Keynes’s Criticism on Classical Theory of Market: 6 Criticisms | Say’s Law

The following points highlight the six criticisms by Keynes’s on Classical Theory of Market. The criticisms are: 1. Underemployment Equilibrium and the Waste of Resources 2. Inevitability of State Intervention 3. Emphasis on the Study of Macroeconomics 4. Refutation of Say’s Law of Markets 5. Lack of Reliability of Wage Cutting as a Cure for Unemployment 6. Recognition to Money as an Active Force.

Criticism # 1. Underemployment Equilibrium and the Waste of Resources:

According to Keynes, the tacit assumption of full employment by the classicals is not wholly warranted by facts since there always exists some unemployment in the economy based upon the philosophy of laissez-faire capitalism.

Booms and depressions are common features of capitalist economies and investments are not only inadequate but also fluctuating.

In such economies less than full employment is the rule and full employment equilibrium only an exception. Thus, Keynes felt that underemployment equilibrium (equilibrium at less than full employment) is the normal situation in such economics. Keynes, thus, gave a rude shock to the classicals by challenging their most important assumption regarding the existence of full employment.

Having presumed the full employment of resources, the only problem with the classicals was how to allocate the given quantity of resources in an optimum manner between firms and industries; to them there was no wastage of resources as these were assumed to be fully employed.

Keynes, however, denounced this assumption on the plea that there is a colossal waste of resources in a free enterprise economy on account of the frequent fluctuations in output and employment in the economy as a whole. Besides, unemployment results in the wastage of time, money and energy.

According to S.E. Harris, “To Keynes the waste of economic resources through unemployment seemed nonsensical and suicidal. He concentrated more of his energies on the solution of this problem than any other, and he had considerable success.”

Criticism # 2. Inevitability of State Intervention:

Keynes’s logic of underemployment equilibrium led him to the view that government intervention in economic affairs is a must in times of depression and inflation. He was convinced that a private enterprise economy may occasionally fall into a slump which could be remedied only through state action in the form of public investment and other fiscal measures. He advocated state intervention with a view to save capitalism from its recurring crisis of depressions and booms.

Criticism # 3. Emphasis on the Study of Macroeconomics:

Keynes drew economist’s attention to the fact that unemployment is a standing problem with a market economy which is much too serious to be regarded temporary. He pointed to the misleading conclusions we might derive regarding macro policy from micro principles. He called there conclusions ‘macroeconomic paradoxes’. He wanted to build a macro theory which could explain trade cycles and provide a forceful policy against them.

Criticism # 4. Refutation of Say’s Law of Markets:

Say’s Law of markets, the core of classical theory, became the subject matter of special attack from Keynes. Keynes particularly condemned Say’s Law for its exhortation that ‘supply’ creates its own demand and that there is no general overproduction and unemployment. According to Keynes, income is not automatically spent at a rate which will keep all the factors of production employed.

Unemployment, according to Keynes, is on account of the failure to spend current income on consumption and investment goods. In a free enterprise economy, supply does not automatically create enough demand within the economy. Classical theory based on Say’s Law is unreal. It is not warranted by facts. The actual state in a free enterprise economy is a fluctuating level of income, output and employment which depends upon effective demand, the deficiency of which causes unemployment and the excess of which causes inflation.

Criticism # 5. Lack of Reliability of Wage Cutting as a Cure for Unemployment:

Keynes never felt convinced that wage cuts can cure unemployment. Prof. Pigou argued that wages should be cut to increase employment. According to him, this was possible because under thoroughgoing competition in the labour market, workers will bid wages down till they are all employed. Keynes, however, did not agree with his thesis. Wage reductions, according to Keynes, were no remedy to reduce unemployment as this will also reduce the general purchasing power of the workers thereby leading to a decline in effective demand.

Keynes also felt that under modern conditions it is not at all easy to resort to wage cuts on account of the strong growth of trade unions resulting in more collective bargaining. In short, Keynes always laughed at the classical reasoning that unemployment would disappear if workers were just willing to accept low wage rates.

Criticism # 6. Recognition to Money as an Active Force:

Keynes linked the theory of money to general theory of value and distribution. Money in the Keynesian system is the link between the present and the future. Denouncing the classical theory of value and distribution as partial theory, Keynes remarked that treatises with little or no attention paid to money are not likely to be popular unless they deal with income formation also. Keynes integrated the theory of employment and money with the theory of income.

He took strong exception to the veil attitude of classicals and denied that money is an illusion. He brought forth the importance of precautionary and speculative motives for money. Money is no more merely an accounting device. Suggesting that inflation (increase in money supply) in the ordinary sense was no longer heinous affair that conservative mood made it out to be, he insisted that a rise in prices could be a pleasant and a respectable experience. In other words, the influence of money on income, output and employment was duly recognised.

Conclusion:

Thus the main point of difference between classical economics and Keynesian economics was that the former is based on the tacit assumption of full employment in the economy, while the latter believes in the existence of equilibrium of the economy at less than full employment. Keynes held the conviction that less than full employment is a normal situation in a ‘laissez faire’ economy and full employment is only an exception. The concept of underemployment equilibrium is an important contribution of Keynes to economic thought and analysis, for it has served to concentrate attention on less than full employment economics and has made the general theory what it is.

The classical case of full employment, then, becomes only a special limiting case. In fact, classicals denied and Keynes asserted the existence of under employment equilibrium. The other points of difference must also be noted. Classicals were mainly concerned with long- run equilibrium while Keynes concentrated on the short-run economics. Classical economics was cast mainly in micro terms while Keynes was concerned all with macro analysis.

Classical economics was mainly of theoretical interest in as much as it advocated ‘no intervention’ in economic affairs and believed in free, automatic workability of the capitalist economy. As against this, Keynes was concerned with practical matters of economic policy. Through his theory of effective demand, lie shifted the emphasis from saving to spending, questioned wage cuts as a practicable way to full employment and brought forth the importance of fiscal policy.