In this second part of his article on Keynes, Hayek, and Marx Adam Booth deals with the limitations of Keynes' economic theory.

The General Theory

Keynes equally despised the idealistic and dogmatic nature of his contemporary bourgeois economists, who, faced with the crisis of the Great Depression and the clear failure of the free market, refused to abandon their assumptions, including those of Say’s Law, and their faith in the invisible hand. In his criticism of the classical economists, Keynes said that:

“[W]riters in the classical tradition, overlooking the special assumption underlying their theory, have been driven inevitably to the conclusion, perfectly logical on their assumption, that apparent unemployment (apart from the admitted exceptions) must be due at bottom to a refusal by the unemployed factors to accept a reward which corresponds to their marginal productivity...

“...The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required today in economics.” (“The General Theory”, chapter 2; Keynes)

In response to his peers in the political and economic community who sought for “supply side” solutions to the problems of mass unemployment and recession – i.e. to eliminate barriers to the free market, such as trade unions, which in the view of these economists restrict the ability for the market to find the “natural equilibrium” for wages – Keynes bent the stick in the opposite direction and simply focused on the question of demand, or “effective demand” as he referred to it – i.e. the ability for the producers of commodities to find a willing buyer who is able to pay (as opposed to demand in the sense of the “needs” or “wants” in society).

As we have explained elsewhere, Keynes saw the crisis of the Great Depression as a vicious circle in which high unemployment resulted in a reduced effective demand for commodities, which in turn led business to scale back or shut down, and thus increase unemployment further. In such a situation, Keynes believed government stimulus was necessary to provide a boost to effective demand and thus turn the vicious circle into a virtuous one, with increasing demand from the government leading to an expansion of production and employment, and thus greater wages and greater demand for consumer goods, etc. etc.

For Keynes, any stimulus would be sufficient, as he wryly comments in the General Theory:

“Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better...

“...If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.” (“The General Theory”, chapter 10; Keynes)

The New Deal in 1930s USA is often cited as the success story of Keynesian policies, but as the “Masters of Money” episode on Keynes highlighted, it was only the militarisation of the economy during WWII that ended the Great Depression, a process that ended in millions of deaths, the destruction of vast amounts of society’s produce capacity, and left a public debt of over 200% of GDP in countries like Britain – hardly a success!

Under-consumption and Overproduction

In essence, the Keynesian explanation of crisis is a theory of “under-consumption” – i.e. of a lack of consumer demand for the commodities that are produced. As we have explained elsewhere, Marxism, by contrast, sees capitalist crisis as a crisis of “over-production” – i.e. that capitalism is inherently unable to find a market for all the commodities that are produced. This arises from the fact that capitalism is production for profit, and this profit is simply the unpaid labour of the working class. In other words, the working class is always paid back less in wages than the value it creates in the labour process; thus their ability to buy back the commodities they produce is always less than the total value of these commodities. Commodities are produced but cannot be sold; profit cannot be realised; production ceases, and the system enters into crisis.

The Keynesian idea of creating demand through government stimulus is ultimately idealistic and undialectical. The simple question must be asked: where does the government get the money from for this stimulus? If the money is to come from taxes, then this will either mean: taxing the capitalist class, which means biting into their profits, creating a strike of capital and thus reducing investment; or taxing the working class, which will reduce their consuming power and thus reduce demand – the opposite of what government stimulus is intended to do!

In modern times, the government has increasingly resorted to borrowing money from the financial markets, through the selling of government bonds. But with the bailing out of the banks and the collapse of tax revenues, countries have been left with large public debts and deficits, and the global financial markets, rather than funding further government borrowing, are insisting that governments cut back public spending.

