How the Concept of
Development Got Started
By Ricardo Conteras
A. Introduction: Development Is a Concept Tied to
the Evolution of Capitalism
"Economic development" or
"development" is a term that economists, politicians, and others have
used frequently in the 20th century. The concept, however, has been in existence
in the West for centuries. Modernization, Westernization, and especially
Industrialization are other terms people have used when discussing economic
development. Although no one is sure when the concept originated, most people
agree that development is closely bound up with the evolution of capitalism and
the demise of feudalism.
Development has many meanings. The meaning a
particular person attaches to the term depends on her subjective view of the
world. Indeed, the meaning of development is not only a product of the
individual's perspective but also of the particular period in time when the
word is being uttered. Thus, in order to understand the various theories of
development, one must place them in a historical context.
This section will be historical in nature. We will
trace the evolution of capitalism and the theories that have been developed to
explain how the process works and what its impact has been on society. When you
finish this section, you will have a basic understanding of the economic
development of Western European society.
The first part of this section will focus on the
transition from feudalism to capitalism. We will compare the feudal view of
economic development with that of the early capitalist middle class or
"bourgeoisie." On a historical time-line, this covers the time period
beginning in the 13th century and ending in the early 18th century. You will
learn that the concept of development as we know it today, which stresses
continuous improvement of social welfare, did not exist in feudal society.
However, with the decline of feudalism and the rise of the nation-state came
increased government concern regarding general economic welfare. Government-led
efforts to increase wealth through exports became an explicit goal under a set
of beliefs referred to as mercantilism.
The second part will cover 1700-1860, a period labeled the Age of Competitive Capitalism. During that period, political and economic power moved from the feudal aristocracy to the capitalist bourgeoisie. With the elimination of the last vestiges of feudalism in Europe, the bourgeoisie turned its attention to the rest of the world. Capitalism was exported to the rest of the world via the colonial system.
Two schools of thought, Classical Political Economy
and Historical Materialism, emerged during this period. Both sought to explain
the role of capitalism in economic development. Adam Smith was a proponent of
classical political economy. Karl Marx was the main representative of the
historical materialism school.
The third part explores the Age of Imperialism from
1860 to 1945, during which time the small enterprise lost ground to large,
monopolistic cartels. Two main schools of thought relating to development arose
during this period: neo-classical economic theory and the classical theory of
imperialism. Various theorists are associated with each school. We will limit
our discussion to the works of Alfred Marshall and Vladimir I. Lenin.
The section will conclude with a summary of Keynesian
economics, which attempted to explain why the capitalist economies were on the
verge of collapsing and how capitalism could be modified to preserve itself.
The critical aspect of the economic puzzle related to unemployment. Keynes'
theory of unemployment attempted to solve the puzzle through state intervention
in the economy via government spending. An understanding of this theory is
crucial to understanding post-war theories of development and the creation of
the International Monetary Fund and the World Bank.
B.
The
Transition from Feudalism to Capitalism: The Early Stages of Capitalism
1.
Development
Policy Did Not Exist in Feudal Society.
Following the collapse of the Roman Empire, the West
experienced a time in which all effective public authority vanished. Feudalism
was a system whose ultimate goal was to create decentralized government. The
system was based on a contractual relationship among members of the nobility in
Europe, and it evolved around the most important warrior in the
region - the Count. The Count maintained strict control over all the lesser
warriors (lords) in his region. The lords accepted the Count as their Lord (or
were forced to do so), thereby becoming vassals of the Count. The Count's duty
was to protect the lords and settle any dispute that arose between them. Most
importantly, the Count guaranteed that as long as the vassals remained loyal
they would be allowed to remain in possession of their land or fiefdoms. This
pattern was replicated all over Europe.
Consequently, a highly localized form of
"government" evolved during the Middle Ages. One of the principal
purposes of feudal government was to combine political and military service
with landholding in order to prevent Medieval Europe from disintegrating into
thousands of "seigneuries" or independent estates run by different
lords. In other words, government was essentially a system of cooperation that
existed to protect and perpetuate the feudal system and to preserve order.
Given society's vulnerability to unpredictable harvests, to whatever type of
governance prevailed at the time, and to frequent wars, active and consciously
designed government programs to improve the welfare of society simply did not
exist. No one conceived of a bureaucracy of government officials responsible
for designing programs to provide people with a better standard of living.
