Does it take a whole chapter to define economics? Practically.
Woody Allen can get away with "Economics is about money and
why it is good," but an economist must take considerably
more care in defining the subject. That is the main purpose of
this introductory chapter - to examine why we need economics and
to define economics. The purpose of this book is to help the reader
understand capitalism. This chapter explains why this is best
accomplished by examining the capitalist economy historically.
There is also a brief introduction to the major themes we will
follow as we trace the development of capitalism. One of the reasons
to study economics is to develop a better understanding of where
capitalism will be going in the future: this chapter closes with
a brief look at what economics can contribute to our understanding
of the future. This is a topic which we shall return to in the
last chapter of this text.
No society can survive without successfully pursuing its material
life. Yet material life does not organize itself. Every society
must find a method of assuring that its members cooperate in the
pursuit of material life. Thus far, human societies have relied
on three major methods of organizing their material lives: tradition,
command and the market. After a brief look at the roles of tradition
and command, this chapter examines the emergence of the market
as a primary force in the orchestration of material life. It also
explores the tendency of market systems to turn all it touches
into commodities.
It is no secret that economists often disagree. Post-Keynesians
and Monetarists, for example, hold opposing and mutually incompatible
theories of inflation. This chapter will examine the nature of
the persistence of disagreement in economics and take note of
some of the differences between the social sciences and the natural
sciences. Then it will conduct a brief tour through the history
of economics. This tour is sort of an aerial view providing an
opportunity to observe the flow of economic thought from the beginning
of capitalism to the present. Later chapters, particularly Chapter
6, will probe these streams of thought in more depth.
The market mechanism, the operation of the forces of supply and
demand, is the very heart of the market system. This chapter explores
the logic behind using the market mechanism to set prices and
output. It explores the method by which the market system maintains
micro-order. This was one of the questions that
intrigued the early economists. How can society be certain that
the 'right' amount of bread and other commodities will be produced?
How can society be certain that the bread and other commodities
will be sold at the 'right' price?
One of the enduring questions of economics is "Where do profits
come from?" One of the ways in which economic philosophers
have tried to answer it is by first answering the question of
value. At the center of most economic paradigms is a Theory
of Value. The classical political economists found value to
be determined in production; since most of the cost of
production could be reduced to labor, this approach was refined
into the Labor Theory of Value. Neoclassical economists
looked for value in the market act of exchange and developed
the Marginal Theory of Value. Both of these theories are
currently under challenge by the post-Keynesians with their Sraffian
Theory of Value, which, like the labor theory of value, is
based on production rather than exchange. Any theory of value
in economics is an extremely abstract formulation: in fact, value
theory is the major intersection between economics and philosophy.
In other words, this chapter is not easy reading.
But it is essential reading. Theories of value are at the heart of two of the major themes identified in Chapter 1: the distribution of wealth and income and the maintenance of microeconomic order. If we were all self-sufficient in our material lives there would be no problem of economic value. I would produce and consume what I value and you would produce and consume what you value. But most of what each of us produces is consumed by others and most of what each of us consumes is produced by others. So the value of what you produce in terms of the conditions under which it can be exchanged for the things you consume will determine the level of your material life.
When we compare capitalism with other economic systems, several features immediately stand out. Viewing the capitalist system over the sweep of several centuries, the most apparent feature is the tendency of a capitalist system to grow. But when we zoom in to examine the system decade by decade, the tremendous unevenness of this growth becomes more apparent.
Equally visible are the differences among various capitalisms. Early 19th Century Britain and modern Japan are both well within our definition of capitalism: there are markets for land, labor and capital as well as markets for goods and services; most income-producing assets are privately owned; the decision to invest or not invest---to expand or contract---is made by the owners of capital or their designated agents; and the primary motivation for investment is the desire to acquire even more income-generating assets. Yet if we compare these two capitalisms with respect to the role of government, the structure of corporations or the relationship between the worker and the corporation, we will find many significant differences. So another apparent feature of capitalism is its ability to take on many different forms over different times and places.
In this chapter we will examine some of the features of capitalism
that differentiate it from other economic systems. These include
the linkages between market production and income and the role
played by profits. Since there are many theories of why capitalist
economies grow, we will briefly examine the theories of three
major economists: the late-18th Century perspective of Adam Smith,
the mid-19th Century analysis of Karl Marx, and the early-20th
Century vision of Joseph Schumpeter. Then we will attempt to shine
some light on the questions of why and how capitalism periodically
alters some of its major features ---- the theory of systemic
change introduced in Chapter 2 (to explain how one economic system
changes into another) will be modified and refined to help us
understand why and how major changes occur within the economic
system of capitalism.
Thus far we have investigated capitalism and the market system
without looking specifically at money. But capitalism could not
proceed very far without concurrently developing an appropriate
form of money. The money supply must be able to grow as business
opportunities expand. In fact, the Federal Reserve System, which
is the central bank of the U.S., was created in part to assure
an "elastic" supply of money. This chapter, then, traces
the evolution of money from bartered commodities to the modern
banking system. It also examines the critical roles of central
banks as lenders of last resort and in controlling the flow of
money through the economy. In this chapter you will learn how
central banks control the flow of money. The question of what
type of monetary policy the central bank should follow will be
taken up in later chapters.
