7

The Functioning of the Capitalist

Economic System

Learning Objectives
To understand the economy under competitive capitalism
To study the economy under monopaly capitalism—Keynes, Schumpeter and Galbraith
To have an overview of the Fordist period
To analyse the economy under the post-Fordist phase
To discuss economic development under feudalism, competitive capitalism and monopoly capitalism
Key concepts to look out for are liberalism; self-regulating market economy: efficiency, full employment,
stability and maximisation of social welfare; Say's law and quantity theory of money: tendency towards
chronic underemployment equilibrium; demand-management policy; anti-cyclical fiscal/budget
policy; police functions; welfare state; dynamic competition; monopolistic practices; planning
versus the market: managerial capitalism; state versus market: supply-side and demand-side
economics; economic and financial globalisation; national sovereignty, nationalism versus globalism.

The discussion throughout the chapter keeps in sight the fact that the functioning of the
capitalist economy has the primary objective of increasing concentration of ownership and/
or control of wealth in the hands of fewer and fewer capitalists.! (This chapter should be read
with the next three chapters.)

! Two things must be kept in mind here. First, ‘wealth’ refers to means of production and not stocks of money or
financial assets per se or of consumers’ goods. The miser collects money but does not spend it. The capitalist wants
use or control over money as a capital asset, that is, because it gives command over productive resources. Control
over wealth is more important than ownership since what matters are custodial rights rather than ownership rights.
Owmership or control over productive resources ensures that others are deprived of the use of the resources and /or
152 e Economy and Society

The capitalist system is subject to far greater changes in the course of its existence than
pre-capitalist systems. These changes are substantial enough to talk of sub-epochs in the
evolution of capitalism; an epochal change would be when the basic features of capitalism
(see Chapter 4) no longer exist. The changes between sub-epochs relate to the size of the
enterprise, the form of business organisation, the product composition of increases in the
national product, work organisation, the nature of the financial system, the nature of glob-
alisation (or internationalisation as Peter Evans describes it) and the role of the government.
The functioning of the capitalist system has not been the same from one sub-epoch to
another. This is to be expected given the differences in the features of the different phases.
Mainstream economists today, however, tend to project the neo-classical economists’
description of the functioning of a competitive capitalist system in terms of an unfettered
market system (and the capitalists’ unfettered pursuit of private self-interest) as an all time
‘ideal’ to be adhered to or restored. This they seek through the advocacy of neo-liberalism.
They thus mislead the layman and the informed into believing that capitalism today is
more or less what it was in its traditional phase of competitive capitalism and therefore that
the state should follow the laissez faire policy that was followed then. Non-intervention by
the state helped the capitalists as a class against the pre-capitalist forces in the period
of traditional capitalism. Non-intervention today would help the big capitalists (MNCs/
TNCs) against the smaller capitalists. But those who advocate neoliberalism instead give the
impression that it would benefit all capitalists.?
This chapter brings out the differences in the functioning of the capitalist economy in its
various phases—even though the impression sought to be given is that capitalist economies
function in all periods and all countries in the same way as described by neo-classical eco-
nomists (and explained in the next section of this chapter).

the fruits of the use of these resources. Second, more important than ownership is control over the use. In corporate
or managerial capitalism, ownership of wealth is diffused over a large number of shareholders. But control is vested
in the hands of a few—the managerial class (the board of directors). The corporate form of business organisation
separates ownership rights and custodial rights. Even though nominal ownership is widespread, effective ownership
is increasingly concentrated. This has led to shareholders who as managers control a much larger amount of wealth
despite owning a small percentage of the total shares of the corporation. (This may be as small as 2 to 3 per cent.)
In post-Fordist capitalism, apparently the numbers of small firms increase giving the impression of a reversion to
competitive capitalism from the Fordist monopoly capitalism stage. The fact, however, is that the small firms are
under effective control by the TNCs. TNCs are able to command much larger amount of wealth (in the hands of
independent small firms) with less of their own. TNCs exercise control in several ways which include franchisees,
market information apart from being among other things purchaser or supplier to many of them.
*It needs to be emphasised further that functioning of the competitive capitalist system described here relates to
England as it emerged out of feudalism in the 17th-18th centuries. It should not be regarded as a model that can or
need be emulated by other countries. One reason is that England was the pioneer industrialising country and so did
not have to face competition in manufactured goods from other countries. Other countries had to withstand British
competition. Free international trade was clearly in Britain’s interests. Another was that the control of the state was
in the hands of the dominant pre-capitalist classes at the time of the emergence of capitalism in England. In most
other countries (particularly in the countries under colonial rule) state power was controlled directly or indirectly by
the capitalists, who therefore did not have to fear that the state would be hostile to their interests. A third reason was
that when capitalism emerged in England there was a proliferation of small capitalist firms, each competing with one
another, each too small to influence market price, each having to survive through their own competitive efficiency.
In the other countries, however, the onset of capitalism tended to be associated with the dominance of big firms.
 Functioning of the Capitalist Economic System e 153

The functioning of the economy discussed in the following pages is divided into the
functioning of the micro economy: allocation of resources between different products (summed
up in the textbook classification of the central problems of an economy of what to produce,
how to produce and for whom to produce), welfare of society in general; the functioning
of the macro economy: stability of the level of production, employment and incomes; and
economic growth, which cuts across the analyses of the functioning of the micro and the
micro economy. The three areas are interrelated. This classification will be maintained to the
extent possible for all the sub-epochs.

THE ECONOMY UNDER COMPETITIVE CAPITALISM

The classical/neo-classical view is that the competitive capitalist economy organises the
functioning of the economy as a self-regulating market system where market forces are
unfettered by interference/constraints imposed by governments or other institutions (such as
monopolies, labour unions). The price mechanism in a system based on competitive-markets
automatically adjusts to changes in supply and demand of resources and products and re-
establishes equilibrium in the economy, at the micro level as well as the macro level, despite
each seller/buyer making decisions atomistically (without association with others—since it
believes it is too small to influence the market) and despite the government leaving the
economy alone. The organising principle of such a competitive economy is the market. The
market system, based on rational pursuit of private self-interest,® acts as the ‘invisible hand’
(to use Adam Smith’s expression) that ensures the macro economy functions efficiently and
relatively smoothly. This is in contrast to the ‘visible hand’ of customs and traditions guiding
the pre-capitalist systems, of directions by a central planning authority in the erstwhile
socialist countries.

The Micro Economy—Resource Allocation

The allocation of productive resources between the different products produced in the
country depends on the prices of the products relative to each other. Relative prices affect
allocation of resources between products because these are indicative of relative profits.
Ahigher relative profit induces producers to produce more of the product by withdrawing re-
sources from products yielding less profit. This process continues till rates of profits become
more or less the same in all the industries. Relative prices determine how much of a product
is produced and how much of the factor inputs is required by each product. This allocation is
associated with simultaneous maximisation of economic benefits to each of the participants,
be it producers/sellers and users of final products or inputs. This happens because the relative
prices facing the producer and the consumer are the same (and is not distorted because of
taxes, subsidies or any other reason).

* Private self-interest amounts to private profits and private wealth accumulation by producer and maxjmum
consumer satisfaction and accumulation of private wealth by households.
154 e Economy and Society

The economy under competitive capitalism would ensure the level and pattern of pro-
duction is such as to simultaneously maximise private benefit positions of both the producers
and the consumers, and hence, of welfare of society as a whole. This is because the price
facing the producer and the consumer will be the same under competitive conditions and net
taxes will be zero. Any interference with market prices (as by the state through taxes, or under
monopoly which causes price todiverge from marginal revenue and hence from marginal costs,
since in equilibrium profits of the firm is maximised when marginal revenue and marginal
costs are equal) would cause price distortions, cause the price facing the producer to differ
from that facing the consumer. This would cause the producers’ and the consumers’ maximum
benefit positions to be at different output patterns so that the market-price mechanism would
no longer lead to maximum social welfare. Hence, if the government does not distort relative
price structures, the competitive capitalist economy ensures that the pattern of output pro-
duced in the economy would be rational and at the same time efficient.
The pattern of production conforms to what the consumers want because the market prices
of the products are the same for the producer and the consumer. The price of the product is
a measure of gain of revenue (called average revenue in microeconomics) to the producer
but of cost (since the money paid represents loss of utility) to the consumer.* The owners
(suppliers) of the factor inputs also achieve maximum economic benefits.*
Since the price at which the seller sells and the buyer buys is the same at that level of output,
both enjoy maximum positions (of profits, satisfactions respectively) when that amount of
output is produced/sold. This analysis is extended to cover all the commodities in the market

* In simplified terms this is because the producers’ maximum profits are when additional revenue (equal to the
Pprice per unit or average revenue) from the sale equals the additional cost (called marginal cost) from it. If additional
revenue is more than additional cost then the producer can add to his profits by selling more. If additional revenue
is less than additional cost then the producer is making a loss. He would need to reduce sales till the two are once
again equal. In perfect competitive conditions this is also the point when price equals marginal cost. The firm will
be, in the long run, in equilibrium if at the output which yields maximum profits, the firm also gets normal profits.
Any deviation from these positions of maximum and normal profits will cause the number of firms in the industry to
change (causing changes in the supply of the product) ill equilibrium is once again restored. (The assumption here
is that additional cost rises as production increases, that is, diminishing returns in production exist. It follows then
that if costs rise but prices remained unchanged then producers will reduce production till the two are equal once
again [because of costs falling and prices rising or both].)
In the case of the consumer, as long as the additional utility (called marginal utility in micro economics) is
more than the additional cost of consuming the product the consumer will gain by consuming more. He would
lose if his consumption level is such that additional utility is less than additional cost (measured in terms of the
utility of the money price of the commodity). He will be in equilibrium position with maximum satisfactions
therefore when the additional utility equals additional cost. (The assumption here is that additional utility or
marginal utility diminishes as consumption increases. Therefore, if for somereason prices rise then the consumer would
reduce consumption and demand.) (The price of the product will be unaffected by the amount of consumption; the
neoclassicists assumed that under competitive conditions the number of suppliers and demanders are too many
for the individual entity to think that its actions will influence the market. But their collective effect will affect the
level of the price in the industry though the individual entity would not be conscious of this.) The market system will
ensure that this process operates for every product.
® This is because in the long-run price of the factor, determined through the market, the marginal benefit (the price
per unit received as remuneration for the factor service) and marginal cost (the sacrifice involved to the factor owner
in supplying the factor service) is the same to each factor owner.
 Functioning of the Capitalist Economic System @ 155

so that in the economy as a whole both producers and consumers attain maximum welfare
positions. Since society consists of individuals who are either consumers or producers or
suppliers of factor inputs, the market system maximises the welfare of society as a whole
despite each person being selfish in maximising his or her own private economic benefit.
The unhindered rule of the market system in international trade will further ensure that
the country’s resources are efficiently used and welfare of society maximised. This is because
such trade will be on the basis of the principle of comparative advantage of the different
countries participating in the trade relationship. International trade on this basis will ensure
that the goods and services available to the country will be greater than otherwise.
The classical/neo-classical economists also believed that unlike pre-capitalist systems,
capitalism was not exploitative. This is because all the economic entities had the freedom
to participate or not to participate in the economic system. Specifically, labourers had the
freedom of choice in offering their labour in different occupations or regions. They could
therefore choose the best of the available alternatives, a choice not available to them under
pre-capitalist production relations. The neo-classical economists were a step ahead. While
the classical economists believed that labour would get wages just about equal to their sub-
sistence, the neo-classical economists argued that every factor owner would be rewarded
for the factor services they supply according to their marginal productivity, that is, the
contribution to production by the additional or marginal unit of the factor employed.
The market system is ruthless since if its rules are not adhered to, it will punish the offender.
If the firm does not ensure that price covers marginal cost then it will not only suffer a loss
but will be forced out of the industry by the more efficient producers. But it is fair in that it
treats everyone equally, rewarding the efficient and punishing the inefficient no matter if
the person is a capitalist or a labourer or a landlord. Thus, despite the system functioning
on the basis of private self-interest, it was deemed to be socially jus.

The Macro Economy—Full Employment Stability

The market system ensures that society attains maximum social welfare through rational
and efficient allocation of resources. It does so also by ensuring that society produces at its
maximum productive potential, with all resources being fully employed.