Thus, development policy as we think of it today did
not exist in feudal society. For much of the period in question, a person did
not witness or expect significant changes in society during his or her
lifetime. One's position in that society was pre-determined and fixed at birth.
Serfs, who worked for the vassals, could not "move up" and become
knights or barons; such mobility was unheard of. Individuals viewed themselves
as victims of their destiny and environment. It never occurred to the average
person that his or her destiny could be tailored and that nature could be
conquered. R.H. Tawney, a well-known historian, captured this frame of mind
when he wrote:
Rapid economic change as a fact, and continuous
economic progress as an ideal, are the notes, not of the history of the West,
but of little more than the last four centuries...[prior to that] the common
man looked to the good days of the past, not to the possibilities of the
future, for a standard of conduct and criterion of the present; accepted the
world, with plague, pestilence and famine, as heaven had made it; and were
incurious as to the arts by which restless spirits would improve on nature, if
not actually suspicious of them as smelling of complicity with malign powers.
Keep in mind that medieval society was not completely
static. Change did occur. But it was not the product of a systematic approach
encompassing the application of science and technology to the production of
material goods, a hallmark of the industrial revolution.
2.
The Transition
to Capitalism Was Driven by Ambition and Self-Interest; Government Involvement
in the Process Was Marginal.
Exactly what fueled the transition from feudalism to
capitalism in its early stages is an issue that is hotly debated. We will
probably never know. What is known, however, is that government played a very
marginal role in the process. The movement was a local one driven by ambitious
men. Some were in search of fame, others sought prestige. But most of all, individuals
were in search of personal financial gain. Development, or
"progress," as the early bourgeoisie called it, was synonymous with
the improvement of an individual's lot in society.
There was no generalized idea that the welfare of
society as a whole needed to be taken into account. Medieval institutions that
impeded progress were dismantled not because people felt that society as a
whole would be better off but because the early capitalists would be better
off. They fought for the freedom of the serf with almost the same tenacity that
they fought for free trade. A victory in both fields was crucial to their
personal economic well-being. A free peasantry would provide the labor for the
capitalist's factories and free trade would expand the market for the factories'
manufactured goods.
3.
Development
Became an Objective of Government Policy With the Rise of the Nation-State and
the Need to Perpetuate State Power.
Feudalism began to decline after its zenith in the
13th century. By the end of the 15th century, the power of the feudal
governments had eroded through wars and feudal rebellion. Banditry was almost
out of control. All of this impeded trade and commerce, which was being driven
at the time by the emerging capitalist middle class. The concomitant rise of the
nation-state and the concentration of power in the hands of sovereigns laid the
foundation for post-Medieval progress and development.
In response to the strife of the period, various
powerful rulers attempted to bring peace to Western Europe. These rulers became
known as the New Monarchs. They consolidated the smaller feudal governments
under the institution of monarchy, which became the legitimate form of public
power. Loyalty and respect for the monarchy were obtained through force,
marriage, or peaceful (and sometimes not-so-peaceful) negotiations. The
monarchs especially sought out and received the support of the middle class
townspeople, who were tired of the petty wars and abuses of the feudal lords
that impeded economic activity.
The monarchs quickly realized, however, that
maintaining a strong central government was expensive. To maintain control of
their nation-state they needed their own private army; they could no longer
depend on the nobles for military purposes. Because they had to pay the private
army, the monarchs realized that their survival was dependent on an important
aspect of development - a growing and sound tax base.
Tax revenues could be increased in two ways:
increasing the size of the tax base - the number of people that could be taxed - or
stimulating an increase in production. Most rulers opted for a combination of
the two. But wars to expand the tax base tended to be too costly, prompting
rulers to stress increases in production. Thus, the promotion of economic
development can be said to have become an objective of state policy during this
time period. Gradually, the notion of promoting sustained increases in economic
wealth became an independent and legitimate aspect of state policy, which came
to be known as mercantilism.
4.
Under Mercantilism,
the Government Was Viewed as the Catalyst for Capitalist Economic Growth Via
Exports to Foreign Countries.
In its early phase, mercantilism was characterized by
a nation-state's desire to accumulate gold and silver. This policy gradually
gave way to one geared at building and maintaining a strong and self-sufficient
economy. Self-sufficiency was to be accomplished by putting the poor to work.
The goal was to create full employment, and to discourage idleness, begging and
vagabondage. The government introduced new crafts and manufacturing processes
into the country. Favorable treatment was given to merchants who created jobs
at home and to those who sold their products abroad.
