Political Economist

1. Discuss the concept of productive labor in Smith. Why is the concept introduced? What is the characteristic structure of the argument? What are some implications of the concept? What arenas, if any, do you think it might apply to in the modern world?

The concept of productive labor and its differentiation from unproductive labor has an important meaning in most classical political economists. Even though, Ricardo did not use this term, it is certain that he also adopted the same notion. Furthermore, it is well-known that Marx tried to reconstruct the concept of productive labor in his major critique of political economics works.

Firstly, Smith distinguished productive labor from unproductive labor. The distinction between the two has nothing to do with moral judgement in the first place. This implies that labor which is not directly associated to material production, such as sales labor, military service, and government officials use up the wealth of scarcity.

Smith provided some examples for this labor. According to him, the sovereign with officers of justice and war who serve him, public servants, those who are engaged in the protection, security and defense of the commonwealth, churchmen, lawyers, physicians, players, buffoons, musicians, actor, etc., do not add to the value of the materials. Even though, their labor deserves to be rewarded, their labors do not fix or realize themselves in some particular subject or commodity. Rather, their labor products perish in the very instant of their performance. In this sense, they are maintained by the annual produce of the industry of other people.

The reason why Smith introduced this distinction between productive labor and unproductive labor can be traced back to his main theoretical concerns. According to Ronald Meek’s explanation, Smith, like contemporary economists, regarded the accumulation of capital as the basic cause of the increase of wealth, and therefore, his theoretical systems were primarily designed to illustrate the nature, causes and effect of capital accumulation. While doing so, Smith criticized and attacked certain socio-political institutions and attitudes hindered and discouraged the effective accumulation of capital, the general increase of the wealth of nations. (R. Meek, “Ricardo and the Labor Theory,” Studies in the Labor Theory of Value)

This distinction between productive and unproductive labor is also implicit in Ricardo’s works, even though he did not use these terms. Considering his theory of rent, especially where he dealt with different distribution of value into different social classes, and his passionate advocate of import of cheap corn from other European countries, Ricardo can also be considered a theorist who drew distinction between the two.

Another interesting point related to this concept is that modern neoclassical economists also have similar distinction between productive labor and nonproductive labor. However, contrary to Smith, their concept of nonproductive labor is only the thing that is oriented to non-market system. This means that all labors which produce certain amount of incomes (not values) are considered to be productive labor. This neoclassical conceptualization of (non-) productive labor seems to fails to understand the nature and cause of value, which had been a central issue or theme in classical political economy.

Finally, we can think of some implications of the distinction between productive labor and unproductive labor. To apply Smith’s notion to modern world, every politicians, government officials, and those who are mot engaged in direct material production, can be described to be nonproductive labor, even though they produce specific utilities for social community. Even though, it is impossible to apply this concept to complicated modern economic world without any modification, the very notion, point of which the only labor directly engaged in material production, may be used as a sort of parameter to which social scientists including economists estimate the social significance and utility of each occupation.

In summary, the concept of (non-) productive labor played a significant role in Smith’s theoretical framework. With this concept and distinction, he was able to reveal the nature and causes of the wealth of nations.  With this concept, he was able to justify the need for the accumulation of capital, and attack certain social institutions which hindered the increase of the wealth of nations.

2. What is meant by ‘value in use’ and ‘value in exchange’? What factors regulate each?

The concept of value has significant meanings in classical political economy. Major classical political economists, such as Smith, Ricardo, and even Marx, started their respective theory with this concept.

To begin with, to Smith, the word value has two different meanings: one is the utilities of some particular objects, and the other is the power of purchasing other goods which the possession of that object conveys. The one is called ‘value in use’ and the other, ‘value in exchange’. According to Smith, the commodities or goods which have the greatest value in exchange have frequently little or not value in use. Smith gave an example for this distinction with water and diamond respectively. (A. Smith, The Wealth of Nations, Book 1: Chapter 4)

Like Smith, Ricardo also drew a sharp line between value in use and value in exchange (exchangeable value). The exchangeable value has the same meaning as ‘exchange rate of other commodity’ and ‘exchanging power’ of particular commodity. If particular commodity can be exchanged on the market, it has to have utilities which satisfy social needs. Ricardo pointed out that commodities which were use value derived their exchange value from following two sources: scarcity and quantity of labor requited for its production.

According to him, exchange value which is determined by its scarcity can only forms a small part of masses of commodities. For example, the quantities of scarce paintings, picture, stamps, statues, and rare wines which can only be produced specific regions of the earth are highly limited, and their value is not influenced by quantity of labor requisite for their production. Utilities are not the measure of exchange value, although they are essential to it.

On the contrary, exchanges value which are determined by the quantity of labor required to obtain them form vast bulk of commodities. The value of these commodities is dependent on the relative quantity of labor which is necessary for their production. In other words, the quantity of labor embodied in commodities regulates their exchangeable value. (D. Ricardo, The Principles of Political Economy and Taxation: Chapter 1 On Value)

With this distinction, Smith and Ricardo explore the determinants of exchange value. If vast bulk of commodities or goods have exchange value, and they are actually exchanged with each other on the market, what kind of rule regulate their relative value of commodities? And what is the underlying principle which regulates market price? What’s the relationship between price and value? Smith and Ricardo tried to deal with these questions in their respective works. Whatever their concrete answers may be, their common theoretical questions would be called the rudimentary ‘labor theory of value’.

To sum up, the concept of value and the distinction between value in use and value in exchange dwell on the center of classical political economists. With this distinction, they were able to develop their researches to the general principle which regulate the relationship between value and labor, the source of income, different components of income, and their relative distribution.