¢ The unequal bargaining position of the proletariat and the existence of the industrial reserve army of unemployed
labour ensure, however, that the labourer actually gets wages just about equal to its supply price. For instance, the
wage-rate which is the price of the factor-service labour and which shows the gain to the labourer equals the disutility
of the last unit of work or marginal disutility of work; the assumption is that the utility from work is measurable in
monetary terms (just as the ufility from consuming a commodity is assumed to be measurable in monetary terms).
Similarly, the rate of interest which is the price of capital equals the disutility of abstinence from present consumption
because of savings (which is regarded to be postponement of present consumption). Normal profits which is the
price of and reward for entreprencurship equals the disutility from the risk involved in undertaking enterprise.
And, rent or the price of land equals the transfer eamings (the disutility from losing earnings from the next best
alternative use, i.e., opportunity cost of land in its niext best use). Thus, it is not only as producers and consumers of
products that people attain maximum welfare positions. They attain maximum welfare also as factor owners.
156 @ Economy and Society

The productive potential of an economy refers to the maximum amount of goods and
services that the economy can produce through utilising all its productive resources to
their maximum capacity under the technology available to it. This is ensured through price
flexibility. An excess supply of a productive resource will cause its price to fall, induce a rise
in the demand for it and thus result in the excess supply being absorbed. Similarly, excess
supply of a commodity would cause its price to fall. The fall in price will raise the demand for
it while the lower price will cause some supplier to reduce supply. Thus, price flexibility will
eliminate the excess supply.
Further, while there can be excess supply (or glut) of a commodity there can be no general
excess supply or glut of all commodities. This is because an excess supply of one commodity
must mean excess demand for another. The presumption is that the quantum of demand
in the economy is equal to the incomes generated in the production process (equal to value
added in production). All this income is necessarily spent either on consumption or invest-
ment. No part of the income is unspent since there is no hoarding when money is a means of
exchange. The part that is not spent on consumption is savings. This saving is invested, that
is spent on capital goods. Thus, savings is not non-spending, It is spending on capital goods.
There is no hoarding in the form of retaining incomes as money-hoards. Consequently, if
less is spent on one commodity then more must have been spent on another, and vice versa.
Hence, the level of economic activity will be stable and producing at full employment level
of output.
The twin theoretical planks of the thesis of automaticity of the economy at stable full-
employment levels of economic activity are Say’s law of markets and the quantity theory of
money.
].B. Say’s thesis is popularly summed up as ‘supply creates its own demand’. To spell this
out: the economy functions through the circular flow of incomes starting with the production
of output (or supply of value-added). The value of the gross output produced minus the
inputs used up in production (which encompasses raw materials and intermediate products
used up in production and depreciation of fixed capital equipment used in production) is
the net vatue added by the production process. This net value added is the source of the
income of the people in the country: this income first accrues to the owners of the factors of
production as factor incomes (wages, rent, interest, profits and mixed incomes) and this is
redistributed as personal incomes through taxes and subsidies.
This personal income, which is the purchasing power with the people, is spent on the
goods and services either on (present) consumption or/and is saved (i.e., added to wealth
through investment). This expenditure of the incomes on consumption and/or investment
constitutes aggregate ‘demand’. Since incomes are not hoarded, therefore, value of output =
incomes generated = expenditure made = value of output (or supply)—the circular flow
is completed. Hence, supply creates its own demand; the circular flows of incomes are
maintained at the same level.
Say’s law rests on two assumptions, namely, the existence of price flexibility and the
validity of the quantity theory of money.
All prices are flexible: flexible prices under competitive capitalism would ensure that
markets would always be in equilibrium for every product and factor service. The belief
 Functioning of the Capitalist Economic System e 157

of the individual sellers and buyers that, being atoms in the economy, any action of theirs
would leave the market price unaffected ensures flexibility of the relative prices of goods
and services. This would ensure that the markets would always be in equilibrium. For
instance, any excess supply relative to demand would set in motion market forces which
would restore equilibrium; sellers would compete with each other causing prices to fall.
Some suppliers would reduce their production (if their costs were higher than that of other
suppliers). But buyers would have increased their demand because of the lower prices. This
would raise prices. Suppliers would react by raising their outputs and buyers by reducing
their purchases, and so on. The actions and reactions of sellers and buyers would equate
demand and supply once again: the new market price may or may not be the same depending
on how the markets of other products and factor services react and what the situation in the
macro economy is. No time lags are factored into the market action and reaction process
despite the fact that equality of demand and supply is ultimately the result of a trial and
error process on the part of the sellers and the buyers. The same price is supposed to prevail
throughout the economy.
The assumption of the validity of the quantity theory of money ensures that all the incomes
generated are entirely spent on consumption and investment so that the level of the circular
stream neither contracts nor expands but remains stable. If a part of the income stream
had been withdrawn through hoarding then the circular flow would contract. This would
happen if the income recipient neither consumes nor saves (invests) but hoards a part of the
incomes. Neo-classical analysis is that this would not happen because money has no other
function but that of a medium of exchange and a measure of value.
This theory” assumes that money is demanded not for itself but only because of its use in
facilitating exchange transactions: the classical/neo-classical economists limited the role of
money to its medium of exchange and standard measure of value functions. Changes in the
supply and demand for money would affect only the general price level (inflation of prices
when supply of money [which is the obverse of demand for goods] exceeds demand for
money [the obverse of supply of goods] and deflation of prices when demand for money
[supply of goods] exceeds supply of money [demand for goods]).
Theargument runs as follows: goods and services are supplied only when money is required
to buy some other good or service which the seller does not have but wants. Hence, supply
of goods and services means demand for money. Conversely, demand for money means
supply of goods. Consequently, the equality of supply of goods and services and the demand
for goods and services axiomatically means the equality of the demand and supply of
money, that is, supply of goods = demand for money, demand for goods = supply of money,
so since supply of goods equals demand for goods (Say’s law), therefore demand for money
equals supply of money. That is, equilibrium in the real market automatically means equi-
librium in the monetary market. O, as the Walrasian equation has it, if M - 1 markets (the
markets for real goods and services) are in equilibrium then the ‘1" market (the money market)

7 The quantity theory of money has two variations. One s the cash transactions version associated with I. Fisher.
The other is the cash balances version associated with the Cambridge School economists, such as A. Marshall and others.
158 e Economy and Society

must be in equilibrium. Thus, changes in the supply and demand for money would not affect
relative prices; this would be affected only by changes in the relative supplies and demands
of the goods and services. It would leave the real economy unaffected. Thus, on the basis of
the validity of the quantity theory of money, the neo-classicists argued that money was only
a veil, which when removed would leave the body (of the real economy) unaffected.

Economic Growth
The classical economists believed that the market systems based on maximising private
self-interest will ensure not only that full employment stability is maintained but also that
economic growth will be accelerated. Demand is not a constraint (because of Say’s law).
Therefore, increases in the supply of productive forces (capital, labour and land) will be
fully and most efficiently utilised in conformity with what the people desire (as expressed
through the market). It is for this reason classical/neo-classical economics is referred to as
supply-side economics (in contrast to Keynesian demand-side economics).
Technological progress is accelerated under capitalism because of the nature of capitalist
production relations. Hence, supply of productive resources would increase faster than the
natural rate of increase of pre-capitalist systems (see Chapter 5). These resources will be more
efficiently utilised under capitalism than under pre-capitalist systems because competition
between the production units will weed out inefficient production units. Thus, social welfare
will increase at a faster pace over time under capitalism.

Self-regulating Market System

Disturbances to the capitalist system will be automatically corrected by the system itself
without government intervention. At the micro level, automatic self-regulation is ensured
by flexible prices, because individual entities cannot influence prices and, most important,
because the guiding principle is self-interest and maximisation of private benefits from the
economic action. For instance, a fall in the price of a commodity will cause consumers to
increase demand. This is because they can gain since the additional utility from increased
demand will exceed additional cost and therefore there is a net gain to the consumer. Sellers
will reduce sales because additional revenue will now be below the existing additional cost.
The increase in demand by consumers and the reduction in sales by producers will cause
prices to rise till demand equals supply and the market is cleared.
At the macro level this is ensured because the flexibility of the rate of interest ensures
equality between saving and investment in the capital market. In classical/neo-classical
analysis the rate of interest is the price for using capital and needed to compensate savers
because of their disutility in postponing consumption (i.e., for their abstinence in short), for
instance, a rise in savings lowers interest rate. This causes investment to rise, savings to fall
till the two become equal at a new rate of interest (which may or may not be the same as the
old depending on the circumstances). This equality between saving and investment ensures
that expenditures (on consumers’ goods and producers’ goods) equal the output produced
(of consumers’ goods and producers/capital goods).
 Functioning of the Copitalist Economic System ® 159

The economy will be self-regulating with respect to international trade and payments
also. Non-interference by the state will mean that the flow of goods and services between
countries will not be hindered by tariffs (import and export duties) and quota restrictions
on trade. Compensatory flows of gold in response to deficit or surplus in the balance of pay-
ments will ensure that the market system will keep the balance of payments in equilibrium.
Compensatory gold movements will affect the price level in the domestic country because
it affects money supply in the country (since the monetary system is on the gold standard,
i.e., money is gold coins or convertible into gold: this was also known as the gold-specie
standard). For instance, if there is a balance of payments surplus then gold will flow into the
country. This will raise money supply, in turn causing rising prices. This rise in prices will
reduce exports and raise imports till the imbalance is removed.
It is for this reason that the classical economists by and large ignored the problem of busi-
ness cycles. (The classical analysis is a long-run analysis. There was periodical crisis but these
were attributed to external shocks. Keynes however famously said ‘in the long-run we are
all dead'. In the short-run, the capitalist economy tends towards chronic underemployment
equilibrium. Keynes’ arguments are given in the next section.)

An Overview of Competitive Capitalism

The capitalist system thus has conscious planning at the micro level (with the production
units consciously planning the use of resources to maximise profits). But it has an anarchic
macro economy since there is no visible body such as the state orchestrating or directing the
activities of the innumerable producers and consumers that populate the system; in short,
the system is planned at the micro level, unplanned at the macro level. Yet, we have seen,
the economy furnctions far better than pre-capitalist systems.
The reason for the superiority of the capitalist system relative to pre-capitalist systems is
that the production unit in pre-capitalist systems is perforce guided by customs and trad-
itions and religious morality. Any initiative on their part would be discouraged because that
might presage ambitions to disrupt the existing social hierarchical order. The ruling classes—
the king/monarch, feudal lords and the church—impose themselves on the economy.
The production unit in the capitalist system, on the other hand, has to consciously compete
and survive against other production units and therefore has to be able to produce at ever
lower costs. This is because it does not have the protection of the state/superstructure but
must survive on its own strength. It not only lacks the protection of the state but must counter
the state’s and the system’s hostility. It is not surprising then that when the capitalist class
captures political power they would seek to downgrade state interference in the economy.
Without state interference, the capitalist producer was clearly on a stronger position to sur-
vive and prosper at the expense of the pre-capitalist producer. Hence, the micro-planner
sought macro anarchy.
Adam Smith brought out the fact that the capitalist system functioned efficiently because
of the market substituting the state as the guiding system. The market system, functioning
on the basis of the pursuit of self-interest, is the invisible hand that brings the atomistic
actions of myriad producers and consumers to a coherent functioning of the economic system.
160 ® Economy and Society

The classical economists’ championing of economic liberalism, of non-interference by the

state in the economy, of the philosophy of laissez faire-laissez passer® has clearly been because
of the need to provide an economic rationale to the political revolution whereby the bour-
geois captured state power. At the time capitalism gained control of state power in England,
the state was imbued with pre-capitalist bureaucratic and religious mindset and generally
pre-capitalist values and ideas were still existent in the economy and society.
Adam Smith’s advocacy of economic liberalism was thus dominantly contextual—the
immediate need to delineate the environment conducive to capitalism from that conducive
to feudalism and mercantilism. His emphasis on private self-interest was to contrast the
basis of capitalist ethics with pre-capitalist ethics based on religion and social customs
and traditions. The renaissance and the concepts of the rational economic man and scientific
spirit emphasised the secular, technological orientation of the capitalist producer. The
superiority of a self-regulating market-based economic system was based on the existence of
innumerable small capitalist producers who functioned on the assumption that they were too
small to change the parameters of the market and economy.
The classical/neo-classical case for economic liberalism as a state philosophy was thus
situation specific. It applied to an economic system emerging out of a feudal-mercantilist
set-up and dominated by small capitalist firms, to competitive capitalism.

THE ECONOMY UNDER MONOPOLY CAPITALISM

Economists have generally been anti-monopoly because the ‘free’ market best promotes
social welfare. Hence, monopolies do not or should not exist, that they be prevented,
discouraged and/or made (by the government) to follow perfect competition rules, through
anti-trust or anti-cartel legislation for example.
In keeping with this ideology they believe that monopolies cause prices to be higher than
marginal costs of production and by implication higher than prices of the firm producing
under perfect competition; they tend to cause outputs to be lower than the technically
optimum output of the firm thereby leading to excess capacity of capital and hence wastes
capital resources; that allocation of resources is not rational and efficient because of the
divergence of prices and marginal costs, the pattern of output produced is on the basis of
marginal costs while consumers’ preferences are based on prices.’