The government's goal was to increase the exports of
manufactured products and reduce all imports except those necessary to produce
manufactured goods. With its trading partners having to pay for their imports
in either gold or silver, the result would be a favorable trade balance for the
country - that is, more gold and silver would flow into the country than
flow out. If a state was able to export more than it imported, at the end of
the year it would be richer than its trading partners.
It was during this period that capitalism was
exported to the rest of the world. A driving force behind Europe's desire to
explore and colonize was the desire to create new markets for European
manufactured goods. The exploitation of colonies was viewed as a legitimate
means of acquiring precious metals as well as the raw materials for export industries.
C.
Competitive
Capitalism (1700-1860)
1.
Capitalism
Witnessed the Rise of the Industrial Sector and Increased Demand for Unskilled
Laborers Whose Wages Were Not Enough to Cover Basic Needs.
During the 18th and 19th centuries, capitalism became
the dominant economic force in Western Europe, thereby planting the seeds for
many of the elements of 20th century development policy. For example,
mercantilism contributed to a shift in focus from agriculture to industrial
development. The industrial sector was geared to the production of goods for
consumption. It was composed of small firms which bought and sold their
products freely in a very competitive open market. Production took place in
factories, which churned out manufactured products using rudimentary but
labor-intensive technologies.
The new factories generally required only unskilled
labor. Skilled craftsmen found themselves replaced by machines with which they
could not compete. Consequently, they were forced to join the army of unskilled
workers populating the new factories. An unskilled factory worker earned more
than his counterpart working in the fields. Still, that factory worker did not
earn enough to support a family. The wage was at times not even enough to
provide for the worker's basic necessities. To survive, the entire family had
to work. The work at the factories was so mechanical that it could be performed
by a six year old child. Indeed, employers often preferred women and children
because they did not have to be paid as much.
2.
Capitalism
Expanded Outward in Search of Raw Materials and Consumers.
In the international arena, this era was
characterized by a push to bring in new regions into the capitalist sphere
through the process of colonialism, which since the 15th century had expanded
Western European power and control to the East Indies and the Americas. Thus,
for example, the English East India Company became a quasi-governmental entity
in the 18th century and, after the British defeated the French in the Seven
Years War, proceeded to conquer India's mainland. After the Napoleonic Wars,
the newly independent Latin American countries entered the world economy as
suppliers of raw materials and consumers of manufactured goods. And the British
Empire of the late 18th century ensured that Asia and Africa would perform the
same function.
D.
Classical
Political Economy: Adam Smith and "Laissez Faire"
1.
Classical
Political Economy Argued that Government Should Play a Limited Role in the
Economy.
In 1776, Adam Smith published Wealth of Nations, where he criticized the concept of mercantilism.
Smith's views regarding limited government intervention and free markets,
better known as the "laissez faire" system, would become key
components of one school of development policy which continues to this day.
Smith felt that the regulatory and monopolistic
practices characteristic of mercantilism limited a country's economic growth.
He believed that the best way to increase the wealth of a nation was through
the reduction of barriers that hindered growth. To Smith, government
intervention in the economy was such a barrier. He criticized the provincial
view of the proponents of mercantilism and argued that the economic system was
world-wide, and as such should not be burdened by political or national
barriers. Tariffs on traded goods should be eliminated; free trade should be
the norm.
Contrary to popular belief, Smith never proposed a
complete ban on government involvement in the economy. He was an advocate of
limited government intervention, arguing that a government's role should be
limited to national defense, internal security, and the provision of reasonable
laws and fair courts in which private disputes could be peacefully adjudicated.
2.
Adam Smith
Believed that Economic Growth Depended on the Free Market and the
Entrepreneurial Spirit of Private Persons.
Under Smith's model, government involvement in any
area other than those stated above would have a negative impact on economic
growth. This is because economic growth is determined by the needs of a free
market and the entrepreneurial nature of private persons. If there is a
shortage of a product its price will rise, and so stimulate producers to
produce more, while at the same time attracting new persons into that line of
production. If there is an excess supply of a product (more of the product than
people are willing to buy), prices will fall and producers will focus their
energy and money in other areas where there is a shortage or where there is a
need which no one has yet satisfied (thereby creating a new market).
Smith argued that this system would be regulated by
the self-interest of each individual capitalist. He believed that each
individual knows his own interest better than anyone, especially the
government. In Smith's model, the sum total of individual interests will
maximize the general welfare and liberty of all.