3. What are the sources of profit and rents? What are the conflicting arguments in Smith, and where does Ricardo stand on the matter? What is the significance of this issue?

The theory of profit was a central issue in Smith’s classical political economy. Smith was the first who appreciate the existence of profits and rent, and accordingly the existence of conflicting social classes. In order to understand his argument on ‘class income’, it is necessary to introduce his basic notion of labor theory of value.

Smith started from ‘early and rude state of society’ where there is no accumulation of capital, no appropriation of land, and thus no profits and rents  in order to develop his theory of value and price. In this imaginary society, competition among producers resulted in equalizing net incomes among them. Smith provided the relationship between beaver production and deer production for examples to illustrate this point. Consequently, incomes become proportional to producers’ labor time in this society. The determination of exchange value by the relative labor time required to its production is the gist of labor theory of value.

Smith went further in order to examine the possibilities of modification of this principle, when modern capitalist production relation was prevailed. According to him, in the more developed situation, there started to be profits and rents because there is ‘stock’ of means of production owned by non-producers. Smith asserted that due to the existence of profit and rent, the rule which was held in rude and early state of society can no long hold.

Ricardo started his theory of value criticizing Smith’s value theory. According to him, even though there are accumulation of stock and appropriation of land, the rule is not necessarily modified. The exchange value of commodities, the relative value of commodities is determined by the relative quantity of labor required for its production. Ricardo pointed out the same logic could also be applied to the rent.

In this sense, the introduction of profit and the appreciation of the existence is a critical point with which reader can differentiate Smith from Ricardo. Even though they shared theory of labor value in common, Smith abandoned his theory on account of the existence of profit and rent.

However, both Smith and Ricardo seemed to fail to understand the nature of profit. They regarded it as a category of income. But they failed to provide scientific explanation of the origin and distribution mechanism of profit and rents.

4. How does accumulation affect the level of the rate of profit over time? What accounts for these changes, and what are some of their implications?

5. How and why does the consideration of equal profit rates alter the relation between the relative price of two commodities and the relative total labor times required for their production?

6. What is meant by Smith’s argument that labor is “the fund which originally supplies all necessaries and conveniences of life?” Does this ignore capital? Land?

Part 1. Three main approaches to economic growth

Most advanced countries have experienced rapid economic growth measured in GDP per capita after the World War 2, especially after the 1960s. Regarding the causes or reasons for this economic growth, three different types of economists provided us with answers.

Firstly, neoclassical economists argue that the determinants of rapid economic growth in most advanced countries are availability of production factors such as capital and effective supply of labor and technological progress. According to the Solow model, which paved the foundations for modern ‘neoclassical synthesis’ of economic growth theory, the aggregate (output per capita) is the function of the combination of capital and labor, or the combination of capital and ‘effective supply of labor’ in its intensive form with ‘technical change.’ In other words, Solow and other neoclassical economists proclaims that economic growth can be attained through increases in capital accumulation with appropriate growth rate of the population which will constitute the labor supply.

With this kind of model, neoclassical economist was able to argue that economic growth can be achieved at a balanced growth path. Unlike previous Harrod-Domar’s unstable growth pattern, neoclassical theory presupposes that there would not be any turbulent business cycle and crisis. In their original perspective, there is no room for economic crisis or unstable growth pattern.

Thus if there is any such a kind of instability, this is easily attributed to the effects of exogenous factors such as state intervention, particular social institution. In this way, neoclassical economists described economic growth as a function of capital and labor based on their smooth possibility of substitution and argued smooth convergence to general equilibrium.

Unlike neoclassical economists, Keynesian economists admit the possibility of the lack of availability of labor supply. In their perspective, equilibrium condition, which can be summarized as a point where aggregate demand and aggregate supply meets, can only be achieved by accident. In most cases, capitalist economic growth is always accompanied by disequilibrium of demand and supply.

Based on this notion, and based on empirical observations of the 1930s’ Great Depression, Keynesian economists formulated the positive role of the government in enhancing aggregate demand/effective demand. By increasing government spending, an economy can achieve the increase in the effective demand, and this in turn leads to the increased level of consumption and investment, which constitute aggregate supply. This approach and its related policies adopted by the government resulted in real recovery of economic growth. Thus Keynesian economics was able to take a dominant position in modern macroeconomics.

Contrast to both neoclassical and Keynesian economists, classical Marxian political economy shows quite different visions of economic reality. Firstly, Marxian economics does not presuppose the lack of factor availability. The capitalist system itself produces endogenously the pool of labor supply. Marx himself called this pool of labor as ‘reserve army of labor’ which is determined by the capital accumulation process. Thus, if there is any kind of economic crisis, this is not due to the lack of labor supply. Instead, this economic crisis is originated from the capital accumulation process.

Another distinctive line between Marxian approach and both neoclassical and Keynesian theorists lies in its treatment of technical changes. As we already saw, neoclassical economists treated technical changes as neutral or exogenous variable which affects on the increase of ‘effective labor supply.’ In his original growth model, Solow regarded ‘technical change’ as various factors which influence the productivity of labor. Even though, he admitted the fact that the increase in the GDP, he left the determinants and directions of the technical changes unsolved. To use his own term, the ‘total factor productivity growth’ was not analyzed in his model.

Later neoclassical economists, admittedly, tried to incorporate the role of technical change in their growth model (‘endogenous growth model’). However, they still fail to explain why technological progress is made and how this progress is closely related to capital accumulation.

