MICHAEL A. LEBOWITZ
How can we understand capitalism? Neoclassical economics, which is to say, mainstream economics, rarely uses the name. Rather, it talks about the “market system” or the free market, a system in which individual property owners (both those who own material resources and those who own merely their personal capacities) contract with each other in their self-interest. And, as long as they are free to contract and free to choose, we are assured that the result gives us the best of all possible worlds.
Neoclassical economics begins (and ends) with the individual. And this individual is treated as an isolated individual atom: the isolated individual consumer, the isolated individual capitalist owner, the isolated worker. Further, this individual is assumed to be rational, which the theory equates with self-interested. So, as a rational individual, this person is always looking to maximize self-interest, that is, to maximize profits or wages or the utility obtained from the goods purchased. If not doing that, then by definition the individual is not rational. In short, this individual always searches for the right point, the optimum point, in his or her self-interest. Thorstein Veblen, at the beginning of the twentieth century, described this as the view of the individual as “a lightning calculator of pleasures and pains.”
And that’s a very accurate picture of the starting point of this theory, which is the idea of the individual as a calculator or, better yet, as a computer. Certain information is fed into this computer: what it wants to maximize, the resources at its disposal, the technologies that are relevant, and the prices of things. And, on the basis of this information, the computer turns out the correct solution, namely the one that maximizes pleasure or minimizes pain. So, for example, the computer, if a consumer, will decide how much it will purchase of different products based upon the relative utility it receives from each product and their relative prices. Pleasure versus pain.
Or the computer, if a worker, will decide how much it wants to work based on its preferences for leisure versus work and the wage (or alternative sources of income like welfare payments). And the computer, if it is a capitalist, will determine whether to use a machine or worker based on the relative prices of each and the nature of the technology—and whether to use a skilled or unskilled worker based upon the relative price and the relative efficiency of each, given the technology. Or the computer may be a criminal. As a rational criminal, this computer considers the benefits and costs of various acts and chooses those crimes for which the benefits are highest and the costs (the likelihood of being caught and the extent of punishment) are least. Or the computer will determine the best possible characteristics of a potential spouse, weighing pleasure and pain.
It’s all about rational choice. In each case, the computer will generate a correct solution given the data. It will choose the optimum point that maximizes pleasure relative to pain or minimizes pain relative to pleasure. That’s the starting point and premise of neoclassical economics—that the individual will be rational and will choose the best solution possible in his self-interest. As Veblen put it, the individual is presumed to be “in stable equilibrium except for the buffets of the impinging forces that displace him in one direction or another.”
Now, the neoclassical economist doesn’t care what equilibrium the computer has generated. What interests the neoclassical economist is how the computer solution will change if one piece of data is changed. It is obvious that if you change the data fed into that computer, it will generate a different optimum solution. So, that is the principal question neoclassical economists pose: let us change the value of one variable and see what the new equilibrium will be. Significantly, neoclassical economists do not pose this as a process that occurs in real time. Rather, they just want to change one variable and to see what the lightning calculator of pleasure and pain would do. But this is not a process that occurs in time. Because in a real world if we did change variable X, this could affect variable Y, and a change in variable Y might affect variable Z or variable X itself (in other words, create a feedback process). In real time, there are always processes of interaction, but neoclassical economics is not considering a real process that occurs in real time. That is why the critical phrase used is “all other things equal” (or, in Latin, ceteris paribus). We change one bit of data and nothing else.
So, with that in mind, let’s think like a neoclassical economist. What happens if we raise the price of one consumer product? Well, obviously that increases the pain of purchasing that product, so the computer as consumer will generate a result in which less of that product is purchased and more of another. A new optimum solution is generated by the computer. Or let us raise the wage. The computer as capitalist, in comparison to the original situation, would choose to use a machine rather than a worker because the pain of hiring the worker has increased. Or let’s increase payments for welfare. The computer as worker chooses to go on welfare rather than to get a job. It’s all very simple. In every case, the question asked by neoclassical economic theory is what that individual, the instantaneous calculator of pleasure and pain, will choose in the second case compared to the first case. And the answer is self-evident. Given that the individual is an instantaneous calculator of pleasure and pain, he would make a different decision. If a potential particular pain is increased, choose less; if a potential particular pleasure is increased, choose more.
