State And Economy Research Paper

1. Doctrines

The terms of debate on the relationship between state and economy over the last two centuries is radically different from what came before. For centuries, European governments used a variety of mercantilist practices to enhance the economic growth of their territories by setting up barriers against imports, investing in education and technology, providing concessions and other support to promising enterprises, and establishing relief policies to protect the poor from economic hardship (Heckscher 1934, Reinert 1999). There is disagreement over when and how effectively these mercantilist practices were codified into a coherent body of economic doctrine, but there is consensus that for centuries, the use of governmental power to enhance economic development was seen as legitimate and desirable.

The classical economists, particularly Ricardo and Malthus, fundamentally changed the terms of discussion by conceptualizing the economy as an autonomous entity that is governed by its own principles, such as the law of supply and demand. Both Polanyi (1957) and Rothschild (1992) stress the important discontinuities between Adam Smith and the later writers of the classical school. Writing in the shadow of Newton’s scientific achievements, they imagined that the workings of the economy were similar to the harmonious movements of the planets in the solar system that could now be fully explained by the laws of physics (Redman 1997). In searching for the economic equivalents of the laws of physics, the classical economists generally viewed the state as an ‘outside’ force whose actions were likely to interfere with the economy’s capacities for self-regulation. In fact, their arguments against various mercantilist policies often emphasized that government actions were likely to have perverse consequences—opposite to those initially intended—precisely because such actions would disrupt the natural and self-regulating operation of economic laws (Hirschman 1991).

The classical economists recognized that there was a fundamental tension between their abstract model of an economy and the real world in which human beings were organized into separate nations governed by states. Just as their mercantilist predecessors, they were writing in order to shape the policies of their own government; they recognized that their vision of the proper organization of the economy could only be implemented through the use of the state. Hence, they distinguished between appropriate government policies—those that supported the full emergence of the economy as autonomous—and those government policies that were inappropriate—that were likely to retard or interfere with an autonomous economy. But while the classical economists agreed on this distinction, they were unable either to define precisely where this dividing line should be drawn or to develop a theoretically sound justification for its location. In fact, they had profound disagreements among themselves on where the line should be drawn. Despite the centrality of free trade to the classical tradition, one of its key thinkers—Malthus—argued consistently that it was appropriate for England to retain the Corn Laws that limited agricultural imports. John Stuart Mill, who played a critical role in codifying classical economics, also entertained a variety of heterodox policy ideas (Schumpeter 1954).

1.1 Purists And Pragmatists

This inability to derive the proper functions of the state from their abstract model of the economy has characterized the mainstream tradition of economic thought through the entire nineteenth and twentieth centuries (for accounts of this tradition that are less Anglo-American centered than most, see Schumpeter (1954) and Screpanti and Zamagni (1993)). The result has been a continuous tension within the tradition between ‘purists’ and ‘pragmatists.’ The purists argue that since we know that expanding the scope of markets improves economic efficiency, it follows that international free trade is always preferable to any form of protectionism. Furthermore, since governments can subvert free trade by providing subsidies to their own producers or by using regulations to discourage imports, it follows that a domestic regime of laissez faire in which government exercises the smallest possible role in the economy is to be preferred. Pragmatists, in contrast, starting with John Stuart Mill, have argued that precisely because the real world of actual economies diverges from the abstract model, there is an affirmative role of government that extends beyond establishing the minimal conditions for private contracting. Pragmatists have differed among themselves as to what government actions they would endorse, but some have favored tariff protection of infant industries, extensive regulatory regimes to overcome market failures, substantial measures to redistribute income, and the provision of a wide variety of public goods, including government participation in planning of the economy’s future growth path (Hutchison 1978 is particularly valuable in tracing out the pragmatism of Jevons, Marshall, and Pigou).

But this longstanding argument between purists and pragmatists within the central tradition of economics has usually been overshadowed by conflicts generated by two other important sets of ideas. The first is the challenge to the market model posed by socialist ideas, particularly those of the Marxist tradition. The second is the emergence of a counter tradition in economics that rejected both the methodology and the free trade preferences of the classical tradition.