* In this context laissez faire refers to the philosophy of non-interferences of the state in the domestic economy;
laissez passer refers to non-interference by the state in the flow of goods and services between countries.
“ The technical optimum output is the output at which average cost of production is the minimum. This happens
under conditions of perfect competition, when the rising marginal cost curve cuts the U-shaped average cost
curve at the bottom of the U, that is, when the decline in average costs has ended and diminishing returns begins.
At this point, marginal cost equals marginal revenue (and price or average revenue, since under perfect condition
average revenue and marginal revenue are equal). This point of tangency is unlikely to happen when markets are
imperfectly competitive or monopolistic because the demand curve facing the firm is downward sloping so that
marginal revenue is below average revenue. Since maximum profits is at the output when marginal cost equals
 Functioning of the Capitalist Economic System @ 161

Further, monopolies prevent price flexibility, prevent free entry of firms, and therefore
adversely affect the self-regulatory role of the market in restoring equilibrium in the eco-
nomy. For instance, a firm selling at a price at which it earns above normal profits would face
new entrants in the industry which would raise supply and hence wipe out the abnormal
profits. This may not happen under monopoly conditions. The monopoly firm fearing no or
minimal threat from new entrants will continue to reap abnormal profits. Governments in
capitalist countries following the advice of economists influenced by the neo-classical eco-
nomists have tended to legislate against monopolies, to seek to restore competitive market
structures.
Economists who adhere to neo-classical economics, however, tend to base their analysis
of the functioning of the economy on the assumption that the capitalist system they describe
is unchanging, immutable. Consequently, they tend to adhere to their analysis and policy
prescriptions on the basis of the competitive phase of capitalism.
The fact is that the capitalist system is an ever-changing system. Marxists are aware of
this as they are cognizant of the dialectical interrelation between productive forces and pro-
duction relations. There are also some among the bourgeois economists (Schumpeter for
instance) who are aware of this.
Monopolies became the dominant form of business enterprise in England and elsewhere
in the then capitalist world towards the last decade or so of the 19th century. Their dominance
has profoundly affected the functioning of the capitalist system both at the level of the micro
economy as well as at the level of the macro economy. The free market system is no longer
the dominant form of organisation at both these levels. Nor does the market ensure that
disturbances in the economy are automatically corrected. The functioning of the capitalist
economy under monopoly capitalism in its different phases is discussed in the subsequent
sections.
The analyses of the functioning of the economy under monopoly capitalism begins
with the views of three economists (representative of Anglo-American economists) on
the functioning of the capitalist system, namely, J. Schumpeter, [.K. Galbraith and J.M.
Keynes, who discuss basically the earliest or Fordist phase of monopoly capitalism. Keynes
deals with the macro economy, while Schumpeter and Galbraith deal with the micro
economy (the firm). They differ in many respects from each other. The common point is
that they all agree that the capitalist system has moved on from the stage of competitive
capitalism to that of dominance by big business: to what Marxists call monopoly capitalism,
Lenin who calls it monopoly-finance capitalism or state capitalism, while others like Strachey
call it managerial capitalism.

‘marginal revenue (after which marginal revenue becomes greater), and this output is likely to be below the tech-
nically optimum output therefore the monopoly output is likely to be below the technically optimum output.
Hence, excess capacity is likely to exist for a monopoly or imperfectly competitive firm.
1 They have many means of doing so. This includes unfair competition tactics. However, high costs of production
or patents—including pre-emptive patents, possession of license, etc—are among other means. Other reasons
include control of scare resources, or high costs of production or distribution.
162 e Economy and Society

J.M. Keynes''
The fundamental breakthrough in the analytical understanding of the functioning of the
modern economy came with Keynes’ book The General Theory of Employment, Interest and
Money published in 1936. His basic thesis was that a capitalist economy functioning solely
through the market system (that is, without government regulations/controls) would tend
towards a state of chronic underemployment equilibrium.
He showed that the neo-classical position that the economy would always function at
full employment level of production, that any disturbance to it would be automatically
corrected, is untenable in a modern economy. His basic point of departure was that the real
and monetary sectors of the economy are interrelated, that therefore the belief of neo-classical
economists that the real economy and the monetary economy were independent of each
other and that money had no effect on the real economy (and, therefore, that money was
merely a veil) was untenable: it may be true of a traditional capitalist economy where static
functions of money predominate, namely as a medium of exchange and measure of value.
It is not applicable to a modern capitalist economy where its dynamic functions are im-
portant, namely those of a store of value and a standard of deferred payments. The most
important attribute of money is that it possesses the quality of ‘perfect liquidity’."? It is this
which makes it the perfect medium of exchange and store of value. It is this quality which
underlies the demand for money.
In Keynesian theory the demand for money is for three reasons, namely, for transaction
purposes, for precautionary purposes and for speculative purposes. The first two relate to
its function as a medium of exchange and depend directly on the level of incomes. The third
relates to its store of value function and varies inversely with the rate of interest.’®

Much of Keynes’ views about the functioning of a macro economy have been relegated to the background
today. This includes his views about the tendency towards chronic underemployment equilibrium, preeminence of
the store of value function of money, liquidity trap, etc. Students today are unaware of these aspects, particularly
about why a capitalist economy tends towards chronic underemployment equilibrium unless the government
intervenes. Keynesian economics studied today has been reduced to the analytical tools developed, particularly
those related to the concept of the muitiplier and the relation between saving, investment and equilibrium condition
for the macro economy.
12 ‘Perfect liquidity’ exists when the asset is immediately transferable from one person to another in settlement of
debt or any other monetary obligation without loss in face value. Gold is another asset but its purity must first be
established; so it is not immediately transferable. Other assets may be transferable even at more than face value given
a time lapse, as immediately but at some loss in face value.
1 Direct dependence on the level of incomes means that as incomes increase the demand for money for trans-
actions and precautionary motives also rise. Inverse relationship with the rate of interest means that as the rate of
interest increases the demand for money for speculative purposes falls.
This is because the rate of interest and prices of stocks (bonds) move in opposite directions. The classic example
is with reference to prices of bonds. (The relationship is in fact arithmetic.) But this relationship is important to
the Keynesian explanation of the tendency towards depression. The reason is that as bond prices rise, more and
more people feel that these prices are likely to fall in the future; in stock exchange parlance they become bearish.
A point may be reached when most if not all feel that fall in bond prices is imminent. That is, all expect a fall in the
prices. Hence, most would hoard money to be able to buy bonds when the prices actually fall. (As Keynes pointed
 Functioning of the Capitalist Economic System @ 183

He argued that in the short run the marginal efficiency of capital (MEC)" tended to fall
below the rate of interest. (The rate of interest in his view was the payment—an inducement—
to the saver for parting with liquidity, and not contrary to the earlier view of an inducement
for postponing current consumption. Interest was not a real phenomenon but a monetary
phenomenon.)®® This was because in times of recession/depression, since increasing num-
ber of people expect bond prices to fall, speculative demand for money causes the demand
for money to become increasingly elastic (resulting in the emergence of the ‘liquidity trap’).
This after a point prevents the rate of interest from falling below a certain minimum while
in the short-run the MEC could fall below zero. Savers consequently prefer to hold their

out, expectations bring about the thing expected. Therefore, one can assume that all or most have become ‘bears’,
bond prices will fail.) This means that bond prices have reached the maximum possible level, given that in the
net, ‘bears’ is more than ‘bulls’. The result is that the demand for money becomes virtually insatiable on account
of the speculative demand for money. The rate of interest reaches the minimum level beyond which it will not
fall, This explanation for the minimum rate of interest beyond which it is inflexible downwards is a psychological
phenomenon. (Keynes adds that the rate of interest is also a conventional phenomenon. If in the past a given rate
of interest prevails in a given economic and socio-political environment, then if that environment exists in the
future then speculators would expect that rate of interest which existed in the past to exist in that future as well.
In other words, the past establishes the normal level of the rate of interest or the norm. Since expectations tend to
bring about the thing expected, the rate of interest tends to become sticky around that norm. Hence, the rate of
interest tends to actually be ‘sticky” around the conventional norm.) Another reason why interest rates may not fall
below a certain minimum is the administrative costs of administering loans etc. (This administrative reason could be
avoided if the state decides to bear the cost.) In the Keynesian analysis it is the psychological trap which is important.
This psychological trapis called the ‘liquidity trap’. At this point the demand curve for money which slopesdownwards
(when the rate of interest is shown on the y-axis and the demand for money on the x-axis) becomes horizontal to
the x-axis (or perpendicularto the y-axis). In other words, the demand for money becomes perfectly elastic.
1 The MEC refers to the rate of discount which equates the supply price of capital (equal to its replacement cost)
with its prospective yields over the lifetime of the capital; the yields constitute the numerator, the supply price plus
the rate of discount the denominator. This rate of discount will decline as the investment rises. This is because a rise
in investment means increasing production of capital goods. This increasing production will cause the supply price
of capital to rise, given that in the short
run the law of diminishing returns operates. On the other hand, increased
production of capital goods means increased output produced. Therefore, prospective yields should be expected
to decline (since increased supply would be expected to reduce prices unless for some reason demand rises—the
demand curve shifts upwards). In short, prospective yields decline, supply price rises. Hence the rate of discount
falls. In other words, the MEC falls.
The Marxist concept of tendency of rates of profits to fall preceded the Keynesian concept of the tendency of
MEC to fall. There are obvious differences between the two. The first is profits relate to returns on capital in one year,
MEC to returns over the lifetime of the capital asset. The second difference is that MEC relates to the short period,
the Marxist tendency to the long period. And, third, the Marxist concept is related to the basic contradictions in the
capitalist mode of production. The Keynesian analysis is limited to the expenditure of incomes already generated.
5 In the classical/neo-classical theory the rate of interest is a reward for abstinence, for waiting, for inducing
the consumer to postpone present consumption. Hence, it is a reward for the sacrifice of present consumption.
In Keynesian theory, on other hand, savings takes place not because it is induced by the prospect of getting a rate of
interest. Savings depend on the level of incomes. If incomes are very low so that consumption needs are barely met,
then no matter what the rate of interest is no savings will take place. It is only when income levels are high that the
desire to save arises.
164 @ Economy and Society

savings in the form of money instead of investing it—money increases in the investment
portfolio of the savers. To this extent incomes are neither spent on consumption goods and
services nor on producers’ goods and services. Instead it is hoarded.
Money incomes flow out of the circular flow of incomes. The circular flow from value added
to incomes to expenditure gets broken at the link between incomes and expenditures since
a part of the incomes gets hoarded. Say’s law is no longer valid. Aggregate demand falls
below the value of the net product produced. Producers are unable to sell at their supply
price (the price which assures them their normal profits). They reduce investment and pro-
duction. Employment and incomes fall. The result is a contraction in the circular flow of
incomes, indicating falling levels of economic activity, of production and employment.
This fall continues till savings equal the lower level of investment. Equilibrium be-
tween savings and investment is thus restored but at lower level of production and employ-
ment. (See the footnote' for a more detailed, though brief, explanation.) Thus, contrary to
the classical/neo-classical position, the capitalist economy would on its own not only not
ensure full employment stability but will tend towards a state of chronic underemployment
equilibrium.

' Some of the areas where the Keynesian theory departs from the classical are:
(i) Emphasis is on the store of value function of money in contrast to the classical emphasis on the medium of
exchange function. This had the effect of extending the reasons for demanding money from the transactions
demand (fo settle market transactions), the precautionary demand (saving for precautionary purposes, for a
rainy day) to the speculative demand. The basic reason for wanting money was that it possessed the attribute
of perfect liquidity, that is, it was immediately transferable (no time gap intervening between it being offered
in settlement of a transaction and its acceptance) without loss in face value (no difference between its face
value and the value at which it is accepted in the settlement of the transaction). The demand for transactions
and precautionary motives depends directly on the level of incomes, rising and falling with it. The demand
for speculative motives depends on the rate of interest and varies inversely with it. The downward slope to
the right of the liquidity preference curve is because of the speculative demand. It shows that as the rate of
interest falls (as the price of bonds rises, the two being inversely related) the demand for money rises since
more and more savers would be expecting that bond prices would fall (so that they sell bonds now, take the
money, hold it, and then use it when the prices actually fall). If their number is sufficiently large then prices
do fall; expectations bring about the phenomenon expected. Interest is thus a psychological phenomenon.
Additionally, Keynes thought they were also a conventional phenomenon in the sense that if in the past a set
of circumstances brought about a certain level of the rate of interest, then a repeat of similar circumstances
in the present would lead investors to expect the then rate of interest to prevail today. If actual rates are
more than this then the expectations would be that it would fall, and vice versa. The rate of interest tends to
fall in line with these expectations. (The speculative demand for money draws attention to money being
transformed from being a medium of exchange between commodities to itself being a commodity. Marx did
talk of the sole concern of the capitalist ideology with commodity fetishism and since money is a universal
commodity hence the capitalist’s worship of money. The implication of the Keynesian speculative deinand
for money is that money itself becomes a commodity, an item of wealth. The buying and selling of financial
assets like stocks and bonds constitute accumulation of wealth through a wholly money circuit [M — M*] in
contrast to the commodity circuit [C — M - C*]and capital circuit (M - C - M*]. The emergence of derivates
in the capital market and speculation in international currencies has brought out this aspect sharply.)
 Functioning of the Capitalist Economic System ® 165

The problem is worsened because inequalities of incomes tend to worsen in modern

capitalist economies. The greater the inequalities the greater would tend to be the primary