Unlike neoclassical economists, Marxian approach regards technical changes as necessary condition for capital accumulation and appropriation of the profit. According to Marx, individual capitals have to reduce the unit labor cost in order not to be defeated by competitions in capitalist market system. With the introduction of technical changes, capital can increase the labor productivity, and this in turn leads to increase in the amount of profit share for the capital. If profitability is the driving force of capital accumulation, and the capital accumulation is the unique source of economic growth, at least in capitalist economic system, the technical changes and any other types of factors which might affect the production process and organization of labor can be reduced or incorporated systematically into the profitability of capital.

In this way, Marxian theory explains the dynamics of economic growth, capital accumulation and the rate of technical changes. As already anticipated, economic crisis comes from profitability. Marx attributed this crisis of profitability to the intrinsic logic of capital accumulation.

Part 2. Three main theoretical approaches to unemployment

Unemployment rate, which is the ratio of the number of unemployed people to total number of active labor force, varies from countries to countries, from periods to periods.

With respect to the determinants of unemployment level, neoclassical economists have tried to argue that there is only one types of unemployment; natural rate of unemployment or voluntary unemployment. According to them, natural rate of unemployment is the concept which describes the rate necessary and natural for ‘search unemployment’ and ‘wait unemployment.’ Because market economy is in its equilibrium condition, full-employment is already presupposed in neoclassical economics. Thus, the term ‘natural rate of unemployment’ is the normal unemployment which occurs naturally under fully employed situations in order for finding a new job (search unemployment) and waiting for better wage terms (wait unemployment).

Thus, in principle, there is no room for excessive high unemployment level and historical changes in the rate of unemployment in neoclassical economics. If there is any sudden change in the natural rate of unemployment, this might be attributed to the adjustment process of an economy to an new equilibrium, or due to external factors such as excessive government spending, etc.

Unlike neoclassical economics, Keynesian economics admits the possibility that there may be high unemployment rate. In their perspective, the equilibrium condition of an economy is not automatic. Thus Keynesian economists argue that proper state intervention through fiscal and monetary policies is necessary in order to achieve effective demand. For them, high unemployment rate and historical change of the rates are good symptoms of economic disequilibria and thus the signal for necessary government policies.

However, both neoclassical and Keynesian economists share the belief of the existence of equilibrium in common. The only difference between them is the extent and time of adjustment, and the necessary means to achieve the general equilibrium. Contrast to these theories, Marxian theory regards the unemployment as a byproduct of capital accumulation. According to Marx, capital accumulation can only achieved through profit gain. Thus investment decisions of the firms and the saving rates are all dependent variables of profitability. In this connection, extraordinary increase in the level of unemployment and reduction of unemployment are all possible in capitalist economy. The points of these whole processes are that these phenomena are dependent on capitals’ profitability.

Secondly, technical change is also determined by profitability. In order to defeat competitors on the market competition, it is necessary for individual firms to introduce new technologies in their production process. This introduction might increase the unemployment rates. However, this can also result in the increased number of employees. In other words, technical change or the introduction of new technologies itself does not determine the level or rate of unemployment. Once again, the level of unemployment is determined not by technical change but by profit gain for capital.

In this connection, the treatment of technical change by neoclassical economists is radically different from Marxian approach. They attribute the rate of unemployment to the technical change in a given condition.

Finally, both neoclassical and Keynesian economists argue that unemployment is negatively related to inflation rate.

Draft of Presentation on Ricardo and Foreign Trade

Background:

1)                  Ricardo states that relative prices are determined by relative labor times

2)                  Theory of money: a country with a trade surplus has gold inflows which cause a rise in all commodity prices
A country with a trade deficit has a gold outflow which a decrease in the general price level

3)                  Absolute advantage: a country can produce a commodity cheaper than another country.
Comparative advantage is a countries ability to produce certain goods efficiently to another country even if that other country produces the good more efficiently.
The comparative advantage is the motive of foreign trade.

Ricardo’s theory in Chapter VII:

Balanced trade

Portugal has an absolute advantage in both, England has a comparative advantage in cloth. Portugal will export wine and import cloth, England will import wine and export cloth.

England exchanges a produce of the labor of 100 men for the produce of the labor of 80 men. This would not be possible in domestic exchange, however it is possible in foreign trade because of the immobility of capital and labor.

“The same rule which regulates the relative value of commodities in one country does not regulate the relative value of the commodities exchanged between two more countries.” (p. 99)

At this point Ricardo abandons the labor theory of value.

Trade will only take place if the commodity produced can be sold for more money abroad than at home.

Assume:

England gains 5 ₤ from selling cloth to Portugal, and Portugal gains 5 ₤ from selling wine to England. There are no international money (gold) flows.

Now assume that there is an improvement in England so that the price of English wine is 45 ₤. Consequently, England will only export cloth but cease to import wine. Portugal only imports cloth but does not export wine any more. There are gold flows from Portugal to England. As a result prices in England increase and prices in Portugal decrease, until the point where Portugal will start to export again.

Foreign trade will not affect necessarily profits, unless the import of commodities affects domestic wages. For example: If corn can be imported cheaper than produced domestically wages will fall.

“Foreign trade and the Law of Value”

Shaikh’s main points:

1)      Intention to redevelop/ discover Marx’s theory on foreign trade

2)      There are benefits from trade but not necessarily for the nation as a whole. Trade is undertaken by individual capitalists who engage in trade because they are able to increase their profits through foreign trade. Hence, individuals benefit not the community.

3)      Neoclassical versus Ricardian theory: different theory of price but similar theory of money. Both believe that foreign trade will be to the benefit of every nation involved.

4)      Modern theory of trade as explained in Hecksher-Ohlin model: assumptions: full utilization of resources, same production technologies across regions, same demand across regions. Thus the only difference that remains is the different endowment in capital and labor. Countries with abundance in capital will export capital intensive goods and countries with a large labor force will export labor-intensive goods. Consequently, factor prices are equalized. This mechanism corresponds to Ricardo’s price adjustments through gold flows.