1.2 Socialism

The socialist tradition predates Marx and includes a range of different theoretical currents, but the Marxist current has been the strongest for almost a century and a half. Moreover, it was Marx who effectively defined the intellectual achievement of the classical economists; he argued that they were the theorists and apologists of the emerging bourgeois social order whose triumph was signaled by the French Revolution. For Marx, this new social order was a coherent system that revolved around the imperatives of profit maximization. Precisely because the capitalist mode of production was a unified system, efforts to reform it were fundamentally futile. Marx repeatedly insisted that the only way for the working class to advance its collective interests was by a revolution that replaced capitalism with a radically different social order in which markets, private property, and the pursuit of profit would be eliminated.

By the end of the nineteenth century, the Marxist tradition developed its own division between purists and pragmatists. Purists continued to oppose any efforts to reform capitalism as inherently futile since they viewed it as impossible to change capitalism’s fundamental logic. Pragmatists argued that meaningful reforms could be won that would strengthen the economic and political position of the working class and make possible further advances in the direction of socialism. Since the pragmatist position often resonated with the views of non-Marxist socialists and with the views of reformists in the trade union movement, it played an important part in expanding the state’s role in the provision of social insurance, the regulation of industry, and the redistribution of income (Sassoon 1996, Hicks 1999).

While purists in the Marxist tradition and purist defenders of the free market have been bitter antagonists, it is worth stressing that they share certain common assumptions. They both insist that the only real alternatives for organizing societies are free market capitalism or socialism. They both see any effort to mix socialist and capitalist principles within a single society to be inherently unstable; sooner or later the instability will be resolved by movement to one of the stable poles. Moreover, they have the same view of the globe—that a world divided between socialist and capitalist societies is unstable; the world ultimately will have to be organized by only one of these principles.

1.3 The Counter Tradition

Marxism, however, was not the only oppositional doctrine that was spawned by the theoretical achievements of the classical economists. Starting as early as the 1820s, a counter tradition emerged that challenged both the classical economist’s emphasis on the desirability of free trade and their methodological assumptions. But while important work has been done in this tradition in virtually every decade from 1820 to 2000, the identification of this counter tradition is largely retrospective (Reinert 1999). It does not have either the organizational or the doctrinal continuity of either mainstream economics or Marxism. Its founding figure was the German, Friedrich List, who argued that the policy proposals of the classical economists were not universally applicable; if poorer nations were to embrace free trade without qualification, they would never be able to catch up with the world’s leading economic power—England. List advocated the use of governmental powers, including tariffs to protect infant industries, as a means to accelerate development of the economy’s ‘productive forces’ (Henderson 1983). The American economist, Henry Carey, also made important early contributions to this counter tradition.

The counter tradition was further elaborated in the 1870s and 1880s by the younger generation of the German historical school, especially in the writings of Gustav von Schmoller. Schmoller rejected both the ‘classical tradition’ view of the economy as autonomous and their laissez faire policy prescriptions (Schumpeter 1954). The German historical school, in turn, inspired both the first generation of academic economists in the United States (Ross 1991) and a group of English historical economists, including William Cunningham, J. W. Ashley, and W. A. S. Hewins who revisited English economic history and found powerful evidence that English economic development had depended heavily on state policies (Koot 1987). In the first part of the twentieth century, further contributions to the counter tradition were made by the American institutionalists and the English Fabians. In the 1930s, despite his orthodox intellectual lineage, John Maynard Keynes joined this counter tradition by breaking with free trade and advocating active government management of the economy. From the 1930s through the 1970s, this counter tradition was enriched by a broad range of scholars including Japanese economists who are little known in the West (Gao 1997), the Latin American group around Raul Prebisch that developed the idea of import substituting industrialization (McMichael 1996), and others. A particularly important contribution was the study of late-industrializing countries by Gerschenkron (1962).

Political leaders in late-industrializing countries have turned repeatedly to theorists of this counter tradition to help develop policies to accelerate their nation’s development. Count Witte, the Russian modernizing minister under Tsar Nicholas II had studied List closely before taking office and followed many of List’s policy prescriptions (Henderson 1983, pp. 215–17). After the Meijii Restoration in Japan, the most influential economic work was that of the German historical school. As Gao writes, ‘The intellectual roots of Japanese developmentalism can be traced to the German historical school’ (Gao 1997, p. 60). More recently, the spectacular economic advances of the South Korean and Taiwanese economies have been attributed to the influence of developmentalist policies inspired by the counter tradition (Wade 1990, see also the important book by Evans 1995).

