SOCIAL REFORMERS

The great challenge to classical and most neo-classical ideas, at that time, and the inevitability of unemployment, came from Lord Keynes¹⁹. As Klein²⁰ argued, and Keynes himself stated²¹, Keynes theories were a reaction to the classical economists. For example, one of the main classi-cal theories was put forward by Say, and known as Say's law, which in its popular form claimed that supply creates its own demand. But Keynes' main source of classical thought was Pigou who, in his earlier work²², believed that the 1930 unemployment in the United Kingdom was caused by the improper allocation of people to jobs and the existence of wage rates above the level called for by the general demand conditions. Following these lines of argument, Pigou supported a policy of wage cuts. Schumpeter too, believed that there could be no persistent unemployment in a perfect, frictionless capitalist system. Aside from his theory of innovations which explained relatively short period movements, he claimed that²³ the forces at work in the early period of the 1930 depression were the agrarian crisis, protection, high taxes, interest rates and wages, and the lack of free price movements. Nevertheless, while Schumpeter could see no valid economic reason for the breakdown of capitalism, like Marx before him, he predicted that the capitalist form of society would eventually be superseded by socialism²⁴.

More recent neo-classical contributions to the development debate include Schultz' reassertion of the importance of investment in human capital²⁵ and Stiglitz, Krugman (and others) attempt to found a new development economics on the basis of a theoretical exploration of the nature and implications of the rationality of small-scale producers²⁶. These later neo-classical views are discussed in the penultimate section below.

4. SOCIAL REFORMERS

Keynes thought that capitalist systems were perfectly viable if it were not for artificial barriers and felt that an unequal distribution of wealth was necessary to maintain the level of savings high enough to supply the abundant demand for capital formation. The principal difference between Keynes and the classicals was in the determination of equilibrium. Keynes argued²⁷ that the

¹⁹ Among many other places this is argued forcefully by Nobel Laureate L. R. Klein in The Keynesian revolution (New York, Macmillan, 1961 (first published in 1947))

²⁰ idem.

²¹ John Maynard Keynes: The general theory of employment, interest and money (London Macmillan; New York, St. Martin's Press, 1936), Ch. 2.

²² Pigou (1945), op. cit.

²³ J.A. Schumpeter: "The present world depression", in American Economic Review (Nashville, Tennessee), Vol. XXI, 1931, p. 179.

²⁴ J. Schumpeter: Capitalism, socialism and democracy (New York, Harper, 3rd ed., 1950).

²⁵T. Schultz, "Investment in population quality throughout low-income countries", in P. Hauser (ed.): World Population and Development: Challenges and Prospects, (Syracuse, 1979).

²⁶J. Stiglitz, "The new development economics", World Development, (Vol.14, No.2, February 1986).

²⁷ Keynes: The general theory . . ., op. cit.

volume of employment in equilibrium depended on (1) the aggregate supply function, (2) the propensity to consume, and (3) the volume of investment. This was the essence of his General Theory of Employment. The classical economists insisted that prices would change to make supply equal demand in product, capital and labour markets. Keynes essentially argued that quantities would change to achieve equilibrium, and that real wages were rigid (actually he did not assume this, but dropped the assumption of perfect information). From the simple Keynesian model given in figure 3 it can be seen that, if there is a fixed quantum of labour and if labour supply is determined by wages, then any decline in aggregate demand (AD) and hence output (Y) produces more unemployment.

Figure 3. Simplified Keynesian model AD = Y L = fixed labour supply

W = cY W = wage bill, c = wage share of output coefficient U = L - E U = unemployment

E = W/w E = employment I = S I = investment Y = f(w, I) S = savings S = (I - c)Y + F w = wage rate F = external flows

It can be seen, further, that, if the wage bill is increased (i.e. c increases), profits will be squeezed and savings and investment will drop. This need not occur if foreign capital flows are obtained, if the government runs a deficit or if the government taxes that part of the income of the rich that does not go to savings. Also, a reduction in real wages exacerbates the situation since it reduces aggregate demand. All these follow from the Keynesian model. As Klein²⁸ remarked, full employment in socialist countries follows directly from Keynes since any sensible central planning board will set the amount of investment at a level which would just offset sav-ings out of a full employment national income. It was once thought by some Marxist economists, such as Paul Sweezy of the United States, that the class-based division inherent in government will not allow the liberal social reform required by Keynesian economics²⁹. The convergence between Marxists and Keynesians is strong in neo-Keynesian economics where vigorous government intervention is suggested to achieve full employment. And both economic schools agreed³⁰ that capitalism faces the problem of aggregate demand C that is, will the level of aggregate demand generated by any level of output be sufficient to purchase the whole of that output?

