The real debate over economic reforms in India

April 5, 2007

By Dipankar Basu (updated)

The debate over economic “reforms” in India has been going on for quite a long time now. This long and heated debate has been centered around the effects of what has been called “economic reforms”, a sharp change in the policy regime governing the Indian economy. It might be useful to recall that the policy regime in India gradually started changing right after Rajiv Gandhi came to power towards the end of 1984; of course the change was considerably accelerated after Manmohan Singh, the current prime minister, became the finance minister in the Congress government in 1991. Since then there has been no looking back; whether it is a coalition government led by the centrist Congress or led by the right-wing Bharatiya Janata Party (BJP), economic reforms have continued apace. In fact, consensus about the necessity and desirability of reforms is evident across the whole political spectrum, ranging from the right-wing BJP to the social democratic communist parties, CPI and CPI(M). Of course there are subtle differences in emphasis and speed of implementation, with the social democrats trying to play an oppositional role at the federal level while adopting those same policies in the states under their rule, notably West Bengal. It is as an attempt to forcefully impose this policy regime on the people of West Bengal, where a broad coalition of social democratic forces has been in power for the last three decades, that we must try to understand the recent brutalities of the State in Singur and Nandigram.

The main thrust of the policy change comprising “economic reforms” was a move towards according greater role to market forces in the economy and came in many guises. For instance it meant the lowering most tariff and non-tariff barriers to promote the trade of goods and services across Indian borders; it meant liberalizing many legal procedures related to investment, corporate taxation, trade, commercial banking, stock market activity and most importantly the hiring and firing of labour; it meant the disinvestment of public assets like public sector units, which in most cases meant selling off public assets built with tax receipts over the years at below-market prices to private capital; it meant an uncritical adoption of “fiscal fundamentalism”,i.e., paying especial attention to the balancing of the budget or at least making some serious efforts at reducing the government budget deficit; it meant the gradual entry of foreign capital into the Indian economy (both as FDI and as portfolio investment); it meant a gradual retreat of the State from the provision of social services like health and education and also meant the simultaneous encouragement of private capital to enter into these areas and many more similar changes. Compared to even the pseudo-socialist policy framework that had been established after the British departed in 1947, the new policy regime meant a massive swing in the direction of unfettered capitalism. And this could not but generate debate, vigorous and heated debate.

The debate centered around the effects of such changes; and since the effects of these policy changes would become clear only after some years, the debate almost wholly concerned itself with predictions, with the future. The crucial question was whether this new set of policies would benefit the economy as the proponents asserted or would lead to disaster as the critics pointed out. Ranged on both sides were the who’s who of the Indian economics and policymaking community. Arguing for the reforms were noted economists Jagdish Bhagwati, T N Srinivasan, Montek Ahluwalia, Manmohan Singh, Arvind Panagariya, Bibek Debroy, Surjit Bhalla, Shubhashish Ganguli and many others; on the other side of the table were equally distinguished economists like Prabhat Patnaik, C P Chandrashekhar, Jayati Ghosh, Praful Bidwai, Ashok Mitra, Amiya Bagchi and others.

Most critics of the economic “reforms” had argued that the adoption of the above set of policies would be disastrous for the Indian economy. They had argued that opening up the Indian economy to trade would lead to “deindustrialization”, i.e., foreign goods would flood our markets and displace locally produced goods leading to closing down of local industries and thus increasing unemployment in the Indian economy. This, they had argued, would lead to a fall in the growth rate of the Indian economy (once the pent-up consumption expenditure boom was over) and lead to a fall in the economy’s overall productivity. They had argued that the poverty rate as measured by the head count ratio (the proportion of the people whose annual consumption expenditure fall below the poverty line) would increase and that income and wealth inequality would also increase dramatically. They had argued that the investment rate in the Indian economy would drop and lead to a shrinking of the capital goods sector. The proponents had, on the other hand, argued exactly the opposite; they had argued that the new policy regime would lead to growth in the economy and reduction of poverty.

Fifteen (or twenty if we start from the mid 1980s) years down the line, the evidence is at best mixed; if anything the empirical evidence seems to bear out the proponents’ claims more than the critics’. The growth rate in the Indian economy (as measured by the growth rate of the per capita income) has certainly increased over the last two decades; opening up the economy has not led to deindustrialization (in fact our exports have increased as also our imports). The Indian economy does not have a large current account deficit which means that we have not been flooded with foreign capital. In fact, over the last few years, outward FDI from India has increased rapidly and in 2006, the Indian economy was a net outward FDI originator. Savings and investment rates have also dramatically increased. And probably most importantly, the poverty rate has consistently declined over the last twenty years; the rate of decline had itself declined in the nineties before picking up again in the last six years. But along with this we also have increasing income inequality, acute rural distress, a degrading environment and most importantly a stagnation in some of the most important indicators of well-being (like the infant mortality rate, the maternal mortality rate, the life expectancy at birth, the primary and secondary enrollment rates and many others).

The process of economic growth and development is more complex than either the well-known proponents or the critics would have us believe; both present only half-truths. When proponents of “reforms” ask us to look at the facts, they want us only to see that the poverty rate (as measured by the head count ratio) has declined; they do not want us to see that this decline has not been accompanied by an improvement in the measures of social well-being, they do not want us to understand the reasons behind the acute rural distress that has led to farmer suicides on such a large scale. The overemphasis on economic growth and the head count ratio by the proponents tries to discount years of research that has drawn our attention to the inherent limitations of this rather narrow measure of development and poverty.

Equally dishonest, I feel, are the intellectuals associated with the official, social democratic left. Faced with evidence that goes against their earlier pronouncements, they continually shift their stands without as much as acknowledging possible problems in their formulations. Notice how they have shifted their discourse on poverty: from poverty decline they have gradually moved onto the rate of poverty decline. Recall that most of them had started the debate by asserting that poverty would increase; once empirical evidence shows that it has not, they have started talking about how the rate of decline has itself declined! Recall also that they used to never focus attention on the indicators of social well-being that they find so important now; issues like education and health were looked at with little more than derision, matters for the “development economists” and not for radicals. Radicals indeed.

To put the whole debate in proper perspective it is important to realize that at bottom, the process of economic development is broadly a matter of increasing the productivity of social labour; and this, we know since Adam Smith and the classical political economists, can be best achieved by increasing the division of labour. Institutions which can support an extended division of labour will lead to increasing labour productivity and thus create grounds for general prosperity in the economy. I think there is much of relevance in classical political economy that can shed light on current debates and let me make a small digression into the writings of Adam Smith. Duncan Foley’s recent book, “Adam’s Fallacy: A Guide to economic Theology”, contains an extremely lucid, well-informed and critical introduction to classical political economy and I will borrow briefly from Foley’s account to motivate the point that I want to highlight.

What makes a nation prosperous, asked Adam Smith at the beginning of his inquiry into the causes of the wealth of nations. His answer is profound because of its stark simplicity: the extent of the division of labour. Not the abundance of natural resources, not the amount of precious metals like gold and silver, but the extent of the division of labour within a country determines the potential prosperity that it can offer its citizens. Behind this assertion lies the understanding – shared by all classical political economists – that the ultimate source of wealth is the labour that goes into the process of social production. The extent of the division of labour, by determining the productivity of that labour, ultimately determines the potential wealth of any nation.

In Smith’s account, the division of labour refers to “the breaking down of useful production into a series of separate tasks, each of which can be accomplished separately from the other”. It is important to realize that Smith sees the division of labour occurring at two very different levels, one at the level of the enterprise and the other at the level of society as a whole. The first, which Smith calls the detail division of labour refers to the process by which production within a firm is broken up into separate tasks; it is the detail division of labour that finally creates the conditions for the introduction of machinery into the production process. But the division of labour also occurs at the aggregate or societal level; this is what Smith refers to as the social division of labour, which is the process by which “parts of a complex production process can be separated into different points of production, which may be located in different firms, or even different geographic regions”.

