The Ideas of John Maynard Keynes (pt 4)

Keynes’s theory of surplus value

Over the last couple of weeks, we saw that Keynes denied that surplus value was produced by the unpaid labor of the working class. So how does surplus value—profit, interest and rent—arise, according to Keynes, if it is not produced by the working class? (1)

“It is much preferable,” Keynes wrote in chapter 16 of the “General Theory,” “to speak of capital as having a yield over the course of its life in excess of its original cost, than as being productive. For the only reason why an asset offers a prospect of yielding during its life services having an aggregate value greater than its initial supply price (2) is because it is scarce; and it is kept scarce because of the competition of the rate of interest on money. If capital becomes less scarce, the excess yield will diminish, without its having become less productive—at least in the physical sense.”

The difference between the “aggregate value,” to use Keynes’s terminology, and the “supply price”—the cost to the capitalist of that asset—is the surplus value that “asset” yields—not produces, according to Keynes—to its owner. But where does this surplus value that is “yielded” come from if it is not produced—that is, if it does not arise in the sphere of production? As we saw over the last several weeks, Keynes accepted the “classical” marginalist postulate, or unproved assumption, that the worker does not produce any surplus value but simply reproduces the value of the worker’s wage.

Neither the working class nor capital, according to Keynes, produces surplus value. That is, contrary to the physiocrats or the Smith-Ricardo school, surplus value is not produced in the sphere of production. From where then does the surplus value come?

According to Keynes, the only reason capital “yields” a surplus value is because it is “scarce.” If capital weren’t scarce, there would be no surplus value. Indeed, the value of capital would be zero, or what comes to exactly the same thing, there would be no capital at all.

The marginalists, including Keynes, have actually reverted to the views of the mercantilists and Malthus—Keynes held Malthus in especially high regard—that surplus value arises not in the sphere of production but in the sphere of circulation. Here marginalism, in its flight from the law of labor value, negates the greatest achievement of the liberal classical political economists. This is the discovery that surplus value arises in the sphere of production, not circulation. Therefore, Keynes defends the tremendous step backwards of the “classical” marginalist economists, their claim that surplus value isn’t produced but arises, due to scarcity, in the sphere of circulation.

Keynes on profit and interest

Where Keynes did make a break with traditional marginalism was his view of the nature and relationship between two different fractions of surplus value, the profit of enterprise and interest. Unlike Marx, who explained “interest” as simply a sub-fraction of profit, which itself is only a fraction of the surplus value produced by the unpaid labor of the working class, Keynes saw interest and profit as the “yield” of money and the “yield” of real capital, respectively. Real capital “yields” a profit because it is “scarce,” just like money “yields” its owner an interest because it too is “scarce.”

In contrast to Keynes, the “classical” marginalists claimed that capital yields interest because it is a scarce factor of production. Keynes, however, distinguished between the profit of the industrial and commercial capitalists—the profit earned by the entrepreneurs, to use Keynes’s preferred terminology—and the interest earned by the money capitalists—or rentiers, as Keynes called them.

The marginal efficiency of capital

Like the “classical” marginalists, Keynes generally avoided the term “profit” or “rate of profit.” Instead, he introduced a new term to distinguish the profit earned by the “entrepreneurs” from the “interest” appropriated by the “rentiers.” Keynes called the profit earned by the industrial and commercial capitalists the marginal efficiency of capital.

Here Keynes used the marginalist method to analyze what in plain language is the rate of profit. Keynes reasoned like this: If a given unit of additional capital is employed, the commodities that will be produced with it will become less scarce, causing their value or price—the same thing in marginalist economics—to decline. Realizing that this will happen, the industrial capitalist will expect a lower rate of profit on each additional unit of capital he invests. The rate of profit expected by the industrial (or commercial) capitalist on an additional unit of capital Keynes defines as the marginal efficiency of capital.

