WHAT IS THIS THING CALLED “POLITICAL ECONOMY?

Two distinct meanings in the literature:

1.The application of mainstream (neoclassical) theory to political processes.

2. Nonmainstream schools of thought also referred to as "heterodox economics”.

•The original aim of political economy according to Marx: “to understand the laws of
motion of society” ⇒analyse forces governing the wealth of nations and growth in that
wealth.

•Not an independent study, but part of broader attempts to understand society.

•Rejection of mainstream method of analysis-partly to blame for GFC.

•Student complaints around the world about the teaching of economics.

SOME METHODOLOGICAL ISSUES

•Keynes': “economics is not a set of answers, but rather a way of thinking. “

•Joan Robinson: economic is a box of tools - the art of being a good economist is
choosing the appropriate one for the problem at hand.

•Harcourt: "Horses-for-courses".

METHODOLOGICAL ISSUES Cont

•Political economists deny the usefulness of general theories which describe all
economies.

•It does not subscribe to a general theory, with modifications to allow some role for
institutions and social phenomena, but instead incorporate these into the essence of
models.

•Cf neoclassical theory: general theory of individual optimization universally applicable.

FEATURES COMMON TO ALL POLITICAL ECONOMY SCHOOLS

1.The economy as an historical process ⇒unchangeable past influences as we move

towards an uncertain future.

2.The appropriate unit of analysis. Mainstream economists ⇒individual consumer or

firm. Political economy depends on the problem. Usually class, as determined by
people’s role in the production process. Typically, workers and capitalist.

3.The role of social and economic institutions and forces: fundamental role in
influencing people’s behaviour. Institutions evolve and change over time.

4. Fundamental role for money and credit. Cf Neoclassical theory ⇒neutrality of

money,

5. The role of effective demand

6. The future is unknowable, and uncertainty permeates all decisions.

7. The denial of validity or usefulness of general theory

HISTORICAL INTRODUCTION

•Adam SmithDavid RicardoKarl Marx

•Reproduction and accumulation main functions of economic activity,

•main actors - classes as determined by the role of individuals within the production
process

•landlords rent out land

•workers provide labour services in return for wages

•capitalists provide capital: hire labour and organise production and earn profits.

Rise of Neoclassical Economics

•1870S: Marginal revolution and neoclassical economics.

•Neoclassical theory ⇒supply and demand can determine market clearing prices.

•Theory deals with the optimal allocation of a given initial endowment and distribution of
resources

⇒prices as "scarcity indexes" and as "optimal allocators" of existing resources.

What is Neoclassical Economics?

•Significant role for ‘market forces’ (demand and supply determined prices)

•Individual rational maximising behaviour

•Economies are inherently stable and tend towards equilibrium positions (especially in
the ‘long-run’)

• ‘Govt intervention’ only desirable under prescribed circumstances (e.g. ‘market

failure’).

•Price stability, efficiency, competitivemarkets (etc) key to economic performance

•Microeconomic policy: deregulation of markets normally supported

•Financial theory dominated by efficient market hypothesis (and related theories)

•Macroeconomic policy: favours policy ‘rules’ as opposed to ‘discretionary’ policy

•Price stability main economics goal, as opposed to full employment

•Long-run neutrality of money and of monetary and fiscal policy

• [i.e. Govt spending and changes in the money supply will not affect real variables in
the economy (e.g. real output, employment) in the ‘long run’, they will only affect the
general price level]
• ‘Financial institutions and capital flows are best deregulated.’• Allow financial capital
to be allocated to most profitable opportunities nationally and globally and markets to
put a price on ‘risk’ etc
•All of these–played important role in GFC
•However, important to realize mainstream economics is not homogenous
•Textbook economics may sometimes understate lack of consensus actually found to
exist within mainstream economics.

Criticisms of Mainstream Economics from within

‘Retrospectives’ by Nobel Laureates:
•". . . economics has become increasingly an arcane branch of mathematics rather
than dealing with real economic problems” Milton Friedman
•“[Economics as taught] in America's graduate schools... bears testimony to a triumph
of ideology over science.” Joseph Stiglitz
•"Existing economics is a theoretical [meaning mathematical] system which floats in the
air and which bears little relation to what happens in the real world” Ronald Coase
•“We live in an uncertain and ever-changing world that is continually evolving in new
and novel ways. Standard theories are of little help in this context. Attempting to
understand economic, political and social change requires a fundamental recasting of
the way we think” Douglass North
•“Page after page of professional economic journals are filled with mathematical
formulas [...] Year after year economic theorists continue to produce scores of
mathematical models and to explore in great detail their formal properties; and the
econometricians fit algebraic functions of all possible shapes to essentially the same
sets of data” Wassily Leontief
•“Today if you ask a mainstream economist a question about almost any aspect of
economic life, the response will be: suppose we model that situation and see what
happens...modern mainstream economics consists of little else but examples of this
process” Robert Solow
Other Important Themes1.
1.Labour not just a “commodity” but a socioeconomic relationship
2.Key role of money and finance
3.Importance of government, especially economic policy, in the economic process

KARL MARX (1818-1883)