(i1 Thus, the rate of interest tends to be sticky around the conventional norm. It is no longer a flexible price,
contrary to what the classical economists believed. Moreover, because of its psychological basis it will
not fall below a certain minimum. This minimum occurs when bond prices are so high that practically
everybody expects it to fall in the future. So bears in the capital market dominate. This is the period
when the demand for money becomes perfectly elastic so that all increases in the supply of money
(by the state) go into hoardings by the savers. Keynes uses another idiomatic phrase to describe this:
“You can force a horse to the water but you cannot force it to drink.” At this stage the economy is caught in
a ‘liquidity trap’, depicted by the liquidity preference curve being horizontal to the x-axis (the axis which
shows the demand for money, the y-axis shows the rate of interest) showing that increases in the supply of
money would not cause the rate of interest to fall any further. It is for this reason that Keynes argued that
monetary policy would be ineffective in depressions.
(iit) Keynes views the rate of interest as the price for money capital, a monetary phenomenon, while the classical
economists viewed it as the price for real capital, a real phenomenon. People preferred to hold a part of
their savings (wealth) in the form of money hoard. Money thus was one of the many assets held by the
saver—the others could include land, commodity stocks, gold and jewellery, bonds and (equity) shares.
If savers prefer to hold money (ie., to hoard it) then the holding of other assets fall, causing a fall in
aggregate effective demand, thus possibly triggering off a depression. Thus, money affects the real eco-
nomy through being one of the assets in which a saver can hold his wealth: it becomes one asset in the
saver’s asset portfolio. It is no longer neutral, no longer a mere veil.
(iv) Keynes advocates the use of fiscal policy to tackle depressions. This is a departure from the non-functional
public finance of the classical school. Fiscal policy now becomes an instrument of economic policy and thus
becomes a functional tool to influence the level of economic activity. This it does through raising the level
of aggregate demand in the economy. Specifically, when government expenditures exceed government
revenues (i.e., when there is a deficit in the fiscal budget of the government, so that government fiscal policy
causes injections into the income stream to exceed leakages from it), aggregate demand in the economy
rises. This excess or deficit in the budget is financed through borrowing from the central bank (in which
case supply of money itself is increased), from commercial banks (thereby raising bank credit), from the
public through sale of government securities (this is called open market operations) or/and from abroad.
This net increase in government expenditures will cause a multiple increase in incomes and expenditures.
This will raise aggregate demand. This in turn will favourably impact private businesses, thereby raising
the MEC. The upward shift in the MEC will stimulate private investment. This will in turn cause a further
multiple increases in incomes and expenditures, thereby contributing towards a general recovery of the
economy.
(v) MEC is described as the rate of discount that equates future yields (expected over the lifetime of the assets)
to the supply price (or current replacement cost) of the capital asset. In the short run, as investments rise
and output increases expectations of future yields decrease. But supply price of the capital rises because
of the diminishing returns. Hence, MEC falls as investments rise. MEC is different from profits. The latter
is calculated for one year. MEC is calculated over the lifetime of the asset. Yet MEC could be indicative of
profits. This approximation makes it easier to grasp the relation between investment, interest and profits.
(vi) The multiple increases in incomes due to the net injections resulting from the fiscal deficit are because of
the operation of the ‘muitiplier’. The concept of the multiplier is another of Keynesian innovations. All it
means is that an initial net increase in expenditures (due to investment, government expenditure or for that
matter exports) will cause a2 multiple increase in incomes and expenditures (or aggregate demand). The
magnitude of the ‘multiplier’ will depend on the marginal rate of savings (MRS), being its inverse, that is,
the value of the multiplier is the inverse of the MRS. Assume for instance an MRS of 20 per cent. This means
that an initial increase of investment of Rs 100 will cause an initial rise in incomes of Rs 100 (the investment
being expended on various inputs and accruing to their suppliers as incomes). These recipients will in turn
166 ® Economy and Society

gap between consumption levels and the level of full employment output.” This gap has
to be filled up by investment demand (and/or export demand) if aggregate demand is to
equal aggregate full employment supply. (See Chapter 8 under ‘Consumption Theories’ for
elaboration.) The level of investment demand needed to ensure full employment equilib-
rium thus tends to rise as inequalities worsen and as economic growth takes place. But
the MEC tends to fall. Hence, the tendency towards chronic under-employment equilibrium
is reinforced.
Keynes went on to argue that the solution lies not in monetary policy but in fiscal policy.
Increasing the supply of money would be pointless since the infinitely elastic demand for
money because of the liquidity trap would only cause this increased supply being hoarded.
The classical quantity theory of money was simplistic in believing that money supply directly
affects price levels and therefore stimulates production.”® As Keynes so picturesquely put
it, ‘there is many a slip between the cup and the lip’, between money supply and prices.”
Keynes argued that, since the rate of interest cannot be reduced, the solution to raising
aggregate demand in periods of depression lay in raising the MEC. Private expenditures
(consumption or investments) cannot be expected to rise on their own; if they could the
depressionary conditions would not have prevailed. The solution lay in raising government
(or public) expenditures. The revenue for this cannot come from increased taxation. The only
other option is borrowing, A budget of the government (i.e., a fiscal budget) where the excess
of its expenditures over its current/revenue receipts (from taxes, fees, fines, etc.) is met by
borrowings by the government is called a deficit budget. (In India this deficit budget includes

spend Rs 80 (saving Rs 20, the MRS). This becomes the income of another set of people, who in turn will
spend 80 per cent of the Rs 80 and so on, till incomes ultimately rise by Rs 500. Additional savings would
then be 20 per cent of the Rs 500 or Rs 100. Thus, savings rise to equal investment. (This incidentally shows
that from the viewpoint of the economy the initial injection has become self-financing.)
(vii) Keynes' specific recommendation was for the government to use the deficit spending on public works
programme—building roads, dams, buildings and the like, even digging up holes and refilling them.
He described this strategy as ‘pump-priming programme’—prime the pump and a gush of water flows out.
The initial investment causes a multiple flow of incomes. His strategy is described as ‘demand management
strategy’.
17 The reason is that as incomes rise the marginal propensity to consume tends to fall. Therefore, additional con-
sumption as a ratio of additional income falls as incomes rise. It follows then that the rich consume less of a given
increase in incomes than the poor. Hence, worsening income distribution would be associated with falling additional
consumption-additional income ratio.
18 The classical view was of course that money supply would not affect the real economy. But their conclusion
'was based on the assumption of full employment. It would be a Jegitimate conclusion if one believes in the validity
of the quantity theory to expect increased money supply to stimulate production.
¥ The link between money supply and prices was long and tenuous. Money supply will reduce rate of interest
if the demand for money does not rise to the same extent. The fall in the rate of interest will raise investments if
the MEC does not fall to the same extent, and if investments are interest-elastic. The rise in investments will raise
production if there are no supply bottlenecks (i.e., if some critical input is not available). The rise in production will
raise employment and hence expenditures if the method of production does not change to favour more capital-
intensive methods of production. A whole lot of ‘ifs” are involved. And this is but a few of the impediments to the
link between money supply and the prices.
 Functioning of the Capitalist Economic System ® 167

deficit finance, or the amount obtained through borrowing from its central bank ([the Reserve
Bank of India); the loans by the central bank constitutes money.) Keynes therefore advocated
that the government resort to deficit budgets. (This contrasts with the classical school’s
emphasis on balanced budgets where current receipts balance current expenditures; this view
was in conformity with their advocacy of government non-interference in the economy.)
The net expenditure of the government through this deficit would act as a pump-priming
device, resulting in a multiple increase in employment, incomes and hence (consumer) ex-
penditures (or aggregate demand) (explained in footnote 16, [iv]). This rise in aggregate
demand will raise MEC, thereby stimulating an increase in private investment. This in turn
will cause a further multiplier effect on investments, employment, incomes and (consumer)
expenditure (see footnote 16, [iv]). Thus, an upward spiral is set in motion leading to a recovery
of the economy from the clutches of depression.
Keynesians generalised this to advocate that fiscal policy be an anti-cyclical budget
policy which manipulates aggregate demand in the economy, causing it to expand through
deficit budgets in times of recessions/depressions and contracting it in periods of boom
and inflation.® This policy is called the Keynesian demand-management policy or, simply,
demand-side economics.
Keynes thus advocated active government intervention in the economy. He emphasised
public works programmes (socialisation of investment) and social welfare expenditures
(which raised consumption levels). Only then would the economy be able to function at full
employment level of production and employment. He has been regarded as the saviour of
capitalism, the father of modern capitalism (Adam Smith being regarded as the father of
capitalism) for his solution to the problem of cyclical depressions to which a capitalist system
is prone. His contribution to the study of the functioning of macro economy was the
forerunner of growth models (such as the Harrod-Domar model) which became the basis of
government intervention not only for maintaining long-run growth with full employment
stability in developed countries but of growth models for the economic growth of (what was
then referred to as) underdeveloped countries. It was also the basis of capitalist-indicative
planning systems. This referred to the government identifying areas in the economy which
need correction through influencing market forces through monetary and fiscal tools.
This planning is described as democratic planning, to contrast it with what was regarded as
dictatorial planning in the:Soviet bloc. However, Keynes was concerned primarily with the
functioning of macro economy.
Keynesianism thus marked a departure from classical laissez faire liberalism. However,
it still adhered to influencing the economy through influencing and controlling the market.
Its socialisation of investment was to influence the level of aggregate demand through
pump-priming measures and thereby stimulate private investments. It was not replacing
private enterprise by government enterprises; the private economy was not to be replaced
by the socialist economy. Keynesians only sought to ensure full employment stability of

* Keynesian policies by Roosevelt (and others in other capitalist countries) did not by itself get the US economy
out of the depression. The build up to the Second World War helped more. But this may have been because the
governments were loath to follow Keynes whole hog.
168 e Economy and Society

the capitalist system. Keynes in this sense continued to be a liberal economist. Keynesian
liberalism was obviously different from classical liberalism, from laissez faire liberalism.

Schumpeter and Galbraith

Schumpeter’s basic thesis was that capitalism was inherently a dynamic system and therefore
its functioning should be with reference to its effect on growth in the long period, not in
terms of how it administers or allocates resources in the short period. In gist, competitive
conditions may ensure more efficient use of resources but would be inferior to monopolistic
conditions in promoting growth in the long period. Galbraith goes further to argue that in
modern capitalist system planning replaces the market as the organising principle of economic
organisation.

J.A. Schumpeter
Schumpeter argued that the belief that ‘capitalist reality once tended to favour maximum
productive performance...but that the later spread of monopolistic structures, killing all
competition, has by now reversed that tendency’ involves ‘the creation of an entirely imaginary
golden age of perfect competition that at some time somehow metamorphosed itself into the
monopolistic age’. The dominance of monopoly firms since the 1890s did not cause a ‘break
in trend” in the rate of increase in output; and, most important of all, that the modern standard
of life of the masses evolved during the period of relatively unfettered ‘big business’. In fact,
the functioning of the capitalist system under monopolistic firms has led to an improvement
in the standards of living of the masses and was thus progressive.
Goods that were earlier under competitive capitalism considered luxuries became
necessities under monopolies; the motor car (under Ford’s revolutionary assembly-line
method of production) is a classic example. This has been made possible because of the very
monopolistic practices criticised by economists with a neo-classical economics bent of mind.
He therefore asserts that the capitalist system because of its dynamic nature (because of the
inherence of the perennial gale of creative destruction) functions best under monopolistic
conditions.
Many cases of restrictive practices or regulating strategy may no doubt have injurious
effect on the long-run development of output. Yet by and large monopolistic practices are
desirable. Therefore, while some state regulation may be/is needed, indiscriminate “trust-
busting’ or the prosecution of everything that qualifies as a restraint of trade is irrational.2
(Refer to footnote 22 for a summary of his case for monopolistic practices as the basis of the
functioning of the capitalist system.) In gist, Schumpeter believed that monopolies were a

' J.A. Schumpeter, Capitalism, Socialism and Democracy (New Delhi: S. Chand and Co Ltd., 1980), 81.
# Schumpeter’s arguments in favour of monopolistic practices (Chapter 8 of his book Capitalism, Socialism and
Democracy) are as follows:

(i) In the process of creative destruction, restrictive practices may do much to steady the ship and to alleviate
temporary difficulties.
 Functioning of the Capitalist Economic System @ 169

progressive development in capitalism. It brought about a tremendous growth of the eco-

nomy in comparison to competitive capitalism. The Marxists generally were in agreement with
the superiority of monopoly capitalism over competitive capitalism. However, they believed
that monopoly capitalism also, like competitive capitalism earlier, would sooner or later become