According to Marx, assuming the industrial or commercial capitalists make the average rate of profit, these capitalists appropriate the interest on their capital plus an additional profit, the profit of enterprise. The average profit, according to Marx, consists of interest plus profit of enterprise.

Keynes, however, because of his peculiar definition of interest, denied that the entrepreneur actually realizes “interest” on his or her capital. Keynes defined interest as the “reward” that a money capitalist—or rentier, in Keynes terminology—gets for not holding money. The marginal efficiency of capital—which plays the same role in Keynes’s system that the average rate of profit does in the classical and Marxist schools—arises, according to Keynes, due the scarcity of real capital, and interest arises due to the scarcity of money capital. Unlike the “classical” marginalists, Keynes, like Marx, sharply distinguished between real and money capital.

The distinction that both Marx and Keynes made between real and money capital is incompatible with the quantity theory of money. According to that theory, changes in the quantity of money relative to the quantity of commodities have no effect—the modern version of the quantity theory of money associated with Milton Friedman would amend this to say no effect in the long run—on real wages or real profits.

The more traditional marginalists—for example, the neoliberal followers of Milton Friedman—would argue that if the quantity of money is insufficient to fully realize the value of commodities at existing prices, prices will simply fall to a level that will realize their values. If the total quantity of money in circulation consisted of one dollar or one euro, for example, all the commodities that are produced would still be sold, though the prices of commodities would be quoted in terms of tiny fractions of a cent.

Therefore, at least in the long run, the quantity of money should have no effect on the rate of interest. At most, according to traditional marginalism, if the rate of growth in the quantity of money exceeds the rate of growth in the quantity of commodities, an “inflation premium” will be added to the “natural rate of interest,” which is determined in turn by the scarcity of real capital.

For example, if, according to Friedman, the natural rate of interest is 3 percent and the expected rate of inflation is 4 percent, the nominal rate of interest will be 7 percent. (3) But even then the real rate of interest, that is the actual quantity of commodities that a given interest income can buy once the effects of inflation are factored out, will not be affected.

Keynes rejected this analysis. As I explained last week, Keynes, in contrast to Ricardo, Marx and marginalist supporters of the quantity theory of money such as Milton Friedman, claimed that the level of nominal prices is determined by the level of money wages. Therefore, a contraction in the quantity of money will raise interest rates, according to Keynes, not lower the general price level. Only if the contraction of the money supply and the consequent rise in the rate of interest leads to mass unemployment that in turn drives down the level of money wages will the general price level finally be lowered. (4) Therefore, Keynes rejected the neutrality of money, supported by Ricardo, traditional marginalists and other economic liberals.

Marx versus Keynes

Marx and Keynes were in partial agreement here. Both Marx and Keynes rejected the quantity theory of money and the neutrality of money that goes with it. Marx and Keynes alike rejected the claim that a contraction in the quantity of metallic money will lower prices, and agreed that instead a contraction in the metallic money supply will increase the rate of interest. (5) Conversely, they agreed that an expansion of the quantity of metallic money, all else remaining equal, will lower interest rates and not increase prices.

Both Marx and Keynes recognized that the split between money and commodities makes general crises of overproduction possible. And both economists rejected Say’s Law. Keynesian economists in general are quite cool to the theory of comparative advantage as well. (6) This is not surprising, since, as I have demonstrated, the view that comparative advantage as opposed to absolute advantage applies in trade between nations under capitalism stands or falls—it falls—with the quantity theory of money.

Pointing to these areas of agreement, many Marxists have jumped to the conclusion that Keynes’s theories represented a major turn in the direction of Marx. The most Keynesian of Marxists have implied that many of the differences between Marx and Keynes are merely terminological, though they admit that, unlike Marx, Keynes failed to draw any socialist conclusions from his critique of “classical” marginalist economics.

If the differences between Marx and Keynes were merely terminological, it would be possible to integrate Keynes’s entire system into Marxism. All we would need is a dictionary to translate the different terms. But this is not the case.