The boundary lines separating these various currents of economic doctrine have sometimes been vague and indistinct. In the twentieth century, the dividing line between pragmatists within the mainstream tradition and proponents of the counter tradition has been crossed by major figures. (There are also important figures whose work spans the boundary line between Marxism and other traditions; of particular interest are those who have contributed to the theory of market socialism.) Two of the greatest economists of the twentieth century—Keynes and Schumpeter—can legitimately be claimed by both the mainstream and the counter tradition. A further complication is that the mainstream tradition of Anglo-American economics whose successive paradigms were codified by J. S. Mill, Marshall, and Keynes, entered into crisis in the early 1970s. As the influence of Keynesian ideas declined, no single theory has become dominant and the tradition has splintered into a number of conflicting views (Heilbroner and Milbert 1995). This is the theoretical context in which the political influence of the purist wing of the tradition has increased dramatically in the USA and throughout the world.

2. Global Constraints

It would be a mistake to imagine that political leaders have been free to choose among these diverse doctrines in deciding what role the state should play in their particular economy. On the contrary, these diverse doctrines have existed within a global structure of power that has constrained and limited the choices of political leaders. But this global structure of power has itself been in continuous flux, so that the severity of the constraints has varied considerably over time. Moreover, the constraints also vary within different historical periods; some countries have had more freedom to maneuver because of the specifics of their location.

The constraints are a direct result of successive national hegemonies over what Wallerstein has termed ‘the modern capitalist world-system’ (Wallerstein 1974, Arrighi and Silver 1999). Dutch hegemony was established initially in the seventeenth century, but it gave way, after an interregnum, to English hegemony in the early years of the nineteenth century. England’s hegemony was undermined first by World War I and then by the global economic collapse of the early 1930s. After another interregnum, the US emerged as the new hegemonic power in the final years of World War II. Moreover, the geographical scope of this capitalist world-system has steadily expanded from its European core so that by the middle of the twentieth century, it encompassed the entire globe.

Hegemony represents a combination of economic, military, and cultural power. In the nineteenth century, for example, the new ideas of the classical economists were a constitutive part of the English- dominated global order. Other nations were under pressure to adopt the ideas of free trade and laissez faire as a way to gain access to English capital, to avoid England’s military wrath, and to partake in the industrial modernity that England exemplified. The same point can be said of US hegemony in the second half of the twentieth century; it is impossible to determine whether the influence of US-sponsored economic doctrines has more to do with financial power, military power, or the powerful imagery of Hollywood and Madison Avenue.

2.1 A Rough Periodization

Even in England, there was a considerable time lag between the writings of the classical economists and the full embrace of free trade. It was only with the repeal of the Corn Laws in 1846 that England began exerting considerable pressure on other nations to embrace the doctrines of free trade and laissez faire. Hence, the period from 1850 to 1875 can be thought of as the first great epoch of free trade. During this period, most European nations lowered their tariff barriers and made at least some efforts to embrace laissez faire (Chase-Dunn et al. 2000). By 1870, many nations had embraced the gold standard by making their currencies freely convertible into gold (Eichengreen 1996). The gold standard represented the fullest expression of English hegemony, since it was designed to equilibrate automatically the global economy without governmental interference.

The dynamic shifted sharply in the next period from about 1875 to 1900. This was a period of slower growth and declining prices that in combination with the gold standard placed severe pressures on national economies (Polanyi 1957). The result was a marked retreat from both free trade and laissez faire. Tariff barriers increased significantly in this era (Chase-Dunn et al. 2000), and rising protectionism was clearly a component of the rush for empire as the European powers, the US, and Japan moved to establish formal colonies (Polanyi 1957). The trade barriers meant the potential loss of access to both markets and raw materials in those regions that had been colonized by other powers. Moreover, national regulations to control market forces expanded dramatically; this was the era in which government-sponsored social insurance was first developed and began to spread.

The brief period from 1900 until the outbreak of WW I is an anomalous and contradictory era. On the one side, the pendulum swung back in the direction of lowering trade barriers (Chase-Dunn et al. 2000), and international capital movements reached unprecedented levels in this period as the global financial system became more tightly integrated. On the other side, there were few signs of a return to laissez faire; the state’s role in managing domestic economies and providing social welfare continued to expand in many nations. Governments were under increasing pressure to make concessions to socialist movements that were growing in power and influence. Moreover, in this period, late-industrializing nations, such as Russia and Japan, did not hesitate to use governmental power to accelerate the processes of industrial development. Moreover, the intensification of the military rivalry between England and Germany in this period was very much a continuation of the imperialist conflicts that had emerged in the previous period.