In fact, the answer is so self-evident that it is not necessary to derive the answer from any evidence. All the economists have to do is engage in a process of deduction: self-examination, self-interrogation. They ask, what would I do under the circumstances? Now, the economists know that they are rational. In other words, they know that rational persons like themselves act out of self-interest and only that. Indeed, neoclassical economists are particularly rational in this sense; that is, people who study neoclassical economics tend to be much more self-oriented and selfish than people who study in other fields.
Here, then, you have the basic wisdom of neoclassical economics, which serves as the basis and justification for neoliberal state policies. For example, if there’s unemployment insurance and the benefits are increased, the logical conclusion of neoclassical economics is that you’ll get more people who choose unemployment. So, the neoclassical economist says, “unemployment insurance causes unemployment.” The same economists also tell us that having programs in support of single mothers causes mothers to be single and need support. Or they’ll tell us that having welfare payments based on the number of children in a family—that is, the larger the number of children, the larger the payment—leads to increases in the number of children on welfare. In other words, increase the benefits and more people will choose to be single mothers on welfare. Or if you reduce the cost to individuals of healthcare and the cost of visits to doctors, people will go to the doctors and use hospitals more and the result will be significant increases in the cost of providing healthcare. Therefore, it is simple neoclassical economics that the way to reduce the cost of healthcare is by charging more for it. Clearly, the rational individual under these circumstances will choose health over sickness. Or they’ll tell us that if you raise the minimum wage, capitalists will hire fewer workers; so, raising the minimum wage produces unemployment. The thinking is pervasive. A neoclassical economist will tell you that seatbelt legislation is bad because, by reducing the risk of serious injury, more people will drive recklessly; thus, seatbelt legislation causes accidents.
Look at the policies that flow from neoclassical economics. Do you want to increase employment? Lower wages, reduce welfare payments, and reduce taxes on capital so it invests more? Do you want to lower the number of children growing up dependent upon welfare? Lower the payments to welfare mothers. Do you want to reduce the cost of healthcare? Increase the charge for healthcare. And, most of all, if you want anything good, reduce the interference of the state in the economy—except, and this tells us something about the real beliefs of the economists, the role of the police and the judiciary in enforcing property rights.
Certainly, you don’t try to solve the problem of poverty through state programs. For neoclassical economists, the way to solve poverty is by removing the state and letting the market work. And it’s by individuals making the right choices, for example, by investing in their education (beginning around age six, one economist said in a seminar at my university). If you try to help the poor, that will reduce their incentive. And it is not appropriate to engage in redistribution of income and wealth by taxing the rich to support the poor; this will lead both the rich and the poor to reduce their incentive. A cartoon on my office door for many years described this theory well. One frame said, “The way to give the rich more incentive is to give them more money”; the other frame said, “The way to give the poor more incentive is to give them less money”!
The message is clear: leave everything to those rational individuals. When you try to “do good” through the state, you just make everything worse. Rent controls? Housing shortage. Price controls for food? Starvation. In the strange world of “all other things equal,” by definition, there is only one answer: hands off, laissez-faire. And it is a strange world. Recall the proposition that unemployment insurance causes unemployment. The premise is that unemployment is the result of rational choice, that is, unemployment is voluntary. People are choosing not to have jobs. They just look like they’re out of work involuntarily. They may even think so themselves, but neoclassical economists know better. Unemployment is voluntary. If people wanted to work, they could get jobs by working for lower wages. But what if you’re a little skeptical and say, No, capitalists are firing and laying off workers! That doesn’t look very voluntary on the part of the workers. One neoclassical economist responded by saying that the employer has anticipated the worker’s choice. He anticipates that the worker would prefer to be fired than to work at a lower wage, and so the employer fires the worker “to the mutual satisfaction of both employee and employer.”