Purpose of Scientific Inquiry
• “Marx’s method was explicitly historical in the sense that it focused on the changing
structure of social relations as the result of the historical unfolding of capitalism the
object of study is ‘the laws of motion of capitalism”. (Dow)
PURPOSE OF POLITICAL ECONOMY
• History strongly influenced by the economy, particularly by class struggle.
• Prevailing theories which gain dominance are those which support the economic
status quo –hence the dominance of neoclassical economics and neoliberalism today
• Agreement between economic theory and economic practice sign of a healthy
economy⇒match between theory and practice.
MATERIALISM
• Starting point: materialism ⇒the physical realm most important determining factor,
shaping the realm of ideas.
• Material base, in particular, economic relations shape social, cultural, legal and other
relations.
• Mode of production (the physical economic relations including technology) depends
on the social relations existing in that society between the economic classes involved in
that production.
• “In the social production of their existence, men inevitably enter into definite relations,
which are independent of their will, namely relations of production appropriate to a
given stage in the development of their material forces of production.
• The totality of these relations of production constitutes the economic structure of
society, the real foundation, on which arises a legal and political superstructure and to
which correspond definite forms of social consciousness. • The mode of production of
material life conditions the general process of social, political and intellectual life.
• It is not the consciousness of men that determines their existence, but their social
existence that determines their consciousness” Preface to the Critique of Political
Economy
• “According to the materialist conception of history, the ultimately determining element
in history is the production and reproduction of real life. ....
• The economic situation is the basis, but the various elements of the superstructure —
political forms of the class struggle and its results, to wit: constitutions established by
the victorious class after a successful battle, etc., juridical forms, and even the reflexes
of all these actual struggles in the brains of the participants, political, juristic,
philosophical theories, religious views and their further development into systems of
dogmas —also exercise their influence upon the course of the historical struggles and
in many cases preponderate in determining their form.

Base and Superstructure

• Economic base.
• Social superstructure
• Clearly not a one way relation
MATERIALISM

• For an economic system to reproduce itself, to sustain and survive rather than wither
and die, these realms have to be mutually supportive. • Customs, culture, ideology,
other institutional forms must support the basic productive forces in the economy.

Value
• Use value: necessary, but not sufficient, condition for value in exchange.
• Use value lies within the realm of the subjective ⇒not a reliable basis for forming an
objective theory of exchange.
• Following classical economists:Value in exchange= cost of production

‘commodity fetishism’
• Science according to Marx must not be satisfied with surface appearances. Needs to
unveil what lies beneath those appearances.
• Exchange occurs only after production and production under capitalism occurs for the
sake of profit alone.
•⇒‘commodity fetishism’
• People mistake relation between people in production with relation between things -
commodities

ORIGINS OF PROFITS
• Where do profits come from?
• Not exchange, as exchange of equals,
• Nor from any power or quality inherent in the input itself
• According to classical/neoclassical theory exchange ⇒producer make commodities in
order to obtain another commodity,
• makes something they don't want in order to get something they do.
• Money only a universal equivalent (means of exchange).
•C →M →C
•But: If trader ends up with same exchange value as started out, what use is
exchange?
Profits and Exchange
• Fair exchange ⇒like value exchanges for like value ⇒no new value created
⇒commodities exchange at their value.
• Additional value can’t be created in exchange.
• Capitalism is about creating and accumulating value
• Does not happen during circulation/exchange but during production process.
ORIGINS OF PROFITS
• In the realm of production
• M→C→M’ M’> M
• Money is the beginning and the end
• M →C →C' →M'
• Capitalists buy factors of production and combine them to form some finished product
which is sold for its value.
• Final product is worth more than its constituent parts.
• Capitalism ⇒commodity production ⇒goods and services produced for their ability to
be exchanged for some universal equivalent.
• “Accumulate, accumulate that is Moses and the prophets” Marx
•All transactions reduce to an exchange of commodities,including the hire of labour.
• To obtain a commodity you must exchange a value equivalent to its value = cost of
production
• Capitalism is peculiar in that it universalises this approach.
Labour
• Capital depreciates and must be replaced, so workers need sustenance to labour
• Exchange value: wages = cost of production =subsistence (social aspect to
subsistence.)
•⇒labour treated as just another commodity
•⇒labour alienable, separable from the worker
• Production requires nonlabour inputs: technologically determined: constant capital

• The amount of constant capital needed to produce a given amount of output is

technologically fixed (constant).

• No new value created by it.

• Labour: variable capital - amount of work actually done is variable, not

technically given.
• Purchased only labour power, ie. potential for working, not the labour itself.
• Actual work labour delivers a matter for struggle between the two classes with
divergent goals
• The profit gained by the capitalist = value of the product made by the worker -
wage worker receives
•⇒capitalism functions on the basis of paying workers less than the full value of
product of their labour.
• Buyer and seller meet on equal terms, but worker/ capitalists don't.
• The creation of value under capitalism requires the maintenance of antagonistic class
relationships between economic classes.
•Value is created not out of the harmony of exchange as pictured by classical and
neoclassical economists but out of class struggle.
• The social relations that underpin this mode of production (capitalism) must maintain
the dominance of the owners of capital over the owners of mere labour power.