Smith’s account of the causes of the wealth of nations is completed by positing a positive feedback loop between the division of labour, labour productivity and the extent of the market; this link, when and where it can take hold, operates as a positive feedback loop. Widening extent of the market (i.e., growth in effective demand) supports an increasing division of labour, which increases the productivity of labour, leading to falling prices and rising real incomes. Growth in real income increases the extent of the market in turn, completing the virtuous spiral.

Notice how, in narrating this story of economic development, Smith the political economist has almost imperceptibly melted into Smith the theologian of capitalist social relations; this is the critical point that Foley helps us understand. For hidden within his “objective” description of the workings of a capitalist economy are two implicit value-laden propositions. First, that the process of technological progress and economic growth – the virtuous spiral of economic development – is beneficial for all members of society, i.e., it is autonomous and class-neutral: how else could it be morally justified? And second, that the defining institutions of capitalism – private ownership of the means of production, and markets – are the only ways to support a society-wide, complex division of labour with its attendant benefits in terms of high labour productivity.

To my mind, this is where the critique of economic “reforms” should really be located, not where the social democratic left has placed it. If India manages to establish the institutions of capitalism properly, then there is no doubt that this can lead to technological progress and economic growth. This growth will also lead to a decline in the poverty rates, much like that has happened in Korea and is currently happening in Vietnam or China. If this is true then why oppose economic reforms? This is a legitimate question which the social democratic left does not even attempt to answer. To my mind, the opposition to economic reforms lies in opposing the claim that capitalism is the only way to support an economy-wide complex division of labour. It is to take account of the cost of economic development alongside the benefits. It is to assess the class-nature of these costs and benefits in an already class-divided society. We must ask ourselves: will we oppose a development path that reduces poverty rates but only at the cost of increasing inequality? Economic development through capitalist industrialization (whose logic is, what Marx famously called, ” Accumulate, accumulate! That is Moses and the prophets!”) will lead to dislocations of millions of lives in the medium and short run, though in the long run, the economy-wide poverty rate might go down. The question really before us is this: are we ready to ignore these medium and short-run costs for the long-run benefits which might materialize only in decades or even longer? Are we ready to accept a dispensation where the costs of economic development are disproportionately borne by those who will rarely, if ever, get to enjoy the benefits of that development?

26 Comments »

26 Responses to “The real debate over economic reforms in India”

  1. kuver Says:
    March 23rd, 2007 at 19:45

    I’ll get back on this as soon as I’ve had time to digest it. Looks promising for a nice discussion!

  2. Prabal Says:
    March 23rd, 2007 at 20:45

    Very well written. I will try to add if I find something useful.

  3. Debarshi Says:
    March 24th, 2007 at 12:32

    Dear Dipankar,
    I have two major points of disagreement with this write up. I shall try to be as brief as possible.

    1. “At bottom, the process of economic development is simply a matter of increasing the productivity of labour” and Adam Smith’s ideas regarding division of labour and extension of market.

    Are we not discounting the role of effective demand here? You have mentioned demand in describing the virtuous cycle. But if Say’s law holds, and supply creates its own demand, then one need not be much worried about availability of markets. I wonder why Smith factored in markets. Is Smith, the practical observer, in contradiction with Smith, the theologist of capitalism? You may be in a better position to answer.

    In poor economies is development simply a matter of increasing productivity of labour? Or is it about increasing employment as well? The equation which connects growth of productivity of labour to growth of output is,

    growth of output = growth of labour productivity + growth of employment.

    The wretched employment conditions in rural (as well as urban) economy are well known. To raise output (rise in output will produce a higher surplus to be distributed) therefore, one may have a strategy of creating greater effective demand, instead of solely focussing on raising labour productivity.

    One may wonder why the planned economies focused so much on heavy industrialisation? The answer may be the following.

    Underdeveloped economies are woefully short of capital stock. Higher state investment does two jobs (a) raising effective demand (b) raising productivity by equiping labour with more and better capital equipments.

    2. “If India manages to establish the institutions of capitalism properly, then there is no doubt that this can lead to technological progress and economic growth. This growth will also lead to a decline in the poverty rates, much like that has happened in Korea and is currently happening in Vietnam or China…”

    Are we not giving capitalism much more credit than the due? Is there anything called proper capitalism? To my mind, Marxist critique of capitalism goes beyond high inequality and worsening living standards of the poorest, which are bound to occur in the wake of capitalist development. The criticism — informed by Lenin’s theory of Monopoly Capital, Mao’s semi-colonial, semi-feudal State, as well as the Dependency School — sees capitalism in developing coutries as incapable of performing the role accomplising the bourgeois revolution.

    Examples abound. Take the colonial period. Sops were thrown to imperial capital, close to zero tariff rates existed on imports. In short, the freest market regime we ever had. Deindustrialisation, falling per capita income and living standards were the results. Or take Latin America. Politically independent for roughly 200 years. There were cycles of protectionist regimes and free market regimes. Where are they now? You have cited China, Korea and Vietnam. But State was/is very much in an intevening role there. In case of Korea the benevolent gaze of US allowed Korea market access to US. One also needs to examine the question of democracy which is supposed to be a companion of free market. I also wonder how you will fit in Africa.

    You know all my arguments. Do you believe that time has come to revise the old Marxist formulations?

  4. kasturi Says:
    March 24th, 2007 at 23:11

    How is proliferation of division of labour ensured under an industrialization scheme (like in Singur) which systematically throws people out of employment? Specially with heavily automated factories which are designed such to keep production costs low?

  5. Dipankar Says:
    March 26th, 2007 at 22:26

    Debarshi has raised two very important points; let me try to respond to them in the order that he has raised them. The first point also relates to Kasturi’s question.

    1. My understanding about Adam Smith’s account of economic development (derived largely from Foley’s recent book) is the vituous cycle that I had referred to earlier: increasing extent of the market leading to higher division of labour leading to higher productivity leading to higher potential properity and further increase in the extent of the market. Now, in this cycle, “extent of the market” is what might be called “effective demand”. Since this figures so prominently in the whole account, I don’t think Smith ignores the demand side.

    Say’s Law is a sleight of hand that is introduced later, mainly to justify the long-term benefits of technological progress (or even free trade) and to ask the readers to ignore the short and medium run costs of technological unemployment.

    Thus, course economic development must include an increase in employment alongside rising productivity; that is one sure way to increase the extent of the market and support and increasing society-wide division of labour. I used the term “labour productivity” as a synonym for the society-wide division of labour, not in the narrow sense of the ratio of total output to total labour time; if that has caused any confusion, then that is my mistake.

    Your comments on the uses of capital investment in poor economies is apt; I think, it should be augmented by noting that poorer economies are short not only of physical capital stocks but also of human capital. Hence, the government should not only invest in machinery but also in education, health and in providing other social services for the population like housing, insurance, public transportation, etc.

    2. Capitalism cannot be separated from the capitalist State; it is the responsibility of the State to ensure that the institutions of capitalism – private property and markets – are organized properly, that they “work”; it is the State that “regulates” capitals to see to it that the interests of Capital is secure.

    All cases of successful capitalist transition, without exception, have seen the State intervening in the interests of Capital. So, there is no question of separating the State from the markets; that separation is not very useful in understanding reality.

    There is lot of sound theory in the Marxist theoretical tradition; one can hardly deny the use of Lenin or Mao’s penetrating analyses. But we must use lot of care to use the categories developed in other contexts and for specific purposes. In this context I would like to advance two ideas for further discussion:

    (i) rather than using the notions of semi-feudal and semi-colonial as a fixed characteristic of a particular State or capitalist class, I think it might be better to understand imperialism as primarily a global system of unequal development. No nation forever need have a fixed characteristic; what is really important is the relative levels of development the world over and the incorporation of local capitals within the international division of labour and commodity chains.