Sometime by the mid-18th Century the economy of Western Europe entered a path of sustained growth. While comparisons of living standards over centuries cannot be particularly accurate, evidence suggests that Western Europe, between 1700 and 1750, had an average standard of living similar to that of the Philippines today. More important, however, than seeking a precise measurement of 18th century incomes, is to keep in mind that incomes and production methods were little changed from what had existed 500 or even 1,000 years before. Prior to the 18th century, Europeans experienced good times and bad times, fat harvests and plagues, but long-term sustained economic growth had been unknown.
Yet, in the two and one half centuries that followed, per capita incomes grew immensely - probably about ten-fold - even in the face of interruptions such as major wars and depressions. The economic revolution that began in Britain and Holland spread to the rest of Western Europe as well as to North America and Japan.
This chapter identifies the economic conditions that must be present for such a transformation to take place. It is necessarily abstract, but will help place the pieces together. The following chapter will compare the different forms taken by the actual industrial revolution as it spread from Great Britain to other parts of the world. The patterns of growth identified here will be applied to the present day problems of the underdeveloped countries later in this text. The concepts in this chapter apply primarily to the economic transformation of market economies. The socialist model of economic development will be examined in Chapter 20.
Political and cultural aspects of the transformation
are also critical. Cultural barriers to change can slow economic
development. A political system that leaves political power in
the hands of classes that have no interest in economic development
will also hinder the transformation process. These issues will
be treated in later chapters. For the present, we will examine
the economic side of the transformation from a pre-industrial
to an industrial economy in a hypothetical market economy with
no cultural or political barriers to economic development.
Karl Marx (1818-1883) helped shape much of 20th century thinking
about the nature of capitalism, the interrelationship of society
and technology, even the very way in which we understand history.
This chapter, after a brief introduction to some of the critics
of capitalism who preceded Marx, will examine the major elements
of Marxist thought as it applies to economics and to economic
history. It will also explore some of the differences between
Marxian economics and what has become mainstream thought in economics.
Finally, from the perspective provided by more than 125 years
of capitalism since the first volume of Capital was published
(1867), we will evaluate some of the predictions that stemmed
from Marx's theories.
The Invisible Hand identified by Adam Smith in 1776 channeled
private interest into the efficient production of goods and services.
But it would only work in markets where there was sufficient competition.
Yet many modern markets are oligopolistic. A handful of large
firms produce most of the output in these industries. The growth
of oligopoly poses problems both for economic theory and for economic
policy. Standard economic theory predicts that any significant
diminishment of competition should lead to slower economic growth;
yet the age of oligopoly has been accompanied by rapid - although
uneven - rates of economic growth. The economic policy problem
is to find an effective way to use public policy as a substitute
for what competition accomplishes in the world of small business.
This chapter explores how this situation came about, looks at
the changes in the social structure of accumulation that it entails,
examines some of the common practices of big business, and investigates
some of the forces - including antitrust laws - that allow an
economy dominated by gigantic firms to function.
The Great Depression begot the Keynesian Revolution. John Maynard
Keynes and his followers charted a new approach to economics -they
were able both to explain how such a thing as a depression could
occur and to offer policy-makers a prescription for overcoming
or even avoiding such downturns. This chapter examines the major
elements of Keynesian economics, identifies some of the differences
between Keynesian economics and neoclassical economics, and briefly
assesses Keynesian economics both as an economic philosophy and
as an economic paradigm.
The purpose of this chapter is to examine how modern capitalism
functions: to dissect this economic system in order to understand
its basic structure and mode of operation. This is necessarily
abstract -we will examine 'Modern Capitalism in General' rather
than any particular form or era of modern capitalism. Modern capitalism,
at least for the purposes of this chapter, starts with the completion
of the ripening process described in Chapter 9.
Now it is time to look at the economies that were left behind
while Western Europe, the United States and, later, Japan experienced
successful industrial revolutions. Chapter 10 examined the nature
of colonization and the manner in which the economies of many
countries were molded during the 19th century and explored the
limits of economic development through exports of agricultural
or mineral commodities. This chapter will examine the fate of
these countries in the 20th century. After surveying some statistics
and general concepts of underdevelopment, we will scrutinize two
approaches to launching an industrial revolution in the 20th century:
the import substitution policies pioneered by the larger
Latin American countries; and the export-oriented industrialization
model developed by Taiwan and South Korea. Chapter 20 will examine
the socialist development policies pursued by countries
as diverse as China, Cuba and the former USSR.
By the mid-1970s the Great Prosperity had ended. GDP growth, productivity
growth and wage growth all slowed. Unemployment rates and inflation
rates increased. The slowdown affected all of the rich countries,
although all did not exhibit exactly the same symptoms. For economists,
the worst part was the simultaneous existence of unacceptable
levels of inflation and unemployment. We coined
the term stagflation to describe a situation that our theories
told us could not happen. This chapter examines the impact of
stagflation, the theories advanced to explain it and the policies
proposed to control it. Then it explores the possibility that
a long and deep economic slump about every fifty to sixty years
is part of the regular landscape of capitalism.