the market is that it is its own guardian. If anyone's prices, wages, or profits stray from levels that are set for everyone, the force of competition will drive them back. Thus a curious paradox exists. The market, which is the acme of economic freedom, turns out to be the strictest of economic taskmasters. One can always appeal to a king for a special dispensation. There is no appeal to the market.
Because the market is its own regulator, Smith was opposed to government intervention that would interfere with the workings of self-interest and competition. Therefore laissez-faire became his fundamental philosophy, as it remains the fundamental philosophy of conservative-minded economists today. His commitment to the Invisible Hand did not make Smith a conventional conservative, however. He is cautious about, not dead set against, government intervention. Moreover, The Wealth of Nations is shot through with biting remarks about the "mean and rapacious" ways of the manufacturing class, and openly sympathetic with the lot of the workingman, hardly a popular position in Smith's day. What ultimately makes Smith a conservative-and here he is in accord with modem views- is his belief that the system of "natural liberty" founded on economic freedom would ultimately benefit the general public.
Needless to say, that is a question to which we will return many times. But we are not yet done with Adam Smith. For matching his remarkable vision of an internally coherent market system was an equally new and remarkable vision of another kind, Smith saw that the system of "natural liberty"- the market system, left to its own devices- would grow, that the wealth of such a nation would steadily increase.
What brought about this growth? As before, the motive force was the drive for self-betterment, the thirst for profits, the wish to make money. This meant that every employer was constantly seeking to accumulate more capital, to expand the wealth of the enterprise; in turn, this led each employer to seek to increase sales in the hope of gaining a larger profit.
But how to enlarge sales in a day long before advertising existed as we know it? Smith's answer was to improve productivity: Increase the output of the work force. And the road to increasing productivity was very clear: Improve the division of labor.
In Smith's conception of the growing wealth (we would say the growing production) of nations, the division of labor therefore plays a central role, as this famous description of a pin factory makes unforgettably clear:
One man draws out the wire, another straits it, a third cuts it, a fourth points it, a fifth grinds it at the top for
receiving the head; to make the head requires two or three, distinct operations; to put it on is a peculiar business;
to whiten it another; it is even a trade by itself to put them into paper... I have seen a small manufactory of this kind where ten men only were employed and where some of them
consequently performed two or three distinct operations. But though they were poor, and therefore but
indifferently accommodated with the necessary machinery, they could when they exerted themselves make among
them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of middling size.
These ten persons, therefore, could make among them upwards of fortyeight thousand pins in a day.... But if they
had all wrought separately and independently ... they could certainly not each of them make twenty, perhaps not
one pin in a day.
*Adam Smith, The Wealth of Nations (New York: Modem Library, 1937), pp. 4, 5.
How is the division of labor to be enhanced? Smith places principal importance on the manner already announced in his description of the process of making pins: Organization is the key. In addition, the division of labor- and therefore the productivity of labor- is increased when the tasks of production can be taken over, or aided and assisted, by the capacities of machinery. In this way each firm seeking to expand is naturally led to introduce more machinery as a way of improving the productivity of its workers. Thereby the market system becomes an immense force for the accumulation of capital, mainly in the form of machinery and equipment.
Moreover, Smith showed something remarkable about the self regulating properties of the market system as a growth producing institution. We recall that growth occurred because employers installed machinery that improved the division of labor. But as they thereupon added to their work force, would it not follow that wages would rise as all employers competed to hire labor? And would that not squeeze profits and dry up the funds with which machinery could be bought? Once again, however, the market was its own regulator. For Smith showed that the increased demand for labor would be matched by an increased supply of labor, so that wages would not rise or would rise only moderately. The reason was plausible. In Smith's day, infant and child mortality rates were horrendous: "It is not uncommon," wrote Smith, ". . . in the Highlands of Scotland for a mother who has borne twenty children not to have two alive." As wages rose and better food was provided for the household, infant and child mortality would decline. Soon there would be a larger work force available for hire: ten was the working age in Smith's day. The larger work force would hold back the rise in wages- and so the accumulation of capital could go on. Just as the system assured its short term viability of self-regulating the output of pots and pans, so it assured its long- term viability by self regulating its steady growth.