Indeed, even leaving aside the fact that Keynes did not draw any socialist conclusions from his work, the differences between Marx and Keynes are a lot more than merely terminological. They involve the most basic question in all economic science: the origins and nature of surplus value.

In addition to this, they involve the very nature of value, money and price. Why do products of labor under certain historically determined conditions of production take the form of commodities at all? What determines the magnitude of the value of a given commodity? What is the meaning of the word value? Marx and Keynes gave radically different answers to these basic questions.

For example, take the economic category of “money.” As I demonstrated in the posts dealing with the theory of money, according to Marx metallic money, token money and credit money are governed by quite different laws. However, Keynes—much like Milton Friedman—made no distinction between these different forms of money. Whether money takes the form of gold coins, banknotes convertible into gold, or paper money, money is money according to both Friedman and Keynes.

While the supporters of the quantity theory of money such as the neoliberal followers of Milton Friedman wrongly apply the laws that govern token—paper—money to metallic money, Keynes and his followers wrongly apply the laws that govern metallic money to token money. (7) Or what comes to exactly the same thing, Keynes falsely claimed that an increase of the supply of token money by the “monetary authority” will have exactly the same effect as an increase in the quantity of metallic money.

When it comes to the effects of an increase in the quantity of token money issued by a “monetary authority,” Marx was actually closer to Milton Friedman than he was to Keynes. Marx and Friedman would both agree that increasing the quantity of token money issued by the monetary authority, the quantity of metallic money and commodities remaining unchanged, even if money wages are not rising or even if they are falling, will be inflationary.

But Marx would be closer to Keynes when it comes to the effects of an increase in the quantity of metallic money. While Friedman would see this as just as inflationary as an increase in the quantity of paper money, Marx would agree with Keynes that an increase in the quantity of metallic money, all other thing remaining equal, will bring about a fall in the rate of interest, not higher prices.

Keynes saw a rise in money wages as inflationary, but did. Unlike Marx, however, Friedman would oppose a rise in money wages, not because he thought it would be inflationary but because he would claim it would increase unemployment. Eager to safeguard his reputation as the darling of the business world, it is hard to imagining the old University of Chicago professor ever supporting higher wages in any real world situation.

Marx, in contrast, as the champion of the working class always supported demands for higher wages by the workers, though he also explained that the real liberation of the workers could not be achieved by rising wages but only by abolishing the wage system—capitalism.

No Marxist, trade unionist or left winger that I know of ever claimed that Milton Friedman’s “anti-Keynesian counterrevolution” was a move toward Marx on the part of the academic bourgeois economists, though as I have shown there are some points where Marx and Friedman are in agreement against Keynes. Therefore, I think we should be careful in hailing the current revival of Keynesian economics on grounds there are some points of agreement between Marx and Keynes as against Friedman.

Keynes on the effects of changes in the rates of profit and interest on production and employment

The “classical” marginalists claimed that when the economy is in “equilibrium” profit will disappear leaving only interest. They argued that if there were branches of industry where profits exceeded interest, the industrial capitalists would invest in those areas as part of their ceaseless drive to maximize profits. They would expand their production in those areas until prices dropped and the profits as opposed to the interest vanished. Assuming that there is “free competition, especially in the labor market,” the only possible economic equilibrium would be an equilibrium of full employment with the industrial capitalists earning only “interest.” For many years before he wrote the “General Theory,” this was the view of Keynes as well.

But Keynes was bothered by the obvious contradiction between the reality of mass unemployment in Britain during the 1920s and 1930s and the great “discovery” of the marginalists that the capitalist economy could only be at equilibrium when it was at “full employment”—leaving aside the effects of trade unions and social legislation.

Keynes’s reconciliation of marginalism with the reality of mass unemployment

In his “General Theory,” Keynes held that the economy tends toward an equilibrium where the rate of interest equals the marginal efficiency of capital. In terms of algebra, marginal efficiency of capital = rate of interest. Or in plain language, where the rate of interest equals the rate of profit. The industrial capitalists in their never-ending search for profit will cease to expand production at the point where they expect that a further investment of capital will yield them only the rate of interest.