5)      Shaikh: under an independent monetary system the depreciation and the appreciation of the exchange rates have the same effect as Ricardo’s outflow and inflow of gold.

6)      3 orthodox critiques of Ricardo:

a)      Keynsians: accept Ricardo’s general principles of trade but seek to modify it to some extent.

b)      Leontief and Chenery give empirical evidence against the Hecksher-Ohlin model

c)      Argument that Ricardo’s law of trade s correct in principle but that it no longer holds today (government intervention, demise of competition, demise of old standard, loss of wage and price flexibility)

7)      Marxist critiques

accept Ricardo’s conclusion that the law of value regulates exchange within a country but not trade between countries. They accept the law of comparative cost as valid on its own grounds. Emanuel however argues that today capital has become mobile. Hence, the Ricardian model is no longer applicable because profit rates equalize across sectors and, consequently, profit rates in underdeveloped regions will be lowered and profit rates in developed regions will increase.

8)      Shaikh’s conclusion: In Marx’s logic law of comparative advantage is not valid. The developed country will not specialize in the export of one good but will export both. The underdeveloped country will end up with a trade deficit. Hence, “free trade will ensure that the underdeveloped capitalist regions will either have to confine their import needs to the low levels supported by exports, or else they will be chronically in deficit and perpetually in debt” (p.301). FDI might offset the trade deficit but “at the expense of destroying native industries, blocking the development of the indigenous forces of production, undermining the terms of trade, and generating corresponding capital outflows”.

3. The Role of Foreign Trade in the Development of the Third World Economies

What is the role of foreign trade in the development of an economy? Does foreign trade increase the wealth of nations? Since Smith and Ricardo, these questions have been among the most critical issues in development economics. Most mainstream economists as well as international monetary organizations such as the IMF and World Bank claim that foreign trade will surely be beneficial to both countries which are engaged in international trade. However, ‘critical’ economists have pointed out that there will be ‘unequal exchange’ between the ‘center’ and ‘peripheral’ countries in the capitalist system, not to mention the huge income inequality among nations.

In order to understand these conflicting notions of the effect of international trade, it seems appropriate to introduce Ricardo’s viewpoint on this issue, because it was Ricardo who originally paved the way of thinking regarding foreign trade, like other economic issues.

In the first place, Ricardo deals with the significant role of foreign trade in the context of the critique of landlords’ unproductive consumption of the wealth which was produced by the employment of capital. According to him, productive capital, which is identified with the wealth of nations and the development of national economy, can be accumulated either by the increase of revenues or by the diminished expenditure of capital. If cheap corn or other subsistence for laborers were imported from other countries through foreign trade, the rents of the landlords and the wages of laborers would fall, and thus the profit of capital would naturally increase. This is why Ricardo argued that the Corn Law, which was preventing import of corn from foreign countries, should be abolished.

However, Ricardo goes one step further, contending that absolute mutual benefits will be achieved from foreign trade. He asserts that it will employ or distribute capital and labor effectively, and increase the variety, and the absolute amount of commodities which will be purchased by laborers. He believes that under the system of free commerce, each country naturally will devote its capital and labor to the employments that are most beneficial to itself, and this pursuit of individual advantage will result in the universal good of the whole.

Of course, Ricardo admits that there might be different production conditions, and thus the natural prices of particular commodities might vary from country to country. But this advocate of the labor theory of value does not pay attention to this kind of ‘unequal exchange.’ He alleges that the rule which has been regulating the relative value of commodities in one country does not “regulate the relative value of the commodities which are exchanged between two or more countries.”(Ricardo 1963: p.70)

Instead, Ricardo introduces the so-called ‘quantity theory of money,’ which is totally different from his previous labor theory of value. According to him, if two countries, e.g. England and Portugal, which have different production conditions, and thus have different prices of two commodities, started to exchange their relatively advantageous commodities, the money would flow from one country (England) into other country (Portugal) which has absolute advantage in both production sectors. This money inflow would, in the long run, raise the general price of all commodities in Portugal. On the other hand, the diminution of money in England would cause the general rise of commodity prices there. If these transactions continued, the increased price level in Portugal would result in its loss of the absolute advantage in both sectors, and simultaneously bring about the gain of absolute advantage in England. With this kind of description, Ricardo claims that even though their initial economic situations were different, both countries would gain benefits from foreign trade.

In this connection, modern orthodox neoclassical economists seem to share Ricardo’s notion when dealing with the issue. They claim that the open market and free trade under ‘globalization’ will bring about various economic opportunities for most new industrializing countries to catch up with the now developed capitalist countries. In order to propagate this kind of belief, they assume that every government in the developing countries engaging in foreign trade would coordinate its ‘factor endowments’ (capital, labor, and natural resources) to an optimal condition. If ‘production possibilities’ and ‘consumption preferences’ were the same in all countries regardless of the economic development stages, they claim that the only difference between them would be the different technology utilization. Thus, if the only problem were the technology, this technological divide would be easily overcome through the technological ‘spill-over effect’ derived from international trade.

However, this Ricardian idea of foreign trade does not explain the antagonistic capital and labor relations inherent in the capitalist production process. Even though we admit that foreign trade would give rise to a certain amount of profits or gains in developing countries, considering the fact that the trade is undertaken by the owner of capital, most of the benefit from international trade will belong to the capitalists, and will not contribute to the general increase of national wealth. Some may argue that the increase in the volume of national capital provides domestic workers with much more employment opportunities than before. However, this employment-generating (‘job creating’) effect has usually been accompanied by the central government’s macro-economic intervention in the resource allocation process, which certainly resulted in brutal oppression of the labor sector, and an authoritarian state-civil society relation as frequently shown under Third World military regimes. These kinds of military dictatorships have been typical phenomena in most Third World countries which became independent from imperialist colonization after the Second World War.