Between 1914 and 1945, nineteenth-century civilization collapsed, and it appeared that the ways of thinking about state and economy developed by the classical economists had become completely obsolete. From Bolshevism to fascism to the experiments of the New Deal, it seemed that there were a multitude of divergent paths for organizing national economies (Polanyi 1957). Moreover, the imperatives of war meant that the major powers, even those that retained democratic institutions, went through extended periods of time when economic life was completely subordinated to political and military control. While much of Asia and Africa remained under colonial control, the larger Latin America nations were able to take advantage of the breakdown of global power to follow the teachings of the counter tradition (McMichael 1996). The overwhelming reality of this period was the human suffering generated by war, dislocation, depression, and unprecedented violence directed at civilians.

During the first period of US global hegemony from 1945 to 1973, the USA struggled, with the help of multilateral institutions, to limit the range of permissible variations in national economic policies. This meant an intensification of the Cold War to restrain the growth of socialism that had spread to Eastern Europe and China. The process of decolonization meant that this battle was now fought out over a far larger group of nations. But while the USA pushed strongly in this period for trade liberalization, there was no effort to restore laissez faire. It was taken for granted that, as with the New Deal regime in the USA, the government would play a large role in the domestic economy in managing the business cycle, regulating private firms, and producing a broad array of public goods. In this period, the pragmatists within the mainstream tradition of economics were dominant with their vision of a mixed economy. The ability of governments to pursue macroeconomic objectives was facilitated further by global rules that severely restricted international capital movements. Even poorer countries were expected to develop ambitious development plans and an elaborate system of foreign aid emerged to finance these efforts. Yet these efforts were biased strongly towards a model of development led by the private sector and countries that were too aggressive in fostering state-led development were pressured to stop (Wood 1986). A few nations, such as South Korea and Taiwan, were able to resist these pressures because of their location close to the fault lines of the Cold War, but their experience was deeply atypical (Wade 1990).

Finally, the period from 1973 to 2000 is the second great epoch of free trade. The steady progress towards reduction of trade barriers that began in 1945 was continued, and it was now joined by the elimination of barriers to international capital movement. The integration of global financial markets reached levels that had only previously been attained in the period between 1900 and 1914. Starting in the late 1970s, with Margaret Thatcher and Ronald Reagan, and intensifying after the collapse of the USSR, the old doctrines of the classical economists were now recycled under the rubric of neoliberalism. Laissez faire ideas were reintroduced on the grounds that government efforts to manage the business cycle were futile and excessive levels of taxation and regulation were destroying the vitality of market economies. Trade negotiations were now expanded to dismantle ‘nontariff barriers’ that included domestic legislation that had the unintended consequence of discriminating against foreign products. Developing nations were told to scrap their planning processes, to privatize state-owned enterprises, and to end subsidies that made food, transportation, and housing more available for the poor (McMichael 1996).

3. Theoretical Confusions

In reviving laissez faire, neoliberals assume that they can distinguish between the legitimate, albeit limited, responsibilities of government and those illegitimate government actions that are bound to have perverse consequences. But neoliberals have been no more successful than their classical predecessors in providing a theoretically justified demarcation line. That this problem has not been solved after two centuries of work suggests that there are deep theoretical confusions operating here.

3.1 Can The Economy Be Autonomous?

The fundamental problem lies with the assumption, introduced by the classical economists, that an economy can be organized around a set of self-regulating markets. Even with the added stipulation that there will be a state and a legal system that enforces property rights and contracts, this is still not enough. This point was elaborated most forcefully by Polanyi (1957), a Hungarian refugee intellectual who developed his own theoretical synthesis drawing on insights from Marxism and the German historical school. Polanyi argued that the flaw in the belief in an autonomous economy is that land, labor, and money are not true commodities; they are not things that were produced for sale on a market. Economists assume, however, that the price mechanism will equilibrate supply and demand for these fictitious commodities just as it does for true commodities. The difficulty is that when the demand for labor suddenly falls, human beings cannot be warehoused like unsold merchandise; those who are out of work must still have income. Similarly, countries that leave it to the market to determine the supply of money and credit are likely to suffer from chronic deflation when credit is too scarce or chronic inflation when it is too abundant. With labor, money, and land, a continuous governmental role is needed to make the market for these fictitious commodities work like other markets.