(ii) Sectors that need protection are those which happen to embody the impact of new things and methods
on existing industrial structure, or new concemns or industries that introduce new commodities or
processes or reorganise a part or whole of an industry. Such protection includes knowledge from the
outset that competition would be discouraged by heavy capital requirement or lack of experience, or
that means are available to discourage or checkmate competition so as to gain time and space for further
developments.
(iii) Practically any investment entails as a necessary complement of entrepreneurial action, certain
safeguarding activities such as insuring or hedging. In a situation of uncertainty, long-range investment
requires resort to such protective devices as patents or temporary secrecy of process or, in some cases,
long-period contract secured in advance.
s All these are asmuch elements of long-run costs as the insurance
premium paid for war risk, fire insurance, theft insurance, etc. Among these, one would include ‘a price
policy that will make it possible to write off more quickly than would otherwise be rational or additional
investment in order to provide excess capacity to be used only for aggression or defense’.
(iv) Monopolistic practices act similarly to brakes which enable motor cars to travel faster than they otherwise
would.
Cartels and other restraints on trade by controlling price act as effective remedies under conditions of
depression.
(v) With regard to rigidity of prices some may be spurious. For example, a constant price per unit for
improving a commodity should not be called rigid without further investigation. Some may be genuine—
prices set after laborious negotiations between cartels. But these often are a short-run phenomenon. There
are no major instances of long-run price rigidity. In the long run prices do not fail to adapt themselves
to technological processes unless prevented from doing so by monetary events and policies or, in some
cases, by autonomous changes in wage-rates.
(vi) Business strategies avoid seasonal, random and cyclical fluctuations in prices and respond only to the
more fundamental changes in the conditions that underlie those fluctuations. This prevents needless
‘waste of capital.
(vii) Effects of price rigidity in worsening depressions may not be much—if a firm does not reduce price and
demand remains the same then other industries may be adversely affected which may have cumulative
movements; or demand for the firm may fall even more than if price fell—but even if price fell demand
may not rise because for instance people may not purchase a new car even if its price fell 25 per cent.
On the other hand, depressions would worsen if prices were allowed to fall, as in the case of labour or
agriculture.
(wiii) Responding to immediate market conditions may be anti-progress because big businesses seek to
conserve their capital and prevent destruction of capital values. The fact is that asset values and
profits are not being simply conserved but maximised (conserving capital values is the same thing as
conserving profits).
(ix) Modern concern establishes a research department to devise improvements. However, these may not be
used promptly or at all. Generally, if the new method has a lower average cost than the prime cost of the
old method then it will be used. Otherwise, management will adapt to method that yields a larger stream
of future returns to future cost than does the method actually in use, unless old machines save future
costs compared with the immediate introduction of the new methods. The value of past investment does
not enter the picture at all. (This is the basis of zero-based budgeting.) This is true for both the private and
the socialist manager.
(x) Often, a new type of machine is in general often
a link in a chain of improvements and may presently
become obsolete. No management would adopt innovations as they are made (i.e., link by link). The real
question is at which link the concern should take action.

i
170 e Economy and Society

a constraint economic development. (The critical views of Paul Baran, as representative of the
Marxist viewpoint, are explained later in the Chapter 8, problems of capitalism).

J.K. Galbraith
Galbraith® showed why the modern industrial system functioned on the basis of planning
rather than on the market principle. His entire analysis stems from the argument that ‘the
enemy of the market is not ideology but the engineer’.*

(xi) Pure cases of long-run monopoly are rare unless backed by fiscal policy.
(xi)) The theory of simple and discriminating monopoly teaches us that normally monopoly price is higher
and monopoly output smaller than competitive price and competitive output. This is true only if the
method and organisation of production is the same. This is not so. Hence, their criticism is misplaced.
Monopolies are far superior in respect of prices and outputs, even if excess capacity exists. (They largely
create what they exploit.) Hence, their usual conclusion on long-run output would be invalid even if they
were genuine monopolies in the technical sense of the term.
(xiii) In the short run, genuine monopoly positions or positions approximating to it are much more frequent.
For example, the gross in a village during floods.
(xiv) Hence, it is no longer possible to say with confidence that a perfectly competitive system is ideally
economical of resources and allocates them in a way that is optimal with respect to a given distribution
of income.
(xv) Further, dynamic theory shows that price flexibility may cause movement away from equilibrium—
cobweb theory. For example, wheat and lagged price effect. The assertion that the market system is self-
correcting is on the assumption that there is no time lag in reactions of demand and supply curves to price
changes.
(xvi) Perfect competition is incompatible with progress because it discourages the process of creative destruc-
tion. Price flexibility in contrast to rigid prices has a discouraging effect on new investments because of
the process of creative destruction. The same would be the effect when free entry prevents abnormal
profits; excess capacity for ‘building ahead of demand’ or for providing capacity for the cyclical peaks of
demand will also be much reduced. Such excess capacity cannot exist under perfect competition.
(xvii) ‘On the other hand, working in the conditions of capitalist evolution, the perfectly competitive
arrangement displays wastes of its own.” {[]t wastes opportunities because it cannot take advantage of
the economies of scale (internal, especially technological, efficiency); it wastes capital because it is in less
favourable position to evolve and to judge new possibilities.” It is more likely to be unable to withstand
the impact of progress or of external business than big business.
(xviii) Its costs are much more than that of big business.
Schumpeter therefore concludes that monopoly business ‘has come to be the most powerful engine of that progress
and in particular of the long-run expansion of total output not only in spite of but, but to a considerable extent
through this strategy which looks so restrictive when viewed in the individual case and from the individual point of
view. In this respect, perfect competition is not only impossible but inferior, and has no title to be set up as a model
of that efficiency. It is hence a mistake to base the theory of government regulation of business on the principle that
big business should be made to work as the respective industry would work in perfect competition. And socialists
should reserve their criticisms on the virtues of the socialist model rather than on those of the competitive model.”

2] K. Galbraith, The New Industrial State (England: Penguin Books, 1972).

* He uses the term ‘engineer” as a euphemism for technological progress, the ‘market’ for the organisation of the
economy and ‘ideology’ for the political system. (In Marxist terminology the equivalent terms are productive forces,
production-distribution relations [mode of production] and superstructure respectively.)
 Functioning of the Capitalist Economic System @ 171

Technological progress causes far-reaching consequences such as changes in production

techniques, increasing outlay on capital and use of fixed capital, increasing division of
labour and specialisation extending not only to the different components of a product but
also to each of the processes going into the making of a product, increasing use of science and
specialised personnel, increasing time period of production—the time that elapses between
any decision to produce and the emergence of a saleable product—increasing need for
organisation in production and increasing need for planning production.
The immediate/short-term market for the product which plays such an important part
in the decision-making of the small competitive firm is of practically no importance to the
manufacturer who looks at the market position of his product some time in the future.
This applies also to the inputs used by the production unit. The firm must ensure that a
market exists for its product at the time it is produced (which could even be decades away),
that input supplies exist when needed in the future, that the different types of personnel
(including scientists, technologists, managers, econometricians, forecasters, and so on) are
available when needed, and that the consumers and the public and the government (society
in general) are favourably inclined throughout its existence. In gist, the market has to be
controlled and magnitudes that were viewed as parameters under competitive conditions
have to be considered as variables when decisions are made. Instead the large business houses
must take the initiative and endeavour to bend the consumer to its will through using high-
pressure advertising and sales techniques to control the market when the product comes into
the market. In short, the industrial firm must plan, not merely react to the immediate or short-
term market. Galbraith stresses planning as being essential for the modern industrial state.

These changes led to the emergence of the large business organisations. This could deploy the
requisite capital, mobilise the requisite skills. The distinguishing features of the modern cor-
poration normally mentioned are such as its sharp legal image or its limited liability. But the more
important feature is its size, its ability to expand. The corporation needs to plan. Galbraith asserts
that this would allow the firm to accept uncertainty where it cannot be eliminated; to eliminate
markets on which otherwise it would be excessively dependent; to control other markets in
which it buys and sells; and it is very nearly indispensable for participation in that part of the
economy, characterised by exacting technology and comprehensive planning, where the only
buyer is the federal government. The corporations accommodate well to this need. They have the
administrative set up to become very large. They have become large.

Galbraith adds, ‘Nothing so characterizes the industrial system as the scale of the modern
industrial enterprise.””
The fact of decomposition of capital (resulting from the innumerable shareholders of the
corporation between whom the ownership of the corporation’s capital is divided) led to
delegation of control to the manager—to the separation of ownership (proprietoral rights)
from control of capital (custodial rights). But the size and complexity of production in the
modern corporation are such that the managerial role had to be decomposed with the aid of

* Galbraith, The New Industrial State, Chapter 7, The Corporation, p. 89.

 172 e Economy and Society

the technostructure. Managerial capitalism in fact meant decision-making by the tech-

nostructure. In other words, apart from the separation of ownership and control, there
was delegation of decision-making powers from the individual to the group consisting of
committees made up of technocrats.
These developments Jed to the view that since basically employees managed the capitalist
enterprise, therefore these enterprises had changed from being exploiters to being socially
responsible to labour, consumer and the society, and the state had become socially just. This
fits in with the view that the Fordist system was conducive to the spread of consumerism.
Managerial capitalism thus meant a change in the basic nature of capitalism.
The relation of the state to the economy has also changed in this period. Galbraith
points out that the government share of 23 per cent in all economic activity in 1969 (against
29 per cent in 1929) ‘far exceeds the government share in such an avowedly socialist state
as India, considerably exceeds that in the anciently social democratic kingdoms of Sweden
and Norway...".* Much of this is on purchase of defence goods. But apart from being a
purchaser of goods and services from the private sector, the state through such purchases
reduces the risks of technological development (such as failure to persuade the consumer to
buy the product or because of a wrong technical judgement) by paying for these technical
developments or guaranteeing a market for the technically advanced products. Modern
" technology thus defines a growing function of the modern state.
Further, apart from the fact that the corporation has to incur heavy expenditures to per-
suade consumers to purchase their product when it is put on sale, the need also is that people
must have the incomes, stable incomes, to be able to have the purchasing power and a sense
of economic stability to want to buy the product. So a major function of the government
must be the stabilisation of demand. This is where the Keynesian revolution came in handy.
The modern corporation has thus become much more dependent on the state than the
entrepreneurial corporation of the pre-Fordist era. The state did affect the entrepreneurial
corporation through its fiscal incentives and penalties (including taxes) but its main benefit
was in the provision of law and order, administration of justice and defence against external
aggression. Galbraith points out:

The mature corporation by contrast depends on the state for trained manpower, the regulation of
aggregate demand, and though less explicitly, for stability in wages and prices. All are essential
to the planning with which it replaces the market. The state, through military and other technical
procurement, underwrites the corporation’s largest capital commitments in its area of most
advanced technology.”

It was not only in the internal economy that the visible hand of the state replaced the
invisible hand of the market. The state intervened in the international sphere as well.
Protectionism in international trade was the general order. Part of the reason was the effect of
the continuation of the ‘beggar thy neighbour’ policy of the depression, pre-war depression.

% Galbraith, The New Industrial State, Chapter 1, Change and the Industrial System, 22.
7 Galbraith, The New Industrial State, Chapter 27, The Industrial System and the State II, 308.
 Functioning of the Capitalist Economic System ® 173

A major reason was the efforts of several of the erstwhile colonial countries and Third
World countries seeking to change their comparative advantage position through import-
substituting industrialisation. This was one of the factors stimulating the growth of MNCs.
(See chapters on globalisation.)

THE FORDIST PERIOD—AN OVERVIEW

The functioning of the economy under monopoly capitalism in what may be described as
the Fordist phase differed sharply from that under competitive capitalism. The market no
longer had the decisive role in the micro and the macro economy. Its invisible hand was
replaced by the visible hand; of the corporation, on the one hand, and the state, on the other.
At the micro level, the corporation planned its operations far into the future. The corporation
in effect meant the managerial class, leading to description of the system as managerial
capitalism.?®
The sophisticated technology and the heavy capital outlays, the increasing time gap
between the decision to produce and the actual sale of the product necessitated that the
firm anticipate future events and plan to have some say in its unfolding. It also meant that,
in view of its long-run perspective, the firm must endeavour to keep in consideration the
reactions of labour and society in general. The better wages and hours of work introduced in
the Fordist system (see previous chapter) were said to be indicative of the social responsibility
of the modern corporation. The decomposition of capital and management led to the
ascendency of the technostructure-led corporation over the entrepreneurial corporation.
Consequently, ‘there has been a large change in its relations and a yet larger one in its relations
with the state’.” The increasing role of the state, the increasing interrelationship between
big industry and the state, has led Marxists to view this stage of capitalist evolution as state
capitalism. Galbraith viewed it from a different angle. He believed that the role of tech-
nology and the consequent growth of the technostructure indicated a convergence of cap-
italism and socialism. Both tended to be governed by bureaucracy, in capitalism by corporate
bureaucracy, in socialism by government bureaucracy.
The great depression had also brought the need for government intervention to manage
the economy. Keynesian demand management, consequent to the depression, led not only to
deficit budgeting but also to development of the welfare state. This indeed was a great trans-
formation in the role of the state compared to its role under competitive capitalism (when
the state confined itself to ‘policing’ functions under a laissez faire philosophy).
Fordism and an increasing role of the state in the economy thus moved in tandem. To
quote Galbraith, ‘Given the deep dependence of the industrial system on the state and
the nature of its motivational relationship to the state, ie., its identification with public
goals and the adaptation of these to its needs, the industrial system will not long be regarded

* Robin Marris, The Theory of Managerial Capitalism (New York: Free Press of Glencoe, McMillan, 1964).
® Galbraith, The New Industrial State, p. 381.
174 e Economy and Society

as something apart from the government.” ‘There is a close fusion of the industrial system
with the state’. ¥
The Fordist period was one where standards of living for most improved largely because
mass production of consumer durables reduced prices to make them affordable to workers
in these factories, where social security ensured a minimum to people, where a middle class
had developed to bridge the distance between the have-nots and the haves that characterised
pre-capitalism and even early capitalism. The state sought to follow a policy of maintaining
economic stability with full employment, sought to ameliorate excessive poverty and
inequalities of incomes (through a system of progressive taxation and expenditure policies),
sought to minimise conflict between labour and capital. In short, firms had become socially
responsible, the state concerned with social justice. (This was in contrast to the exploitation
of labour under competitive capitalism where firms were under the proprietor-manager.)
This was also the period when countervailing powers (to the growth of monopolies and
their exploitative might) in the form of labour unions (large factory-places encouraging
labour unions) and consumer movements developed. All in all, proponents of the capitalist
system believed that there never was such prosperity, that capitalism had come to stay.
Commentatators in subsequent periods were to view the period from 1950 to the early 1970s
as the golden period of capitalism.
In short, it was believed that the essential nature of capitalism had changed. It was no
longer the exploitative system that it was under competitive capitalism. Some even sought
to call it a different system. Managerial experts like Peter Drucker” sought to regard it tobe a
post-capitalist system: it was not capitalist because it was concerned with social welfare, nor
was it socialist.”
It needs to be pointed out that circumstances were favourable to private industrial
investment in the decades after the Second World War. (See Chapter 5 for reasons.)