In Keynesian economics, as production increases—all else remaining equal—commodities become less scarce, causing their prices to fall, which in turn reduces the rate of profit on additional units of capital applied to production. The marginal efficiency of capital falls as production increases. However the industrial capitalists will keep increasing production, despite the prospects of a falling rate of return, as long as the expected rate of profit—marginal efficiency of capital—exceeds the prevailing rate of interest.

However, this process will come to a halt the moment the rate of profit yielded by additional units of capital invested in industry is expected by the industrial capitalist to equal the rate of interest. At that point, the economy has reached an equilibrium where the rate of interest and the marginal efficiency of capital are equal.

But this may or it may not—here Keynes breaks with traditional liberal marginalism—be equal to “full employment.” Since the rate of interest is determined by the relative scarcity of money relative to the demand for money—what Keynes called liquidity preference—there is no mechanism in a capitalist economy that automatically ensures that the point where the rate of interest is equal to the marginal efficiency of capital corresponds to full employment. According to Keynes, the rate of interest and the marginal efficiency of capital could just as well equalize at a level that corresponds to mass unemployment.

In practice, Keynes assumed that the economy would fluctuate around the equilibrium point defined as satisfying the equation marginal efficiency of capital = rate of interest—just like in classical economics and Marx, market prices fluctuate around the prices production of individual commodities.

Sometimes production will be below the equilibrium point where the marginal efficiency of capital and the rate of interest are equal. In this case, the industrial capitalists expect that the investment of additional quantities of capital will yield a rate of profit greater than rate of interest. Under this type of disequilibrium, industrial production and employment in the economy are increasing. This corresponds to the rising phase of the “trade cycle.”

At some point, however, as production increases and prices and profits start to fall, the marginal efficiency of capital will fall below the prevailing rate of interest. The industrial capitalists will then start to reduce production and lay off workers. The economy enters the downward phase or recession phase of the “trade cycle.”

If, according to the Keynes of the “General Theory,” the equilibrium level of production—the point where the marginal efficiency of capital is equal to the rate of interest—corresponds to mass unemployment, the level of unemployment across “the trade cycle” will be high with much “involuntary unemployment,” such as it was in Britain during the 1920s and 1930s.

The traditional marginalist position that Keynes was breaking with in the “General Theory” held that since the only possible capitalist economic equilibrium was “full employment,” any rise in unemployment caused by a recession would be short lived, since by definition any level of unemployment except “full employment” represents a disequilibrium. Therefore, the conclusion that was drawn was that if a recession did occur, the capitalist economy without any government intervention would always rapidly return to full employment.

Starting with the “General Theory,” Keynes, in contrast, held that the economic equilibrium could just as well be reached at levels of mass unemployment. If that is the case, which he certainly believed was the case when he wrote the “General Theory,” Keynes in contrast to the “classical” marginalists believed that—barring appropriate action by the government—mass unemployment could persist—with cyclical fluctuations—indefinitely.

According to Keynes of the “General Theory,” the traditional marginalist claim that assuming free competition, especially in the labor market, the capitalist economy would always rapidly return to “full employment” after a recession was true only in the special case where the level of production that equates rate of interest with the rate of profit happened by chance to coincide with “full employment.” Therefore, according to Keynes, the “classical” marginalists made the mistake of confusing what was only a special case—where economic equilibrium happened by chance to coincide with “full employment”—with the many real world situations where equilibrium coincided instead with mass unemployment.

According to Keynes, therefore, there was nothing fundamentally wrong with marginalist economics or indeed the capitalist society that it championed. The only thing that was necessary was to analyze not only the “special case” where economic equilibrium happened to coincide with “full employment” but the other case where it didn’t as well. Once this was done, it would become evident that there was an important role for government to play in ensuring that economic equilibrium actually does coincide with “full employment.” Keynes was confident that this could be done within his beloved existing order of society—the system of capitalist class rule and exploitation.