Secondly, neoclassical economists’ notion of the mutually beneficial effect of international trade fails to explain the problem of the high rate of foreign debt in Third World countries. They are suffering from chronic international debt directly originating from international trade. The Third World countries, which have traditionally been engaged in agriculture, have to export their raw materials such as crude oil, cotton and wood, and various kinds of primary products in order to earn international standard currency.

Sometimes, governments in the periphery of the world capitalist system have tried to borrow huge amounts of money from international monetary organizations such as the IMF (International Monetary Fund), World Bank and ADB (Asia Development Bank) in order to invest in domestic industrial sectors. However, the more they export their primary products, the more they have to face the cold economic reality, i.e., a chronic trade deficit and a huge economic development divide. Sometimes, they have adopted to issue their domestic currency much more than necessary as a last resort in the hope of paying foreign debt because if they maintained expensive domestic currency compared to the dollar or pound sterling, they could buy dollars or pounds sterling with the increased volume of their domestic currency. However, this policy has resulted in the hyper-inflation and low investment rates instead of reducing foreign debt. This circulatory movement between huge foreign debts and domestic financial catastrophe has been among the most typical aspects of most Latin American countries especially after the 1970s’ oil shock. Thus, unlike the rosy fantasy of neo-liberal globalization, the optimal endowment of production factors, namely the effective employment of capital and labor, and the specialization of industry, remains far remote from reality.

Finally, although foreign direct/indirect capital investment can provide developing countries with opportunities to modernize their management skills and to follow up new technologies, these processes can only be achieved at the huge expense of destroying national industries, undermining the potential of endogenous development of production and thus increasing the rate of the ‘industrial reserve army’ (high unemployment rate). Furthermore, recent experiences of financial crisis in Latin America and East Asian countries showed that drastic financial capital volatility seeking short-term arbitrage on the stock market and the international junk bond market would devastate national economies.

Even though there are a lot of theoretical debates on the real causes of cyclic financial crises in Latin America and Asian countries, and even though I admit that many non-Western countries are suffering from non-transparent corporate governance and underdeveloped financial market system, cyclic financial crises cannot be attributed to those problems. As most Western scholars and economists asserted until the Asian Financial Crisis of 1997-98, the secret of East Asian ‘economic miracle’ was mainly due to an effective bureaucratic resource allocation mechanism in both government and corporations. Then how and why can the same economic pattern or system be the fundamental reason for an economic miracle in the one hand, and be designated as the typical chronic mal-functional tradition in the corporate management on the other? In short, the real causes behind the financial crises in the Third World countries lie in the drastic financial capital flight seeking temporary interests and profit-gain. Thus, international trade, in this case unregulated financial capital movements, would not reduce the economic inequality among regions but generate chronic instability of economic ‘fundamentals.’

In conclusion, unlike the Ricardian perspectives, I believe that so-called ‘trade balance’ and ‘optimal allocation of resources’ cannot be achieved naturally from international trade. Foreign trade, in most cases, is accompanied by huge amount of trade deficit, unequal and uneven development, and domestic income inequality. Thus contrast to the dominant notion of neo-liberal orthodox economists, I maintain that we should still pay due attention to the proper role of government or other non-market systems such as NGOs in civil society in order to develop sustainable economic patterns and reduce prevailing poverty in the Third World countries. While doing so, it seems necessary for us to examine concrete economic developmental processes and strategies of individual countries in historical and comparative perspective.

References

Ha-Joon, Chang. Kicking Away the Ladder: Development Strategy in Historical

Perspective, Cambridge: Anthem Press, 2002

Ricardo, David. The Principles of Political Economy and Taxation, ed. by R.D. Irwin,

Illinois: Homewood Press, 1963, pp.67-76.

Shaikh, Anwar. “Foreign Trade and the Law of Value: Part Ⅰ.” Science and Society,

Fall 1979, pp.281-302.

----------------. “Foreign Trade and the Law of Value: Part Ⅱ.” Science and Society,

Spring 1980, pp.47-57.

Vernengo, Martias. “Globalization and endogenous fiscal crisis: theory and

experience of Latin America.” Nov. 11th 2004. Center for Economic Policy Analysis

conference paper.

2. Review of David Ricardo’s Theory of Value

Since Adam Smith, to what extent the theory of value has empirical validity in economic analysis had been a hot issue among (various) political economists. (As we already know,) modern ‘neo’-classical economists adopted their basic concepts and categories from Smith, and it is well known that concepts such as ‘perfect market competition’ and the conceptualization of the market as an ‘optimal allocation mechanism’ or ‘autonomous order’ basically originated from Smith’s troublesome ‘invisible hand.’

However, orthodox economists dismissed classical labor theory of value which was one of the most significant contributions of Adam Smith to the development of modern economics. In order to understand the history of economic thought, it is necessary for us to follow (in every detail) how Smith’s labor theory of value is developed by later political economists. In this context, we should pay due attention to David Ricardo’s critique of Smith’s notion and his original theme.

Ricardo developed his own theory of value in his path-breaking book, The Principles of Political Economy and Taxation, especially in chapter 1, “On Value.” Like Smith, Ricardo reveals that the value of a particular commodity, to whatever production sectors it may belong, is determined by the relative quantity of labor which is bestowed on its production. He also succeeds in pointing out the opaque fact that ‘market values’ are ultimately regulated by a commodity’s ‘natural price.’

