Classical Economic Theory

Classical Economic Theory

Classical economic theory

Classical economic theory was dealt a blow by the Great Depression from which it has not recovered.

According to that theory there can be no long-lasting depression because "supply creates its own demand." According to Say's law there is always a sufficient rate of spending to maintain full employment.

Money which people save from their income is channelled into investment uses by the interest rate. The theory was elegant, precise, and logical; but as often happens with beautiful theories, it was strangled by some brute facts. There was a depression!

The discrepancy between theory and reality stimulated John Maynard Keynes to develop a new theory to refute the classical economics.1' He reasoned that there is no necessary reason why the capitalist economy operates at full employment. It can just as well be in a slump for a protracted period. The key to full employment is an adequate level of income. If \consumption plus investment spending is not great enough to fully employ economic resources, the only way to attain full employment is for the government to make up the difference through deficit spending. Keynes's theory is today the basis of monetary and fiscal policy in the nations I of the free world.

Why, then, does the business community cling to the profit ethic when it has lost the popular support it once had? The reason is a political one. The New Deal brought about a reorganization of the political power of the various economic interest groups. Previously the business community had enjoyed practically a monopoly of this power. When the Supreme Court gave the company the status of a legal person, it gave business a powerful competitive advantage over other economic groups. As a result of the New Deal, the courts gave unions the same protection and immunities against legislative and executive controls which are guaranteed individuals under the Fifth and Fourteenth Amendments.

Agriculture has also improved its political position since the New Deal. It now has one of the strongest lobbies in Washington. The result is that the business community has lost some of its political power to labour and agriculture. Consequently businessmen who have a strong feeling for free enterprise ideology believe that America is going down the primrose path of social-ism. They believe that economic freedom is disappearing in America. What actually has happened, of course, is them has been a redistribution of the total amount of economic freedom among the major economic interest groups with no necessary decrease in the total.

Business has seldom been more profitable than it is today. Yet business-men are apprehensive. They feel that things are not as they should be. The difficulty they sense has nothing to do with "the facts." It is a product of ideological distortion of changes in the power structure. When faced with a changed environment, one in which the relative political position of the business community is weakened, it is easy for businessmen to conclude that the future is dangerous. Thus they continue to believe in the profit ethic which was so gloriously in tune with the march of events in the great days of the 1880s and 1890s. The Age of Enterprise stands for them as the high watermark of UK progress and economic sanity.

To be fair to the business community, it must be noted that it has received precious little help from academics and other intellectuals in developing an ideology that is congruent with the contemporary scene. Most economists, for example, are still quite committed to the profit ethic because of the key role it plays in their model building.13 We have moved so rapidly toward a unique combination of private and public economic institutions in the past few decades that the old dichotomy between capitalism and socialism has lost much of its meaning. What we need today is a new ideology to replace laissez faire and a new economic theory to complement the classical economics. When our ideology builders and economic theorists provide these, businessmen will have an alternative to which to turn. Then they will no longer be forced to worship a dead ideology while helping to forge the new world which killed it.

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