Surplus value
• s = Surplus value ⇒source of capitalist profits
•Labour, combined with ‘c’, earns value of its subsistence (i.e. wage) with only a few
hours work
• Value of output for the remainder of the working week appropriated by the capitalist
as surplus value
• workers receive subsistence wage < contribution to value of output
Constant Capital [c]
• Portion of the value of machinery and materials used up in production and added to
the value of the product
• Does not undergo any quantitative changes in value during the production process
• The amount of constant capital needed to produce a given amount of output is
technologically fixed – ie constant
Overall value of a commodity
• Decomposed into constant capital, variable capital and surplus value
•o=c+v+s
•Rate of exploitation: ratio of surplus value to variable capital (necessary labour) : e =
s/v
•Rate of Profit
• = ratio of surplus value (s) to total capital (c+v)
• r = s / (c + v)
•Organic composition of capital: = c / v
TENDENCY OF WAGES TO SUBSISTENCE: RESERVE ARMY OF THE
UNEMPLOYED
• Surplus value results from the extra time labour works above what it takes them to
produce the value of their wage.
• Amount depends on the struggle between worker and capitalist over the length of the
work day and the intensity of work.
• Capitalism creates a reserve army of unemployed
•→high cost from job loss →pressure on wages ↓
•Unemployment serves an important function in capitalist economies
•e↑⇒r↑
Crisis as an inherent characteristic of capitalism
• Can take many formsa. Tendency for the rate of profits to fallb. The disproportionality
between different branches of productionc. Realisation of surplus value into profits and
problems of effective demand
Reserve Army of the Unemployed

• Early stages of the development of capitalism: large potential work force moving from
rural areas allows for expansion with no pressure on wages.

• High profits (low wages) →investment.

• Accumulation > labour supply until the labour surplus all absorbed

•→ W↑ ∏ ↓ → I↓ → downturn in the cycle

• Firms restore profits by introducing labour saving innovations

•→ W ↓ ∏ ↑ and so cycle starts again

Tendency for the rate of profits to fall

• r = s / (c + v) = (s/v) / (c/v + v/v)
•⇒Rate of exploitation s/v↑ → r ↑
•Organic composition of capital c/v↑ → r↓
• Marx concluded c/v tends to increase through time (more capital intensive
technology) → r↓
•Unless s/v↑ by increasing rate of exploitation or increasing labour productivity
⇒tendency for the rate of profit to fall through time → crisis in capitalism
countervailing tendencies
•‘There must be some counteracting influences at work which thwart and annul the
effects of the general law, leaving it merely the character of a tendency’
•Cheapening in the elements of constant capital (i.e. c↓)
•Increasing in rate of exploitation (s/v↑) by prolonging the working day or reducing
wages or increasing work intensity
•Relative overpopulation → ↑ reserve army of unemployment
countervailing tendencies
• Foreign trade (may, for example, reduce cost of raw materials → c↓) or cost of
subsistence goods
• Increase in the stock of capital may lead to increased industrial concentration leading
to economies of scale in usage of capital (c↓)
• Decrease in wages below the value of labour power; equivalent to raise rate of
exploitation (s/v)
The disproportionality between different branches of production
• Marx developed 2 sector model1.Department 1 produces the means of production
(i.e. constant capital)2.Department 2 produces consumption goods for workers and
capitalists (v + s)
•Simple reproduction: no economic growth

SIMPLE REPRODUCTION
• o1= c1+ v1+ s1Capital Goods Sector
• o2= c2+ v2+ s2Consumption Goods Sector
•o1= c1+ c2= c1+ v1+ s1
•o2= v1+ s1+ v2+ s2= c2+ v2+ s2
• where v1+ v2represents workers consumption and s1+ s2represents capitalists
consumption, and c1and c2represent constant capital.
SIMPLE REPRODUCTION
• c2= v1+ s1
• Required for simple reproduction, otherwise disproportionality problem arises
• Nothing in model to ensure this condition is met
• The logic of capitalism, especially due to competition, imposed imperative for firms to
grow and to accumulate capital ⇒expanded reproduction.
•The conditions for non-problematic growth, in terms of intersectoral flows, become
complex and extremely unlikely to eventuate ⇒business cycles arising from problems
with intersectoral flows.
• Price flexibility could not remedy the matter.
•→ instability and disequilibrium growth

Realization of surplus value into profits and problems of effective demand

• Crisis emerges because of the inability of society to consume what it produces →
overproduction (under consumption) due to the nature of capitalism
• The process of making profits involves 2 stages, separated in time and space:(1)The
creation of surplus value through production (2)Sale of commodities on the market
Realization Problem
• (2) limited by the consuming power of society.
• The process of exploitation and competitive struggle over accumulation (more capital
intensive production) → consuming power kept low
• Result: Periodically, overproduction of necessities reduces the realization of the
surplus-value
STAGES IN THE DEVELOPMENT OF SOCIETY

• Orthodox economics takes the existing social system as given.

• Transition pre-capitalist modes of production (feudalism) →capitalism →monopoly

capitalism.