Of course, Smith wrote about a world that is long since vanished- a world in which a factory of ten people, although small, was still significant enough to mention; in which remnants of mercantilist, and even feudal, restrictions determined how many apprentices an employer could hire in many trades; in which labor unions were largely illegal; in which almost no social legislation existed; and above all, where the great majority of people were very poor.
Yet Smith saw two essential attributes in the economic system that was not yet fully born at that time: first, that a society of competitive, profit-seeking individuals can assure its orderly material provisioning through the self regulating market mechanism; and second, that such a society tends to accumulate capital, and in so doing, to enhance its productivity and wealth. These insights are not the last word. We have already mentioned that the market mechanism does not always work successfully, and our next two economists will demonstrate that the growth process is not without serious defects. But the insights themselves are still germane. What is surprising after two centuries is not how mistaken Smith was, but how deeply he saw. In a real sense, as economists we are still his pupils.
KARL MARX (1818-1883)
To most Americans, Karl Marx's name conjures up revolutionary images. To a certain extent, that is perfectly correct (see box on page 34). But for our purposes, Marx is much more than a political activist. He was a profoundly penetrative economic thinker, perhaps the most remarkable analyst of capitalism's dynamics who ever lived, So we will spend no time at all defending or assailing his political philosophy. What interests us is what he saw in capitalism that was different from Smith.
Adam Smith was the analyst of capitalism's orderliness and progress. Oddly enough, he failed to see the regenerative inventiveness of the new technology of industry-which, in all fairness, was still in its infancy during his lifetime. Smith actually believed that after a time a Society of Perfect Liberty would accumulate all the capital for which it had a need, after which it would go into a deep decline! As to what might happen next, he said nothing. *(Wealth of Nations, pp. 94-95.)
Marx was the diagnostician of its disorders and eventual demise. Their differences are rooted in the fundamentally opposite way that each saw history. In Smith's view, history was a succession of stages through which humankind traveled, climbing from the "early and rude" society of hunters and fisher folk to the final stage of commercial society. Marx saw history as a continuing struggle among social classes, ruling classes contending with ruled classes in every era.
Moreover, Smith believed that commercial society would bring about a harmonious, mutually acceptable solution to the problem of individual interest in a social setting that would go on forever- or at least for a very long time. Marx saw tension and antagonism as the outcome of the class struggle, and the setting of capitalist society as anything but permanent. Indeed, the class struggle, expressed as the contest over wages and profits, would be the main force for changing capitalism and eventually undoing it.
A great deal of interest in Marx's work focuses on that revolutionary perspective and purpose. But Marx the economist interests us for a different reason: Marx also saw the market as a powerful force in the accumulation of capital and wealth. From his conflict- laden point of view, however, he traces out the process-mainly in Volume II of Capital- quite differently than Smith does. As we have seen, Smith's conception of the growth process stressed its self-regulatory nature, its steady, hitch-free path. Marx's conception is just the opposite. To him, growth is a process full of pitfalls, a process in which crisis or malfunction lurks at every turn.
Marx starts with a view of the accumulation process that is much like that of a businessman. The problem is how to make a given sum of capital- money sitting in a bank or invested in a firm- yield a profit. As Marx puts it, how does M (a sum of money) become M', a larger sum?
Marx's answer begins with capitalists using their money to buy commodities and labor power. Thereby they make ready the process of production, obtaining needed raw or semifinished materials, and hiring the working capabilities of a labor force. Here the possibility for crisis lies in the difficulty that capitalists may have in getting their materials or their labor force at the right price. If that should happen- if labor is too expensive, for instance- M stays put and the accumulation process never gets started at all.
But suppose the first stage of accumulation takes place smoothly. Now money capital has been transformed into a hired work force and a stock of physical goods. These have next to be combined in the labor process; that is, actual work must be expended on the materials, and the raw or semifinished goods transformed into their next stage of production.
