Lecture 7: Critical Political Economy

Introduction 

The study of political economy, and political science, can be distinguished from the study of economics/econometrics because of it’s focus on:

  • Power
  • Institutions
  • Distribution

In terms of power: whereas economists tend to analyze the market in terms of Pareto-optimality, political economists tend to analyze markets in terms of whose interests are being served by a given set of economic arrangements.

In terms of institutions: political economists tend analyze the economy as a diverse set of institutions that vary across time (history), and space (country).

These institutions are the rules of the game that shape actor behaviour.

In terms of distribution: political economists study the market as a social construct whose conception is not based on natural laws but the primacy of politics.

They are primarily interested in the question: who gets what, when and how.

This tradition stems from Adam Smith but took a critical turn when Karl Marx published the first volume of Capital in 1867, fifty years after Ricardo published his Principles on Political Economy. 

  • Think about the year 1867. What was happening across Europe?

It was twenty years after the 1848 European revolutions, which swept across Italy, France, Germany, Netherlands, Poland, the Austrian Empire, and even Ireland.

What all of these nationalist revolutions shared was the attempt to overthrow feudalism and to replace it with more participatory forms of democratic government.

This gave birth to the nation-state as we understand it today.

The revolutionary fervour began in Milan when 70 people were killed whilst protesting against tax increases on tobacco, imposed by their Austrian rulers. These protests spread to Sicily, where local citizens demanded a liberal constitution to replace the autocratic rule of King Ferdinand II.

Before long people were rioting in Geneva, Paris and across several cities in what we now call Germany.

Historical context

It was against this background that Marx published Volume I of Capital.

Think about the context. England had the fastest growing economy in the world. Thousands had left the land to work in factories. All of these new labourers were living in urban slums. This is what inspired Charles Dickens to write his famous novel, Oliver Twist.

From 1840-1890 poverty was widespread, real wages were stagnant, whilst profits increased. It was not until the second half of the 19th century before real wages began to increase for the emergent industrial/working classes.

Keep in mind Adam Smith’s labour theory of value that we discussed last week.

National income (all earnings in a country) can be divided into wages, rent and profit. During this period of growth, the share of wages in national income did not rise.

The capital share of national income (industrial profits, land rents and building rents) increased massively in the first half of the 19th century.

As we will see from Piketty’s data, from 1870-1914 inequality stabilized at an extremely high level, marked by an increased concentration of wealth.

  • The industrial revolution gave birth to a period of rapid economic and productivity growth, stagnant wages and a growth in economic inequality.

This is the historical context that led Marx to write the ‘communist manifesto‘ in 1848.

The method

After this polemic, Marx spent the next twenty years writing Das Kapital, which he considered the first scientific attempt to systematically analyze the internal logical contradictions of the capitalist system (based on the Hegelian dialectic).

For Marx, the most important resource in a market economy is not land but capital.

He takes Adam Smith’s analysis and works through the logical outcome of commercial markets. He concludes that markets lead to centralisation not competition.

Keep in mind that Capital in 1868 was increasingly industrial (machines, factories) rather than landed property. Hence, contrary to Ricardo, for Marx there can be no limit to industrial capital. This led Marx to formulate his “principle of infinite accumulation“.

A free market for capital/money, when left to its own devices will keep accumulating and become more centralised. For Marx, this principle of infinite accumulation implies that capital is doomed to perpetual crises (in the Hegelian sense).

Why?

  • For Marx, either the rate of profit will steadily decline (leading to violence amongst capitalists) or capital’s share in national income would increase indefinitely (leading to workers revolution).
  • For Marx, there is no stable equilibrium in a capitalist society, it will “build it’s own gravediggers“.

The theory (M-C-M)

Let’s unpack this theory further.

First, it is crucial to note that Marx is in dialogue with Adam Smith. In chapter 2 of volume I he accepts the Smithean argument on exchange, reciprocity and private property and then proceeds to deconstruct it entirely.

He points out that contrary to the positive outcomes suggested by Adam Smith, competitive markets will lead to:

  • the centralization of capital (markets lead to corporations)
  • the concentration of capital (centralization leads to class power)

The entire book can then be read as a deconstruction of the system of free competitive markets, in order to show why they can never be ‘free’.

Marx, much like Smith, tell a story about capitalist development: the capitalist starts out with a certain amount of money. He then purchases two crucial commodities:

  • Labor power and
  • Means of production (raw materials, machines)

He then puts these two to work within a given technology to produce a fresh marketable commodity. This is then sold in the market place plus a surplus value to make a profit.

But it does not stop here. The capitalists does not consume all the profit as luxury. Rather he/she re-invests it to produce more commodities.

To do this, the capitalist must expand labour and apply new technologies to produce new and better commodities.

Why? For Marx the coercive laws of competition compels the entrepreneur to reinvest the surplus. If he/she does not he/she will be destroyed by his competitors.

The outcome is a simple formula for the circulation of capital: M-C-M. Money-commodity-Money.

The 5 crises tendencies 

For Marx the capitalist mode of production always leads to crises. It contains 5 major problems that lead to the following questions:

  • Money: Where does it come from?
    • Solution: Secure the legal-state
  • Labour: how to source supply and demand?
    • Solution: Weaken organised labour
  • Environment: How to deal with scarcity?
    • Solution: Invest in technology
  • Technology: The falling rate of profit?
    • Solution: Source new markets
  • Debt: How to keep the system liquid?
    • Solution: Ensure aggregate demand

Keynes would later suggest that the role of the state and fiscal policy can be used to stimulate the economy if the market is faced with a lack of effective demand.

