The breakdown of the Keynesian consensus has, thus, brought back conventional economics to its non-interventionist, neoclassical position. It is now believed that government intervention in the economy through expansionary monetary and fiscal policies cannot be successful in attaining a permanent increase in output and employment. This raises the crucial question of how social goals can be realized if the laissez faire model has failed empirically and government intervention through monetary and fiscal policies is also considered to be ineffective. Conventional economics has no answer to this question. There is hardly any discussion of how and by what process efficiency and equity as conceived within the theoretical construct of Pareto optimum translates into humanitarian goals. It is tacitly assumed that these goals may be ‘ultimately’ realized if the market is allowed to play its role.
Such an assumption is only justifiable if there is only one market equilibrium. However, the undeniable fact is that it is possible to have several equilibria depending on which tastes and preferences based on which values and institutions interact with market forces. Which of these different equilibria would then be called Pareto optimum? Would it be any equilibrium, or would it be the one which is consistent with humanitarian goals? This question is not explicitly addressed. It cannot be because this would require an analysis of all possible equilibria in terms of their relationship with the humanitarian goals, leading ultimately to a point where one of them may have to be chosen because of its being closest to these goals. If this requires a specific behavioural pattern on the part of consumers and firms, and hence a change in existing consumer tastes and preferences and socio-economic institutions, then value judgements and social reform become imperative.
Social reform cannot be entertained in positive economics because of the anathema it presents to value judgements and the commitment it requires to unrestrained individual freedom. Hence, only the ceteris paribus clause was so extensively employed. Tastes and preferences together with values and institutions were assumed to be exogenous and the Pareto optimum became associated with those sets of the same that were extant. It did not matter whether these were, or were not, conducive to the realization of humanitarian goals. It was implicitly assumed that every market equilibrium would be consistent with normative goals. Equilibrium economics thus became “an apologia for existing economic arrangements”28 by leading to the belief that any intervention to change the status quo would necessarily lead to results which were less efficient and less equitable.
What Keynes did was to show that every market equilibrium was not consistent with full employment because of market imperfections and rigidities. He, therefore, proposed the use of fiscal policy to ensure full employment. Keynes was, however, not concerned with the other goals of social policy (need fulfilment, the equitable distribution of income and wealth, ecological balance and social harmony). From his point of view, the prevailing market system appropriately solved the problems of resource allocation and income distribution. It failed only in realizing full employment. He, therefore, specified only a small change in the market system. He did not talk of a change in the attitudes and preferences of individual economic agents. The rational expectations theory, which has now become generally accepted, has shown that monetary and fiscal policies cannot even help realize full employment. The inflation expected by individuals as a result of the policy change would automatically generate the expected inflation, without a permanent reduction in unemployment. The government would not, therefore, be able to accomplish anything in spite of its good intentions.
Even though the Keynesian consensus has broken down in academic circles, the goal of full employment lives on. Nevertheless, conventional economics has so far been unable to formulate an effective strategy that can realize a market equilibrium which is in harmony with this goal as well as the other goals of social policy. Is it possible for a society faced with social turmoil to accept the pessimistic verdict of the rational expectations theory that the government is helpless and can do nothing and that, hence, the only alternative left open for society is to wait until the market is, itself, able to realize the needed equilibrium in the long-run? Will the market be able to do so in the long-term until the tastes and preferences of all agents operating in the market have been changed through social and economic reform?
The silence of conventional economics is understandable, given its epistemological commitment to value-neutrality and the unhindered freedom it places on individuals to pursue their self-interest. However, the realization of goals of social policy is important and the market may not, itself, be able to help realize these goals with minimum government intervention unless certain background conditions are satisfied. The most indispensable of these conditions include: (a) harmony between individual preferences and social interest; (b) equal distribution of income and wealth; (c) reflection of the urgency of wants by prices; and (d) perfect competition.
Adam Smith assumed that condition (a) was automatically satisfied in a competitive free-market economy. This assumption has become the bedrock of the economics paradigm. However, while there is undoubtedly a harmony between individual preferences and social interests in some cases, there is also a conflict in other cases. It is the existence of this conflict which tends to make the realization of normative goals difficult unless the conflict is removed. This difficulty may be better appreciated if one were to examine the need for reducing domestic absorption (aggregate consumption and investment by both the public and the private sectors) to remove the macroeconomic imbalances that a number of countries are now encountering. If the effect on normative goals was to be disregarded, then the market strategy may, perhaps, be the most effective way of reducing domestic absorption. However, given the high levels of unemployment which prevail, it is not necessarily possible to satisfy the imperative of full employment without accelerating investment and growth.
If absorption, however, is to be reduced in a way that investment does not only not decline but rather rise, then consumption may be the primary component of domestic absorption that has to be reduced. Moreover, if the goal of need-fulfilment is not to be compromised, then it may not be desirable to reduce the consumption of all goods and services. It could be argued that the social interest may be better served if the consumption of luxuries, status symbols, and other consumer goods that do not necessarily fulfil a need or reduce a hardship were reduced. However, such a distinction between different goods on the basis of normative goals is not possible or acceptable within the paradigm of conventional economics, for it does not allow the passing of value judgements on individual preferences and relies primarily on choice through the market to determine those individual preferences that may or may not be satisfied.
It is not certain whether choice through the market necessarily helps reduce the different components of domestic absorption in a manner that conforms with normative goals. The market strategy would rely primarily on a rise in prices, interest rates, and taxes to the exclusion of all other means, and in particular socio-economic institutions based on value judgements. A rise in prices may not help because, while the rich may be able to afford whatever they wish at the higher prices, the real income of the poor may be further squeezed and their well-being suffer. Primary reliance on prices may thus shift a significant part of the burden of reducing absorption onto the poor.
Similarly, a rise in interest rates does not necessarily help reduce absorption in the manner desired. Higher interest rates do not of themselves reduce the luxury consumption of the rich or the defence and unproductive outlays of the government. They may, however, adversely affect the well-being of the poor. They may also tend to jeopardize the commitment of funds for long-term productive investments, while not curbing short-term speculative sprees in the commodity, stock, and foreign exchange markets. This may hurt the overall, long-run performance of the economy.