If socially-agreed values were denied any role in filtering, motivation and restructuring, the government could be assigned an important role in the realization of social goals. However Say’s Law,19 which is an important by-product of the application of the laws of Newtonian physics to economics, and which constitutes one of the cornerstones of classical economics, would not allow this. It asserted that, just like the universe, the economy will run perfectly if left to itself. Production will create its own demand and there will be no overproduction or unemployment. Any tendency on the part of the economy to create overproduction or unemployment will be corrected automatically. In this respect ‘Economic laws’ were all powerful and brooked no interference.
This led to the concept of laissez faire, which stands for government non-intervention in the operation of the market. The government could do nothing and had no other option but to abstain from intervention. Market forces would themselves create an ‘order’ and ‘harmony’, and any effort on the part of the government to intervene in the self-adjusting market could not but lead to distortion and inefficiency. The mechanical concept of the universe and of man thus gave rise to a blind faith in the efficacy of market forces.
The seeds for Say’s Law had been laid earlier by Adam Smith’s claim that there was a symmetry between private and public interests. If everyone pursued his or her self-interest, the ‘invisible hand’ of market forces would, through the restraint imposed by competition, promote the interests of the whole of society, thus bringing about a harmony between private and social interests.20 Hence there was no need for the government or anyone else to intervene in the operation of the market. The general equilibrium theory further reinforced this logic by showing mathematically “how the unintended consequences of uncoordinated selfishness result in the most efficient exploitation of scarce resources in the satisfaction of wants.”21
To prove that the market would if left to itself lead to maximum efficiency, it was argued that individuals in their capacity as sovereign consumers, act rationally and try to maximize their utility by buying at the lowest price the goods and services that occupy a higher place on their preference scales. Their preferences are reflected in the market place through their demand or willingness to pay the market price. Individuals, in their capacity as producers, also act rationally and respond ‘passively’ to this demand by producing at the lowest cost whatever will help them maximize their profits. The free interaction of utility-maximizing consumers and profit-maximizing producers under perfectly competitive market conditions determines the market clearing prices for goods and services. These prices (and costs, which are also prices) serve as an impartial, value-neutral filter mechanism and lead to the transfer of resources from one use to another. Thus, without anyone’s conscious effort or intervention, there is the production of that configuration of goods and services which is in maximum harmony with consumer preferences. This configuration is called the Pareto efficient. It is the most ‘efficient’ because it is not possible to improve upon it without making someone worse off. There is perhaps no other concept which has acquired as firm a place in the paradigm of conventional economics as Pareto efficiency.
The word equity is not explicitly mentioned within this framework. However, it is assumed that the configuration of goods and services which is Pareto optimum is also the most ‘equitable’,22 because it reflects the incomes earned by the respective factors of production on the basis of their contribution to the Pareto optimum output and revenue. Friedman very clearly argues that: “However we might wish it otherwise, it simply is not possible to use prices to transmit information and provide an incentive to act on that information without using prices also to affect, even if not completely determine, the distribution of income.”23 Thus, equity also found itself defined in terms of Pareto optimum rather than normative goals. At the point of equilibrium, consumer satisfactions (utilities) are maximized, supplier costs are minimized, and factor earnings (including wages, salaries, rents and profits) are maximized. Market prices, it is thus concluded, determine not only the most ‘efficient’ use of resources but also the most ‘equitable’ distribution of income in a rational and impartial manner without value judgements.
Private and public interests are thus automatically brought into harmony. Questions about whether this configuration satisfies basic human needs and whether the distribution is equitable are improper because such questions cannot be answered without collective value judgements which, unlike market clearing prices, cannot be established impartially. Questions about differentials in wealth holdings are similarly improper because the wealth of individuals largely represents the savings resulting from the market value of their own or their parents’ contributions to output and abstinence from consumption. Hence, there is no need for value judgements or government intervention.
All that needs to be done is to ensure competitive markets to enable prices to reach their equilibrium levels, without any restrictions on sovereign consumers to maximize their utilities by purchasing whatever they desire in keeping with their preferences and ability to pay the price, or on producers to respond to consumer preferences in a way that enables them to maximize their profits. Anything that prevents this from taking place is a distortion and automatically leads to an inefficient and inequitable use of resources. Government intervention may be acceptable only where it is necessary to remove such distortions, to ensure competition and orderly markets, and to offset market failure in the supply of public goods.
The logic of the claimed symmetry between public and private interests thus had the effect of gradually turning eyes away from the social obligations of individuals to the ‘unintended’ social outcome of their actions, and made the market the primary instrument for realizing efficiency and equity in the allocation and distribution of scarce resources. This eliminated the role of all institutional factors, including moral values, and of government. Market-determined prices became the only filtering mechanism, and self-interest the only motivating force. These together would also bring about the needed restructuring in resource use until the most efficient and equitable outcome was attained. Hence the tacit acceptance that competition was sufficient to serve social interest and to bring about harmony in human society.
THE KEYNESIAN CONSENSUS AND ITS BREAKDOWN
The Great Depression clearly established the logical weakness of Say’s Law and the concept of laissez faire. It was evident that market economies were not necessarily able to constantly maintain full employment and prosperity.24 They could rather slump into depression and not automatically rebound to full employment because of market imperfections and rigidities. Nobody had the patience to wait for the long-run because, as Keynes put it, “in the long-run we may all be dead”.25 What Keynes did was to provide a theoretical rationale for this empirical failure. Inadequacy of demand was diagnozed by him to be the cause of depression. This led to the Keynesian consensus in conventional economics and the general acceptance of an important role for the government in the economy through fiscal and monetary policies. Governments intervened to a greater or lesser extent to promote growth and employment and to offset, at least partly, some of the adverse effects of market failure on both efficiency and equity.
The Keynesian consensus had, however, a logical weakness in the same way as Say’s Law. While Say’s Law put the entire burden of goal realization on the market, the Keynesian revolution put the whole burden of correcting the unemployment equilibrium on the government. There was no room even in his thought for the role of values and of family and social solidarity in realizing social goals. The excessive burden on the government generated high rates of fiscal deficits and inflation in the 1970s without significantly redressing the unemployment problem. The Keynesian fiscal remedy was unable to successfully cope with stagflation, or the simultaneous presence of both high rates of inflation and unemployment. This led to a breakdown of the consensus and to a revival of faith in the laissez faire model. If there were any doubts still left about the inefficacy of monetary and fiscal policies, they were shaken by the rational expectations theory.26 It was argued that the rational individual took account of all available information, including expected changes in monetary and fiscal policies, and reacted accordingly. This made government policies ineffective. Intensified calls from both