For the Keynesians, and the reformist leaders of the labour movement that are inspired by Keynesian ideas, the answer is simple: we must tax the rich and increase wages! But under capitalism, as we have explained above, production is for profit, and the working class can never receive in wages the full value of the commodities they produce, as Marx explained in Capital in response to the under-consumptionist theories of his day:

“It is sheer tautology to say that crises are caused by the scarcity of effective consumption, or of effective consumers. The capitalist system does not know any other modes of consumption than effective ones, except that of sub forma pauperis or of the swindler. That commodities are unsaleable means only that no effective purchasers have been found for them, i.e. consumers (since commodities are bought in the final analysis for productive or individual consumption). But if one were to attempt to give this tautology the semblance of a profounder justification by saying that the working-class receives too small a portion of its own product and the evil would be remedied as soon as it receives a larger share of it and its wages increase in consequence, one could only remark that crises are always prepared by precisely a period in which wages rise generally and the working-class actually gets a larger share of that part of the annual product which is intended for consumption. From the point of view of these advocates of sound and “simple” (!) common sense, such a period should rather remove the crisis. It appears, then, that capitalist production comprises conditions independent of good or bad will, conditions which permit the working-class to enjoy that relative prosperity only momentarily, and at that always only as the harbinger of a coming crisis.” (Capital, Volume II, chapter 20; Marx)

The Keynesian explanation for crisis is, in reality, not really an explanation for the cause of capitalist crisis at all. At best, it is an explanation for the continuation or deepening of a crisis in economy that already exists, or a suggestion for how governments can try to escape a crisis within the confines of capitalism. If a lack of effective demand – i.e. under-consumption – is to be blamed for the crisis, then one must surely ask: what leads to this under-consumption in the first place? As Engels points out in his polemic against Duhring:

“[T]he under-consumption of the masses, the restriction of the consumption of the masses to what is necessary for their maintenance and reproduction, is not a new phenomenon. It has existed as long as there have been exploiting and exploited classes...

“...The under-consumption of the masses is a necessary condition of all forms of society based on exploitation, consequently also of the capitalist form; but it is the capitalist form of production which first gives rise to crises. The under-consumption of the masses is therefore also a prerequisite condition of crises, and plays in them a role which has long been recognised. But it tells us just as little why crises exist today as why they did not exist before.” (Anti-Duhring, Part III, chapter 3; Engels)

In other words, since the working class can never buy back all of the commodities that they produce, why is capitalism not always in crisis?

Historically, this contradiction of overproduction has been overcome through the role of investment, whereby the capitalists continually spend and reinvest a large proportion of their profits on new means of production – on research and new machinery, in order to improve productivity, drive down costs, gain a greater market share, and increase profits even further. As explained earlier, it is this investment, arising from competition and the pursuit of profits, that allowed capitalism to play a historically progressive role in developing the means of production. But as was also explained earlier, this re-investment of profits, rather than resolving the contradiction of overproduction and restoring economic equilibrium, only creates even greater productive forces – producing greater quantities of commodities and values, which must still be sold on an ever-restricted market –thus exacerbating the contradictions and preparing the way for a larger crisis in the future.

Unproductive investment – such as the earlier example given by Keynes of burying old bottles filled with banknotes – has also been used in the past in order to provide demand and create jobs. For example, there were a number of so-called Marxists during the post-war boom who believed that military spending by governments could be used to permanently avert a crisis. But as has been pointed out, governments cannot simply “create” demand; in reality they must take raise their money by taking a slice of wealth from either the capitalist class or from the working class. This unproductive investment is spending without producing any real value and serves as fictitious capital, which ultimately generates inflation – i.e. increases the circulation of money in the economy without generating an equivalent value that is also in circulation. This is exactly what was seen at the end of the post-war boom, whereby Keynesian policies lead to the crisis of the 1970s, in which economic stagnation was seen alongside rising inflation – a previously unseen phenomena known as “stagflation”.

All of this again shows the undialectical and mechanical nature of Keynesianism and other reformist solutions to crises, which do not follow through the implications of their suggestions to their logical conclusion. If investment is used to avert a crisis, this means investing in something material – i.e. in means of production, which must then produce further commodities, thus adding to the crisis of overproduction. If wages are to be increased in order to increase demand, this means biting into the profits of the capitalists; but this, in turn, reduces investment, which under capitalism is only conducted in order to make a profit. If demand is to be “created” through government stimulus, this, in reality, means either taking money from the capitalists and biting into profits, or taking money from the working class and biting into consumer demand.