    (ii) that the capitalist class cannot accomplish the bourgeois revolution need not imply that the socialist revolution must wait for its completion; probably we already have capitalism without a bourgeois revolution? And perecisely because of the absence of the bourgeois revolution this capitalism is so deformed, so inhuman, so brutal.
    So the struggle should probably be to replace this brutal, aggressive, deformed capitalism with a libertarian socialist economy rather than to prop it up by social democratic politics.

  6. Prabal Says:
    March 27th, 2007 at 00:01

    Theoretically, it is impossible to dispute that increase in productivity is good. That increase in productivity has a negative impact on employment in general is also not necessarily true. The unemployment problem is a combination of many factors – outdated labor laws, politicizing government jobs, lack of concern for small and medium scale enterprises to name a few. In principle, there can be sectoral reallocation of labor. Also in theory, division of labor is not limited by the market if you can export your surplus. The East Asian examples that are figuring time and again are mostly examples of the so-called export-led growth. On the other hand, it is also true that planned economy can produce better results, because one can plan and maintain those sectoral balances.
    Unfortunately, reality lies in between all these. The so-called market-driven strategies do not necessarily work – either because the agriculture in the developed world is still heavily protected, or because the manufacturing is dominated by countries who are either more productive (hardly believable) or work under such a regimented system that cannot be matched by democratic systems. I think West Bengal’s industrialization strategy is a good reference point here. The government vows to give land at a rock-bottom price, promises to waive taxes and the companies promise to produce at a very competitive price. Who is bearing the cost? The common people who do not have a say in the policy making. Therefore, we have to make a choice – whether we uphold people’s rights or go after dreams of making goods cheaper than China. To me the choice is obvious – people’s right to self-determination with respect to their own will or property cannot be compromised. This does not necessarily mean that Adam Smith was wrong. This means that global reality does not allow us to pursue such strategy without compromising citizens’ rights. Coming back to where we started, under this scheme of things, productivity isn’t even increasing ( they are not saying that TATA will make more cars from the same resource, just that it will be cheaper). It is just an artificial way of lowering the cost, something unsustainable in the long run. Ironically, a complex democracy is also not very healthy for planned development either. Too much lobbying, favoritism, regionalism and most importantly lack of market test make it harder to be an efficient economy.
    About the second point, I do not know what is a/the “proper” execution of capitalism. Modern theory is too technical to summarize here, but it does assign an important role to the State, mainly in terms of regulating, solving market failures and providing incentives for the actors. I personally think that state intervention should be discussed on a case by case basis rather than making a sweeping generalization. Clearly it’s none of a State’s business to act as a broker for MNCs. Therefore, while I am aware of the perils of free markets, I am cautious about state intervention in curing effective demand and planning investments also. Fifty years of state intervention has created a small, well-paid, unproductive organized sector and a huge unprotected, undocumented, un-lobbied-for unorganized sector. But that is a different debate in itself.

    In response to Kasturi: I think the issue is not so much of employment-replacement, but more of self-determination. If you recall that CPM moron in “Abadbhumi”, he argues that housewives from the displaced families can work as domestic helps in the new multistoried buildings. Even if there were more such jobs than families displaced, I would take that an outrage to the self-esteem of those displaced people.

  7. Debarshi Says:
    March 28th, 2007 at 16:05

    Dear Dipankar,
    I am still not very clear about the second point. You will pardon me for being repititive. My contention was, to put it bluntly, the write up seemed to be pretty at peace with the march of Capital in poor countries. There will be rising inequality, degradation and brutalisation of the lower rungs. But in the long run, it seemed, things might smooth out. Our opposition to the neoliberal project springs from the injustices which bound to occur in the short run.

    So far as my understanding goes, one should also consider the possibility that things may not look up in the long run. Theories of imperialism suggest the same. Capitalism, without the State, is a myth (recent rumbling within the mainstream economics testify to the same). I fully agree with you on this point. Capital, with the State and other paraphernalia, creates a matrix of political and economic relations which ensures that the colony never experiences the kind of capitalist development which blesses the metropolis. One may also be sceptical about the possibility of a colony-unassisted birth of capitalism.

    If this is the position we share, can we be certain that there would be any long run benefit at all? (incidentally, there are some who doubt if poverty rate has at all gone down during the last five decades: http://www.macroscan.org/anl/jan07/anl060107Poverty_Neoliberalism.htm)

    Perhaps, you are hypothesising that even if a country is internally or externally colonised and is placed at some point on the global system of unequal development (I find Arundhati Ray’s description of India colonising itself useful), it may be possible for it to attain long run benefits –- at the cost of short run costs. I am not very sure about this. I also doubt –- from this end of the stick at least –- if capitalism has any non-brutal, benign form. Primitive accumulation was a rage in England during the birth of classical capitalism. Currently it is ruling the roost in India.

  8. Dipankar Says:
    March 28th, 2007 at 17:24

    Dear Debarshi,

    I agree with most of what you have said and probably your recent most post helps me clarify my thoughts even further. I think you have misunderstood my critique of neoliberalism: I have suggested that we should oppose neoliberalism even if it entails economic growth and reduction of poverty. This, I believe, is a critique (or opposition) of neoliberalism giving it all the benefits of doubt. We should attack it at its stronghold: economic growth.

    What you have suggested is an attack on a weaker version of neoliberalim: you have said that economic growth and poverty reduction is not possible in a ex-colony like India under neoliberal policies. If that is the case, then we should ofcourse oppose neoliberalism. I have suggested that we should oppose it even if neoliberalism leads to growth and poverty reduction!

    And the reason is that capitalist growth, even at its best, is undesirable. Capitalist institutions support and foster the economics of greed and competition; we must replace that with the economics of equitable co-operation, merely another name for libertarian socialism. Even at its best, capitalism means extranalization of costs on those who are least capable of bearing them and accrual of benefits to those who have borne hardly any of the costs. Primitive accumulation is precisely the inauguration of this process at the birth of capitalism. As you have rightly put it: “Primitive accumulation was a rage in England during the birth of classical capitalism. Currently it is ruling the roost in India”. Hence, I totally agree with you that capitalism is never benign and non-brutal. And that is why I ask that we re-orient our struggles for the establishment of socialism instead of the vague rhetoric of social-democratic capitalism (as the official Left does).

    On the issue of whether poverty has decreased in the last two decades or not, I have gone through Utsa’s piece. He main point is to redefine the poverty line keeping the nutritional norms in mind (2400 kcal for rural and 2100 kcal for urban areas); with this redefinition, one gets the result that current poverty rates in rural India is 75 percent and in urban India is 49 percent. Moreover, one sees that the poverty rate has not decreased since 1973-74; it had declined in the mid-eighties but then jumped back up during the neoliberal era.

    I was not aware of this literature and thought the point rather important; the article as such is shrouded in unnecessary rhetoric. But a little search showed that this idea is not novel. Jaya Mehta has been arguing along these lines for a long time, and you can get the main ideas in a five page commentary in EPW (instead of going through 53 pages). See

    (1) EPW Commentary: July 01, 2000.
    (2) http://gamma.nic.fi/~otammile/povindia.htm
    (3) Alternative Economic Survey, 2001-02

    When I looked further into the literature, I saw that this idea has been debated for a long time. Currently I am trying to read the important articles that have dealt with this issue: there might be theoretical or empirical reasons why nutritional norms are not used for the construction of poverty lines. I am not very clear on this issue as yet; it requires more investigation.

    The following references are important (I am trying to get hold of them):

    (1) EPW Research Foundation (1993): “Poverty levels in India: Norms, Estimates and Trends”, August 21.