What is important to note is that these blockage points within the capitalist mode of production need to be overcome.

For Marx capital is a flow, if you stop the flow, capital gets lost. This is why Marxian economists are critical of Piketty, who thinks of capital as a stock of wealth.

For Marx, capitalist politics is a perpetual class struggle over all of these factors that keep the system intact. If there is no resolution then stagnation occurs. Crises = Revolution.

Why Marx was wrong

Marx predictions on the inevitable demise of the capitalism turned out to be wrong. He assumed that capitalism would collapse. It didn’t.

This mistaken judgement is not so much related to his insightful historical analysis, but to his use of dialectical Hegelian method, which assumes, by definition, implosion.

At the end of the 19th and into the 20th century, wages gradually began to increase, and the purchasing power of workers spread everywhere.

In Western Europe, workers and citizens explored the alternative avenue of social democracy, rather than communism.

Marx did not anticipate the emergence of a propertied middle class, the social state, nor the emergence of new technologies, or a steady increase in productivity.

The balance of power among different classes associated with trade unionization complemented the emergence of a new power configuration, with a a relatively autonomous state apparatus with the capacity to tax and spend.

This gave birth to the social state as we understand it today. Or capitalist democracy.

What did he get right?

Marx’s principle of accumulation contains an important insight that contemporary economists have tended to ignore: competitive markets have a tendency toward the centralization of ownership and the concentration of wealth.

Just think about the influence of large corporations, such as Google.

The accumulation and concentration of wealth does lead to the concentration of power, which has destabilising effects in both politics and economics.

It would be naive to think that growing income and wealth inequality does not impact on equality of opportunity and democracy.

Why then have economists tended to ignore the distributional question?

Simon Kuznets 

The narrative during the 20th century shifted away from apocalyptic predictions to happy endings. It was now assumed that a rising tide lifts all boats.

Simon Kuznets predicted that income inequality would automatically decrease in advanced stages of capitalist development, regardless of the economic policy choices pursued by government.

This theory was based on US data from 1913-1948. It built upon Robert Solow’s (1956) theory of a “balanced growth path”.

Economists increasing assumed that all the core economic variables in society: output, incomes, profits, wages, capital, asset prices, would progress at the same pace.

In the end,  a market economy would benefit everyone, as it is the best way to achieve high levels of economic growth.

This was the opposite conclusion to Ricardo and Marx’s assumption of an inegalitarian spiral built into the process of capitalist development.

Kuznet’s was the first to analyze social inequality using sophisticated statistical and mathematical tools. His data (which Piketty has since developed) was based on federal income tax returns.

This allowed him to measure top incomes, particularly the income shares going to upper deciles and centiles, in the overall income distribution.

What he observed was a sharp decline in income inequality between 1913-1948.

In 1913, the upper decile (top 10 per cent of earners) claimed 45-50 percent of national income. By the late 1940’s this had declined to between 30-35 percent.

This decrease was equal to half the income of the poorest 50 percent of Americans.

This decline in income inequality shaped the debate on the politics of distribution in the USA, and various international organizations, throughout the Cold War.

Capitalism was clearly working for everyone whilst the Communist experiments were not. This was an important normative justification for market economies.

Kuznets curve 

Kuznets delivered a paper titled ‘Economic Growth and Income Inequality‘ to the American Economic Association, which gave birth to a new theory: the ‘Kuznets curve’.

This predicted that inequality would initially increase during industrialization and decrease at a later advanced stage of capitalist development.

The internal logic of capitalist development was now assumed to be one of equalization not wealth concentration Market competition leads to a balanced growth path.

As we will see in the coming weeks, it is true that wealth and income inequality decreased in the 20th century, particularly after the shocks of two world wars.

But it is also true that wealth and income inequality have since increased, everywhere, since the late 1970s. This is the opposite prediction of Kuznets theory.

The income of the wealthiest have reached extraordinary levels whilst the incomes of the vast majority have stagnated. This is now clearly observable in the data.

This table and graph illustrate the point.

The question we need to ask is why this has occurred?

Conclusion 

The important question we will now try to address is why there was a decline in inequality in the 20th century, and and a rapid rise during the 21st century.

There are two competing explanations: economists tend to focus on skills-based technological change. Political economists focus on politics and bargaining power.

What we will see over the coming weeks is that in the aftermath of WW2, various forms of progressive taxation, capital controls, collective bargaining, rents control, minimum wages and expanded social programs worked to redistribute capital across society.

These were the ‘happy days‘ of a growing middle class.

There is now growing skepticism about the assumption that growth is “naturally” balanced. There are clearly winners and losers. In the US, the top decile receives over 52 percent of national income (a new historical record).

What the data increasingly suggests is that the gains of “economic growth” are being distributed disproportionately to the top of the income ladder.

But to explain the U shaped curve of inequality from 1900-2013, we need to examine the structural origins of this inequality (1890-1913), which is what we will do next week.

The industrial revolution, in addition to the race to colonize the world, completely transformed the face of capital-wealth in Europe. Wealth was totally transformed.

The lecture slides can be found here: lecture-7

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