POST-FORDIST PHASE
Foster® sums up the post-Fordist phase period thus: ‘Changes in capitalism over the last
three decades have been commonly characterized using a trio of terms: neoliberalism, glob-
alization, and financialisation.” These three features form the basis of the functioning of the
capitalist system in this period.

Features of the Functioning of Post-Fordist Capitalism

The post-Fordist period is broadly the period after 1970. The common characteristics of
this period are the triumph of neo-liberalism as state policy and globalisation. However, as

¥ Galbraith, The New Industrial State, Chapter 1, Change and the Industrial System, pp. 384, 385.
31 Peter F. Drucker, Post-Capitalist Society (New York: Harper Business, 1993).
3 This view has been severely criticised by Robin Blackburn. It may also be pointed out that the reconciliation
between labour and capital may be at the expense of the people of the Third World countries (see Chapter 9 and
Chapter 10).
# John Bellamy Foster, ‘The Financialisation of Capitalism’, Analytical Monthly Review, 5, no. 1 (April 2007), 1~12.
 Functioning of the Capitalist Economic System @ 175

pointed out in Chapter 6, globalisation started as economic globalisation but with increasing
liberalisation moved on to financial globalisation. The current phase is therefore one of
economic-cum-financial globalisation. The mix between the two is different from country to
country. The 2008 financial crisis emanating from the USA has raised doubts about many of
the liberalisation measures, mostly with regard to the financial sector {both nationally and
internationally), and the desirability of unbridled globalisation (particularly amongst the
masses even in the developed countries).
The functioning of capitalism in the post-Fordist period cannot therefore be as conven-
iently summarised as in the period of competitive capitalism or Fordist-monopoly capitalism.
One can only point out the broad areas of differences in the functioning of the capitalist sys-
tem in the Fordist and post-Fordist periods. These relate to the concept of liberalism, the role of
the state and of the market, the nature of globalisation, the financialisation of the economy
and the decline of national sovereignty.

Concept of liberalism
A primary difference was in the concept of liberalism. Economists justified liberalism under
competitive capitalism basically to neutralise the state bureaucracy which was steeped in
the feudal-mercantilist mindset. Besides, liberalism helped the more efficient capitalist
enterprises vis-2-vis the feudal production units or the mercantilist trading corporations.
Classical liberalism was largely abandoned in the Fordist period because of Keynesian
prescriptions. It is back as neo-liberalism under post-Fordism. This return to liberalism was
largely because of the problems generated by the Fordist system (see Chapter 5), and the
features of the post-Fordist period (see Chapter 6). But this resurrected liberalism worked
in favour of the big capitalists, particularly those that operated on a world scale (i.e., the
MNCs/TNCs), often to the detriment of the smaller capitalists and national capitalists
(see Chapters 9 and 10).
Neo-liberalism helped the corporate sector in their dealings with labour as well. Labour
even under competitive capitalism had a weaker bargaining position because of its prole-
teranised state. Its position improved during Fordism. It weakened once again under
post-Fordism. In fact, it was in a weaker position now because of several additional reasons,
which included:

1. The competition is no longer limited to labour from within the country. It had
become international, partly due to immigration and partly due to outsourcing. The
Marxian ‘industrial reserve army of labour” had an inflow both from within the nation
(from small capitalists and self-employed joining the labour force) and from abroad.
2. The general state of growing capital, intensity of production, because of which growth
in value-added was not matched by growth in employment.
3. Moreover, growth in employment was largely in the service sectors, of highly skilled
professionals, who, apart from being averse to trade union activities, preferred flexi-
hours and working from home. The factory conditions that had engendered labour
unions in the Fordist period were absent in the new growth areas. Those employed
with the technocratic sector tended to identify themselves more with capitalists than
with labour.
176 ® Economy and Society

4. The collapse of the Soviet bloc removed the ‘competition” with and threat from the
socialist system, particularly in regard to the welfare of labour and of the masses.

The role of the state and the market

The most significant is the withdrawal of the state from intervention in the production and
distribution systems in the country.* Overall, this withdrawal meant implementation of the
Washington Consensus.
At the macro level this required that the state revert back to non-functional or sound
finance of the competitive capitalism era. It meant reverting back to classical economists’
supply-side economics instead of the Keynesian demand-side economics. Supply-side
economics is a school of macroeconomic thought that argues that economic growth can be
most effectively created using incentives for people to produce (supply) goods and services,
such as adjusting (which effectively means lowering them on the high income groups) income
tax and capital gains tax rates and by allowing greater flexibility by reducing regulation.
Consumers will then benefit from a greater supply of goods and services at lower prices.
Keynesian macroeconomics (associated with demand-side economics), by contrast, contends
that tax cuts should be used to increase demand, not supply, and thus should be targeted
at cash-strapped, lower-income earners, who are more likely to spend additional income.
Many early proponents argued that the size of the economic growth would be significant
enough to ensure that the increased government revenue from a faster growing economy
would be sufficient to compensate completely for the short-term costs of a tax cut, and that
tax cuts could, in fact, cause overall revenue to increase. This tilt towards supply-side eco-
nomics was also associated with the shift to monetary policy rather than fiscal policy largely
under the influence of the monetary school led by Milton Friedman.
At the micro level it meant denationalisation or privatisation of public sector enterprises,
of previously nationalised industries. Withdrawal from the distribution system led to the
state winding up or reducing its social welfare expenditures/activities. In short, the market
mechanism increasingly reverted to the unfetterred position under competitive capitalism.
Each economic player was left to prosper or lose out depending on their success in negotiating
market forces. Labour was to ‘live by the sweat of their brows’, to willy-nilly work.
The state’s withdrawal from social welfare expenditures, from provision of social in-
frastructure like health and education, from public utilities like water and sanitation and
hygiene, etc., marked a clear tilt towards the upper income groups. Many of the countries which
had erected an impressive welfare system did in fact begin winding up their welfare pro-
grammes on the argument of increasing the competitiveness of their industries/economies.
This has included recently the Scandinavian countries (regarded by most conservatives as
being socialist). This tilt towards the upper income groups was further confirmed when

* The withdrawal of the state from the economy in the post-Fordist period which led to its progressive deregu-
lation is discussed in Chapter 5 (under Contradictions Inherent in Fordist-Monopoly Capitalism) and Chapter 6
(under Features of the Early Phase of Post-Fordism: Economic Globalisation, Section (vi), and under Features of
Financialised Global Economy, Section (iii) Economic Sovereignty and Role of the Government).
 Functioning of the Capitalist Economic System e 177

tax policy drastically reduced tax rates on upper income groups on the basis of the Laffer
curve thesis that lower taxes meant higher tax revenues. The private sector tended to take
over provision of services/amenities earlier provided by the state at market rates. Increasing
inequalities interacted with flexible production to distort pattern of output of consumers’
goods and services in favour of the consumers’ preferences of the upper income groups;
this added on to the unequal incomes distribution. Economic liberalism thus went beyond
limiting state intervention to only ‘policing functions’, from being avowedly neutral (to the
distribution of resource endowments of the people) to favouring a shift in wealth distribution
towards the richer sections of the population.
The difference from the period under competitive capitalism was that now private
monopolies/corporations dominated the economy. The different entrepreneurs no longer
had a level playing field. The innumerable new proprietoral enterprises in the sunrise
industries (information and communication technology etc.) functioned under competitive
conditions. But these depended for crucial inputs on the MNCs and TNCs. Many of them
were spin-offs of these large corporations. Whether spin-off or independently established,
these proprietoral/partnership concerns benefitted the large corporations which outsourced
a part of their processes to these small concerns. This reduced costs to the corporations
while providing large (than previous wage) incomes to the small producers. Alternatively,
these small concerns expanded the markets for the products of the large corporations. For
instance, web-designers and graphic designers all over the world are dependent on the
large MNCs for their software. Consequently, while liberalism under competitive capitalism
benefited all capitalists (since all of were price-takers in a competitive industry), under
monopoly and finance capitalism liberalism worked to the advantage of the large corpor-
ations, and within these to the advantage of the MNCs and TNCs.
Pursuit of economic liberalism ensured that the market mechanism is unfettered or
least interfered with by the state. This has different implications in the different stages of
the evolution of capitalism. In the pre-Fordist phase of capitalism consumers’ preferences
was predominant: the producer had to adjust the product to suit the consumer and had to
adjust to reduce costs. Resource allocation under competitive conditions was projected as
being ‘rational’ on the argument that this ultimately reflected consumers’ preferences, that
consumers ruled the production decisions. The producers could not affect the market through
their individual actions and could compete for the existing market through cost competition
through technologically induced efficiency in production. In the Fordist period, monopolists
and monopolistically competitive-markets predominated.
Advertising and marketing came into their own; instead of the producer adapting the pro-
duct to the consumers’ preferences, the producer now sought to adapt the consumer to the
product. Producer’s sovereignty rather than consumers’ sovereignty determined allocation of
resources. There were practically no restrictions by the state on the nature and content of the
advertisements used by the producer. (The state intervened in many other ways so that stable
aggregate demand levels could be maintained.) However, in the event that the producers’
sales efforts failed to entice the consumer then it faced a loss. It is in this sense that the market
continued to be important. In the post-Fordist period also the producers sought to influence
consumers’ preferences, to adapt the consumer to the product. The difference was that
178 e Economy and Society

the consumer was not only more receptive to developing new tastes but had access to pur-
chase on credit—instalment purchase, credit cards (plastic money) and the like. Consequently,
consumers had the incentive to consume in excess of their incomes. Consumerism in the
real sense of the term came into existence in this post-Fordist period. (Galbraith had argued
that since in countries like the USA the savings function had been taken over by the
corporations—through undistributed profits—the only role that the household had in the
economy was that of the consumer.)
Thus, apart from sales/advertising/marketing, finance played an important part in the
producers’ arsenal to influence the consumer. Unregulated markets now worked in favour
of the big corporations and against the small capitalist (unlike under competitive conditions
when all capitalists were on more or less equal footing). Liberalism thus had a far different
connotation in the post-Fordist phase than in the pre-Fordist phase. This was another reason
why non-intervention by the state worked in the interests of the bigger corporations.

Globalisation
Another difference was that while globalisation under competitive capitalism was through
trade, under monopoly capitalism through foreign direct productive investment, under
monopoly-finance capitalist of the post-Fordist phase globalisation was of capital-in-finance.®
Further, exchange rates were pegged in the earlier phases to gold under the gold standard,
to the dollar under the Bretton Woods system; in the post-Fordist phase the exchange rate
was left to the market.
Globalisation had changed its texture and form. The trend was towards removing nation-
-insulating restrictions on international movements of goods and services inspired by import-
industrialising strategies. Globalisation moved from establishing subsidiary branch-plant
establishments of MNCs to increasing division of labour and specialisation through global
supply chains between independent production units, connecting the production systems
of many countries across the globe. The production process and productive forces were
becoming increasingly socialised.
The invisible hand of the market now coordinated production units not only within a
country but internationally. This coordination differed from competitive capitalism in that
the interrelation between production units in the different countries was not trade in whole
products (of different economic sectors—primary, secondary—or of different vertical stages
of production, suppliers and users of capital inputs such as looms produced in England for
use by spinning mills in India during the colonial period) but in parts or processes of the
products and even in same products or similar products of differing qualities (catering to
different income levels—clothes for different income classes). This wide spectrum of the

* For more, see the Chapter on Globalisation in: Peter Evans, “Transnational Corporations and the Third World
States: From the Old Internationalization to the New’, in Richard Kozul-Wright and Robert Rowthorn, eds,
Transnational Corporations and the World Economy (McMillan, 1998); Prabhat Patnaik, ‘Globalization of Capital and the
Theory of Imperialism’, Social Scientist 24, nos. 11-12 (November-December 1996).
 Functioning of the Capitalist Economic System @ 179

socialisation of the production system across the world economy exposes directly or indir-
ectly every single production unit in practically every country to the vicissitudes of market
forces—even production units in dominant economies such as the USA.
But the world capitalist system has extended from economic globalisation (of production,
distribution and use of real goods and services) to financial globalisation. Economic glob-
alisation exposed production units of different countries to each other and to international
market forces. Financial globalisation rendered the macro economies of the different
countries vulnerable to international market-induced financial forces. This is of far-reaching
consequence since the real economies became affected not because of factors within it but
because of factors from without. It became susceptible to speculative activities wholly con-
fined to financial transactions. This was largely because of free capital convertibility and the
subjection of foreign exchange rates entirely to market forces, leading to rapid growth of
hot money movements across the globe. International mobility of capital was increasingly of
capital-as-finance, not capital-in-production. (See Chapters 9 and 10.) Keynesian speculative
- motive (M - M*) now extended to the international sphere.