It is here, on the factory floor, that Marx sees the genesis of profit. In his view, profit lies in the ability of capitalists to pay less for labor power-for the working abilities of their work force-than the actual value workers will impart to the commodities they help to produce. Thus, profit- the difference between M and M'- essentially resides in underpaid labor. This theory of surplus value as the source of profit is very important in Marx's analysis of capitalism, but it is not central to our purpose here. Instead, we stop only to note that the labor process is another place where accumulation can be disrupted. If there is a strike, or if production encounters snags, the money capital (M) that is invested in goods and labor power will not move along toward its objective, a larger sum of money capital (M').
But once again suppose that all goes well and workers transform steel sheets, rubber casings, and bolts of cloth into automobiles. The automobiles are not yet money. They have to be sold- and here, of course, lie the familiar problems of the marketplace: bad guesses as to the public's taste; mismatches between supply and demand; recessions that diminish the spending power of society.
If all goes well, the commodities will be sold-and sold for M', which is bigger than M. In that case, the circuit of accumulation is complete, and the capitalists will have a new sum M', which they will want to spend on another round, hoping to win M''. But unlike Adam Smith's smooth- growth model, we can see that Marx's conception of accumulation is riddled with pitfalls and dangers. Crisis is possible at every stage. Indeed, in the complex theory that Marx unfolds in Capital, the inherent tendency of the system is to generate crisis, not to avoid it.
We will not trace Marx's theory of capitalism further except to note that at its core lies a complicated analysis of the manner in which surplus value (the unpaid labor that is the source of profit) is squeezed out through mechanization. Someone who wants to learn about Marx's analysis must turn to other books, of which there are many.* [At the risk of appearing self-serving, a useful introduction is R. L. Heilbroner, Marxism: For and Against (New York: Norton, 1980)].
Our interest lies in Marx as the first theorist to stress the instability of capitalism. Adam Smith originated the idea that growth is an inherent characteristic of capitalism, but to Marx we owe the idea that that growth is wavering and uncertain, far from the assured process Smith described. Marx makes it clear that capital accumulation must overcome the uncertainty inherent in the market system and the tension of the opposing demands of labor and capital. The accumulation of wealth, although always the objective of business, may not always be within its power to achieve.
In Capital, Marx sees instability increasing until finally the system comes tumbling down. His reasoning involves two further, very important prognoses for the system. The first is that the size of business firms will steadily increase as the consequence of the recurrent crises that rack the economy. With each crisis, small firms go bankrupt and their assets are bought up by surviving firms. A trend toward big business is therefore an integral part of capitalism.
Second, Marx expects an intensification of the class struggle as the result of the "proletarianization" of the labor force. More and more small business people and independent artisans will be squeezed out in the crisis ridden process of growth. Thus the social structure will be reduced to two classes- a small group of capitalist magnates and a large mass of proletarianized (i.e., propertyless), embittered workers.
In the end, this situation proves impossible to maintain. In Marx's words:
Along with the constant decrease in the number of capitalist magnates, who usurp and monopolize all the
advantages of this process of transformation, the mass of misery, oppression, slavery, degradation and exploitation
grows; but with this there also grows the revolt of the working class, a class constantly increasing in numbers, and
trained, united and organized by the very mechanism of the capitalist process of production. The monopoly of
capital becomes a fetter upon the mode of production which has flourished alongside and under it. The
centralization of the means of production and the socialization of labour reach a point at which they become
incompatible with their capitalist integument. This integument is burst asunder. The knell of capitalist private
property sounds. The expropriators are expropriated.*
[ Karl Marx, Capital, Vol. I (New York: Vintage, 1977), p. 929.]
Much of the economic controversy that Marx generated has been focused on the questions: Will capitalism ultimately undo itself.? Will its internal tensions, its "contradictions," as Marx calls them, finally become too much for its market mechanism to handle?
There are no simple answers to these questions. Critics of Marx vehemently insist that capitalism has not collapsed, that the working class has not become more and more miserable, and that a number of predictions Marx made, such as that the rate of profit would tend to decline, have not been verified.
