Keynes did was to show that every market equilibrium was not consistent with full employment because of market imperfections and rigidities. He, therefore, proposed the use of fiscal policy to ensure full employment. Keynes was, however, not concerned with the other goals of social policy (need fulfilment, the equitable distribution of income and wealth, ecological balance and social harmony). From his point of view, the prevailing market system appropriately solved the problems of resource allocation and income distribution. It failed only in realizing full employment. He, therefore, specified only a small change in the market system. He did not talk of a change in the attitudes and preferences of individual economic agents. The rational expectations theory, which has now become generally accepted, has shown that monetary and fiscal policies cannot even help realize full employment. The inflation expected by individuals as a result of the policy change would automatically generate the expected inflation, without a permanent reduction in unemployment. The government would not, therefore, be able to accomplish anything in spite of its good intentions.
Even though the Keynesian consensus has broken down in academic circles, the goal of full employment lives on. Nevertheless, conventional economics has so far been unable to formulate an effective strategy that can realize a market equilibrium which is in harmony with this goal as well as the other goals of social policy. Is it possible for a society faced with social turmoil to accept the pessimistic verdict of the rational expectations theory that the government is helpless and can do nothing and that, hence, the only alternative left open for society is to wait until the market is, itself, able to realize the needed equilibrium in the long-run? Will the market be able to do so in the long-term until the tastes and preferences of all agents operating in the market have been changed through social and economic reform?
The silence of conventional economics is understandable, given its epistemological commitment to value-neutrality and the unhindered freedom it places on individuals to pursue their self-interest. However, the realization of goals of social policy is important and the market may not, itself, be able to help realize these goals with minimum government intervention unless certain background conditions are satisfied. The most indispensable of these conditions include: (a) harmony between individual preferences and social interest; (b) equal distribution of income and wealth; (c) reflection of the urgency of wants by prices; and (d) perfect competition.
Adam Smith assumed that condition (a) was automatically satisfied in a competitive free-market economy. This assumption has become the bedrock of the economics paradigm. However, while there is undoubtedly a harmony between individual preferences and social interests in some cases, there is also a conflict in other cases. It is the existence of this conflict which tends to make the realization of normative goals difficult unless the conflict is removed. This difficulty may be better appreciated if one were to examine the need for reducing domestic absorption (aggregate consumption and investment by both the public and the private sectors) to remove the macroeconomic imbalances that a number of countries are now encountering. If the effect on normative goals was to be disregarded, then the market strategy may, perhaps, be the most effective way of reducing domestic absorption. However, given the high levels of unemployment which prevail, it is not necessarily possible to satisfy the imperative of full employment without accelerating investment and growth.
If absorption, however, is to be reduced in a way that investment does not only not decline but rather rise, then consumption may be the primary component of domestic absorption that has to be reduced. Moreover, if the goal of need-fulfilment is not to be compromised, then it may not be desirable to reduce the consumption of all goods and services. It could be argued that the social interest may be better served if the consumption of luxuries, status symbols, and other consumer goods that do not necessarily fulfil a need or reduce a hardship were reduced. However, such a distinction between different goods on the basis of normative goals is not possible or acceptable within the paradigm of conventional economics, for it does not allow the passing of value judgements on individual preferences and relies primarily on choice through the market to determine those individual preferences that may or may not be satisfied.
It is not certain whether choice through the market necessarily helps reduce the different components of domestic absorption in a manner that conforms with normative goals. The market strategy would rely primarily on a rise in prices, interest rates, and taxes to the exclusion of all other means, and in particular socio-economic institutions based on value judgements. A rise in prices may not help because, while the rich may be able to afford whatever they wish at the higher prices, the real income of the poor may be further squeezed and their well-being suffer. Primary reliance on prices may thus shift a significant part of the burden of reducing absorption onto the poor.
Similarly, a rise in interest rates does not necessarily help reduce absorption in the manner desired. Higher interest rates do not of themselves reduce the luxury consumption of the rich or the defence and unproductive outlays of the government. They may, however, adversely affect the well-being of the poor. They may also tend to jeopardize the commitment of funds for long-term productive investments, while not curbing short-term speculative sprees in the commodity, stock, and foreign exchange markets. This may hurt the overall, long-run performance of the economy. Even the imposition of taxes on luxuries and status symbols to internalize social priorities in the price system may have to be ruled out, because these involve interpersonal utility comparisons and value judgements. Such taxes also violate the condition of Pareto optimality by making the rich worse off through the payment of more than the market-determined price for such goods; something that they would prefer not to do as ‘free’ individuals.
Likewise, one could argue that preventing the pollution of a country’s rivers is in the interest of social well-being. The market paradigm, however, leads one to argue that pollution is primarily a consequence of the misallocation of resources that results from the failure of the market brought about by the divergence between private and social costs. However, any measure to internalize the externality (making the social cost of pollution enter private costs) not only requires value judgements but also violates the condition of Pareto optimality by making the consumers and producers of that product worse off through a higher price and lower profit even though it makes society as a whole better off. If social costs were to be entered into private costs in this case by means of government intervention, then why should not the social costs resulting from lack of need-fulfilment, unemployment, inequitable distribution, and economic instability also be taken into account?
Satisfaction of condition (b), the equal distribution of income and wealth, gives all consumers an equal weight in influencing the decision-making process of the market. Producers, assumed as passive suppliers, automatically fall into line. Thus, given that everyone would give priority to need-fulfilment, there would be no distortion in resource allocation against need-fulfilment.29 However, since there are substantial inequalities in income and wealth, and since the rich enjoy far greater access to credit, they have the ability to buy whatever they wish at the prevailing prices. Primary reliance on prices does not automatically create any significant dent in their demand for status symbols and other inessential and unproductive goods and services. They may divert scarce national resources, by the sheer weight of their votes, into products which tend to command lower priority on a social preference scale.
The value-neutral price system is not even concerned with how many votes an individual has and how he uses them. It evaluates the urgency of wants of different consumers on the basis of their ability to pay the price. However, although the urgency for milk may be the same for all children, irrespective of whether they are poor or rich, the number of dollar votes that a poor family is able to cast for milk is not the same as those that a rich family is able to cast for luxuries and status symbols. If the ability to pay prices does not necessarily reflect the urgency of wants, condition (c) remains unsatisfied. Hence Arthur Okun has rightly observed that markets tend to “award prizes that allow the big winners to feed their pets better than the losers can feed their children.”30 Such a result
