By R.M.B Senanayake –

R.M.B Senanayake

Response to Mr. Sumanasiri Liyanage’s comments on Dr W.A Wiijewardena’s article on Bastiat

I refer to Mr. Sumanasiri Liyanage’s comment on Dr. Wijewardena’s article which he says is to offer “legitimacy to Capitalism and its latest phase, neoliberalism, including the undefined economic policies and strategies of the present government”.

Yes indeed it is a defense of Capitalism against the attacks of those like Mr. Sumanasiri Liyanage who keep on harping on how immoral the Capitalist system is. He refers to what he calls the new neo-liberal version of Capitalism which was the answer of the defenders of Capitalism to the crisis that had emerged in the 1970s when because of strong trade unions acting irresponsibly was endangering not only Capitalism but the entire process of economic development in the modern world.

A capitalist economy involves millions of individuals and capitalist firms, all making decisions that are not deliberately coordinated beforehand. When some people decide to save part of their incomes, it does not automatically mean that they will find others who want to borrow and invest. When some people decide to invest, it does not automatically mean that they will find buyers for the goods produced as a result. Keynes pointed out that there was no automatic mechanism to ensure the two are equated always. So Capitalism had a tendency to alternate between periods of boom and periods of decline or bust.

Generally such crises were short lived and did not need much corrective action by the State or anybody else. But things had changed with the Full Employment ushered in by the Keynesian policies in the post war period. Workers had been protected by the State and termination of employment was made difficult. The trade unions had become strong and still held the Marxist view that the capitalist was an enemy of the worker. The workers were by and large socialists and were opposed to the capitalists although much less so than in the past.

Capitalism requires capital accumulation and the investment of such accumulated capital in the process of production. It is this process of capital accumulation followed by investment and innovation that drives economic development. It requires social conditions which provide for the capitalist producers to make a sufficient profit to cover the cost of capital. Keynesian policies had provided for the recovery of the economy from a deep depression in 1929. But the postwar years had led to the emergence of strong trade unions which had a much larger and more secure place in the capitalist economies owing to State protection. The unionization rate had peaked and the trade unionists were aggressive and mouthed anti-capitalist and socialist slogans. They considered the capitalists as the enemies of the workers- a hangover from the earlier Marxist rhetoric. In such an environment where workers demanded and obtained higher wages outstripping productivity increases. Capitalist firms cannot turn a profit and they will not have an incentive to invest. If capitalist companies do not invest, factories will be shuttered and workers unemployed.

Such crises in the past ( except in a few exceptional situations) generally led to a more or less automatic recovery as unemployment increases and the wages of workers stop rising creating an environment for the recovery. But over-regulation by the State and over-protection of the workers had caused a social structure to emerge in the 1970s where capitalist production and wealth creation had stagnated. This social environment was to be blamed and in the 1970s there was stagflation- inflation with stagnation. Then came another shock in the form of the sudden oil price increases. In 1973-1974, the first of two major “oil shocks” increased the price of petroleum four-fold, dramatically raising energy costs for both consumers and businesses. Workers’ wage demands outpaced the rate of productivity growth, driving up unit labor costs for businesses. The annual inflation rate in the developed economies, spiked to over 10% in 1974 and again in each of the three years from 1979 to 1981. Economists realized that the driving force of the capitalist economies had petered out. They realized that it depends on the institutional framework in which capitalist companies operate. If the institutional framework does not work, and the market forces do not mesh, the result is a crisis.

The economy seemed trapped in “stagflation,” so called because it combined low economic growth and high unemployment (“stagnation”) with high rates of inflation. Traditional macroeconomic policy tools seemed powerless to deal with it. In the 1960s, the idea of a stable inverse relationship between unemployment and inflation (known as the “Phillips curve”) became part of the economic-policy orthodoxy. If the unemployment rate was high wages would fall. This no longer seemed to work.

Keynesian economic policies were found to be failing in dealing with inflation and the freedom of the markets was sought to be restored. The institutional framework that had fostered economic growth was no longer working. It was necessary to curb the power of the trade unions while respecting their trade union rights.

Margaret Thatcher realized the need to tame the trade unions and tightened the laws regulating them. She was followed by other western countries and even the statist European States like France had to follow suit.

In fact our economy has been unable to forge ahead because of the excessive power of the trade unions particularly in the public sector which are still dominant in our economy. The over-protection of labor and the extremist actions of the trade unions have to be curbed for economic growth whether by the State driven or Capitalist driven.

I don’t want to write a eulogy for Frederic Bastiat for neo-liberal economists recognize his work as important for economic growth through free markets. The Bastiat society was inaugurated recently and its task is to promote free market ideas and expose the un workability of socialist economics.