    (2) Dasgupta Partha and Debraj Ray (1990): “Adapting to Undernourishment: The bIological Evidence and It’s Implication”, in The Political Economy of Hunger by Dreze and Sen, Vol. I

    On the issue of poverty and inequality in India, I have found Deaton and Dreze’s article most comprehensive and useful. Their conclusion was that “poverty decline in the 1990s proceeded more or less in line with earlier trends” which was consistent with independent evidence on per capita expenditure from the National Accounts, state domestic products and agricultural wages; inequality (among regions, states, between urban and rural and within urban areas) increased dramatically in the 1990s; development indicators showed mixed results. Hence they concluded “We find no support for sweeping claims that the nineties have been a period of ‘unprecedented improvement’ or ‘widespread impoverishment'”.

    Here is the reference:

    Deaton, Angus and Jean Dreze (2002): “Poverty and Inequality in India: A Re-examination”, September 07.

    A very useful, non-technical introduction to poverty analysis (without much of the useless rhetoric) can be found here:

    http://www.princeton.edu/~rpds/downloads/deaton_povertymeasured.pdf

    Hope this clarifies matters and takes the debate forward.

  9. Prabal Says:
    March 28th, 2007 at 20:10

    Debarshida,
    I am little confused about your concern with “march of capital” in the South and reference to “capitalist development that blesses the Metropolis”. Do you mean that the real issue is to change the way capitalism is practiced in poor countries?

  10. Subhasish Says:
    March 28th, 2007 at 23:49

    Dipankarda,

    Wanted your response on this. When you say
    “The question really before us is this: are we ready to ignore these medium and short-run costs for the long-run benefits which might materialize only in decades or even longer?”,
    one thing that you do not address is the
    issue of compensation mechanisms. Is it
    possible to think of compensation mechanisms
    that will weaken this trade-off for those
    who are affected?

    I think it is important to address this question because this is what most of the outpouring of emotions against Nandigram amounts to: capitalist
    industrialization should continue but those
    who would lose their land must be brought
    on board as partners in the process. In fact,
    if you look carefully, this is also what the
    national government and the CPI(M)’s policy
    posturing on SEZ’s have been in the last few
    days, suggesting that they have been “listening” to “aggrieved intellectuals”. In a nutshell,
    it is extremely important at this juncture
    to dissect this position, otherwise a great
    political opportunity to create a democratically-minded alternative to the CPI(M)in West Bengal
    will soon be lost.

    Personally, I think there are several ways in
    which this position can be challenged. First
    of all, the idea of democratic deliberation
    in which decisions are arrived at consensually
    completely ignores the power that is exercised
    simply through the ability to argue forcefully. It is hard to imagine that ordinary peasants will
    be able to match up on this count to the seasoned Alimuddin-trained (I should also add JNU-trained) rhetoricians that the CPI(M) will
    undoubtedly bring to the discussion table.
    Second, there is the bigger issue of a commitment problem. It seems to me that
    whatever compensation mechanism is devised
    will involve a commitment on the part of the state to honor some future exchange. Who
    will enforce this commitment if the state
    violates it? The judiciary? All talk of
    an activist judiciary notwithstanding, the
    fact is that the average case before the
    Indian court system drags on for years.

    These are some thoughts. It is ofcourse
    critically important to think about
    what an alternative economic model
    to capitalist industrialization should
    be, which has been the tenor of the
    discussion so far. I have merely tried
    to bring a more explicitly political
    perspective to the discussion.

  11. Anonymous Says:
    March 29th, 2007 at 06:59

    Perhaps this is why CPI(M) is so weary about “outsiders”. Though examples abound in the rest of India also.

  12. Ramesh Says:
    March 29th, 2007 at 09:55

    Certainly, there is a need to go back to the basics and leave out the social-democratic left in India and their analyses…

    May be it is necessary to read Adam Smith in terms of political geography – the virtuous spiral of labour and market demand which he describes happens in a concrete geographic world of social relations where state has the last-instant capacity to guide capital into a particular space and mobilise resources from other spaces. This is where Marx brings out what is concealed in Smith and to some extent in Ricardo.

    If the Smith model has to be replicated elsewhere, its politico-geographic-historic space too has to be already there. Therefore, there is no subject as such economics and the continent of economics is necessary economic history.

  13. Debarshi Says:
    March 29th, 2007 at 15:20

    Dipankar, clarified, thanks. I also believe West Bengal provides an example how social democratic attempts in a poor country soon degenerates into capitalism.

    Prabal, my concern is not how capitalism is practiced in poor countries. Capitalism, to me, is an unequal way of organising soical life. It creates wealth for some and destitution for the rest. When a country, as a whole, benefits from it, it is believed to have experienced capitalist development. The mirror image of that ‘development’ is the set of drained out colonies. The existence of the stagnation in the colonies does not imply capitalism is not present there, or that it is not practised ‘properly’ there. It simply means that the colonies are at the receiving end of the unequal system.

  14. Pinaki Says:
    March 29th, 2007 at 15:51

    is it possible to characterize the extent of ‘capitalist’ development in a country like india ?

  15. Prabal Says:
    March 29th, 2007 at 21:17

    Debarshida,
    I can see your center-periphery argument, though “country, as a whole” benefitting is unclear as there are holes of poverty in rich countries also. Though I think some amount of inequality is inevitable – partly because of how people react to incentives and partly because of randomness of nature. This has nothing to do with economics imperialism.

  16. Prabal Says:
    March 29th, 2007 at 21:17

    Debarshida,
    I can see your center-periphery argument, though “country, as a whole” benefitting is unclear as there are holes of poverty in rich countries also. Though I think some amount of inequality is inevitable – partly because of how people react to incentives and partly because of randomness of nature.

  17. Subhasish Says:
    March 30th, 2007 at 01:17

    Dipankarda,

    Just to buttress my earlier arguments. There
    is in fact a tradition in political philosophy
    which has been highly skeptical of deliberative
    processes. The philosopher Rousseau, atleast
    in my reading, saw any form of communication
    before voting on social alternatives as a corrupting influence.In his normative universe, the public forms its opinions independently, votes and somehow the general will is articulated through this process. I always found this idea very fascinating though in my mind I have not completely unraveled the logic behind it. Maybe now is the right time to revisit this strain in Rousseau’s thought. At the least it
    will help us problematize “getting peasants on
    board”-type of arguments which frankly is becoming annoying by the day. It almost seems
    like a balm that many liberal intellectuals
    are using to somehow get them over this crisis
    and help them resume normal lives.

    Also, to connect my arguments to the general
    discussion you have been having with Debarshida,
    I was wondering if one can view mechanisms like
    deliberation or compensation as the defining
    features of social-democratic politics? The problem is other political ideologies may also have elements of these so maybe it is not a distinctive aspect of social-democratic politics.
    I’m not sure, but its certainly worth pondering
    over.

