Economics canna change the laws of physics!

Behind such arguments lies a certain conception of the economy and society. In the seventeenth century Isaac Newton discovered the laws of the action of forces upon material bodies, known as classical mechanics.1 Just as Newton's mechanics spell out the laws of motion of objects, the reigning school of economics, known as neoclassical economics, imitates Newtonian mechanics to analyze human society.2 It sees each participant in the economy - each worker, peasant, big landowner, capitalist, and so on - as an independent actor. Each one acts on his/her own, striving to get the greatest possible satisfaction (termed his/her ‘utility'). Neoclassical theory claims human beings' actions throughout history have been (and will continue to be) driven by individual, selfish gain. Yet the sum of their strivings, pushing and pulling in different directions, brings about an ‘equilibrium', a state of balance, which yields the greatest sum of ‘utility' possible in the given conditions. (What exactly ‘utility' is, and how, if at all, it is to be compared, measured or added up, was never meaningfully defined.)

In this conception, every participant in the economy is, in a sense, a trader, and the forces driving the actions of all these individuals are fundamentally similar. It portrays each individual - worker, land-owner, industrialist - as possessing some resource: land, capital, or labour, which it calls ‘factors of production'. The worker hires out his labour; the landowner rents out his land; the capitalist gives the use of his capital. Each does so for a price (the price of hiring labour is wages; the price of hiring land is rent; and the price of hiring capital is the rate of interest).

That price, according to the reigning theory, is determined by supply and demand in each market. According to the proportions in which these three factors - land, labour, and capital - are available in a particular society, their prices automaticallyand simultaneouslysettle at some equilibrium which makes full use of all of them. Where capital is scarce and labour plentiful, interest rates would be high and wages low. In that case, it would be attractive to capitalists to employ less capital-intensive methods of production, that is, hire workers rather than buy machines. If any of the three resources lay idle, its price would fall till it was fully absorbed. Full employment is a central assumption of this theory.

However, say the neoclassicals, if prices are kept artificially low or high by outside intervention, all factors might not be employed fully: the gears become sticky, as it were, preventing the machine of the economy from running smoothly. For example, if wages were prevented from falling to ‘equilibrium' level by minimum wage laws, or by trade union action, capitalists would tend to buy machines that replace labour; and so some labour looking for work would remain unemployed. Thus unemployment, according to this theory, is the result of wages not being allowed to sink low enough.3

Price plays the key role in this theory. Price not only signals how much to use of each ‘factor of production', but also how much to produce of each commodity. Every consumer, whether worker, peasant, capitalist, or landlord, whatever his/her income, is driven by the same considerations. Each consumer chooses what to spend on in a way that gives him/her the greatest possible satisfaction (‘utility'). This sends the required signal to the producer on what and how much to produce. When demand for a commodity grows, some consumers would be willing to pay more for it, and its price would rise. The higher price makes it profitable for producers to produce more of the good, and its production rises (with the increased supply, the price then falls, and further adjustments take place up and down till it settles at some equilibrium level). Again, any ‘interference' with market forces is counter-productive: If the price of a good is kept artificially low (eg by price controls), it would deter capitalists from investing in producing that good, and hence it would remain in short supply.

This theory assumes that producers can shift their production seamlessly from one commodity to another. Each producer can adjust the quantity he/she produces. Each consumer too can shift his/her purchases from a given product to a substitute. No producer or consumer (or group of producers/consumers) can directly influence prices, since there is a large number of producers and consumers (if you price your goods higher than others, you will lose customers; if you price them lower, so will others, and you will not gain customers, but lose profits). Only when individuals increase or decrease their production or purchases do they affect prices, indirectly, by changing supply or demand. That is to say, perfect competition is assumed by the theory.

Nor could there ever be a shortage of demand in relation to production. The orthodox theory assumes that all that is left after consumption goes directly or indirectly toward investment. So the whole of income creates demand for what is produced.

The beauty of this theory is that, given the different quantities of land, capital and labour individuals possess, and their demand for different commodities, the laws of supply and demand work to deliver full employment and the maximum ‘utility' possible for consumers in the circumstances automatically. If a change takes place in the conditions - for example, if more land, or labour, or capital, becomes available - the system automatically adjusts its mix of the three to absorb fully all of them. Like a pendulum which, when pushed, rocks back and forth but ultimately comes to rest on its own, the equilibrium, when disturbed, gets restored automatically.

Some aspects of classical theory appeal to us because they correspond to ‘commonsense'. We all know that if something becomes scarce its price goes up. And we also easily accept the notion that people are fundamentally motivated by the desire for individual gain, and that this cannot be changed; after all, is that not what we see around us every day?

The obvious fact is that this theory serves to justify capitalism. It provides a justification for profit and rent - these are presented as just the prices of hiring capital and land. (The problem of where the capitalist's capital come from is not answered; it is assumed that he was thrifty, and saved it up.) And at any rate, whatever the distribution of wealth, unfettered capitalism is shown to maximise the use of resources of society; it maximises utility (whatever that means) in society; every participant in the economy makes individual, voluntary decisions - about how much to work, how to spend, and so on. Innate, immutable human nature (which, in its view, is greedy and selfish) is not suppressed, but harnessed; no section is oppressed, but a harmony of interests is automatically achieved. Any attempt to run counter to this system harms the interest of the whole of society.