Implementation of a Keynesian approach requires an activist government to achieve full employment. As Bhatt³¹ remarked, how can governments assume responsibility for the

²⁸ Klein: The Keynesian revolution . . ., op. cit.

²⁹ See, for example, P. Sweezy: "What has Keynes contributed to the analysis of capitalism?", in Science and Society (New York), Oct. 1946.

³⁰ See P. Kenway: "Marx, Keynes and the possibility of crisis, in Cambridge Journal of Economics (Cambridge), 1980.

³¹ V.V. Bhatt: Sterility of equilibrium economics (Washington, DC, Economic Development Institute, World

maintenance of adequate investment growth without inquiring further into the pattern of investment which is so relevant to the nature and structure of growth and welfare?

In developing countries a Keynesian approach suffers from a number of problems. Berry and Sabot³² have pointed out three of these. First (following Reddaway³³), although there is abun-dant labour, at least of unskilled types in the poorer nations, a general increase in demand will not lead to a general increase in output, because other co-operating factors are needed to work with labour. The traditional one to take is capital, i.e. real capital equipment, "nothing much can be done with bare hands alone". The MACBETH model, described in Chapter IV and applied to Sri Lanka in Chapter V, illustrates this as increased aggregate demand leads to increased demand for educated labour but overall unemployment remains high since uneducated labour cannot be absorbed with the technological mix chosen. Adrian Wood has also modelled this in his two sector, two country model of trade and comes to the same conclusion³⁴.

Second, demand deficiency tends to ignore longer-run influences on output such as the negative effects of population growth, and the positive effects of technological change and capital accumulation. Technological change is more difficult to quantify; new techniques can be introduced at a marginal productivity lower than the wage rate of labour even though a number of institutional factors, such as social investment, quality of product and environment, may make them undesirable. On the other hand entrepreneurs often prefer to buy in technology which is both labour saving and enhances product quality. Labour saving technology is often preferred in developing countries, despite low wages, because of rigid labour legislation that hinders labour flexibility.

Third, the specificity of location and the pattern of unemployment, which, in LDCs, may be urban surplus and rural scarcity, contradict the Keynesian models that maintain that the direction, if not the rate, of change in aggregate demand is the same in all sectors.

The Hungarian economist Kornai's analysis is interesting in that it embodies both neo-Keynesian and Marxist thought. Kornai believed that the inefficiencies in the capitalist mode of production, as exemplified in the West, manifested themselves mainly in terms of unemployment. In the former socialist countries of Eastern Europe, inefficiencies manifested themselves not in unemployment but in the form of shortages³⁵. Hence it was not possible to discuss problems of unemployment in centrally planned economies since it simply did not exist. The main problem was that of shortages in the supply of goods both consumed and produced. The absence of incentives or price signals in the system would not allow a rapid response of the forces of production. This was the key economic problem of centrally planned economies. Hungary,

Bank, 1974).

³² A. Berry and R. Sabot: "Labour market performance in developing countries: A survey", in World Development (Oxford), Nov.-Dec. 1978.

³³W. B. Reddaway: "The economics of underdeveloped countries", in Economic Journal (London), Mar.

1963.

34 A. Wood: North-South Trade, Employment and Inequality: Changing Fortunes in a Skill-Driven World, Clarendon Press, Oxford, 1994.

³⁵ J. Kornai: The economics of shortage (Amsterdam, North-Holland, 1980).

under Kornai's persuasion among others, led to the partial re-introduction of competitive markets well before most of the other former Socialist countries. This has given it a head start and is now generally believed to be one of the successes of the transition from socialist to a market economy.

As Kornai remarked, in Hungary the centralisation of economic management started in 1948-49³⁶. The majority of firms were nationalised and a wide co-operative sector was established.

Public firms were controlled centrally, with the aid of a hierarchical multi-level apparatus. The fulfillment of production plans given to firms, as well as adherence to the input quotas allotted to them, was obligatory. Price setting and the allocation of investment were highly centralised.

The main purpose of the 1968 reform was to free public firms from bureaucratic ties and increase their autonomy. The firm did not then receive a binding directive as to what it should produce in the next year and rationing of inputs through fixed quotas almost ceased. Hungary's former

"command economy" was then replaced by a system in which independent firms were connected, to a large extent, through the market. Some prices continued to be set centrally but the number of contract prices determined by the seller and buyer were enlarged considerably. Investment decisions were shared among central organisations, credit-granting banks, and the firms themselves who were able to finance part from their own savings.

The reform brought tangible results, according to Kornai, with production growing at 5-6 per cent yearly during the ten years after the reform. Full employment continued and, in some cases, led to a labour shortage. Real wages rose regularly, the supply to consumers noticeably improved, and the variety of consumer articles widened. However, the pace of change put into place by these reforms accelerated the eventual rejection of centralism and a wider embrace of market mechanisms.