  18. Partho Sarothi Ray Says:
    March 31st, 2007 at 10:50

    I started following this interesting discussion rather late but would like to make a few layman’s observations. A crucial point which seems to have not been considered in detail in this discussion on the “neo-liberal” economic reforms in India is globalization. What Dipankar has stated about Adam Smith’s observation that “division of labour” being the cause of prosperity of an economic system (by “economic system” I refer to anything from an enterprise to a society or a national economy, better word), is true, because in division of labour lies the efficiency of extracting profit, and for generating the so-called virtuous spiral. Although Adam Smith describes this division of labour as “parts of a complex production process can be separated into different points of production, which may be located in different firms, or even different geographic regions”, he considers this division to still work in a sort of unified economic system, as in a corporation or a national economy. But I think that globalization, and particularly the globalization of the “division of labour”, adds a new dimension to this, which we must appreciate to understand the nature of neo-liberal “reforms”.
    I’ll try to clarify the point which I have so clumsily put. By globalization of the division of labour I mean that the process of social production, which today includes both manufacturing and services, is no more restricted to a single unified economic system such as a national economy, but is spread out around the world. This is old hat, but the crucial point is that a dominant capitalist economy, like the economies of the North, is based on a world-wide division of labour, where, because of the greater efficiency that it gives to the process of extraction of profits, the costs of production have been externalized. This is epitomized by the economy of the USA, the most developed capitalist economy, where manufacturing has been greatly externalized (to countries like China) and services have been externalized (to countries like India). I think the reason why this has been done is basically to go out of the “virtuous spiral”, because with increased efficiency of production and rise of “social needs” of workers, the rise in wages (or the rise in the expectation of wages) has been such as to make the extraction of profit inefficient. On the other hand, removal of the processes of production from the national economy would result in a stop in the rise of incomes, unemployment, reduction in purchasing power, contraction of the market and social upheaval, all of which is detrimental to the capitalist system. So, cost of commodities and services have to be kept low enough, such that the majority of people, regardless of the fact of decreasing or stagnant incomes, still have the purchasing power to meet their social needs and to sustain and expand the market. Today, the USA has the most unequal economy in the industrialized world, with I think 10% of the population owning 60% of the nation’s wealth, but this rising inequality seems not to have significantly affected the purchasing power of 90% of the population. So, the solution to this dual problem, of maintaining the efficiency of the process of profit extraction and of sustaining the market, was globalization. Globalization would externalize not only the costs of production, but also the forces of production, and would also maintain the supply of cheap goods and services, that would keep the economy running. I think we have to consider the nature of economic reforms in India against this backdrop, because therein lies their fallacy.
    So, let me consider that the economic “reforms” in India leads to the process of capitalist industrialization which, although at immense short term costs, would lead to general prosperity in a space of 20-25 years. That might be acceptable to many people, of course you cannot have long term benefit without some short term costs. But what type of an economy are the policies building up in the meantime? Therein lies the crux of the matter. We are building up what I call a “service economy”, an economy designed to serve the “dominant economy” based upon a globalized division of labour. The economy will serve the purposes of globalization which I have enumerated earlier, to externalize the processes of production (in the case of India it will be mostly the service sector) of the dominant economy and to act as a source of supply of cheap commodity (again, in the form of cheap white collar labour in the case of India). Moreover, any social unrest tied to this process will become a problem of the state running the service economy, as we have seen in NAndigram and everywhere else in the world. This service economy, servicing the global capitalist system and superimposed on the national economy, will increasingly have resources allocated to itself from the traditional economy…in the form of land, power, subsidies, tax breaks etc., because of its apparently high returns (leaving aside the fact that the class which will profit from this economy is also the ruling class). The proposed Tata small cars factory in Singur is a beautiful case in point. I was talking to a friend of mine in Kolkata about a month back who has three car dealerships in the city. According to him, the largest purchaser of passenger cars in the city now are not individuals, but companies which maintain fleets of cars to transport employees of software/BPO firms to Salt Lake. The small cars rolling out of Tata’s assembly line will supply the needs of these people. So what is the bottomline…Singur represents the removal of a resource (land) from the real economy (agriculture) to service transporters who will service ITES firms who will service the dominant economy in the USA. The short term costs are apparent, 10000 people will lose their means of livelihood. But will there be long term benefits, will it lead to an overall rise in prosperity, will it lead to the “virtuous spiral”? I don’t think so, and therein lies the fallacy of these economic policies. To keep the system profitable for global capital, the reason why in the first place the division of labour was globalized, the service economy has to remain relatively underdeveloped, to remain as a source of cheap goods and services. For real incomes to rise up in the, wages have to increase, but that will replicate the process that already happened in the dominant economy, so that cannot happen. To keep the wages low, there has to be a constant pool of the unemployed, so that people are always ready to come into the service economy at low wages. To keep the production process profitable, there has to be a continous reallocation of resources, in the forms that we have seen…land, subsidies, electricity etc. as a result of which state expenditure on the social sector has to reduce. And the superimposed service economy, employing a small number of people, will drive up the prices of commodities, which we have seen happen in everything from education to real estate, further impoverishing people. Therefore not in 20-25 or a 100 years, but possibly never, will these policies result in an increase of general prosperity, because they are enmeshed in a global system predicated on maintaining the service economy “underdeveloped”. It is something which I compare to thermodynamics. Energy flows from a source to a sink, but only along a gradient. Wealth can also flow only along a gradient, from the producers to the accumulators, and global flow of wealth from the service economies to the dominant economies, can only be maintained if the gradient of inequality is maintained. To draw an imperfect analogy, something that has already been referred to in this discussion, we can look at the relationship between the colonies and the imperialist countries. That relationship was also based on a sort of division of labour, although not to the extent that globalization has done today, but that never resulted in the prosperity of the colonies vis-a-vis the colonizing economy. It resulted in a net drain of wealth, although it gave rise to a small prosperous class of landlords etc. whose economic functions were centered around servicing the dominant economy again, mostly in the form of providing raw materials. The analogy is imperfect, but I think is the indicator of the fallacy underlying the process of capitalist development which the neo-liberal policies have ushered in in India.

  19. kumarila Says:
    April 1st, 2007 at 10:41

    It would be better if Partho’s comment is put as another article, with the same title as Dipankar’s while also subtitling it as “a response to Dipankar Basu” etc. That would do justice to both the comment and Dipankar’s article, and also to the reader who has to scroll down so much to read Partho’s comment.

  20. Ramesh Says:
    April 14th, 2007 at 05:50

    Partho’s point that India is going in for a service economy on the basis of a global division of labour is to be buttressed with a spatial understanding of what a “hub” and “spoke” system can be. Perhaps India has three distinct developing “hubs” – manufacturing, services and defence production and currently there is no parity among the three, with services taking the lead. This is just a hypothesis and perhaps needs to be discussed further.

  21. kolkatababoo Says:
    April 18th, 2007 at 21:21

    Disclaimers: I was directed to this website by my classmate Anindya B. who, rather characteristically I am afraid, is absent or anonymous in the discussions. Also, I don’t kneel at the altar of KHM or VIL, but I am a practicing economist (for whatever that is worth). Therefore, I am interested, though not precipitously, in some of the issues that this blog raises; hence this entry.

    Dipankar writes: “The question really before us is this: are we ready to ignore these medium and short-run costs for the long-run benefits which might materialize only in decades or even longer.” I have a couple of reactions to this: First, this sort of frames the topic of the “real debate” without really engaging in the debate–it would have been interesting if the author had provided some real-world examples about how this might play out. Here is an example of the latter via Abhibit Banerjee: http://econ-www.mit.edu/faculty/download_pdf.php?id=1482. Second, I am not sure Dipankar’s quote is particularly helpful as a prescription, even as a topic of debate, because it is overly broad. I am no expert in economic growth (or development, if you want to gild the lily with capabilities and all that SENse), but isn’t this tradeoff inevitable? Aren’t the real questions when, how, and what to tinker with successfully? (Because to tinker is the best we can hope for as economists–the rest is the puffery of mediocre minds.) It would be awfully nice, though not polemically expedient, to disaggregate this into smaller pieces that *can* be answered.

    I look forward to seeing a comeback to Banerjee, for instance.

    Finally, here is Robert Solow’s review, quite instructive in my estimation, of Foley’s book (Solow’s review was published in the New York Review of Books). I am pasting the review and not a link because the website is restricted to subscribers.