Keynes remained a marginalist

The great 20th-century physicist Albert Einstein did not break with his special theory of relativity—which applied to the special case where acceleration is absent—when he expanded it to take into account cases where acceleration is present. Einstein’s generalization of his theory of relativity is known as the general theory of relativity.

Einstein was able to generalize his special theory of relativity into the general theory because the special theory, at least within a broad domain, corresponds to physical reality. In contrast, marginalist economics is based on a set of postulates that are in basic conflict with the economic and social reality of the capitalist system.

Next week, I will contrast Keynes’s analysis of “economic equilibrium” employment and unemployment with that of Marx.


1 Though bourgeois economists, of course, don’t use the term surplus value, all schools of economics have to have *some* explanation of the origins of profit, interest or rent. It was characteristic of all writers on economics before Marx that surplus value was dealt with under the *title of a portion of the surplus value such as rent, interest or profit* rather than as a *category as such* with its own name. The mercantilist or pre-liberal early bourgeois economists assumed that surplus value arose in the sphere of circulation. That is, a merchant added a profit above and beyond the cost price of the commodities he dealt in. This is sometimes called “profit upon alienation.”

The pioneering liberal economists of the French physiocratic school saw surplus value, or rent as they called it, arising in agricultural production. A seed of wheat produces a whole ear of wheat. They therefore wrongly drew the conclusion that only agricultural labor was productive of surplus value.

The physiocratic theory, which reflected the semi-feudal, pre-industrial conditions of the France of their day, was, however, a vast step forward from the theory of the mercantilists. Adam Smith, in his more scientific passages, and Ricardo saw the origins of surplus value as the unpaid labor of the working class. Indeed, the classical school, in contrast with the marginalist school, distinguished between productive labor that produces surplus value and unproductive labor that does not.

But the Ricardian school could never reconcile the view that the labor of the working class is not fully paid for with its basic law of value that held that commodities on average exchange in proportion to the quantity of labor that is on average necessary to produce them.

The Ricardian socialists treated the exchange of equal quantities of labor embodied in commodities not as a description of capitalist reality but rather as a programmatic norm yet to be achieved in practice. They assumed that if the exchange of equal quantities of labor embodied in commodities were actually put into effect, surplus value and with it the landlord and capitalist classes would disappear.

It wasn’t until Marx that the theory of surplus value as the unpaid labor of the working class was fully reconciled with the exchange of commodities in proportion with the quantity of embodied labor they represent. In addition, Marx was the first writer on economics to treat surplus value as a category in its own right with its own name rather than under a name such as profit, interest or rent. Marx wrote a whole book on the history of the theories of surplus values entitled in English “Theories of Surplus Value,” though it wasn’t published in his lifetime. This book is sometimes considered the fourth volume of “Capital.”

2 In Marshall’s economics, supply price is the lowest price for which a seller is willing to sell a commodity. It is roughly equivalent to the price of production in Marxist economics. The price of production—supply price—for an industrial capitalist who produces a commodity that will function as an element of the constant capital of its buyer, a second industrial capitalist, is part of the cost price of the second industrial capitalist.

3 A logical problem with this analysis arises in the case of falling prices. Those of us who have grown up since the “Keynesian revolution”—almost everybody alive today—may not realize that falling prices were not so unusual before World War II. Under the international gold standard, prices fell about as often as they rose.

For example, suppose the “natural rate of interest” is 3 percent, as Friedman generally assumed, but the general price level falls at the rate of 10 percent, which it actually did during the crisis of 1929-33. This would imply that the rate of interest would be -7 percent. But nobody would ever loan out money for a negative rate of return of 7 percent when they could simply hoard it incurring a rate of return of 0 percent—minus whatever the storage cost would be—which is a lot better than a negative rate of interest of -7 percent. The fact that interest rates in terms of currency can never fall below zero is a problem for the Friedmanite analysis.

