Often, in trying to get at the “essentials” of how a capitalist economy functions, we consider a simplified model of a closed economy without government. Through such models it is possible to make the argument that exploitation, instability, unemployment and/or demand deficiency (depending on the particular Marxian or Keynesian flavor of the model) are endogenous to a private market system in which production is for monetary profit. Not only is it then possible to hold that the problems are inherent to laissez-faire capitalism but also that their solution can only come from the “outside” – either through revolutionary overthrow of the system or reformist management by the state. In debate between the proponents of laissez-faire capitalism and its dissenters, the approach is useful and informative. Proponents of laissez-faire desire an economy in which the role of the state is minimized, and the simplified models take that line of thought to its logical conclusion and suggest it is untenable. However, it is also easy to lose sight of what is missed in abstracting from the state. A habit of thought tends to emerge in which the state is seen as peripheral to capitalism and perhaps even powerless to do much at all when faced with the supposed awesome might of private market forces and the realities of capitalist social relations of production. But the state is actually foundational to capitalism, and the current economic system would not exist, let alone function effectively, without it.

The state is foundational as:

1. definer and enforcer of private property rights and rules of the game;

2. guarantor of a currency and its acceptance;

3. reverser of persistent deficiency in private demand (Kalecki, Keynes) or backstop in the face of a falling rate of profit (if Marx’s perspective on crisis is adopted);

4. corrector of chronic underinvestment in infrastructure and basic research.

1. The importance of private property rights is self-evident. Without the definition and enforcement of private property rights, there can be no stable class division into those with or without property, those with or without a need to sell their labor power to a capitalist in exchange for a wage. Without rules defining the parameters within which private exchange occurs, markets, to the extent they continue to exist at all, degenerate into mayhem. It is possible to conceive of a private rather than public entity defining and enforcing private property rights and laws, but that would simply mean that this private entity was functioning as the state. It would be a privatized and undemocratic state, perhaps complete with private police force and military.

2. The capacity to ensure currency acceptance is really an outgrowth of the state’s capacity to enforce its laws. A monetary production economy requires a functioning currency. The surest way to ensure a functioning currency is to compel it. The state does this through its enforcement of obligations on citizens in the form of taxes and, to a lesser extent, fees, fines and other impositions denominated in the state currency. The state could forgo this role if it wished and instead ensure the effective functioning of a private currency. It could instruct a private bank or corporation to issue a currency and to ensure its acceptance by imposing a private contractual obligation on citizens denominated in the private currency. The state could then enforce the private entity’s contractual obligation with the force at its disposal.

3 & 4. The state can address demand deficiency, falling profitability and underinvestment in infrastructure and basic research because it can ignore profit considerations. This is especially true of states sovereign in their own currency (i.e. currency issuers), but all states must act independently of profitability to a substantial degree if there is to be any viability for a capitalist economy.



State as reliable source of demand

Demand deficiency, to focus in more depth on just one of the above factors, tends to emerge in a simplified closed economy in which we abstract from government because of the individual need, under conditions of private property, to save and the unlikelihood of investment being at the level sufficient to sustain this rate of saving at full employment output. Everybody, really, would have a need most of their lives to save (or depend on a saver) in an idealized system of laissez-faire capitalism in which there was no public provision of pensions, social safety net or key services. By accounting identity, this level of saving would be impossible unless businesses and retirees, taken together, just so happened to desire a financial deficit sufficient to offset the saving intentions of other households. If, in fact, deficit entities were willing to take on enough debt to maintain strong levels of demand, the situation would quite likely become unstable and any growth financially unsustainable (a discussion of related issues, though in the context of a four-sector model, can be found here). The growth process would break down sooner or later under the debt burden placed on borrowers. If, instead, households and businesses were overwhelmingly determined to run financial surpluses, realization of which would be an accounting impossibility, they would be frustrated in their objective by the weakness of demand and resulting negative income adjustments. The internal logic of private market forces offers no reliable solution to this problem. Interest rate adjustments cannot be relied upon to rectify the situation. (This conclusion follows from the capital debates and is also consistent with experience, for example since 2007.) Nor can wage adjustments be expected to resolve the problem, for related reasons.