E.
Karl Marx
and the Socialist Revolution
1.
According to
Marx, the Government was a Tool Used by Capitalists to Perpetuate Themselves in
Power.
In 1867 Karl Marx published Das Kapital, a work that systematically and historically
analyzed the capitalist system. His theories would provide much of the material
for arguments that have opposed development models based on capitalism and the
laissez faire system.
Marx lived at a time when capitalism was at its
prime - it was spreading throughout the world. Members of the capitalist
class had become masters of both the social and political spheres. Their power
was the fruit of the industrial revolution and of the many political and
military battles that the capitalist class had waged against the nobility. The
capitalists had joined with the working class to wrestle power away from the
nobility. The first great battle, labeled the French Revolution, was fought in
1789 in France. In 1848, once again beginning in Paris, the capitalists staged
a new revolution with the help of the working class. As a result of these
victorious revolutions, the capitalists obtained political control. According
to Marx, this allowed the capitalist class to create a government that would
allow it to exploit the working people. Thus, for Marx the government was
nothing more than a tool of the capitalist class.
2.
From a Marxist
Perspective, Development is a Process of Class Struggle.
Marx believed that just as the bourgeoisie (the capitalist
middle class) had relied on revolutionary movements to wrestle power from the
nobility, so, too, could the working class, called the "proletariat,"
eventually overthrow the bourgeoisie. For Marx, the eventual fall of the
bourgeoisie was not only desirable, it was inevitable. He reached this
conclusion based on his economic theory of labor. Specifically, he developed
the doctrine of surplus value. At the heart of the doctrine was the conclusion
that the worker was being robbed. The worker received only a fraction of the
value of the product which his labor produced. The remainder was kept by the
capitalist class. This theft eventually led to an economic crisis caused by
overproduction- the vast majority of the population could not afford to consume
the products that the owners of capital produced. The capitalist's answer to
this problem was the continual creation of new markets.
Marx saw capitalism as an historical necessity
because it was the most productive and flexible economic system in human history.
It could move capital and labor to meet demand faster than any of the previous
systems that it had replaced. Marx, however, refused to accept capitalism as
the ultimate mode of production (economic system). He believed the system was
plagued with internal contradictions that would inevitably lead to its
destruction and replacement by a more advanced system.
According to Marx, the relations of production (the
way people interact in a particular economic system) create different economic
classes. For example, under the feudal economic system, two classes existed:
the nobility and the peasantry. The dominant class, the nobility, created a
system to maintain its position. Religion, government, laws, and morals
reflected the needs of the dominant class and were used to perpetuate its
position of power. As capitalism emerged, a new dominant class, the
bourgeoisie, began to appear. The nobles and the bourgeoisie eventually clashed
and the latter was victorious.
3.
According to
Marx, Capitalism's Inherent Contradictions Would Eventually Cause its Downfall.
Marx believed that the advent of capitalism set in
motion its own final downfall. He reasoned as follows. The capitalist system
cannot exist without workers. As more factories are built, more people will be
forced to work in them. Thus, under capitalism, the army of workers will
continually expand. With the expansion of capitalism around the world comes the
global creation of a working class.
This system is ruthless, however. In order to
survive, capitalists must continually strive to outproduce one another. But not
all capitalists will be able to compete. Capital will become concentrated in
fewer hands. Those bourgeoisie that are unable to compete will be forced to
join the working class or perish. This process will continue until one day the
proletariat masses will be able to take control of the system by overthrowing
the bourgeoisie, resulting in a classless society. No new class will arise
because class arises from economic differences, and capitalism will have
eliminated these differences by making everyone a proletariat.
Since the concepts of state, religion, morality, and
laws were mechanisms to maintain class differences, they, too, will disappear.
Government will not be eliminated immediately, however. A limited form of
government (a proletariat dictatorship) will be put in place to prevent a
possible attack by any surviving bourgeoisie. This dictatorship will eventually
become useless, and when it does, it will "wither away." At this
point, socialism will have been achieved.
4.
Marxism Views
Government-Led Social Reform and Nationalism as Mechanisms to Perpetuate
Exploitative Development.
For Marx economic development was tied to class
struggle. Economic development could only be achieved as a class; individual
achievement was not emphasized. Trust in the government and cooperation with
its goals were also viewed as betrayals of the class struggle. The government's
involvement in social reform was nothing more than an attempt by the
bourgeoisie to appease the workers and thereby force them to abandon the
struggle. Since the government reflects the will of the dominant class, it
would never enact any law benefiting the subservient class.
