word equity is not explicitly mentioned within this framework. However, it is assumed that the configuration of goods and services which is Pareto optimum is also the most ‘equitable’,22 because it reflects the incomes earned by the respective factors of production on the basis of their contribution to the Pareto optimum output and revenue. Friedman very clearly argues that: “However we might wish it otherwise, it simply is not possible to use prices to transmit information and provide an incentive to act on that information without using prices also to affect, even if not completely determine, the distribution of income.”23 Thus, equity also found itself defined in terms of Pareto optimum rather than normative goals. At the point of equilibrium, consumer satisfactions (utilities) are maximized, supplier costs are minimized, and factor earnings (including wages, salaries, rents and profits) are maximized. Market prices, it is thus concluded, determine not only the most ‘efficient’ use of resources but also the most ‘equitable’ distribution of income in a rational and impartial manner without value judgements.
Private and public interests are thus automatically brought into harmony. Questions about whether this configuration satisfies basic human needs and whether the distribution is equitable are improper because such questions cannot be answered without collective value judgements which, unlike market clearing prices, cannot be established impartially. Questions about differentials in wealth holdings are similarly improper because the wealth of individuals largely represents the savings resulting from the market value of their own or their parents’ contributions to output and abstinence from consumption. Hence, there is no need for value judgements or government intervention.
All that needs to be done is to ensure competitive markets to enable prices to reach their equilibrium levels, without any restrictions on sovereign consumers to maximize their utilities by purchasing whatever they desire in keeping with their preferences and ability to pay the price, or on producers to respond to consumer preferences in a way that enables them to maximize their profits. Anything that prevents this from taking place is a distortion and automatically leads to an inefficient and inequitable use of resources. Government intervention may be acceptable only where it is necessary to remove such distortions, to ensure competition and orderly markets, and to offset market failure in the supply of public goods.
The logic of the claimed symmetry between public and private interests thus had the effect of gradually turning eyes away from the social obligations of individuals to the ‘unintended’ social outcome of their actions, and made the market the primary instrument for realizing efficiency and equity in the allocation and distribution of scarce resources. This eliminated the role of all institutional factors, including moral values, and of government. Market-determined prices became the only filtering mechanism, and self-interest the only motivating force. These together would also bring about the needed restructuring in resource use until the most efficient and equitable outcome was attained. Hence the tacit acceptance that competition was sufficient to serve social interest and to bring about harmony in human society.
THE KEYNESIAN CONSENSUS AND ITS BREAKDOWN
The Great Depression clearly established the logical weakness of Say’s Law and the concept of laissez faire. It was evident that market economies were not necessarily able to constantly maintain full employment and prosperity.24 They could rather slump into depression and not automatically rebound to full employment because of market imperfections and rigidities. Nobody had the patience to wait for the long-run because, as Keynes put it, “in the long-run we may all be dead”.25 What Keynes did was to provide a theoretical rationale for this empirical failure. Inadequacy of demand was diagnozed by him to be the cause of depression. This led to the Keynesian consensus in conventional economics and the general acceptance of an important role for the government in the economy through fiscal and monetary policies. Governments intervened to a greater or lesser extent to promote growth and employment and to offset, at least partly, some of the adverse effects of market failure on both efficiency and equity.
The Keynesian consensus had, however, a logical weakness in the same way as Say’s Law. While Say’s Law put the entire burden of goal realization on the market, the Keynesian revolution put the whole burden of correcting the unemployment equilibrium on the government. There was no room even in his thought for the role of values and of family and social solidarity in realizing social goals. The excessive burden on the government generated high rates of fiscal deficits and inflation in the 1970s without significantly redressing the unemployment problem. The Keynesian fiscal remedy was unable to successfully cope with stagflation, or the simultaneous presence of both high rates of inflation and unemployment. This led to a breakdown of the consensus and to a revival of faith in the laissez faire model. If there were any doubts still left about the inefficacy of monetary and fiscal policies, they were shaken by the rational expectations theory.26 It was argued that the rational individual took account of all available information, including expected changes in monetary and fiscal policies, and reacted accordingly. This made government policies ineffective. Intensified calls from both intellectual and political platforms for liberalism, or a return, as near as possible, to the classical model with ‘minimum’ government intervention was the result. This approach presently dominates the thinking and economic policies of not only Western industrial countries but also a substantial part of the Third World and the now-liberalizing Communist countries.27
The breakdown of the Keynesian consensus has, thus, brought back conventional economics to its non-interventionist, neoclassical position. It is now believed that government intervention in the economy through expansionary monetary and fiscal policies cannot be successful in attaining a permanent increase in output and employment. This raises the crucial question of how social goals can be realized if the laissez faire model has failed empirically and government intervention through monetary and fiscal policies is also considered to be ineffective. Conventional economics has no answer to this question. There is hardly any discussion of how and by what process efficiency and equity as conceived within the theoretical construct of Pareto optimum translates into humanitarian goals. It is tacitly assumed that these goals may be ‘ultimately’ realized if the market is allowed to play its role.
Such an assumption is only justifiable if there is only one market equilibrium. However, the undeniable fact is that it is possible to have several equilibria depending on which tastes and preferences based on which values and institutions interact with market forces. Which of these different equilibria would then be called Pareto optimum? Would it be any equilibrium, or would it be the one which is consistent with humanitarian goals? This question is not explicitly addressed. It cannot be because this would require an analysis of all possible equilibria in terms of their relationship with the humanitarian goals, leading ultimately to a point where one of them may have to be chosen because of its being closest to these goals. If this requires a specific behavioural pattern on the part of consumers and firms, and hence a change in existing consumer tastes and preferences and socio-economic institutions, then value judgements and social reform become imperative.
Social reform cannot be entertained in positive economics because of the anathema it presents to value judgements and the commitment it requires to unrestrained individual freedom. Hence, only the ceteris paribus clause was so extensively employed. Tastes and preferences together with values and institutions were assumed to be exogenous and the Pareto optimum became associated with those sets of the same that were extant. It did not matter whether these were, or were not, conducive to the realization of humanitarian goals. It was implicitly assumed that every market equilibrium would be consistent with normative goals. Equilibrium economics thus became “an apologia for existing economic arrangements”28 by leading to the belief that any intervention to change the status quo would necessarily lead to results which were less efficient and less equitable.
What