4 In 1958, the Keynesian economist William Phillips claimed that there was a definite relationship between the rate of inflation and the level of unemployment. A given rate of unemployment would yield a given rate of inflation. This is called the “Philips curve.” Philips, following Keynes’s theory of wages and prices, reasoned like this:

The lower the level of unemployment the more favorable will be the position of the sellers of “labor” relative to the buyers of “labor.” If unemployment is low, money wages will rise at a relatively rapid rate. Therefore, since according to Keynes higher money wages mean higher prices, the rate of inflation will increase.

If, on the contrary, the rate of unemployment is high, money wages will fall, causing, again according to Keynes a fall in prices. During the 1960s, Keynesian economists, basing themselves on the Philips curve, claimed that if a somewhat higher rate of inflation was tolerated—perhaps 4.5 percent as opposed to 1 to 3 percent—a much lower rate of unemployment and a much higher rate of economic growth would be obtained. They therefore claimed that a somewhat higher rate of inflation was a price well worth paying in return for faster economic growth and a recession-free capitalism.

During the decade of the 1970s, however, both inflation and unemployment rose sharply discrediting the Philips curve.

5 On a global scale, the quantity of metallic money can never contract, since new gold is being continuously mined and refined. However, the global quantity of metallic money can decline relative to the global quantity of commodities if the global quantity of commodities increases at a faster rate than the growth in the global quantity of gold. In a given country, an absolute decline in the quantity of metallic money is possible if the country experiences a negative balance of payments.

6 After World War II, many Keynes-influenced bourgeois economists in the ex-colonial countries advocated policies of *import substitution*. To do this, they had to reject the traditional claims of economic liberals that free trade is equally in the interests of “underdeveloped” oppressed capitalist nations and “developed” oppressor capitalist nations.

These “developmental” bourgeois economists therefore represented the interests of the industrial capitalists of the oppressed nations relative to the capitalists of the imperialist nations, who were eager to protect their monopolistic position in the world market. To this extent, the developmental economists, though they are still bourgeois economists, play a relatively progressive role compared to the bourgeois economists of the imperialists countries, whether they are Keynesians or Friedmanites, who represent the interests not only of the capitalists against the working class but also the interest of the oppressor countries against the oppressed countries.

7 Friedman’s failure to differentiate between token and metallic money led him into major errors. In his “Monetary History,” for example, he and Schwartz argued that since the general price level if anything was tending slightly downward during the 1920s, there were no inflationary tendencies at that time. Therefore, the Federal Reserve System should have done everything necessary to prevent the general price level from falling.

What Friedman—or the followers of Keynes for that matter—don’t suspect is that the general price can be *too high relative to underlying labor values* even if the rate of inflation is zero. Under these economic conditions, zero inflation or even a slightly negative rate of inflation is *too much inflation*!

In their “Monetary History,” Friedman and Schwartz ignore the fact that though prices weren’t increasing in the years immediately preceding the Great Depression, they were higher than they were before World War I. Since prices were stable or declining slightly on the eve of the Depression, Friedman, Schwartz and their followers ended up drawing the absurd conclusion that the U.S. economy was fundamentally stable during the 1920s and that there was every prospect of this stability continuing if only the Federal Reserve System had prevented the U.S. money supply from contracting sharply between 1929 and 1933.

In the final years of the “Great Moderation” of 1983-2007, Friedman-influenced economists argued that the U.S. and the world capitalist economies were *extremely stable* and that this time the stability would continue because, under the influence of Friedman’s work, the U.S. Federal Reserve System and other central banks would never again allow the “money supply” to contract significantly. No less an economist than Ben Bernanke, the current chairman the Fed’s Board of Governors, endorsed this view. The sudden violent contraction of the U.S. and world capitalist economies that began last fall caught the Friedmanite economists completely off guard.

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