Indeed, Marx viewed politics as a mechanism created
by the bourgeoisie to confuse the workers and divide them. Political divisions
fuel nationalism which, in turn, misleads workers from one country into
believing that the workers of another country are enemies. Marx would argue,
for example, that there is no difference between the class relations in Mexico
and those in the United States. Workers in both countries are being exploited.
F.
Imperialism
and Economic Theory (1860-1945)
Capitalism flourished during the latter half of the
nineteenth century and first half of the twentieth. Alfred Marshall and
Vladimir Lenin were two well-known thinkers whose theories about capitalism
would lay additional groundwork for post-World War II development theory.
Before describing their work, we will provide you with important background.
1.
Imperialism Flourished
During this Period.
a.
During this
period, capitalism spread to most of the world; but not all areas of the world
partook equally of the wealth.
By the beginning of the twentieth century it was safe
to say that a truly global economy existed (today's globalization is not a new
phenomenon). Most, if not all, of the traits characteristic of capitalism could
be found almost anywhere in the world. A traveler could board a ship in England
headed for the Americas, Africa, India or Asia with little or no concern of
what he would find there. If he was headed to a "modern" or civilized
place, he would be able to find anything that he could find at home. Capitalism
had by this time help spread Western European science, weapons, industry,
medicine and lifestyle to almost every corner of the globe. Any corner void of
capitalism's presence was considered savage or uncivilized.
Not all people, nor all regions, reaped the rewards
of capitalism. Western European nations divided most of the world's
economically underdeveloped areas among themselves. As the capitalist modes of
production spread around the world, capitalism supplanted local industries and
with them the livelihood of many local craftsmen. The need for raw materials by
the industrialized Western European countries led to a realignment of land use.
Indigenous populations were driven out of their lands.
b.
European nations
dominated most of the world economically and politically.
Western Europeans were no longer satisfied with
purchasing what the "natives" could produce. They wanted goods of a
type or in a quantity that local craftsmen could not produce. Europeans
invested capital and transferred the technology necessary to meet their needs.
The economies of these regions were assimilated into the capitalist market.
Traditions and customs had to give way to progress. Indigenous people had to
give up their lifestyles and join the working class. Their fortunes were now
tied to the market. If the market thrived, they survived. In times of economic
depressions, they starved.
Control was obtained and maintained through the use
of force. Europe relied on its economic power and its modern military weapons
to maintain control of the rest of the world. As a point of reference, between
1875 and 1900 Great Britain added 4,500,000 square miles to her empire; France
added 3,500,000; Germany, 1,000,000; Belgium, 900,000; Russia 500,000; Italy
185,000; and the United States, 125,000. This colonial system was to remain in
place until World War I. Indeed, the imperialistic rivalries among the various
European powers led to the Great War.
2.
Alfred Marshall,
a Neoclassical Economist, Believed Capitalism Would Benefit Everyone in the
Long Term.
In the late nineteenth century, neoclassical
economists shifted the focus of economic analysis from the impact of scarce
resources on prices (the focus of the classical economist) to the effect of
consumer preferences on supply and demand (and therefore on price). The British
neoclassical economist Alfred Marshall explained demand based on a product's
marginal utility to a consumer (the consumer's satisfaction with the last unit
consumed), and supply by marginal productivity (the cost of producing the last
item of a given quantity). Markets performed efficiently by allowing prices to
be set by fully informed producers and consumers. This type of analysis is
still influential today.
a.
Marshall
believed that capitalism would lead to a civilized and classless society.
Marshall's thinking was also important in a broader
context, for he tried to rationalize the imperialistic exploits of capitalism.
Marshall believed that capitalism would triumph over the challenge posed by the
socialist movement. He argued that progress would abolish all classes; in the
long-run, every man would become a gentleman. The classless gentleman was to be
created through better education, a reduction in physical labor, shorter
working hours and through a greater distribution of society's wealth. This
process was not going to happen overnight nor through a revolution. This
classless society was to be a by-product of capitalism. As capitalism advanced,
the proletariat would be transformed from unskilled workers to skilled workers.
b.
He also believed
that the state should play an important but limited role in achieving long-term
growth.