To some extent, these findings are not unique to Ricardo: it was Smith who laid the foundation for classical theory of value, and paved the way for the distinction between market prices and natural prices. However, Smith abandoned his original intuition – the value of the commodity depends on the quantity of labor bestowed on its production compared to that of other commodities, and it can be measured and expressed by the natural price via fluctuation of market prices on the market –, considering the situation where the accumulation of stock and the appropriation of land occurred. He contended that his labor theory of value could only be applied to ‘the rude and early state of society’ where there was neither accumulation of stock, nor concentration of land in the hands of individuals.

That is why Smith has erected himself another standard of measure of value, and speaks of things such as ‘corn’ and ‘labor quantity’ which command other commodities in the market, and finally gold and silver as an invariable medium for exchange. However, corn and labor themselves are not invariable media for exchange as gold and silver. All of them are subject to fluctuations from the change of price level of corn, which is influenced by various factors such as abundant or scanty harvest, import of cheap corn from foreign countries, etc., from the changing cost of laborers’ subsistence mainly due to the changes in the price of corn, and finally from the discovery of new and more abundant mines which affects the natural price of gold and silver.

Ricardo admits that the theory of labor value is somewhat modified by the accumulation of capital stock (introduction of machinery, i.e. ‘fixed capital’ and its ‘unequal durability’), and the existence of rents for landlords. But this ‘variation’ does not mean that the principle must lose theoretical validity in depicting the mechanism of capitalist production. Rather, he points out that even though the value of a commodity has to be divided into wages of labor and profit for capital (or rent for landlord), the basic rule that the relative value of a commodity is determined by the relative labor time required for its production continues the same.

Ricardo also concludes that whatever inequality there might be in laborers’ dexterity, whatever different durability of fixed capital might be in various capitals which competes with each other in a particular production sector and market, this principle remains the same. Furthermore, drastic changes in the price of gold (money), general improvement of machinery, and finally general increases in labor productivity will not change the proportion between the different rates of wages and profits, because these changes, though they affect the general rates both of wages and profit, will in the end affect them equally.

In this way, Ricardo was able to develop classical labor theory of value. In fact, Ricardo’s theory started from the very point where Smith ended or abandoned his ‘primitive’ theory of value. While Smith concluded that the validity of the labor theory of value would no longer hold due to the introduction of ‘employment of capital’ and ‘concentration of land,’ namely due to the very existence of social classes, Ricardo pointed out that in spite of the existence of social classes, and thus regardless of the distribution of aggregate incomes into different social classes, i.e. wages of labor, profit of capital and rent of landlord, the relative value of a commodity would still be determined by the relative quantity of labor bestowed on its production. This is the original contribution of Ricardo in the development of value theory in classical political economy. The rest of Ricardo’s book is wholly dedicated to the application of this principle to various economic phenomena such as the genesis of the rent of land, the introduction of tax and its different forms, etc.

Of course, there is a critical point or dead angle where Ricardo’s analysis starts to no longer hold. He failed to explain the nature and role of foreign trade. Unlike Smith and Marx, he asserted that foreign trade would give rise to mutual benefits to both countries (which participated in international trade.) In order to claim the beneficial effects of foreign trade, he introduced different theoretical resources in the name of ‘quantity theory of money’ which radically differed from the labor theory of value we have dealt with until now. This was the point where Karl Marx started to develop his ‘critique’ of political economy. Considering this whole theoretical developmental process, especially focusing on continuity and discontinuity among classical political economists, it is not at all surprising to find that Marx begins his major economic works by analyzing the characteristics of commodity and money, not by discussing capital as such, even though his primary and ultimate theoretical concern was to reveal the law of motion of capital.

At any rate, with respect to the theory of value, Ricardo has demonstrated to the validity of the classical labor theory of value, criticizing Smith’s theoretical oscillation. Even though he leaves some fundamental concepts, such as ‘fixed capital’, ‘circulating capital’, and their relationships unexamined, and even though he fails to elucidate in detail the category of ‘different durability of capital’ and its considerable effect on the extent of variation of labor value theory, his strong arguments are persuasive, and thus are worthy of attention, especially from those who are interested in the history of economic thought.

Research Note on Classical Political Economy

1. Adam Smith’s Theoretical Contributions to Classical Political Economy

The history of economics can be traced back to Plato and Aristotle, who tried to theorize the economic foundations for viable and socially desirable political communities. However, no one can deny that modern economics started with Adam Smith, because it was he who perceived modern capitalist economy as a dynamic system which was divided by social classes in conflict, and which had intrinsic tendencies toward continuous expansion. In this short essay, I would like to address the main theoretical contributions of Adam Smith to the development of classical political economy.

First of all, Adam Smith introduced systematic approaches to modern economic phenomena. He treated the introduction of the relationship between capital and labor as a totally new one in human economic history, and believed the division of labor in the process of production, with which he began his An Inquiry into the Nature and Causes of the Wealth of Nations, opened new era in the realm of modern economy. In order to grasp underlying principles in modern capitalist market economy, he examined the history of the introduction of money into the market.

Regarding this phenomenon, Smith raised the following questions: How can different goods and products which have different shapes and utilities be exchanged with each other on the market? How can we measure the value of various products in terms of money? At what point, and how can the price of goods be determined? While trying to answer these questions, Smith differentiated use value (‘value in use’) from exchange value (‘value in exchange’), ‘natural prices’ from ‘market prices’. With the help of Smith’s logical and genealogical inquiries, his theoretical successors such as David Ricardo and Karl Marx developed their own theoretical frameworks. From this perspective, Adam Smith can be justifiably regarded as the founder of classical political economy (Dobb, 1972, pp.53-54).