In contrast to bourgeois economics, Marxism seeks to examine the economy dialectically – that is to say, Marxism seeks to explore the full implications of any action; to see the interconnectivity and feedback between different process and phenomena; to examine the system in its motion and in all its complexity. Marxist economics is about seeing the contradictions within the processes at play, and to show how these contradictions can always be resolved, but only by creating new contradictions in the process. This is the case with capitalism: a crisis can always be averted temporarily, but this only serves to heighten the contradictions and pave the way for a greater crisis in the future.

In addition, unlike the bourgeois economists, Marxists do not separate their economic analysis from their general analysis of society. The economy is made up of living, breathing human beings; as Lenin stated, “politics is concentrated economics”. The ruling class can always restore stability in the economy, but only at the expense of creating political instability and class struggle in society.

In the final analysis, the crisis of capitalism is not simply the result of this or that process; this or that contradiction. Crises are the result of the many interacting processes and contradictions within capitalism itself. As Marx says in Capital:

“Capitalist production seeks continually to overcome these immanent barriers, but overcomes them only by means which again place these barriers in its way and on a more formidable scale.

“The real barrier of capitalist production is capital itself. It is that capital and its self-expansion appear as the starting and the closing point, the motive and the purpose of production; that production is only production for capital and not vice versa, the means of production are not mere means for a constant expansion of the living process of the society of producers. The limits within which the preservation and self-expansion of the value of capital resting on the expropriation and pauperisation of the great mass of producers can alone move — these limits come continually into conflict with the methods of production employed by capital for its purposes, which drive towards unlimited extension of production, towards production as an end in itself, towards unconditional development of the social productivity of labour. The means — unconditional development of the productive forces of society — comes continually into conflict with the limited purpose, the self-expansion of the existing capital. The capitalist mode of production is, for this reason, a historical means of developing the material forces of production and creating an appropriate world-market and is, at the same time, a continual conflict between this its historical task and its own corresponding relations of social production.” (Capital, Volume III, chapter 15; Marx)

Keynes, Profit, and Investment

As the “Masters of Money” episode on Keynes pointed out, Keynes was able to recognise the interconnectivity of the capitalist system, whereby one capitalist’s wage costs are another capitalist’s market, and therefore what may be rational and necessary for one capitalist – to cut wage costs – is not necessarily rational for the capitalists as a whole. Vitally, however, Keynes did not see the interconnected relationship between wages and profits – that these were two sides of the same coin, both merely representing a divided proportion of the total value created by the working class through the application of labour – and that increasing one necessitated cutting the other, and vice-versa. Hence the inability of Keynesians to see that overcoming “under-consumption” – i.e. overcoming the lack of effective demand – through increasing wages or government stimulus can only create new contradictions by reducing profits for the capitalists and leading to a strike of capital – i.e. a reduction in investment.

Keynes defined the total demand in society, also known as the “aggregate demand” in macroeconomics, as being equal to the total income, which is also equal to the total output. This aggregate demand is composed primarily of two sources according to Keynes: consumption from households and investment by firms. This definition is similar to Marx’s two departments, defined in Capital Volume II, of production of capital goods (department one) and production of consumer goods (department two). Unlike Marx, however, Keynes did not then subdivide these two departments into their various components of value: constant, variable, and surplus.

Throughout Capital, Marx frequently highlights the need to examine the economy in its totality, rather than simply isolating specific aspects of the system or concentrating on the behaviour of single individuals and transactions. However, Marx also showed that it was the dialectical interaction between opposites within this totality – between labour and capital; between wages and profits; between department one and department two – along with the patterns that emerged from the anarchic and chaotic (and yet rational) actions of many different individual capitalists, that was key in understanding the dynamic and crisis-ridden nature of capitalism.

As mentioned earlier, the classical economists who preceded Marx were unable to understand the origin of profit, due to their treatment of the economy either as a “Robinson Crusoe”, desert island system, in which one man was both producer and consumer, or as a simple transaction between one buyer and one seller, whereby profits were simply created in the process of circulation by buying cheap and selling dear. In both cases, by reducing the economy to an individual or pair of individuals, the division of society into classes is lost.