Marshall built incrementally upon the thinking of
classical economists regarding the state. For him, the role of the state should
not be limited to providing external security and domestic law and order, as
classical economists had argued. Marshall believed the state should also
advance education, encourage trade unions, provide public health, restrict
monopolies, and provide relief to the poor by creating employment for them. But
he stopped there. He agreed with the classical school that the state should not
otherwise intervene in the operation of the economy.
Vladimir Lenin also attempted to rationalize the
capitalism of the imperialist era, although he did not share Marshall's
optimism about the long-term prospects of capitalism. Given the conditions in
Russia in the early twentieth century, Lenin pushed for a socialist revolution
sooner rather than later. This belief would influence the theories of a
particular school of development in the 1960s-1970s.
a.
Lenin believed a
socialist revolution was possible even before capitalism had eliminated all
traces of feudalism.
In order to understand Lenin's theories, you must
understand the historical context in which he lived. Lenin was from Russia,
which at the beginning of the twentieth century was still a feudal society.
Political, and to some extent, economic power still remained in the hands of
the nobility. This is not to say that capitalistic modes of production or a
capitalist class did not exist in Russia. They both did. Using Marx's theory on
the composition of a society, it could be said that Russian society was
composed of four classes: the peasantry, the nobility, the proletariat and the
bourgeoisie.
Given the state of global capitalism at the time,
Lenin argued that capitalism had entered its highest and final
stage - i.e., that the proletariat had firmly established and consolidated
itself as a class and that it had replaced the bourgeoisie as the revolutionary
class. He argued, however, that the bourgeoisie, who viewed the proletariat as
a threat, would align themselves with the nobility on many issues. This new
alignment allowed many feudal practices to continue. The promised democratic
freedoms would never materialize because the capitalist class was afraid that
such freedoms would allow the proletariat to organize and carry out its class
struggle more effectively.
Thus, Lenin believed it was up to the proletariat to
take over the struggle, with the peasantry as an ally. The end result would be
that the proletariat and the peasantry would overthrow the capitalist state and
establish a dictatorship. The dictatorship would serve three purposes. First,
it would destroy any counter-revolutionary activity. Second, it would
completely abolish all vestiges of feudalism and establish conditions under
which the proletariat could enjoy democratic freedoms. Finally, it would
improve the material condition of the working class.
b.
Lenin believed
the state should promote economic development by generating wealth and
distributing it.
Lenin's view of development differed from that of
Marx. Marx believed that given the continual deterioration of the proletariat's
plight and the continual concentration of economic forces in a smaller and
smaller number of people, the capitalist system would be unable to perpetuate
itself. The workers would revolt and a new socialist economy would be created.
After the capitalist wealth was distributed, all forms of government would
eventually wither away.
By contrast, under Lenin's theory, the proletariat
class was expected to take an active role in bringing about that downfall of
the capitalist class even before capitalism has eliminated all traces of
feudalism. Because the state would not have generated the kind of wealth Marx
had envisioned, Lenin's model required the state - in the form of a
proletariat dictatorship - to pursue economic policies to generate wealth
for subsequent distribution.
G.
John
Maynard Keynes and the State
John Maynard Keynes was a student of Alfred Marshall
and an exponent of the neoclassical school until the 1930s. After the Great
Depression, many policymakers lost faith in the neoclassical school's promise
that the market would eventually bring prosperity for all. Keynes' subsequent
work provided policymakers with the justification for state-driven development.
1.
Unlike
Neoclassical Theory, Keynes' Theories Seemed to Provide Plausible Explanations
for the Near-Destruction of Capitalism.
The severity of the Great Depression of 1929, the
resulting growth in unemployment, and the spectacular growth of the
non-capitalist market in the USSR caused many economists to become dissatisfied
with orthodox classical and neoclassical views of development. The traditional
view held that unemployment in a capitalist economy was a short-term adjustment
problem. The economy would eventually reach an equilibrium point in which the
supply of labor would equal the demand for labor. Given the high unemployment
rate in the capitalist markets, economists began to doubt that employment was
determined by supply and demand. Indeed, the USSR's non-market economy did not
experience unemployment in the 1930s.
Thus, the world envisioned by many neoclassical
economists, in which supply and demand was in equilibrium in every market and
every economic aspect was determined by the equilibrium of supply and demand,
no longer made sense. The rise in unemployment that the capitalist world was
experiencing was not an isolated event. It was not limited to a geographical
region or an isolated economic sector. If the system was to be saved, drastic
countermeasures were in order. Appropriate countermeasures, however, could not
be put in place until the cause of the malady was understood.
