How Does Socialism Avoid Depressions?
Prabhat Patnaik
DURING the anti-colonial struggle, many activists in India got attracted to socialism by virtue of the fact that while the capitalist world was reeling under the Great Depression and mass unemployment, the Soviet Union appeared completely untouched by it; Comrade EMS Namboodiripad was one such person and has written about it. They understood that there was something immanent to the functioning of a socialist economy that enabled it to avoid Depressions, and indeed any situation of generalised over-production, in contrast to capitalism. It is worth asking: wherein lies this difference?
A situation of over-production is said to exist when the maximum output that can be produced at full capacity use of the available capital stock, is greater than the demand for it when that output is produced. At that output therefore unwanted inventories pile up and hence output is curtailed until only that output is produced which is demanded when it is produced.
Bourgeois economics holds that such a situation of over- production can be overcome if money wages and prices are flexible. Suppose, to start with, because of over-production output has fallen below the maximum output; then there would be a fall in money wages and prices that would raise the real value of cash balances that people hold, making them spend more and hence raise aggregate demand. This would go on until the full capacity output is actually produced and demanded, at a new set of money wages and prices. Hence if output and employment are less than at full capacity, then the reason for it lies in the fact that money wages and prices are not flexible, in short, that markets are not allowed to work as they should; and the reason for their not doing so lies in the existence of trade unions. They bargain for and obtain a certain money wage and do not allow it to fall below that level. This rigidity of money wages underlies over-production and mass unemployment; and it is because of the operation of trade unions. The panacea for over-production and the associated unemployment therefore is to smash unions and make the markets work; this is what Margaret Thatcher and others sought to do.
This argument of bourgeois economics however is sheer ideological humbug. If over-production is sought to be overcome through a fall in money wages and prices, then, far from improving output and employment, it can cause a catastrophe in a capitalist economy. Firms have inherited debt commitments in money terms, and if money wages and prices fall, then their revenues fall relative to these commitments, which would drive many of them to bankruptcy. Far from the fall in money wages and prices leading to a rise in employment and output through larger demand, there would be a fall in employment and output as firms are overwhelmed by a wave of bankruptcy.
On the other hand, if prices fall but money wages remain unchanged whenever there is insufficient demand at full capacity output, then, demand will indubitably increase because of the rise in real wages; but profit-margins will fall. This will of course be opposed by firms; but, what is more, some firms will even make losses and be driven out of business, so that output and employment will still be lower than the original full capacity output. It follows therefore that in a capitalist economy over-production at full capacity output can never be overcome through the functioning of the market mechanism.
In a socialist economy by contrast, the means of production are socially owned, which, for practical purposes means State-owned. All enterprises’ profits accrue to the State budget, so that whether an individual enterprise makes a profit or loss is of no great concern to its owner, the State; what matters is that in the aggregate, the enterprises must earn a positive amount of profits. Individual enterprises therefore do not close down if they are loss-making. The State can order all enterprises to produce at full capacity, and let the price drop, with the money wage remaining unchanged, to that level which clears the market. At this price, some firms would be making profits while others would be making losses if demand in the economy happens to be low. The profit-making firms will make a positive contribution to the state budget, while the loss-making firms will be subsidised from the State budget. But output can always be at full capacity; and what is more, at this output the profits of the profit-making firms will always be larger than the losses of the loss-making firms, so that the State budget will never be in the red under this policy.
The reason for this last claim is simple. As long as there is positive investment, there must be positive savings in the economy (we ignore foreign investment). Assuming for simplicity that all wages are consumed and that all savings are from enterprise profits (which broadly corresponded to the reality under the old socialism), positive investment in the economy must mean positive savings and hence positive profits. It follows that as long as the socialist economy makes positive investment, there will always be positive profits in the aggregate; that is, the profits of profit-making enterprises will exceed the losses of loss-making ones. The socialist State therefore can always ask all enterprises to produce at full capacity and yet be able to cross-subsidise loss-making enterprises from the budget.
A socialist economy, it follows, can always work at full capacity. This is because all firms are socially owned and hence do not have to individually avoid losses. There are no doubt fluctuations in aggregate demand at base prices even in a socialist economy because the level of aggregate investment can fluctuate. An important reason for such fluctuations in investment is what is called “echo effects”, which means that an initial bunching of investment when for instance socialist construction had begun, entails that some years down the line there would once again be a similar bunching when a lot of the old equipment becomes simultaneously obsolete. The point however is this: such fluctuations in investment do not lead to any actual fluctuations in aggregate demand, because the movement of prices relative to money wages ensures that consumption rises when investment falls and falls when investment rises. Real wage movements in other words are made to counterbalance fluctuations in investment, causing aggregate demand always to remain equal to full capacity output.
All this is not just abstract theorising about a socialist economy; something of this sort had actually happened in the Soviet Union, and later in East European countries, where fluctuations in investment did not give rise, as under capitalism, to similar but exaggerated fluctuations in overall output, through what is known as the “multiplier”; they remained merely fluctuations in investment, with the consumer demand counterbalancing such fluctuations to make sure that the economy always functioned at full capacity.
Put differently, in a capitalist economy, fluctuations in investment give rise to fluctuations in consumption in the same direction, and hence to fluctuations in total output (whether or not accompanied by some change in prices). In a socialist economy, fluctuations in investment give rise to fluctuations in consumption in the opposite direction, to ensure that full capacity output is always realised. This is possible because capitalism entails private but scattered ownership of the means of production, so that a fall in demand, if at all it leads to a fall in prices (it may of course directly lead to a fall in output in an oligopolistic setting with prices being rigid downwards), must mean that some producers will be making losses and hence cutting back on output. A fall in demand under capitalism therefore necessarily means a fall in output, while a fall in demand under socialism is absorbed entirely through a fall in prices with no change in output.
Michal Kalecki, the renowned Polish Marxist economist, had distinguished between a demand-constrained system, and a supply-constrained system, a distinction later used by the Hungarian economist Janos Kornai. Kalecki had seen capitalism as a demand-constrained system and socialism as a supply-constrained system. The former is one where a rise in aggregate demand causes an increase in output while the latter is one where it does not. Under socialism a rise in aggregate demand raises not output but prices, since output is always at its maximum level. Correspondingly, under socialism there is no involuntary unemployment in the sense of unutilised labour that would get utilised if the demand for goods and services increases.
Not being characterised by involuntary unemployment was a great achievement of old socialism. It was an achievement unprecedented in modern history and it still remains unsurpassed to this day.