    *****
    “How to Understand the Economy, By Robert M. Solow”
    Adam’s Fallacy: A Guide to Economic Theology
    by Duncan K. Foley
    Belknap Press/Harvard University Press, 265 pp., $25.95
    Educated friends who have never studied economics themselves often ask the economist Duncan Foley to recommend a book that will explain what economics is about. He does not find it easy, sees correctly that the standard seven-hundred-page elementary textbook is essentially unreadable, and usually ends up by suggesting the late Robert Heilbroner’s 1953 classic The Worldly Philoso-phers, not a bad choice. But he feels the urge to try his own hand at it, and teaches a course for nonspecialists at Barnard College and the New School University. Adam’s Fallacy is the result.
    Like Heilbroner’s book, it proceeds through the standard list of Great Economists, beginning with Adam Smith, T.R. Malthus, David Ricardo, and Karl Marx. That is one possible device, but the mere history does not reveal by itself what Foley thinks the curious educated reader should know. The tip-off is the subtitle: the book is a guide to “economic theology.” I don’t like that word: theology is about God, and God does not play any role in these pages. I understand Foley’s reluctance to say “ideology,” because controversy has left so many layers of meaning on that word. It is clear anyway that he is interested in big, general themes, especially about capitalism, and not in nitty-gritty like the price of beer or the balance of trade.
    There is an alternative view of the content of economics. I once wrote a brief comment on Heilbroner’s book and entitled it “Even a Worldly Philosopher Needs a Good Mechanic.” Any capitalist economy is full of “mechanisms,” compounded out of natural and technological facts, legal rules, individual motives and behavior patterns, social norms, historically contingent institutions, and the like, that together have a lot to do with the price of beer, the balance of payments, the degree of wage inequality, and so on. These mechanisms may differ from one capitalist economy to another, and will certainly differ between any feudal economy and any capitalist one. The job of economics, in my view, is to figure out how these mechanisms work, and maybe how they could be made to work better, or at least differently. The educated reader needs to understand how economists try to achieve that understanding. There is little or nothing about “how things work” in Adam’s Fallacy.
    The split between “theology” and “mechanics” is much more than an expository preference; it is a determining substantive choice. Here is an illustration of the difference in approach implied by the choice. The beginning of the book—in fact the first two thirds, which is itself indicative—takes up the ideas of Smith, Ricardo, and Marx. The “labor theory of value” figures very prominently in their work and in Foley’s discussion. It claims that the “value” of a produced commodity is the cumulative amount of labor (of average skill, say) directly and indirectly required to produce it. There are many possible subtleties here, but we can ignore them. I put “value” in quotation marks because this is actually a definition; the “value” of a bottle of beer is not something you could look up in a catalog.
    Adam Smith and some of the classical economists thought of this value as the “natural price” of a commodity, and expected that the actual market price of, say, a bottle of beer might fluctuate above and below, but over time would average out to, its labor-value. Ricardo eventually had his doubts about this proposition and Marx probably did not accept it at all. In any case, in actual fact prices in a modern economy do not approximate labor values, not even in any average sense. In a modern economy, wages and salaries, including fringe benefits, add up to more than twice the sum of interest, rent, and profits, so labor costs must be the most important component of prices. But that empirical statement is not nearly the same thing as the labor theory of value.
    Modern economics dispenses with the notion of “value” altogether, and deals only with ordinary, observable market price. The object of the exercise is to understand why the prices of commodities (and the quantities produced, bought, and sold at those prices) are what they are, and why they change.
    The modern notion of “equilibrium” price and quantity does some of the duty of “natural price” (but not of value). A market is in equilibrium when supply and demand are in balance and there are no internal forces inducing participants and potential participants to change their behavior and thus cause prices and quantities to change. For example, the equilibrium price of a bottle of beer must cover production and marketing costs as well as yield the going rate of profit, and it must attract just enough buyers to keep current capacity in adequate use. “External” forces, like population growth and the invention of new commodities and new methods of producing old commodities, are forever disturbing preexisting equilibrium prices and quantities, and this process is forever causing observed prices to deviate, at least for a while, from equilibrium. In the beer industry, the invention of a new, cheaper process of fermenting would normally force a general reduction in price, the exact amount depending on how many more customers will buy beer at the lower price. The price may fluctuate until the equilibrium level is found. Foley would say, and I would firmly agree with him, that many modern economists tend to slide too easily into the tacit presumption that deviations from equilibrium prices and quantities are almost always small and transient. This is just an error; and it may become a “theological” error, because an atomistically competitive economy in equilibrium is known to have some desirable properties that disequilibrium nullifies. So excessive optimism about equilibrium can translate into apologetics for current institutions and practices. It often does.
    Suppose, for example, the demand for summer rentals diminishes, because of expected bad weather or high gasoline prices. It may take a long time before rents fall correspondingly. In the meantime, there are many vacancies, and prolonged disequilibrium. Some devotees of neoclassical (“marginalist”) economics presume that competition will almost always be sufficient to bring rents down promptly. “Marginalism” refers to the principle that market equilibrium is achieved when no agent—buyer or seller—can find any small—i.e., marginal—change in behavior that improves his or her situation, at a set of prices that balances supply and demand in the market as a whole. As Foley puts it,
    Where classical political economy conceives of equilibrium as the averaging out of ceaseless fluctuations, marginalism sees equilibrium as actually being attained or approximated in reality.
    A moment ago I described population growth as an external force acting on the market system. From the Malthusian point of view, population growth is an internal—the jargon word is “endogenous”—force. Malthus believed that a rise in wages or a reduction in the price of food would lead directly to faster growth of population. In turn this would cause wages to fall or food prices to rise until poverty and disease brought population back to equilibrium and real wages back to subsistence level. For that matter, some aspects of technological change are also endogenous. For example, a perceived opportunity to make a high profit will induce industrial researchers to seek and find new products and processes and bring them to market, where again prices and quantities will have to adjust.
    One of the ways that economics makes progress is by trying to extend its scope, converting what had been treated as “exogenous” into part and parcel of economic theory, by which more and more can be explained. Marxism in particular has ambitions to be a sort of universal social science. Many mainstream economists also work in their own way at absorbing family behavior, political decision-making, and technological innovation, for example, into the general conceptual scheme of economics. I suspect that Foley is less skeptical than I am about the success of such efforts.
    On the whole, Foley is an admirer of the Marxian intellectual enterprise, though not uncritically. He is certainly aware that many of Marx’s confi-dent predictions about the long-run trajectory of capitalist economies have been dead wrong. He is also a critic of mainstream—”neoclassical”—economics, but with some real appreciation of what it can do. The picture of how the prices and quantities of goods are determined by supply and demand in interrelated markets, as worked out by Alfred Marshall and others toward the end of the nineteenth century, is a workable and flexible apparatus that has been developed in many directions, especially for markets that are less than fully competitive. Most amateurs who attack neoclassical economics and its offshoots have no grasp of the thing they are attacking. The mainstream does a better job of self-criticism than the critics. Duncan Foley (who, I should say, is a friend and former colleague of mine) is in a different class. He understands the assumptions, methods, and results of mainstream economics as well as anyone.
    He does, however, make some decisions that are surprising and puzzling. Why, for instance, should a 228-page exposition of what the educated reader should know about economics contain a sixty-eight-page chapter on Marx and a single twenty-three-page chapter (entitled “On the Margins”) on a century and a quarter of mainstream economics? After all, the educated reader will come across neoclassical economics in contemporary discussions of many concrete issues, such as the level of wages or the setting of oil prices. To begin to understand Foley’s aim, and to get on to “Adam’s Fallacy” —Foley’s phrase for Smith’s central assertion that “capitalism transforms selfishness into its opposite: regard and service for others”—it is useful to come back to the labor theory of value and the dichotomy between value and price.
    Everyday life is about prices, not values. The daily decisions of buyers, sellers, workers, employers, investors, trade unionists, and other market participants depend on current and expected prices. If labor values were good forecasters of future prices or price trends, they would have an important function; but they are not. For example, a product that may require a great deal of labor may actually cost far less than a similar product that requires comparatively little labor, but instead uses more capital and raw materials. Karl Marx realized that there was a problem here, and he improvised a complicated story about the “transformation of value into price.” This turns out to be either mystification or bad algebra. Foley’s long chapter mentions the rather Talmudic literature on this subject and passes on. So what is the labor theory of value for, and why should the educated reader care?
    I think the labor theory of value is not a part of the economics of everyday life at all; it is a part of what Foley calls economic theology. It is not intended to help explain what happens in the world; it is intended to crystallize and support an attitude toward capitalism as a social form. It is, in short, the basis for an argument that capitalism rests on the exploitation of labor.
    The idea that the worker is entitled to the whole product of his or her labor is an old one. Marx sees that if workers actually got the whole product, they might well consume it all, and society would stagnate. If instead they chose to save and invest some of it in exchange for a reward, they would have become part-time capitalists. So Marx decomposes the sales revenue of any enterprise into three parts: the cost of purchased inputs, the wage bill, and the rest. The rest he calls “surplus value,” and it is the existence of surplus value that constitutes exploitation. (Mainstream economics has a different definition: if employers have some monopoly power in labor markets and can thus pay lower wages than active competition would establish, workers are said to be exploited. Who would storm the Winter Palace or transform a whole society to get rid of a byproduct of monopolistic power?)
    So the labor theory of value paints a picture in fundamentally moral terms. Labor is the “ultimate” source of “value,” whatever that may mean. The social institutions of capitalism— private ownership and control of the means of production, wage labor, freedom of contract, and so on—are devices to facilitate the extraction of surplus value from labor and its appropri-ation by a class of capitalists. You learn from this story how to feel about capitalism, not how to predict the price of a bottle of beer.
    A conservative wing of mainstream economics paints a slightly different picture. A capitalist economy consists of a collection of free and independent families and individuals, each with his or her own tastes for present and future goods, hard work, leisure, risk-taking, travel, calculating, and so on. Some of those individuals are stronger or cleverer or more artistic than others, and some start off life richer than others, as the result of the efforts of ancestors much like themselves, secured by the protection of property rights. The human propensity to bargain and barter, along with the enormous advantages of efficiency that result from the division of labor and the benefits of coordinated large-scale production, induces them to contract freely with one another to their mutual advantage. Any contract entered into voluntarily must, after all, according to this reasoning, benefit both parties to it. The outcome is the great wealth now enjoyed by all. Attempts by a democratic government to modify this process in the interest of equity or some other soft-hearted goal such as price controls or state-subsidized pensions can only limit its efficiency and very likely make things worse for most people. This set of half-truths is obviously intended to evoke a different feeling about capitalism.
    Economic theology masquerading as economics is not anyone’s exclusive property, right or left. Foley is right to insist on that, and it is a useful lesson for educated general readers. But relegating modern mainstream economics to the “margins” is not a favor to his audience because they are deprived of some interesting intellectual machinery that can help them to understand the economics of everyday life. The allocation of fifty pages instead of twenty-three would have given him the opportunity to sketch a validly agnostic reading of some modern economic theory. Instead one finds a casual brush-off, often so casual as to be a misleading distortion.