Supporters of Marx argue the opposite case. They stress that capitalism almost did collapse in the 1930s. They note that more and more people have been reduced to a "proletarian" status, working for a capitalist firm rather than for themselves; in 1800, for example, 80 percent of Americans were self employed; today the figure is less than 10 percent. They stress that the size of business has constantly grown, and that Marx did correctly foresee that the capitalist system itself would expand, pushing into non capitalist Asia, South America, and Africa.
It is doubtful that Marx's contribution as a social analyst will ultimately be determined by this kind of scorecard. Certainly he made many remarkably penetrating statements; equally certainly, he said things about the prospects for capitalism that seem to have been wrong. Most economists do not accept Marx's diagnosis of class struggle as the great motor of change in capitalist and pre capitalist societies or his prognosis of a trend toward socialism. But what Marx's reputation ultimately rests on is something else. It rests on his vision of capitalism as a system under tension, and in a process of continuous evolution as a consequence of that tension. Few would deny the validity of that vision.
There is much more to Marx than the few economic ideas sketched here. Indeed, Marx should not be thought of primarily as an economist, but as a pioneer in a new kind of critical social thought: It is significant that the subtitle of Capital is A Critique of Political Economy.
In the gallery of the world's great thinkers, where Marx unquestionably belongs, his proper place is with historians rather than economists. Most appropriately, his statue would be centrally placed, overlooking many corridors of thought- sociological analysis, philosophic inquiry, and of course, economics.
For Marx's lasting contribution was a penetration of the appearances of our social system and of the ways in which we think about that system, in an effort to arrive at buried essences deep below the surface. That most searching aspect of Marx's work is not one we will pursue here, but bear it in mind, because it accounts for the persisting interest of Marx's thought.
Finally, what about the relation of Marx to present-day communism? That is a subject for a book about the politics, not the economics, of Marxism. Marx himself was a fervent democrat- but a very intolerant man. More important, his system of ideas has also been intolerant, and may thereby have encouraged intolerance in revolutionary parties that have based their ideas on his thought. Marx himself died long before Soviet communism rose and fell. We cannot know what he would have made of it probably he would have been horrified at its excesses but still hopeful for some kind of democratic socialism in the future.
Here a parting thought may help sum up this complex and certainly seminal thinker. To no small degree, Marx's analytic penetration was based on his insistence that the economy was the "base" of society, whence his energies arose, and that the political and social framework was but a "superstructure" where these energies would exert their influence. This came as a galvanizing view at a time when most social observers looked to politics as the driving force of society and relegated the economy to a relatively secondary place.
But in our times we have come to see that Marx's view, however perceptive in "normal" times, can be a source of misperception in critical periods. The hideous lesson of the self-demolition of Yugoslavia, of the Soviet Union's meltdown, and of central Africa's ferocious ethnic hostilities indicates that there is a subbasement beneath Marx's base-a place where political and social passions may slumber for decades but erupt with terrific force when a spark strikes the wrong place. If there is any one reason why Marxism has lost much of its once powerful intellectual magnetism, it is the rediscovery of the lurking power of political and social beliefs, perhaps the most disconcerting lesson of our time for economists.
JOHN MAYNARD KEYNES* (1883-1946)
*[This is probably the most mispronounced name in economics. It should be pronounced "canes:' not "keens."]
Marx was the intellectual prophet of capitalism as a self-destructive system; John Maynard Keynes was the engineer of capitalism repaired. Today, that is not an uncontested statement. To some people, Keynes's doctrines are as dangerous and subversive as those of Marx- a curious irony, since Keynes himself was totally opposed to Marxist thought and wholly in favor of sustaining and improving the capitalist system.
The reason for the continuing distrust of Keynes is that more than any other economist, he is the father of the idea of a "mixed economy" in which the government plays a crucial role. To many people these days, all government activities are suspicious at best and downright injurious at worst. Thus, in some quarters Keynes's name is under a cloud. Nonetheless, he remains one of the great innovators of our discipline, a mind to be ranked with Smith and Marx as one of the most influential our profession has brought forth. As Nobelist Milton Friedman, an avowed conservative, has declared: "We are all Keynesians now."