Smith is also the inventor of the ‘theory of labor value’ which was developed into the ‘theory of surplus value’ by other classical political economists. The main concept of the theory is that only labor can produce the value of a commodity. Without human labor, Mother Nature can only be either an alienated object or wild external threats to human existence. Only with the help of laborers’ productive activity can we buy and sell specific commodities and services on the market.

It was Smith who emphasized the significance of human labor in the production processes. While doing so, Smith also drew a sharp line between ‘wage’ and ‘profit’, between ‘profit’ and ‘rent’. With these distinctions, he revealed the secret sources of the modern concept of profit, which had been previously identified with other types of incomes (Meek, 1967, esp. pp.19-22). According to Smith, the source of an employer’s profit is originated from the employees’ productive labor. The profit is not at all a reward for the direction and/or inspection labor of the capitalist (Smith, 1999: Book Ⅰ, Ch. Ⅵ, p.151). In this very point, we can say that he was the inventor of the labor theory of value, and succeeded in providing us with systematic approaches to modern economic phenomena.

Finally, Adam Smith viewed the modern capitalist market as a continuously expanding economic system. Modern capitalist economy, according to his explanation, has tendencies toward unlimited expansion. Not surprisingly, the basic motive behind capital accumulation lies in capital’s insatiable instinct to amass profit. With the help of technological innovations – it was mainly the introduction of new machinery in Smith’s age –, and with the help of increased labor productivity based on the division of labor, capitalists can accumulate capitals continuously (Smith, 1999: Book Ⅰ, Ch.Ⅰ; Book Ⅱ, Ch. Ⅲ).

The only constraint on capital accumulation is associated with ‘equalization of the rate of profits’ in various production sectors which was forced by ‘market competition’ (Smith, 1999: Book Ⅰ, Ch.Ⅴ-Ⅶ). To put it in modern terms, Smith regarded competition in the market as the driving force of ‘effective resource allocation mechanism’ or ‘equilibrium condition for prices’, because he thought individual economic agents (i.e., laborers, capitalists and even landlords) could withdraw from or invest in particular production sectors their relative capital stock or land due to the existence of market competition. Upon this notion modern neoclassical economists laid their own economic doctrines or sacrosanct presuppositions such as ‘perfect market competition’, ‘transparency of market’ and ‘individual economic agents as utility maximizers’ and so on (For comparisons of different basic premises of neoclassical and post-Keynesian economics, see Shaikh, 2004). In this sense, Adam Smith can be considered one of founding fathers of modern mainstream orthodox economics.

In conclusion, Adam Smith’s classical political economy can be described as the center of theoretical divergence. On the one hand, his systematic and holistic approaches to modern capitalism, especially his primitive labor theory of value, together with his basic concepts of prices, values, and profits, etc., were succeeded by David Ricardo and Karl Marx in the name of ‘radical’ political economy (Ricardo) and ‘critique’ of political economy (Marx). On the other hand, Smith’s distinctive premises such as the primary role of market competition, and the conceptualization of markets as autonomous orders (‘invisible hand’) implicit in his theoretical framework would be exploited by neoclassical economists about 150 years later. All in all, no one can ignore Adam Smith’s theoretical contributions to the development of economic thought. And in this respect we can say justifiably that Smith is still alive.

References

Dobb, Maurrice. “Classical Political Economy.” in Political Economy and Capitalism,

Connecticut: Greenwood Press, 1972, pp.34-54.

Meek, Ronald. “Adam Smith and the Classical Theory of Profits.” in Economics and

Ideology and Other Essays, London: Chapman and Hall, 1967, pp.18-33.

Shaikh, Anwar. “The Power of Profit,” Social Research, Summer 2004, Vol. 71

pp.371-381.

Smith, Adam. The Wealth of Nations Books Ⅰ-Ⅲ. Andrew S. Skinner, ed. London:

Penguin Books, 1999.

Paul Krugman, Peddling Prosperity – Economic Sense and Nonsense in the Age of Diminished Expectations, New York: WW. Norton & Company, 1994

http://www.amazon.com/exec/obidos/ASIN/0393312925/qid=1123532989/sr=2-1/ref=pd_bbs_b_2_1/002-4015594-3319237

Paul Krugman, an economics professor at Princeton University, is one of the most well-known scholars in the U.S. Unlike common sense, however, his fame is not from his journalist activities as an opinion editor of the New York Times, but from his ability to offer the most succinct and clearest explanations of current U.S economic affairs. Krugman succeeds in revealing his brilliant talent as an economist in another book, Peddling Prosperity – Economic sense and nonsense in the age of Diminished Expecations (New York: WW. Norton & Company, 1994).

This book deals with the interaction between economic ideas and politics in the U.S from 1973 to early 1990s. More specifically, the author focuses on “the interplay between economists and politicians, about how politicians try to find economists with ideas that they can package, and how economists both develop ideas and try to translate ideas into political influence.”(p.5)

In order to show this interplay, Krugman distinguishes “professional economists” doing research at universities from “economic entrepreneurs” who are ready to translate profound economic ideas into the simplistic version of policy prescriptions for politicians.

According to Krugman, the chosen period for research can be characterized by “the age of diminished economic expectations” in which economic growth and overall standard of livings of the U.S has decreased due to the continuous slowdown of labor productivity, rapid inflation and huge “twin (both trade and budget) deficits.”

In this sense, Paul Krugman’s previous book, The Age of Diminished Expectation – U.S Economic Policy in the 1990s (Cambridge, Massachusetts: The MIT Press, 1990, 1994, 1997, 1999) is a good source to understand what problems the U.S economy has faced and how the government tries to treat those issues. However, while his previous book deals mainly with economic problems and the government’s policy responses, this book focuses more on the underlying economic ideas from which certain economic policy packages have been developed.