    I will mention one minor example, because it points to a bad habit in mainstream economics that bugs me even more than it does Foley. He remarks, quite correctly, that the mainstream (“marginalist”) project of tracking equilibrium prices and quantities is intrinsically complex and difficult because the buyers and sellers (“agents”) in an economy differ substantially in their interests, tastes, capacities, information, and social positions. Foley writes:
    One short-cut, which neoclassical economists frequently take, is to assume that all the individuals in society are exactly alike, so that they can be reduced to a “representative agent,” and then to work out how the representative agent would allocate the existing stock of commodities, and what marginal utilities (whose ratios will be interpreted as market prices) will result.
    He then points out that this device is very likely to give wrong answers (and, he might have added, more emollient, Panglossian answers).
    This is fine as far as Foley goes, but it does not go very far; I think it is basically uninformative to a non-specialist. It would have taken only a couple of pages to explain that the representative-agent device is far from universal in mainstream economics; it appears mainly in a few sub-areas of the discipline, but one of these is important. The representative-agent device has been adopted by a significant, perhaps dominant, school of thought known as real business cycle theory, and it is applied to a problem of everyday life where it can do a lot of damage: the theory of those irregularly alternating states of affairs we call prosperity and recessions. The representative-agent device, by simply assuming away the more or less obvious differences in desires, expectations, and beliefs among groups of consumers, investors, workers, and business firms, manages to convert the business cycle from a (large or small) pathology of the economic system into a sort of optimal adaptation to unforeseeable disturbances. Thus, a recession is seen as the “rational,” even inevitable, market response to an unforeseen event, not a possibly preventable reaction to excessive capital investment or financial speculation. Here and elsewhere, Foley misses an opportunity to teach useful lessons about both economic theology and economic analysis.
    With this background, we can turn to the major theme of Adam’s Fallacy. (The Adam in question is Smith, of course, but the reminder of the First Man is surely intended.) Here is Foley’s first extended statement of what he means:
    For me the fallacy lies in the idea that it is possible to separate an economic sphere of life, in which the pursuit of self-interest is guided by objective laws to a socially beneficent outcome, from the rest of social life in which the pursuit of self-interest is morally problematic and has to be weighed against other ends. This separation of an economic sphere, with its presumed specific principles of organization, from the much messier, less determinate, and morally more problematic problems of politics, social conflict and values is the foundation of political economy and economics as an intellectual discipline.
    Elsewhere in the book there are many references to Adam’s Fallacy in specific contexts, some of which do not seem to me to fit the basic definition. “The moral fallacy of Smith’s position,” writes Foley, “is that it urges us to accept direct and concrete evil in order that indirect and abstract good may come of it.” But is this a fallacy? Consider one of Foley’s examples:
    From Malthus’s perspective, charity to the poor was self-defeating or, even worse, exacerbated the problem of poverty: charity or the dole allows workers to reproduce even when they have no employment. Thus subsidizing the poor pushes down the wage and standard of living at which population stabilizes…. This kind of reasoning is characteristic of Adam’s Fallacy. Its method lies in contrasting the immediate effects of action (charity relieving the suffering of the poor) with indirect, systemic effects (charity expanding the population and lowering the standard of living of the poor). Its burden is the moral necessity of resisting moral impulse….
    Now Malthus may have been wrong. Certainly no one in Britain today would think of appealing to the Iron Law of Wages, which holds that wages will be driven down to subsistence levels. But if Malthus was right in eighteenth-century Britain or in some poor country now, then I do not see that his argument involves any “separation” of an objective sphere of economics from a broader moral sphere. He is claiming that, in this case, the pursuit of short-run moral benefits (money for charity) will, through the working-out of certain empirically valid patterns of human behavior (Foley calls them objective laws), result in long-run moral costs that outweigh the sought-for benefits. If your oncologist tells you that this course of chemotherapy will be exceedingly painful but will lead to an enduring improvement in quality of life, you hope she is right, but you do not suspect a fallacious separation of an objective medical sphere from a broader moral sphere. Similarly, refusing charity to the poor may be painful for them in the short run but may have broad beneficial effects over time. Of course, the modern successors of Malthus, who have sometimes argued that the relief of poverty through public assistance actually creates and prolongs poverty, may drastically overstate the case.
    The reach of Adam’s Fallacy may thus be a little less than Duncan Foley suggests. But the original statement of it is interesting and important. Someone like me, who adopts the mechanic’s-eye view of economics, has to deal with it.
    Students of economics are indeed taught to make a clear distinction between positive statements (this is how this piece of the world works) and normative statements (some states of the world are better than others). They are taught that no “ought” follows from an “is,” except with the addition of a clearly defined ethical criterion. And then they are taught a very stringent criterion of betterness, devised in the early twentieth century by the Italian economist Vilfredo Pareto: a state of the world A is “Pareto-better,” or more Pareto-efficient, than state of the world B, if and only if every person is better off in his or her own estimation in state A than he or she is in state B.
    There are three important things to say about that criterion. First, it is totally individualistic; no person’s well-being can legitimately be traded off against any other person’s. Second, for that very reason, it is almost impossible to satisfy in practice; not many policy moves that are of benefit to many will be costly to no one, and certainly not redistributive moves. Third, for that very reason, there is a temptation to violate the Pareto rule in practice; but it serves the purpose of reminding the violator to be clear about the “welfare criterion” being appealed to.
    There is a common, theologically fraught pitfall here. We are all familiar with statutory regulations that are said to “distort” economic decisions, and prevent resources from being allocated to their socially most productive use. Presumably they are enacted for some worthy purpose. Rent control is an example: large rent-controlled apartments may house small families who cannot afford to leave, while larger families pay higher uncontrolled rents for smaller spaces. (Leave aside any effect on new construction.) An end to rent control would allow an increase in “efficiency,” in the precise sense that everyone could be better off: those who gain from decontrol could in principle compensate—perhaps through state-imposed taxes and transfers— those who lose, and have something left over to share around. But that never happens: instead, the rise in rents following decontrol amounts to a transfer of wealth from tenants to landlords. The Pareto criterion is not satisfied in practice. But acolytes of the free market focus on the gain in efficiency and tend to neglect the equity or distributional consequences.
    This is, just as Foley says, an illegitimate separation of economic from moral considerations, an example of Adam’s Fallacy. But it is not intrinsic to marginalist or neoclassical economics. In fact the analysis of the effects of abolishing rent control that I just sketched is neoclassical economics. The trouble is that neoclassical economics is amazingly good at teasing out the last detail about efficiency gains and losses, but it has no special tools for analyzing equity considerations. So there is a tendency to marshal “economics” on behalf of free marketeering, knee-deep in Adam’s Fallacy. The remedy, it seems to me, is to show where the applications have gone wrong rather than to abandon the theory in favor of some inferior mode of thinking.
    Foley is deeply skeptical about the ability to correct misguided applications of neoclassical economics. “In its sophisticated form,” he writes, “neoclassical economics finesses the question of morality through a version of pragmatism.” But are there really any significant instances where the economic and the moral are so inextricably intertwined that careful analysis and fact-finding cannot succeed in elucidating the issues? The only cases I can think of are those where the economic act itself is felt as immoral: for example, we do not allow the voluntary sale of body organs for transplant. Even so, we mechanics would opt for sticking to those problems—of which there are many—where one can figure out (a) how the system works, and (b) exactly what moral issues are implicated. These might include, for example, the price of oil, the control of pollution, the inequality of wages, the persistence of unemployment, and the necessity of some public investment. Render unto Marshall…
    My tentative view is that Adam’s Fallacy is better regarded as a bad habit that certain ways of thinking about economics may encourage, though not necessarily imply. Maybe it should be called Duncan’s Temptation. Infatuation with the remarkable properties of decentralized markets, and with the capacity of modern economic analysis to sort them out, does not provide a free pass to “leave it to the market” regardless of distributional and other ethical considerations.
    This conclusion is worth some emphasis. Foley reflects on Adam Smith’s claim that unfettered competitive markets guide the consequences of self-interest to a socially beneficent outcome. Modern students learn that this “beneficence” has to be carefully interpreted. The economy starts with a set of participants, each endowed with a certain bundle of resources, property, and capacities. According to the remarkable “First Theorem of Welfare Economics” (conceived by Kenneth Arrow, among others), a perfect free market system—and months of study go into the precise meaning of “perfect” here—will achieve a Pareto-optimal outcome. No feasible reallocation can make anyone better off without making someone else worse off. That might be described as a certain kind of beneficence. But if the initial endowments of each participant in the economy had been different, a different Pareto-efficient outcome would have come about, and very likely those individuals whose endowments of wealth and skills had been improved would fare better in the outcome. So the free market outcome is no “better” than its starting distribution of wealth. It can be described as socially desirable only if the allocation of initial endowments was socially desirable. The theological free marketeer likes to omit that proviso. A good student should not.
    Toward the end of Foley’s short book, there is another short chapter about four maverick early-twentieth-century economists: John Maynard Keynes, Thorstein Veblen (a favorite of mine too), Friedrich Hayek, and Joseph Schumpeter. Keynes is the most important of these, and Foley does well by him, though I would have liked more attention to the uses that mechanics have made of Keynes’s ideas in analyzing the day-to-day operation of the economic system as a whole. This is especially important when there is excess unemployment and idle capacity, and the beautiful neoclassical rules do not apply.
    The space available for Veblen is not nearly enough to allow a discussion of the variety of his offbeat insights, but I am glad that Foley included him. He is also good on Hayek, especially at drawing a line between Hayek’s essential contribution about the informational content of decentralized markets and his purely ideological utterances. I was especially delighted to hear that Duncan Foley finds Hayek’s book on business cycles as incomprehensible today as I found it as a student sixty years ago. I am less of an admirer of Schumpeter than most contemporary economists, apparently including Foley. Here, too, I would have liked a little less of Schumpeter’s Capitalism, Socialism, and Democracy, and a little more about his earlier Theory of Economic Development, with its focus on entrepreneurial innovation as the driving force of economic progress. Anyway, the best these short vignettes can do is to induce some readers to go further.
    So what would I tell an educated general reader who is looking for a book on economics? Duncan Foley could not fail to have written a book with spark and depth. He has done that, and it ranks right up there with Heilbroner’s classic. Heilbroner has more to say about the political and economic setting in which each of his worldly philosophers emerged; but Foley gets deeper into the analytical content of major schools of thought. Still, Adam’s Fallacy is not the book I would have wished for. That would have been more of a Popular Mechanics: this is what they say about the exchange value of the dollar; this is what they say about the combination of recession and inflation; this is what they say about the estate tax; and this is how they tie these things together. Yet another take will be available next spring when Oxford University Press publishes Partha Dasgupta’s Economics: A Very Short Introduction, which is more about the institutional infrastructure required for a well-functioning market economy. Maybe the best thing to tell the educated general reader now is: you know, you could read two books.