But how do we go from those isolated individual computers to talk about policy proposals at the level of a society? Well, those neoclassical economists just combine those computers, assuming that society is simply the sum of the isolated individuals within it. That’s what society is for them, the place where those computers can interact. It is where those isolated self-interested individuals come together for their mutual benefit. And that’s all society is! No one made this point better than former British prime minister Margaret Thatcher: “There’s no such thing as society. There are individual men and women and there are families.”
So that’s what happens in society according to the neoclassical economist. We move from a single rational computer to two rational computers, each attempting to maximize its self-interest, and they engage in exchange; they can specialize in a certain kind of activity and exchange. Just start everyone off with an “initial endowment” and let the trading begin (quickly, before there are any questions about the inequality of those initial endowments!). Each person gets what he or she wants from the other by showing that it is to the other’s advantage. As Adam Smith stated, “It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from regard to their own interest.” So each party to an exchange benefits or there wouldn’t be an exchange. Further, as long as people are free to engage in any exchange, they will be able to make the best possible exchange. For example, if a particular capitalist won’t pay a worker what she is worth, the worker can go elsewhere. So the result is that in a free market everyone will get what each deserves. John Bates Clark, a leading U.S. economist early in the last century, said it all very explicitly. He began his book, The Distribution of Wealth, by announcing:
It is the purpose of this work to show that the distribution of the income of society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates.
You get what you deserve. So don’t complain. If you don’t get very much, it’s because you are not worth very much. But it is the best you can do.
The result of the combination of these rational, self-seeking individuals, thus, is that everyone benefits. This is what Adam Smith called the “Invisible Hand.” It is the proposition that allows neoclassical economists to move from the rational individual to the rational society. It says, simply, that when an individual seeks his self-interest, he promotes the public good: “He is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” In other words, selfishness is good. Or, as Gordon Gecko said in Oliver Stone’s classic movie Wall Street: “Greed is good.”
Where did the invisible hand come from? For Adam Smith and many others at the time and after, the answer was clear: it came from God. A familiar view in the eighteenth century was that God created a world of economic harmony in which everyone benefits everyone else by following his own self-interest. That particular religious faith became economic faith, a secular religion, and a central part of that secular faith is that as long as there is no interference by the state, all will be well. As the U.S. economist John Kenneth Galbraith described this view, “In a state of bliss, there is no place for a Ministry of Bliss.”
Very simply, neoclassical economics is a justification of the existing society, with all of its inequality and injustice. Neoclassical economics serves as a justification of capitalism. But not because it talks about capitalism. Rather, that justification flows from its fundamental assumption that “if you can understand the smallest parts of the system in isolation from one another, then all you have to do is to put them together correctly in order to understand the whole.”6 Accordingly, since every unit acts rationally and maximizes self-interest, so also does society, the sum of the many ones. As Frédéric Bastiat, a nineteenth-century French economist, articulated this premise, “That which is right with regard to one person is also right with regard to society.”7 As long as all are free to choose, it is the best of all possible worlds.
True, there is a problem with the way neoclassical theory moves from the premise of a rational individual to the conclusion that the society is rational. As Keynes pointed out in a famous example, there is a significant fallacy in this inference. Any individual can decide to increase his savings and improve his future position. However, all individuals cannot. By lowering their consumption, they reduce aggregate spending and that leads to lower production, lower employment, and lower income for all. This is called the “paradox of thrift,” and it is a classic example of the “fallacy of composition,” the logical flaw in saying that what is true for one is necessarily true for all.