Keynesian economics was an attempt to explain why the
capitalist economies were on the verge of collapsing. What factors led to the
unemployment of millions of workers? Why did the output of goods and services
drop so drastically when the supply of resources and the industrial base
remained constant? Keynes felt that all of this could be explained if one
understood the basics of unemployment. Through his Theory of Unemployment,
Keynes attempted to explain the causes of the near-collapse of capitalism.
2.
Keynes' Theory
of Unemployment was Based on the Inevitable Collapse of Investment.
As a starting point, Keynes examined the process of
production. In a given period, a firm produces a certain quantity of goods.
These goods are then sold, say for $100. It cost the firm $70 to produce the
product. The latter figure includes the cost of maintaining the plant and
equipment, wages, administrative expenses, the cost of inputs (raw materials)
and the cost of capital (the cost associated with having the capitalist's money
tied up in the venture). The remaining $30 is the net profit for that time
period. This represents the income of the firm's owner. This, however, is not
the total income produced by this firm. Keynes' theory holds that during the
production period in question this firm actually produced an income of $100.
The $70 cost-of-production figure represents income to other participants in
the production process. Thus, the worker received part of that $70 in the form
of wages, the managers in the form of salary, the landlord in the form of rent
and so on.
This simple model is applicable to the entire
economy. The value of everything produced in the United States in a given
period is equal to the total incomes received during the same period. Thus, if
all that is produced is to be sold, people must spend all of their income.
Remember, under this theory, total income equals total production. In this
manner money moves from the businesses to the public in the form of wages,
salaries, rents and profits. It then flows back to the businesses when the
public buys goods and services. Keynes termed this process "the circular
flow of money." He argued that as long as people spent all of their
income, businesses would be able to sell all of their production. As long as
this equilibrium was maintained that process would continue.
Keynes argued that a perfect circular flow of money
does not occur automatically. Not all money that leaves the business sector as
a cost of production is returned to the business via public consumption of
goods and services. Keynes identified three reasons for this phenomenon: (1)
people do not spend all of their income, (2) people buy goods and services from
foreign business sectors, and (3) people do not have control of all of their
income - some is taken by the state in the form of taxes. Keynes viewed these
occurrences as leakages in the system. If left uncorrected, the leakages would
lead businesses to reduce production. The result would be unemployment.
According to Keynes, the effects of the leakages may
be neutralized through a proportional infusion of money into the economy. The
import leakage may be offset if the country is able to export goods and
services of a value equal to that being imported by its citizens. The tax
leakage can be plugged if the government spends on goods and services an amount
equal to its tax revenue. The leakages caused by private savings will be offset
if businesses expand their capital base by borrowing the funds that were saved.
Inherent in this solution is its failure. The
capitalist must expand his or her capital base in order to bring private
savings back into the system. This expansion results in an expansion of the
production capacity of the business sector. To recoup their investment,
businesses must increase their output. This, by definition, leads to an
increase in income, which, in turn, leads to higher savings.
This cycle repeats itself until it is no longer
economically feasible for the business sector to continue to invest. Hence, the
result is economic collapse (e.g., the Great Depression), unless a solution is found.
Keynes saw government intervention as the solution.
3.
Keynes Believed
Government Spending Could be Used as a Mechanism to Create Full Employment.
Keynes proposed that the vicious cycle described
above could be avoided by injecting money back into the system without
expanding the capital stock. In other words, increases in the money supply must
not be allowed to expand the production capacity of the country. Keynes
proposed that when savings exceeded investment, the government should borrow
the savings and spend that money on social projects. The government should not
invest in projects that will increase the productive capacity or reduce the
investment opportunities of the business sector.
Thus, the government should focus its investment in
areas where it is not profitable for the private sector to invest. It should
build schools, roads, and hospitals and provide other public services. This
would result in full employment. Employment would no longer be directly linked
to the productive capacity of the business sector. The net result of this
government action would be to restore economic equilibrium. The money that had
leaked out in the form of private savings would be pumped back into the economy
without placing a strain on the business sector's need to invest.
Keynes' proposed degree of government intervention had not been advocated before. Marshall hinted that government should be involved in a limited way but not as a vital component in the capitalist economy. In Keynesian economics, government involvement is seen as a crucial element if the system is to survive. This was the ideology held by many of the leaders at Bretton Woods.
[OUTLINE] [PART 1:I] [BIBLIOGRAPHY]
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