  22. Dipankar Says:
    April 25th, 2007 at 14:27

    I thought Solow’s review essay totally missed Foley’s argument; here is why:
    http://radicalnotes.com/content/view/30/39/

    I will read Abhijit Bannerjee’s piece and post my comments later.

  23. S.m,jAFFAR Says:
    November 15th, 2007 at 03:34

    The article and the comments on globalization are very informative.I wii first make a detailed study and then comment.The one thing that is clear is that the rampant consumerism is degrading the environment and secondly it is making people selfish.Secondly while the number of billioners is increasing,the poverty at the social base is also increasing with geometrical proportionworldwide .S.M.Jaffar,a freedom fighter

  24. Groguirlgon Says:
    January 13th, 2008 at 19:54

    Make peace, not war!

  25. sisir Majumder Says:
    January 30th, 2008 at 10:08

    Since Industry is in the union list and financial Institutions are under the central government,industrialization in any state is crucially dependent onthe policies at the National level.Over several years inthe past there has been serious discrimination at the National Level against state in granting Industrial Licenses.The deleberate policy of selective freight equalization has also robbed the state of its comparative local advantage in terma of import industrial raw meterials,such as Steel and coal.The new economic policy followed by the changed Industrial Scenario inthe country–The West Bengal Govt. laid emphasis on Vital issues of Industrial Development, Rehabilitation of Sick units and generation of employment opportunities and protection of the Legitimate interest or right of the lobour. In line with Liberalization process unleashed in 19991 and the changed Scenario,The Govt. of West bengal welcomes foreign Technology and Investment to play an important role for ensuring social justice and balanced growth–welcomes private sectors for investment in power generation. State Govt. looks upon joint and assisted sectors for Economic activity wherever feasible. State Govt.has taken initiative for improving Social Infrastructure–Satelite Township,Housing,Health and Education,Water supply etc. Major thrust has been given to Technical Education and Training through Polytecnics and ITIs, Information Technology etc. so make peace nor war in this Industrial developmental process.

  26. Sensbachtal Says:
    March 17th, 2008 at 10:58

    Just wanted to say Hello to everyone.
    Much to read and learn here, I’m sure I will enjoy !