From that year, according to Krugman, U.S academia has been influenced by conservative economic ideas such as “monetarism” and “rational expectation school” represented by Milton Friedman and Robert Lucas respectively. Krugman argues that under these conservative influences, a group of policy entrepreneurs, whom he calls “supply-siders” came to the forefront between the realm of academia and political parties as economic advisers to the President and other Republican politicians under both Reagan and Bush administrations.

But, according to Krugman, the ideas of supply-siders not only caused detrimental effects to the U.S trade deficits but also aggravated income inequality among social classes. The underlying policy prescription to the U.S slowdown of productivity and inflation was radical tax cuts and reduction of the government spending. They argue that the U.S Americans have been suffering from heavy burden of taxes, and this in turn reduced the potential source of investment. With its surplus budget, supply-siders argued, the unmonitored government wasted huge amounts of money for bureaucrats and the undeserving poor.

These policy packages were actually adopted by both Reagan and Bush administration. However, the result was a huge and widening income gap between the rich and the poor, as well as budget and trade deficits partly due to excessive military spending.

Due to these disappointing results, there emerged new liberal ideas emphasizing “imperfect market competition” and “the asymmetry of information” in the market. These liberal economists argued that the market was not exempt from turbulent business cycles even when we assumed the “rationality of economic agents.” Furthermore, every economic development has been influenced by its own institutional arrangement and past history. This “path-dependent” property of the market opens the door for the government’s active interventionist policy.

In this way, Krugman points out that the ideological pendulum swung from the prevalent attacks on Keynesian interventionist state to liberal Keynesianism. The theoretical hegemony, escaped from the hands of right-wing conservatives, once again became dominated by liberal economists.

However, there has been also another type of policy entrepreneur, one ready to offer a simplistic version of neo-Keynesianism for Democratic Party politicians. But at this time their focus is not on domestic policy but on international trade area.

Krugman names them “strategic traders” because their main argument is that the U.S government should subsidize certain corporations in value-added industry in order for them to compete with other firms abroad in the global market. In other words, they claim that it is necessary for the government to support strategic corporations in order to reduce trade deficits and raise domestic productivity.

Apart from some simple questions such as who can decide what the strategic firms are, and whether this kind of thinking is simply based on old-fashioned strategic decision making model for business corporations which boomed in the 1960-70s, in other words, whether this idea is based on simple analogy between the business firms in domestic market and national economy as a whole in global context, Krugman argues that strategic traders have the following serious problems.

Firstly, strategic traders overestimate the magnitude and the effects of international trade on the U.S economy. Even though the U.S has involved in global economy, the real percentage rate of the amount of international trade only amounts to 10% of GDP. Furthermore, even though the percentage rate of traditional manufacturing sectors measured in the GDP only accounts for 20%, strategic traders are misleading the reality and may distort the rational allocation of resources by paying exclusive attention to the significance of manufacturing sectors. Their common slogan is that the government should subsidize strategic manufacturing sector to let them win global competition.

Secondly, strategic traders unjustifiably link two unrelated points: the productivity growth and global competitiveness. Productivity growth is necessary for the overall increase in GDP and the improvement of the standard of living. But it has nothing to do with competition in global market. They argue government’s strategic support for selected corporations will bring about much more chance to win more market share in global market, and this in turn will be accompanied by domestic productivity growth. But according to Krugman it is not the case.

Finally, they also argue that strategic subsidies are necessary to develop high-value industry and secure job stability. But under what criteria can we decide which industry is better than others? Moreover, the increasing job instability stems not from aggravated global competitions but from the development of technology itself. Thus, “deindustrialization” or “industrial hollow” has nothing to do with globalization, and does not support strategic traders’ ideas.

In this way, Krugman criticizes various sheer economic non-senses advocated by policy entrepreneurs during two conservative administrations and the Clinton government. In so doing, he draws clear pictures of the history of the development of the U.S economic thinking.

On the whole, he seems to succeed in offering us how hegemonic shifts from the U.K to the U.S occur in the realm of economics. The most interesting point was that this process was not purely theoretical occurring in the ivory tower, but was also accompanied by the rise of the U.S economic hegemony after World War Ⅱ.

Considering the devastating repercussions of the Great Depression in the 1930s and the war, it was not surprising to see that both the theoretical pavement and barrier was Keynesian economics at that time. Krugman leads us to see how after-war-economists in the U.S have tried to overcome the Keynesian notion of active government policy in the name of monetarism and the rational expectation revolution since the 1970s.

He also shows us how the ideological pendulum swings from the myth of self-governing market to path-dependence approach to economic development. However, he introduces how so-called economic policy entrepreneurs have taken the place to access political power and mislead the reality in the name of self-righteous policy recommendations.

Written in plain English, Krugman’s book has strong merits with respect to its style and structure. Even ordinary readers will not find any serious difficulties in understanding the author’s main arguments. This book will be a useful guide for those who are interested in the history of U.S economic policy and real economic development process. Furthermore, readers interested in what kinds of economic policies the U.S government would likely adopt in the near future to deal with various global economic affairs will find this book a good guide.

* For those who want more information on current issues of the U.S economy, Joseph Stiglitz’s book, The Roaring Nineties – A new history of the World’s most prosperous decade will be a good supplementary material. You can compare these two famous economists’ arguments on current U.S economic affairs.

* If you are interested in the U.S financial and banking system, the book Secrets of the Temple – How the Federal Reserve runs the country will provide you with clear image of the operation and the function of the FED in the global context.