It is not even clear that there is anything within the internal logic of laissez-faire capitalism to turn the economy around in a depression. Imagine truly flexible wages and prices. Appeals to diminishing marginal returns would be misplaced in the context of output far below capacity. A fall in wages under competitive conditions would be more or less matched by a fall in prices. The impact on real wages, even if this could reliably influence the level of employment, would be minimal and not even obvious in direction. Creditors would gain and debtors would lose. The latter would be even more indebted in real terms and less likely than before to spend. Real assets could be purchased more cheaply, and might or might not be exchanged in greater quantity depending on whether the prices were expected to fall even further in the future (which they probably would). Even if real assets were exchanged more readily due to the lower prices, there would be little reason to utilize available productive capacity more fully let alone expand capacity while demand remained weak. The only “out” in this scenario would be for creditors to take up the slack in spending. But why would they do so? Additional investment would be largely out of the question until demand conditions picked up. And, as for additional consumption, well, creditors are creditors, and they typically want to be. The accumulation of financial surpluses is what mainly drives them. True, they might decide to spend more. Some day. But, then, they might not. There’s nothing in the private market mechanism that would necessarily induce them to do so.

What has to occur, to end a depression, is spending. Not price movements, not wage adjustments, not interest-rate cuts. Spending. The state is a source of spending – including spending of last resort – and can spend, if it is a currency issuer, on its own terms and for its own reasons (no need for profit). But when, instead, we abstract from the state, and imagine pure laissez-faire capitalism, there is no certain source of spending beyond the sheer physical subsistence requirements of workers. And even that is not a hard constraint given that under true laissez-faire workers might just be left to die of starvation. In reality, of course, workers in advanced economies receive more than physical-subsistence wages, somewhat raising the floor on demand. And wages and prices are sticky, establishing a somewhat more resilient lower limit to demand. That stickiness, though, is largely contingent on the state enforcing wage and pricing contracts. With no legal rights for workers, again enforced by the state’s legal system, wages might be truly flexible, and capitalism even less viable than otherwise.



The high-wage economy and class-compromise capitalism

The above reasoning, posed as a response to supporters of laissez-faire capitalism, could be addressed instead to those who deny the efficacy of a high-wage economy. It is not uncommon to see arguments on the left along the lines that higher wages are harmful to capitalism (harmful to capitalism, not humanity) by making production less profitable for capitalists. The impact on profitability, it is argued, will mean weaker investment. Outcomes under capitalism will be even worse than under present circumstances.

For starters, the claim regarding investment is debatable, to say the least. The first impact of higher wages is a strengthening of demand for worker-consumption items. It is highly unlikely that producers in this sector will cut back production in response to higher demand. If, instead, they expand production, this will have further positive income effects on consumption demand. To the extent the stronger demand conditions justify expansion of capacity, there will also be a subsequent spur to investment and so to production in the investment-goods sector. The notion that an increase in wages will hurt investment requires that capitalists’ initial response is to cull staff, despite the stronger consumption demand. Possible, but far from certain.

Let’s say it happens anyway. Private investment drops off. This would only underscore the dependency of capitalism on the state. The state, especially if a currency issuer, is not beholden to the profit motive. It can spend on whatever is available for sale in its own currency and for whatever reasons and for whatever purposes it finds instrumental to its ends. Whether the impact on capitalists is positive or negative (it will, in all likelihood, be positive) is immaterial. If the capitalists wish to go on investment strike, let them go ahead! They are not needed. The state is perfectly capable of accumulating capital equipment and infrastructure on the capitalists’ behalf and then handing it over to them down the track. If this were not possible, the whole Soviet experiment would hardly have turned out so well for Russian oligarchs upon the transition to capitalism. The state built up real wealth and then handed it over to its cronies. None of this turned out to be a threat to capitalism. To the contrary, the state was essential to capitalism’s “success”.