Financialisation of the economy (refer also to Chapters é and 8)

A third major difference was the financialisation of the capitalist economies. Under com-
petitive capitalism money was dominantly a medium of exchange. The saver and the investor
were connected directly, through ‘direct finance’. Under monopoly capitalism, the role of money
as a medium of exchange had also become important, largely because of the growth of new
financial instruments (likes stocks and shares) and the growth of financial intermediaries.
Keynes showed that this led to the likelihood of speculative investments. Yet speculation
related to the real economy. Under post-Fordism, as a result of the growth of new financial
instruments (futures, options derivatives, etc.) speculative investments could relate both
to the real economy as well as to pure financial transactions. Freedom from regulations in
the pure financial markets would ensure that there would be no restraints whatsoever in the
proliferation of derivates (futures, options, hedge funds, insurance of derivatives and the like)
and leveraging of credit on the basis of securities of derivatives. The result has been that
funds tended to move increasingly into the financial sector. Liberalisation in the flows of cap-
ital between countries led to the dominance of capital-as-finance over capital-in-production
and to international financial flows far outstripping internal real commodity flows.

National sovereignty (see also Chapters 9 and 10)

The extension of the invisible hand of the market to the world economy, the growing im-
portance of financialisation in both the internal capitalist economies and the global economy,
and the growing importance of international capital flows in the form of capital-as-finance
over capital-in-production meant the loss of economic sovereignty of the nations. It deprived
most nations of their economic sovereignty; a few like the USA, however, were to follow
independent policies, even contrary to their prescriptions for other nations. Economies of
countries that allowed capital convertibility fluctuated with ‘hot money’ movements in and
 180 e Economy and Society

out of the country, rendering their governments impotent. The pursuit of Keynesian demand-
management policies died a natural death so to say. (See Chapters 9 and 10 for a fuller
discussion, including the view that all nations have become equal just as all individuals were
equally treated by the market under competitive capitalism.)
The increasing globalisation of the world economy has led some observers to argue that
national boundaries are becoming blurred and that an international ruling class consisting
of the elite of all nations have become the dominant class (see Chapters 9 and 10). There is
also a growing advocacy of a world economic body, a world government so to say, to oversee
the functioning of global capitalism. The November 2008 financial meltdown which started
in the USA and spread across the globe has once again fuelled the demand for world gov-
ernance. However, as we shall see in Chapter 10, nationalism is still very much alive and the
recurrence of nation-based economic rivalry is a distinct possibility—all the more so given
increasing scarcity of resources, including water, and the effects of environmental damage.

- CAPITALISM AND ECONOMIC GROWTH

Capitalism witnessed dramatic growth in the stock and productivity of productive forces
(thatis, of capital, labour and technology) and hencein the level of production and surplus.
Capitalist countries witnessed accelerating rates of growth in production/imports of
foodstuffs, commercial crops, minerals, petroleum, sources of power (coal, petrol, nuclear,
wind, solar, bio fuels, etc.) and in buildings, machines and other fixed capital equipments/
instruments (that is, in inventory or working capital and fixed capital) and in economic and
social infrastructure. Even more important was the rapid growth in technology—in division
of labour and specialisation, engineering and scientific knowledge, research and develop-
ment, in organisation and management, in finance and financial instruments and so on.
There seems to be no end to the discovery of new resources, new technology and new areas
of investment. The progress in electronics, information technology, biotechnology, medical
engineering and the like now seem to be just the beginning. Labour at one time possessed
few skills. Today there is a proliferation and still multiplying growth in the types of labour
personnel with the result that the number of years of education and training required has
tended to increase over time. In short, the production process becomes more and more
roundabout and capitalistic.®
The growth in productive resources has been accompanied by increasing socialisation of
the production process. This is the result of increasing division of labour and specialisation.
In the primitive communal mode the whole tribe cooperated to produce a single product

% ‘Roundabout’ in the sense that instead of producing the consumer good directly, humans divert a part of their
labour time to produce a capital good or to acquire knowledge and then produce the consumer good. For instance,
a man by a riverside can attempt to quench his thirst by using his hand to take the water up to his mouth or by first
making a utensil (coconut shell for instance); hence the thirst is satisfied in a roundabout way through first producing
a capital good. This use of capital is referred to as roundabout or capitalistic. It should be noted that capitalistic refers
to productive forces, that is, to inputs in production while capitalist refers to the way production is organised.
 Functioning of the Capitalist Economic System & 181

(namely, food limited to meat/fish and roots, fruits etc.). In the subsequent modes, division of
labour extended to separation of agriculture, manufacture, trade and transport. Therefore,
a person’s needs involved more and more people. Under the capitalist mode this process
has expanded to such an extent that a smgle product involves the labour of innumerable
people; for instance, the shirt that one wears is the result of the labour of the tailor and of all
those involvedin the production of the tailor’s sewing machine and the thread and scissors
he uses, apart from all those involved in the production and growth of the cotton, its con-
version into thread and cloth, in the production of the spinning wheel and the loom and the
chemicals used, in the production of fuel and minerals and engineers used in the production
of the various capital equipment, and so on. This one shirt thus is the result of workers round
the world.
This rapid and accelerating growth in productive forces is the result of the deliberate
attempts to continually improve productive efficiency. This is unlike pre-capitalist systems
where the natural progress in productive forces does on its own tend to pick up speed because
knowledge feeds upon itself and some can be quite catalytic, like the discovery of fire or the
invention of the wheel. But the capitalist mode contributes to this advance because the search
for new resources, for new technologies is inbuilt in the system. It is this inbuilt feature that
distinguished the capitalist mode from all other modes.
The basic features of the capitalist mode of production thus led to rapid economic growth
at a rate unprecedented in human history so far. The reasons are best explained in terms of
the four factors enumerated by Paul Baran® as affecting the rate and direction of economic
growth. These are (i) the extent of utilisation of existing resources, (if) the maximisation of
surplus from the available output, (iii) the maximisation of the share of surplus going into
productive investment, and (iv) the availability of investment outlets.

Competitive Capitalism and Feudalism

Competitive capitalism scored over pre-capitalism on all these counts. With regard to the
first factor, for instance, capitalist production relations ensured that the capitalist must
strive to maximise efficiency and productivity so that growth in productive resources would
be deliberately promoted. Say’s law ensured full employment of these increases in resources.
The impact of customs and traditions and the fact that competitive survival was not involved
meant that increases in productive resources need not (and may not) be fully used.
Competitive capitalism is superior on the second count also. The feudal lord is no doubt
as interested in maximising surpluses as the capitalist. But the influence of status, customs
and traditions, social and religious obligations and so on may mean that the feudal lord
may not try to squeeze as much out of the surplus of the direct producers (workers) as the
capitalist who is guided by no other consideration but that of maximising his surplus (profit).

¥ Paul Baran, Chapter 3: ‘Standstill and Movement under Monopoly Capitalism I, in The Political Economy of
Growth (England: Penguin Books /Pelican Books, 1973), 156-208.
182 e Economy and Society

The expropriation of the surplus is hidden under capitalism since the market is imper-
sonal (treats everyone equally) and rewards everyone according to their contribution® to
production: under competitive capitalism no single economic entity (capitalist employer or
the worker or, for that matter, the consumer) can influence price. In fact, the worker tends
to identify his well-being with that of the employer, unlike the quite overt and visible ex-
propriation under pre-capitalist systems. Further, competition among workers (and increase
in population) would tend to keep wages near the subsistence.
Moreover, excessive consumption by royalty and courtiers and by the church would
tend to be minimised with the collapse of feudalism and the rise of Protestantism and
Puritanism (and the associated emergence of what Weber and Sombart called the capitalist
spirit). So also would be the huge costs of administration because of the reduction in the
interference of the government in the economy and society. Hence, surplus will be higher not
only for the individual producer but also for the economy as a whole. (The reader should also
look up Chapter 5, particularly the sections comparing pre-capitalism and capitalism, and
Schumpeter in the foregoing.)
With regard to the third factor: the capitalist’s compulsion to increase productivity and
competitiveness forces him to invest in the production process. Hence, he tends to maximise
the use of surpluses in productive investment. The feudal lord or slave-owner depends on
extra-economic force and hence does not feel compelled to use his surpluses in improving
productivity. The result was the spending of the surplus on conspicuous consumption,
monuments, gold and jewellery, or armaments and maintaining an expanding army. Thus,
the surplus tends to be used unproductively, though military expenditure may well be
regarded by the feudal lord to be productive use since it facilitates his ability for primitive
accumulation (extra-economic siphoning off of the surplus).
With regard to the fourth factor: Price flexibility under competitive conditions and non-
existence of institutions that. prevent price flexibility ensures that no factor will remain
unemployed. In feudal agriculture prices are practically irrelevant, while in industry the
guild masters ensure that no one resorts to price or quality competition, that these remain
uniform for all members of the guild.
Thus, for all these reasons, apart from other reasons to do with concomitant changes in
the superstructure (for instance, in value systems, education, attitude to work and enterprise,
religion, family, rule of law and so on), competitive capitalism was a definite improve- .
ment over pre-capitalist socio-economic formations. The competitive phase was supposed to
be the golden age of capitalism, a period when the entrepreneurial spirit had full freedom,
a period of rapid economic growth and full and efficient use of resources.

Competitive Capitalism and Monopoly Capitalism

Protagonists of competitive capitalism have argued that monopoly capitalism is inferior
because it causes output to be lower and prices higher, and therefore does not lead to

% According to their marginal productivity.

 Functioning of the Capitalist Economic System e 183

maximisation of output from available resources. Their argument is that the perfectly elastic
demand curve facing the competitive firm ensures that production will be at minimum
average costs (shown by the firm being at long-run equilibrium when average costs curve
and demand curve [showing average revenue] is tangent to each other). The fixed capital
will be optimally utilised, and hence there would be no excess capacity. Equilibrium under
imperfect competition would be at a higher average cost; the tangency between the average
cost curve and the average revenue (demand) curve would be to the left of the minimum point
on the average cost curve. Output would then be below optimal, excess capacity would exist.
In short, output would be less than potential, less than if competitive equilibrium conditions
were possible. Correspondingly, prices would be lower under competitive conditions.
However, the comparison of output and prices between the competitive and monopoly
firms is between non-comparables. Markets become imperfect because internal economies
of scale lead to fewer firms surviving in the market. Consequently, even if the imperfectly
competitive firm produces at less than optimal capacity this over-restricted output would be
much greater than the optimum output of the small competitive firm. Hence, output would
in fact be larger, as was the fact under Fordist production methods, and prices would be
much lower. Schumpeter had in fact pointed out that monopolies contributed to luxuries of
the past becoming necessities as in the case of motor cars or consumer durables.
Economists do not see much difference between monopoly capitalism and competitive
capitalism as far as maximisation of surplus from available output is concerned. Empirical
evidence (by Kuznets and others) indicates constancy in the share of wages and profits, and
savings or surplus is associated with profits. However, as we argued in Chapter 5 under the
reasons for the emergence of post-Fordism, inequalities within each factor income category—
wages and profits—in fact increased. Consequently, savings (i.e., surpluses) in fact were
much greater under monopoly capitalism. (In the USA, as Galbraith pointed out, the savings
function was taken over by the corporate firms.) It is a different story that because of excess
capacity available output is less than potential output and, therefore that, surplus less than
what could have been if all available resources were utilised to full capacity. Baran compares
the transition from feudalism to capitalism in this regard:

[Als the transition from feudalism to competitive capitalism led not only to a vast expansion of
the economic surplus but also to the transfer of a large share of it from the feudal to the capitalist
businessman, the transition from competitive capitalism to monopoly capitalism has resulted
likewise in a tremendous increase of the absolute volume of the economic surplus and in the shift
of the control over it from the relatively small capitalist to a few giant corporations.®

Competitive capitalism is conducive to the productive use of the surplus. Their compulsion
to increase productivity results in all inventions being used in production. This stimulates
productive investment and forces all other firms to follow suit, in fact spurs each to outdo
the others. The process never comes to a rest. The cheapening of the output of one industry
would create pecuniary external economies to those who use the output. In this way

* Baran, Chapter 3, in The Political Economy of Growth, 178.