In short, a market economy cannot be autonomous because the state is involved intimately in three of the most important markets. What follows from this insight is that capitalism, defined as a society organized around an autonomous market in which actors seek to maximize utility, has never existed. Polanyi went on to argue that the market societies that actually exist are constituted by two opposing tendencies. The first are the ongoing efforts to expand the scope of markets—the project first announced by the classical economists. The second are parallel efforts to protect the social order from the consequences of market competition that includes regulatory efforts, social welfare policies, and other macroeconomic policies. Polanyi emphasizes that business firms participate in both of these tendencies, since they often need to protect themselves from market situations where uncertainty is uncomfortably high.

In recent years, scholars have produced a body of work that elaborates this Polanyian insight by analyzing the existence of a number of varieties of capitalism that vary significantly in the way that key markets are organized and in the relationships between state and economy (Block 1994, Crouch and Streeck 1997, Hollingsworth and Boyer 1997). These studies represent a fundamental challenge to the assumptions of both mainstream economists and Marxists that market societies should converge towards some common pattern. At the same time, however, some commentators (Gray 1998) have expressed concern that the neoliberal rules of the global economy might have the consequence of destroying varieties of capitalism that are actually more efficient than the Anglo-American type.

3.2 Transition To A Borderless World

A second theoretical confusion has to do with the tension between a unified global market and a world of nation states. Both the classical economists and contemporary neoliberals have been motivated by a vision of a peaceful planet in which military rivalries and warfare are replaced by the competition of individuals and firms to reach higher levels of efficiency. Both have imagined a gradual withering away of the nation state as the globe becomes economically unified. While there is much that is appealing in this vision, there has been a lack of clear thinking about the actual staging of this transition to a borderless world.

Ironically, the historical periods in which this vision has been most influential were marked not by the disappearance of state power, but by the unchallenged military and political hegemony of a single power— first England and then the USA (Kindleberger 1973). The temporary dominance of a single power hardly seems a sound foundation for a transition to a world beyond nations. A closely related problem is that this transition requires that nations give up the various measures that buffer their populations from the pressures of the global economy just as those pressures are intensifying. Creating a unified global market for agricultural goods, for example, requires that governments dismantle programs designed to stabilize the income of farmers just as those farmers are becoming more vulnerable to cheaper agricultural imports. The neoliberal vision rests on the willingness of millions of ordinary people—farmers, workers, and small businesspeople to be extraordinarily flexible—to accept that years of reasonable income periodically will be interrupted by years in which their income might fall by as much as 40–60 percent. (These figures reflect income losses in Asia and Mexico in the financial crises of the 1990s.)

For the affluent, such flexibility might seem logical and reasonable; they know that years of high returns on their portfolios can alternate with periods of negative returns. But those who lack an investment portfolio tend to resist this type of flexibility; their ability to pursue a life plan depends on some stability and predictability in their income flows. When such people are able to exercise political influence on their national leaders, they demand to be protected from extreme instability of their income. This is precisely what happened in the period from 1875 to 1900; ordinary people demanded to be protected from the costs imposed on them by global economic integration, and the result was a significant retreat from global free trade. Moreover, if governments are constrained by global power and are unable to respond to these popular demands to be protected from income instability, discontent does not disappear. It is often channeled into militant movements of the left or of the right that target both the ineffectiveness of the government in power and the foreign enemies who have imposed economic hardship on the local people. The efforts of centrist political leaders in the 1920s and 1930s to restore the gold standard and a liberal world economy were defeated by these types of movements. The deep historical irony is that the effort to create a pacified, borderless world produced exactly the opposite; extreme forms of nationalism and war on a global scale.

4. Conclusion

The period from 1973 to 2000 has seen unprecedented growth in a variety of indices of economic globalization. However, these theoretical confusions about the autonomy of the economy and the transition to a borderless world raise concerns about the sustainability of these trends. How the organization of economies and states will evolve remains an open question.

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