Similar could be said of post-war America in which the state, having taken over half the US economy and built up productive capacity considerably during wartime, basically sold assets on the cheap to the private sector. Maybe similar is unfolding in the Eurozone. Welfare-state capitalism with a significant role for public investment and in some cases nationalized industry built up real assets over decades that are now ready for the divvying up among oligarchs. Perhaps the Chinese state intends to do much the same. It probably beats replicating the period of early industrialization in England by making for a less radicalized populace. Judging by the rapidity of industrialization in early Soviet times, it is probably a quicker way to accumulate riches in any case – riches that can then be duly privatized after the fact.

The state calls the shots under capitalism (on behalf, of course, of private capitalists, at least to the extent that such behavior goes effectively unchallenged by the general population). The reason the high-wage economy is resisted by the state is not that it is unviable under capitalism – the reality is quite to the contrary – but because it is not desired by the state and its cronies in the private sector. Under the right circumstances, however, it will be tolerated, and has been tolerated from time to time. It will be tolerated if and when the collective mood of general populations makes it expedient. The mood of an average American in the 1930s or 1940s, and his or her willingness to demonstrate displeasure industrially and politically, would have made the state and private capitalists somewhat more willing to countenance class-consensus capitalism, at least temporarily while biding their time. The two decades of consensus-capitalism were not less successful than neoliberalism in any important respect, economically speaking. Employment outcomes were stronger. Growth rates were typically higher. Even if capitalists had suffered in terms of profitability, this would have had little bearing on what actually mattered to most people at the time, and therefore would have had little bearing on the viability of capitalism in the context of competition with an alternative socioeconomic system. The class compromise, irrespective of profitability, was clearly more viable than laissez-faire capitalism. And neoliberal “reform” – embraced by a later generation of gullible voters – would have been difficult to push through any earlier than achieved because of fresh memories of what had occurred in the decades immediately preceding the post-war period.

In any case, far from hurting profitability, one effect of the state taking over half the US economy during the second world war was a massive increase in the rate of profit. Far from impacting negatively on profitability, a more dominant state underpinned a period of capitalist strength at a time when it might otherwise have been threatened by the appeal of an alternative system. The impact on profitability is not actually surprising if we keep in mind the effects of state deficits and public investment on profitability, both on the revenue and cost sides (this is discussed in here and here).



The state is logically prior, and necessary, to capitalism

The deficiencies of laissez-faire capitalism are inherent to the profit system itself. It is only the state, with its capacity to bypass the profit imperative completely, that makes it possible to maintain an incoherent set of social relations in which everyone would wish to be a net saver but many must be consigned to debt servitude; in which everyone would wish to be the owner of net wealth but most must be left with nothing but their labor power to sell. It is only the state that gives the system any viability at all. And, yet, even on the left, we frequently start our analyses by abstracting from the state. Granted, this makes clear inherent weaknesses of the profit system, and is an appropriate abstraction for some purposes. But it is worth remembering that the state is logically prior. There can be no capitalism until the state has established property rights. There can be no capitalism until acceptance of a currency is assured, and this assurance (as opposed to mere hope of spontaneous emergence and longevity of a currency) requires state compulsion, as chartalists emphasize. There can be no capitalism with any social viability without the state’s key role as autonomous spender. We can only imagine how diabolical the present world recession would have been in the absence of government spending, or employment contracts limiting downward flexibility of wages or firing of workers, or minimum wage laws, or what remains of the welfare state and so on.

The bad news is that this system will continue for as long as we let it, or until we exterminate ourselves. There is nothing else standing in the way of business as usual. The state will always be able to keep the ball rolling. Unless and until we act in sufficient numbers and with sufficient assertiveness, both industrially and politically, there is no reason things will change. There will be no fiscal crisis of the state coming to the rescue, killing the system for us. There will be never-ending capitalism for as long and far as the eye can see, with the majority not only voting for more of the same – in the past they’ve torn down walls to embrace this stuff – but with the majority also continuing to absorb the worldview of the elites and taught to despise dissenters and any sign of dissent.

Admittedly the mob will form its view, or have its view formed, under the influence of opinion shapers and propagandists of capitalists and the state – by the capitalist state, in fact, which is the system’s only real source of longevity, stability and strength, a source of strength that will last for as long as the mob continues to lend its support.