The great economists were all products of their times: Smith, the voice of optimistic, nascent capitalism; Marx, the spokesman for the victims of its bleakest industrial period; Keynes, the product of a still later time, the Great Depression.
The Depression hit America like a typhoon. One half the value of all production simply disappeared. One quarter of the working force lost its jobs. Over a million urban families found their mortgages foreclosed, their houses lost to them. Nine million savings accounts went down the drain when banks closed, many for good.
Against this terrible reality of joblessness and loss of income, the economics profession, like the business world or government advisers, had nothing to offer. Fundamentally, economists were as perplexed at the behavior of the economy as were the American people themselves. In many ways the situation reminds us of the uncertainty that the public and the economics profession have shared in the face of inflation in modem times.
It was against this setting of dismay and near-panic that Keynes's great book appeared: The General Theory of Employment, Interest and Money. A complicated book- much more technical than The Wealth of Nations or Capital, The General Theory nevertheless had a central message that was simple enough to grasp. The overall level of economic activity in a capitalist system, said Keynes (and Marx and Adam Smith would have agreed with him) was determined by the willingness of its entrepreneurs to make capital investments. From time to time this willingness was blocked by considerations that made capital accumulation difficult or impossible: In Smith's model we saw the possibility of wages rising too fast, and Marx's theory pointed out difficulties at every stage of the process.
But all the previous economists- even Marx, to a certain extent believed that a failure to accumulate capital would be a temporary, selfcuring setback. In Smith's scheme, the rising supply of young workers would keep wages in check. In Marx's conception, each crisis (up to the last) would present the surviving entrepreneurs with fresh opportunities to resume their quest for profits. For Keynes, however, the diagnosis was more severe. He showed that a market system could reach a position of "under-employment equilibrium"- a kind of steady, stagnant state--despite the presence of unemployed workers and unused industrial equipment. The revolutionary import of Keynes's theory wasthat there was no self-correcting property in the market system to keep capitalism growing.
We will understand the nature of Keynes's diagnosis better after we have studied a little more economics, but we can easily see the conclusion to which his diagnosis drove him. If there was nothing that would automatically provide for capital accumulation, a badly depressed economy could remain in the doldrums unless some substitute were found for business capital spending. And there was only one such possible source of stimulation. This was the government. The crux of Keynes's message was therefore that government spending might be an essential economic policy for a depressed capitalism trying to recover its vitality.
Whether, or not Keynes's remedy works and what consequences government spending may have for a market system have become major topics for contemporary economics-topics we will deal with later at length. But we can see the significance of Keynes's work in changing the very conception of the economic system in which we live. Adam Smith's view of the market system led to the philosophy of laissez-faire, allowing the system to generate its own natural propensity for growth and internal order. Marx stressed a very different view, in which instability and crisis lurked at every stage, but of course Marx was not interested in policies to maintain capitalism. Keynes propounded a philosophy as far removed from Marx as from Smith. For if Keynes was right, laissez-faire was not the appropriate policy for capitalism- certainly not for capitalism in depression. And if Keynes was right about his remedy, the gloomy prognostications of Marx were also incorrect- or at least could be rendered incorrect.
But was Keynes right? Was Smith right'? Was Marx right? To a very large degree these questions frame the subject matter of economics today. That is why, even if their theories are part of our history, the "worldly philosophers" are also contemporary. A young writer once remarked impatiently to T. S. Eliot that it seemed so pointless to study the past, because we know so much more than they. "Yes", replied Eliot. "They are what we know".
a) In the reading, the authors note that a Keynesian contribution is the notion that there was no 'self-correcting property' in Capitalism.
b) In the reading, the authors note that according to Smith, the market mechanism will direct 'selfish activities' into 'socially useful outcomes' as if an "Invisible Hand" was guiding the economy.
c) In the reading, the authors note that while Marx was concerned about the poor and their poverty, he agreed with Smith's emphasis on the 'orderliness and progress' of capitalism.
d. Only a and b.
e. Only b and c.