When people act as if the properties of the individual parts can be assumed to be the properties of the whole, the results can be quite different from their expectations. If one person stands up in a theater, he can see better. But if all people stand up? If one country devalues its currency, it can increase exports, reduce its imports and stimulate the economy. But if all countries devalue their currency? What happens if a country decides that it can be more competitive internationally by destroying trade unions and driving down the wages of workers? What happens if all competing countries do the same? One person goes to university in order to improve his chance at getting a job, but what if all people do? (Well, the answer is go to graduate school!) In this case, one writer commented, the value of your education depends not only on how much you have but also on how much the person ahead of you in the job line has.
In short, we can’t just add up the individuals. Because they are interdependent. And interdependence is pervasive in the real world, as are its effects, which can be seen most obviously in the crisis of our common home, the earth. In its theory, though, given that it begins with each rational individual only taking into account the things he has to pay for, neoclassical economics has some difficulty explaining how the rational choices of individuals can lead to irrational social outcomes. So, to the extent that it can, it sweeps results of interdependency offstage into a category called “externalities.” As it turns out, externalities are everywhere, and they are an anomaly for a theory that simply adds up individuals without taking into account their interdependence and interaction. So, the way neoclassical theorists deal with this in their work is by assuming that there are no interdependencies, no externalities, and if there are, they are trivial—minor, second-order effects that can be ignored without losing too much explanatory power. Unfortunately for the theory, this increasingly lacks any credibility, as we exist in a conjuncture marked by the crisis of the earth system.
By not beginning with the recognition of interdependence, neoclassical economics falsifies the nature of both parts and whole. Consider the following example of interdependency, which relates to the fallacy of composition. The idea comes from G. A. Cohen, a British Marxist philosopher, but I liked it so much I revised it and made it my own and introduced it in my first lectures for my Marxian economics class:
On the floor of a locked room in which there are ten people, there is a single heavy key. Anyone can pick up the key, go to the door, unlock it, and leave. But once that happens, no one else can get out. So, the question Cohen posed is: Are these people free? Each individual is free to pick up the key and leave. But it is a fallacy of composition to conclude from this that everyone can leave. Their freedom is conditional; it depends upon no one else exercising their freedom. Whatever happens, there will be nine people trapped in the room. Cohen used this example to talk about what he called the “structural unfreedom of the proletariat,” namely, how any worker could become a capitalist, but all workers couldn’t become capitalists (a point that Marx had earlier made in one of his many examples of the fallacy of composition).
But why in this case is it wrong to assume that what is true of an individual is true for the whole group? Because there is a constraint on the whole. It is a structural constraint upon the whole that doesn’t apply to any single individual. There is only one key. The particular interdependence of these people is given by the particular structure in which they exist, and their properties and characteristics flow from being parts of that particular whole. To describe and define those people accurately, they can’t be viewed as isolated atoms, as individual computers that can be added up. Can we talk about those individuals without first describing the society of which they are part? All we know about the individuals in the room at this point is that they are interdependent because of the external constraint. But surely there is more to say. We don’t know the particular structure in which they exist, that is, the society of which they are part. Is this a society characterized by equality? Are these individuals separate and self-seeking or do they know and care for each other? If, for example, there is a limited quantity of water in this locked room, surely the nature of social relations among those individuals matters. Are they atomistic individuals free to take what they want or are they functioning as members of a community? How can we understand anything without beginning with the whole and the nature of relations within that whole?
This is one way Marxian political economy differs from neoclassical economics. Rather than starting with individuals and markets, it begins with the nature of the system, a whole characterized by particular relations among parts of that whole. In particular, Capital’s focus was upon exploring capitalism as a system, upon analyzing the logic of capital and the dynamic tendencies that flow from the properties of that system.
Michael Lebowitz is professor emeritus of economics at Simon Fraser University in Vancouver, Canada, and the author of several books including The Socialist Imperative, The Contradictions of “Real Socialism” and The Socialist Alternative. He was Director, Program in Transformative Practice and Human Development, Centro Internacional Miranda, in Caracas, Venezuela, from 2006-2011.
This essay is a chapter in Michael A. Lebowitz’s latest book Between Capitalism and Community (New York, Monthly Review Press, 2021).