184 e Economy and Society

extra-profits would be created in various branches of the economy; investment would be

stimulated in these industries resulting in the perennial gale incessantly propelling economic
growth. Though research and development arid hence inventions were likely to be more
under monopolies because of their greater capital, Baran believed that they were reluctant to
implement most of the inventions. (See the following under Baran’s views on technological
progress). Schumpeter did argue that dynamic competition necessitated monopolies.
However, he believed that monopolies tended to be ruled by bureaucrats, and bureaucracy
was inimical to innovations. Further, monopolies encourage indirect finance and financial
capitalism. They therefore tend to cause investible funds to be diverted from productive
investments to speculative investments.
This brings us to the fourth criterion, namely, availability of investment outlets. Economists
assumed that conditions under competitive capitalism were such that the validity of Say’s
law would be ensured and therefore full employment of increased savings (capital) and
labour would prevail. Monopoly capitalism suffered in comparison because it reduced
investment outlets. Hansen attributed this to exogenous factors. Keynes argued that the
reason is to be found in factors endogenous to the capitalist system. (The reader should also
look up economic crisis in Chapter 8.)
The best known formulation of the ‘theory of vanishing investment opportunities’ due to
exogenous factors was that by Alvin H. Hansen (in 1944). His belief was that such exogenous
factors as falling rates of population growth, the drying up of the frontier and decline in
the rate of technological progress and technological innovations did not in fact limit spurts
in the growth of investments. If investment outlets did fall in the long run the reason was not
because of factors exogenous to the capitalist system but because of endogenous factors.
1t is an accepted fact that demand depends not so much on the size or rate of growth of
population but on many other factors including purchasing power of the population and
hence on the level of incomes (as well as its rate of growth and distribution). (Some com-
mentators have even talked about India having the advantage of a ‘population dividend’!)
As Baran concludes, *...far from determining the volume of investment,
the demographic
situation itself assumes a different complexion at different stages of economic development—
depending on the extent of capital accumulation, on the nature of technological changes, on
the speed and intensity of shifts in the occupational structure of society, and so forth.”%
Similarly, with regard to the drying up of geographical frontiers, of new discoveries, the
limiting factor is not the drying up but the unwillingness to invest unless profit rates are
attractive. Investment has been forthcoming to explore new areas of discoveries or new
substitutes for natural resources when the prospect for large profits is bright.
With respect to technological innovations also history has not supported the view that
technological innovations are slowing down. (The latest has been in information technology.)
Where demand has been forthcoming (either spontaneously or as is more likely induced—see
Chapter 6 under post-Fordism), technological progress has resulted in a spurt of innovations.
The fact is that there is a continuous and growing inadequacy of private investment in
relation to the volume of economic surplus under conditions of full employment. This is

* Baran, Chapter 4: ‘Standstill and Movement under Monopoly Capitalism IT', in The Political Economy of Growth, 187. -
 Functioning of the Capitalist Economic System e 185

despite the fact that large parts of the population do, with much less of consumer goods
and social amenities than what they need or their better off fellow men, enjoy so that in a
society sense there should have been no lack of investment opportunities. The reason that
this did not happen is not because of exogenous factors or because of random disturbances
(whether economic, political or others). Though both these groups may and did play a part,
the reason for the lack of investment opportunities is because of factors endogenous to the
logic of capitalist growth. Baran sums up the Marxist position in this regard thus:

In actual fact, however, to explain the inadequacy of private investment in relation to the volume
of economic surplus under full employment, there is no need to seek refuge in factors ‘external’
to the working principles of the capitalist economy, in errors of government or in unfavourable
adversities of fate. It can be adequately accounted for by a process that is deeply rooted in
the basic structure of capitalism and promoted by its entire development: the growth of large-
scale enterprise, of monopoly and oligopoly, and their ever increasing sway over all sectors and
branches of the capitalist system.*

Baran on Technological Progress under Monopoly Capitalism

Competitive capitalism ensured that all investible surpluses would in fact be utilised, that
unemployment was because there was insufficient capital to employ all the available labour.
This was a structural factor, a problem of economic growth. Apart from this, some employ-
ment was lost because of wasteful utilisation of the economic surplus due to premature
destruction of capital assets because of, among other factors, the need to adopt almost every
technological innovation in order to competitively survive. Otherwise, ease of entry and exit
of firms and the large number of firms in the industry ensured that Say’s law would more
or less operate. These conditions do not exist under the monopolistic and oligopolistic struc-
ture of industry. Many factors make free entry difficult. These include patents, trademarks,
government concessions, high-powered intense advertising, the large amount of capital
required for the establishment of a new firm and so on. Consequently unlike the competitive
firm the monopoly firm has considerable leeway in its response to technological progress.
Monopolistic market structures moreover introduce another element, namely, a difference
in profit-maximisation calculation. The relevant profit rate for the monopolist is the marginal
profit rate alone. For the competitive firm the average and the marginal rates are the same’
because more can be sold at the prevailing price. But for the monopolist, more can be sold
only at a diminishing rate because of the inelastic demand curve facing the monopolist—the
fall will be steeper the more inelastic the demand curve—so that additional investment will
entail a reduction in the profit rate on the old investment.
Yet another consideration likely to retard technological progress under monopolistic
conditions is that not only should average total costs of production® because of the new

! Baran, The Political Economy of Growth, 191.

“ Average total costs are the total costs of production divided by the number of units of the product produced, that
is, it is per unit total costs of production. This is the sum of fixed costs of production per unit of outpit plusthe prime
costs on the additional units of output produced, prime costs being the costs of the variable inputs such as additional
labour and raw materials required for the additional inputs.
186 ® Economy and Society

machine be less than average prime costs of output turned out by the old machine but that
the saving should be large enough and/or the economic life of the new machine long enough
for the capital loss on the huge capital outlays made earlier (prior to the new machines)
to be recovered. If the rapid rate of technological progress renders the economic life of the
new machines short then only major technological improvements would have a chance of
‘breaking through’ (while minor ones would be introduced only when the old equipment
wears out). This option of not having to adopt innovations as and when they occur despite
capital losses is not available to the competitive firm.
Further, the attractiveness of technological progress in contributing to reducing costs and
hence prices are reduced by the threat of cut-throat price-wars between oligopolistic giants.
The consequent tendency to live and let live allows for continuance of high-cost firms and
of excess capacity in the oligopolistic industry. But this excess capacity discourages new
investment, particularly in an industry where its existence is well known in view of the small
number of the relevant firms. This reluctance of new entrants is reinforced by such other fac-
tors as the fear of their entry causes prices to fall significantly thereby affecting prospective
rates of profit on new investments. Another deterrent is the fear that an ologpolist trespassing
into another oligopolistic industry would not only run the risk of retaliation in his own market
on the part of some members of the invaded industry, but would invite the displeasure of
powerful financial interests involved simultaneously in a number of such industries.
The foregoing set of problems may lead to such enterprises breaking into competitive
industries in their search for profitable areas to invest in. Thus, monopoly and oligopoly spread
from one branch of the economy to another and large-scale enterprise takes over where
small, competitive business used to be in control. (The recent tendency to enter into retail
trade or fast food joints is illustrative of this tendency. Scientific and technological advance
has enabled extension of monopolistic tendenciesin fields hitherto considered the preserves
of competitive business, agriculture for example.) Thus, the economy asa whole increasingly
tends to become a system of monopolistic and oligopolistic empires.
Thus, while Schumpeter argued that it is ‘only with the presence of monopoly that
technical progress is at all possible in a capitalist economy (see Chapters 5 and 6), Baran
argued though ‘the growth of large-scale enterprise, of monopoly and oligopoly was a pro-
gressive phenomenon furthering the advance of productivity and science,...this very same
phenomenon tends to turn economically, socially, culturally, and politically into a retrograde
force hindering and perverting further development’.#® Yet the fact that competition is not
compatible with modern, technological with modern, technologically advanced, production
is by no means tantamount to the proposition that monopoly is a rational framework for
the long-run development of productive forces. But the latter is not an argument in favour of
free competition.
Marxists more or less agreed that monopoly capitalism is superior and is therefore
progressive in comparison to competitive capitalism in terms of the growth of productive
forces. But they held that after a point monopoly capitalism would act as a fetter to further
progress.

* Baran, Chapter 4: ‘Standstill and Movement under Monopoly Capitalism II', in The Political Economy of Growth, 208.
 Functioning of the Capitalist Economic System ® 187

They believed that monopolisation promotes both socialisation of the production pro-
cess, of the productive forces and at the same time concentration and control of the means of
production in fewer and fewer hands. This causes a disharmony between productive forces
and production relations. This results in a host of problems in the functioning of the capitalist
system. These tend over time to become increasingly destabilised and lead ultimately to the
collapse of the system. In the longer period therefore monopoly capitalism would retard
progress. Marxists believe that, consequently, capitalism will self-destruct when these prob-
lems intensify beyond a critical point. The rest of this chapter deals with these problems
and the issues raised here.
Baran’s arguments go to show that the evolution of capitalism into the monopoly phase
was inevitable but tended to cause underemployment and stagnation. This long-run ten-
dency was exacerbated by it being accompanied by a succession of economic crises, each
more severe than the other, which would ultimately lead to the collapse of the capitalist
system. More recently, the problems associated with the functioning of the capitalist system
has gone beyond that of business cycles to those relating to income inequalities and poverty,
class conflict and ecological crisis. Marxists have for long emphasised that economic growth
under capitalist production relations is necessarily associated with increasing inequalities
in the distribution of incomes and wealth and the growing impoverishment of the masses.
Class consciousness in fact is a phenomenon that arises only under capitalism. Marx had
also referred to ecological problems. These problems have tended to be analysed more or
less independently of each other. But it is becoming increasingly evident that they are inter-
dependent, and it is a moot point as of now about which of these could act as the tipping
factor in the evolution of the next socio-economic formation. These problems are discussed
in the next chapter.

CONCLUSION
The projection today is that efficiency and growth of the economy had been best under the
economic liberalism and the policies subsumed under supply-side economics. And, therefore,
governments should revert back to both today. However, capitalist economies had long
outlived (by the end of the 19th century) competitive capitalism. The further evolution of cap-
italism was under monopoly capitalism through its successive sub-epochs, each promoting
socialisation of productive forces through furthering the globalisation of the world economy
and in the process increasing concentration of ownership and control of resources in fewer
and fewer hands. Contrary to the claims of the neo-liberals, capitalism was at its best in the
Fordist phase (the period from 1950 to early 1970s being regarded as its golden period), a
phase which saw active Keynesian-inspired government intervention and macro planning
(though dominantly of the indicative variety) and social welfare expenditures, though of
course other factors contributed. Both growth and social welfare (welfare of people in general)
benefited. The post-Fordist period has seen frequent recurrences of crisis. And, even at the
best of times, as in the latter half of 1990s, unemployment, inequalities and poverty have been
on the increase in most of the capitalist countries.
188 @ Economy and Society

Despite economic growth being much faster than in pre-capitalist system, the capitalist
system has been suffering from endemic business cycles and growing inequalities. The his-
tory of capitalist growth bears out the Marxist view that growth and poverty are the two sides
of progress under capitalism. The post-Fordist phase has seen aggravation/proliferation
of problems, many of them seemingly new but actually dating back to the start of capitalism
(see Chapter 8).
The extent and form of state intervention in the economy has changed to protect and pro-
mote the interests of the dominant capitalist class. In the initial phases when capitalism
emerged from pre-capitalism, the spheres of the economy and of society were clearly
demarcated. The state played an active role in the economy in the Fordist period. Yet this role
was by and large within the framework of the basic features—of private property, commodity
production and market forces—which are only modified to ensure that socio-political unrest
does not overwhelm the capitalist system. The consideration for social use-values implied
in the social security measures or public works programmes (meant to pump-prime and
stimulate aggregate private demand) are essentially of this genre. Subsequent measures
proved that resort to Keynesian demand management was to meet the challenge posed by the
experience of socialism in the USSR. The state withdrew from intervention in the economy
once socialism collapsed; it minimised even its regulatory role.
The diminishing importance of the state shows the dominance of the basic features. The
capitalists’ desire that the economy be left completely to them was clearly the ‘regime’ they
desired and got. The extent of withdrawal of the state can be gauged from the fact that many
of the functions believed to be traditionally the sphere of the state is now being taken over
by the market—management of prisons, army, education, health, sanitation and hygiene,
law and order and even social functions like event management, sports and cultural activities
and folk music/dance.
Thus, while under the pre-capitalist system the economy was embedded in society, in
traditional (competitive) capitalism the two were viewed as more or less independent of each
other; in today’s globalised capitalism the superstructure is increasingly being embedded in
the economy.