theory of price determination.14
All this depends upon an understanding of the individual, with his or her given tastes and talents, as the atomic unit of human life. This idea is the foundation of the common sense that informs contemporary economic understanding, the basis upon which modern economic institutions and policy are considered legitimate and logical. It is no exaggeration, I think, to say that although you don’t hear people walking around talking about value and distribution, these theories are the logic behind the form capitalist institutions take. The idea that the distribution of socially valuable assets, resources, and so forth is a product of individuals pursuing their subjective self-interest, in combination with Smith’s “invisible hand,” leads easily to the normative proposition that unrestricted individual pursuit of self-interest produces, almost despite itself, optimal collective well-being.
These ideas helped justify a social philosophy called utilitarianism, which originated in the mid-eighteenth century, and whose last bastion is modern economics, where it continues to exercise a mind-numbing stranglehold in the form of “welfare economics.” Utilitarianism explains all human action as a motivated by the quest for pleasure and the flight from pain. Consequently, it proposes perhaps the simplest theory of human welfare imaginable for both individual and the community. It works like this: people act rationally when they maximize their self-interest or “utility” (given certain constraints, like how much money they have). Since those interests are subjectively determined, whatever you are doing, it is probably a utility-maximizing choice. The corollary, of course, is that the community is merely a set of individuals making these calculating choices, and community “welfare” is measurable only by the maxim “the more utility, the better.” Because utility is experienced entirely at an individual level, no distributional or fairness problem arises. If you add pleasure, even if only for individuals who already have a lot of it, it’s all good. You are not “taking away” from someone else. In fact, many utilitarians claim that added utility, even if it increases inequality, will eventually “trickle down” to those who didn’t get the extra to begin with.
In combination, these conceptual tools—rational pursuit of self-interest, clearing markets in which prices are determined by individual tastes, the invisible hand—form the core of modern “economic” knowledge, and its assertion that markets can make predictability, calculability, stability, and equilibrium possible.
John Maynard Keynes
From the early 1800s to World War II virtually all orthodox economists and “statesmen” in Europe and North America camped somewhere in the neo/classical range. The Great Depression that began in 1929, however, initiated a massive shift in what ideas were considered acceptable. So began the Keynesian era, named for the “revolutionary” work of the British economist John Maynard Keynes (1883–1946). We shouldn’t exaggerate the abruptness of the change. There were forerunners to Keynes’ ideas, and his took some time to become common sense. Classical/neoclassical ideas and policies persisted into and after the Depression. But there is no denying that between 1929 and the end of World War II, the world of political economy was transformed.
The key theoretical break turned on the theory of money. Orthodoxy had come to be associated with laissez-faire liberalism, a commandment to the state to “let them do as they will”: “free markets,” “free trade,” and unfettered pursuit of self-interest. Laissez-faire thinking understands money basically as Smith did: as a convenience for exchange and a way to make accounting easy. Money exists so that instead of me bringing my piano to market, and finding some combination of barter exchanges that ends with the fishing-net I want, sale and purchase can be separated in time and space. Accordingly, the orthodox economics of Keynes’ time assumed money had no utility as wealth, only as a convenience. It was economically neutral, a “veil” over the “real” economy. It made no sense to hold on to it; one would naturally put it back into circulation as soon as possible to enable the Smithian circular flow of wealth generation.15
When the Depression hit, Keynes (who had long defended this older thinking), saw that these ideas were just plain wrong: people wanted to hold money more than other stuff. They were buying less, investing less, and in general keeping the money and money-like things they had (things easy to use in exchange, like gold). And that, he said, should never ever happen if classical economics is right. Money was clearly not neutral, but had a very real, and fluctuating, value of its own as a security in the face of uncertainty. If money had ever been neutral in the classical sense (something he doubted), it was no longer. Modern capitalism, he said, is a “monetary production economy,” and money was perhaps its central institution, much more complex than a convenient means of payment and accounting device.
Like most of his ideas, Keynes arrived at this conclusion via what he thought was simple common sense. Yes, he said, it is true that from a purely utility- or profit-maximizing perspective it makes more sense to use one’s cash holdings to consume and invest. But because the future is always uncertain, it makes sense, in the real world, to hold at least some money most of the time, and a lot of money at especially unstable times. Keynes called this propensity to hold assets in money form “liquidity preference,” “liquidity” being the ease with which an asset can be readily monetized, i.e., exchanged for money. So if “liquidity preference” is high, it suggests people feel insecure or uncertain, and do not want to be holding on to assets they will have trouble selling if things go south.
Keynes argued that the state of liquidity preference among market participants, fluctuating in response to everything from weather to war, exercises enormous influence on modern monetary economies. The stock market, for example, enables rapid purchase and sale of highly liquid assets—indeed, the whole point of the stock market is to turn an enterprise, which on its own and as a whole is about as “illiquid” as it gets, into a collection of easily exchanged units of property. This is, of course, extremely useful and appealing to stock-holders, but difficult for the firms in question, whose bits and pieces are picked up and dropped in a flash—often for no apparent reason other than investors’ whims (a volatility only exacerbated in the “information age”). This is only one example of how prone capitalism is to what we might euphemistically call “inefficiencies.” It is one of a whole suite of dynamics that make the fundamental assumption of classical and neoclassical economic theory—that markets clear, resources are fully employed, and all engines are running full-bore—a highly improbable description of the world. Full employment, if it ever happens, will not hold for long. Keynes was pretty sure that, at least since the beginnings of capitalism, it had never happened.
The idea that “free markets” will realize capitalism’s “full potential” is proven wrong by more than just investors’ uncertainty. Fundamental features of capitalist institutions are also responsible. Keynes showed this, for example, in his demolition of the orthodox theory of unemployment. If we assume (as many orthodox economists do) the market economy would run at full capacity were it not for “inefficient” individual or state decisions, then any unemployment is due to the free choice of unemployed individuals. Remember utilitarianism? Here is a good example of the role it plays in orthodox economic analysis: unemployment represents a “preference” for leisure (that is really the word used) over available jobs at existing wages.16 But if Keynes was right, and money is kept out of circulation due to uncertainty, then much if not most unemployment is involuntary. This hurts both workers and employers, by reducing consumer demand and investor profit expectations, which means they will not buy and invest enough to get the economy running busily enough to pull all the workers into jobs. The changing intensity of unavoidable uncertainty regarding the future makes it impossible to expect that somehow everyone will just “get over it” and get the economy going full steam ahead.
The older, Smith-Ricardo-Jevons traditions knew levels of activity could decrease, but they said that if prices, especially wages, decreased too, then firms would start producing, investing,