By contrast, Keynesianism, on which modern macroeconomics is based, arrives at a similar result to the pre-Marxist classical economists, but from the opposite direction: by simply aggregating the economy into a single equation or schema of total demand, Keynesianism loses sight of the class struggle and the interconnectivity between wages and profits, and in fact often ends up ignoring the role of profit altogether. One can see the mechanical nature of the Keynesian schema by the example of the “Phillips machine” or “MONIAC”, a physical model of the economy based on Keynesian macroeconomic principles that uses water storage and flows to represent the stores and flow of capital and money, and which is supposed to be able to predict the behaviour of the real economy on this basis.

As a result of this aggregated, undialectical, mechanical view, Keynesianism and modern macroeconomics cannot explain the material basis behind investment under capitalism. At its best, bourgeois macroeconomics describes investment as being a function of the interest rate, with lower interest rates providing an incentive for investors to spend rather than save. But at the current time, interest rates are almost at zero percent, and yet there is no investment to be seen. At its worst, whilst consumption from households is materialistically explained as a function of disposable income, investment by businesses is idealistically explained as simply being due to “animal spirits”. These days a similarly idealistic explanation for investment is given in terms of the need for “business confidence”.

Resorting to “animal spirits” and “confidence” clearly explains nothing. One must ask: what then causes confidence? The argument given in response is typically of a circular nature: businesses invest if there is confidence; there is confidence if the economy is growing; there is economic growth if there is investment; and so on and so on. Whilst it is true that confidence, uncertainty, and risk play a role in determining the decisions of investors, this confidence and uncertainty must have a material basis. Under capitalism, investment is made in pursuit of profit; if commodities cannot be sold at a profit –or indeed sold at all, as is the case in the current crisis of overproduction – then production, and investment in new production, will not occur.

It is not a subjective lack of confidence that causes the crisis, but the objective crisis of capitalism that causes a lack of confidence. As has been seen on numerous occasions in the recent period, there have been frequent rallies of the stock market in response to the latest “plan” by politicians to “solve” the crisis; but these rallies are short lived, going up like a rocket and coming down like a stick, as the contradictions reappear and the next phase of the crisis emerges on the horizon.

The figures for the current crisis highlight the contradiction of overproduction in relation to investment: in 1990, business investment in the UK was approximately 14% of GDP per year, but has fallen to less than 8% today; but meanwhile, British companies are now sitting on more than £700bn in cash savings. At the same time, businesses that have survived the crisis are posting record profits, as the Economist (March 31st 2012) explains:

“The past four years have been bad for workers and savers but good for the corporate sector. Profit margins in American are higher than at any time in the past 65 years...

“...Margins have been boosted by firms’ tight control of labour costs and by a reduction in interest expenses cause by the policies of central banks throughout the rich world...

“...However, the current high level of profits is not leading to a surge in investment. As a proportion of GDP, American business investment is close to 30-year lows...

“...the high profit share of GDP is simply a corollary of the low share taken by labour...

“...American and European companies are choosing to spend their cash on mergers and share buy-backs rather than capital expenditure.”

In other words, rather than invest in new means of production, which must produce new commodities that must find a market and be sold, businesses are recognising that there is a chronic over-capacity in the system, and are instead choosing to spend their money in buying up existing companies – i.e. existing means of production. This process leads to concentration of capital, but without creating any new value. Instead of being used to develop the means of production and provide socially necessary goods and services, the hoard of wealth that has been amassed by the capitalist class is being squandered.

The Economist (July 21st 2012) continues to highlight the crisis of overproduction in causing the low level of investment:

“The big gap at the moment is between workers and corporations. Although unemployment remains stubbornly high and wage rises are hard to come by, corporate profits are taking a larger share of American GDP than before the financial crisis...

“...A high return on capital should encourage a wave of investment. The resulting expansion in capacity should increase competition and reduce returns. But that has yet to happen: companies are hording cash...

“...firms are reluctant to invest in the face of weak demand. Domestic consumers have been under pressure from austerity and higher commodity prices; the euro-zone crisis and a slowdown in developing economies is weighing on export prospects. Companies may have milked all they can from productivity improvement. The irony here is that high share of GDP for profits automatically results in a low share for wages and thus may eventually be self-limiting – a positively Marxist outcome.”