Impact of EU free-trade agreement on Ukraine

EU and Russian perspectives on pros and cons of imminent FTA reflect their respective political agendas.

Mid-October 2013

Russia and the EU are Ukraine's leading partners for trade, investment and remittances. In the lead-up to the crucial summit of the EU's Eastern Partnership, at which　an EU-Ukraine free-trade　agreement (FTA)　will probably be signed, the EU and Russia have presented sharply divergent visions of the likely impact on Ukraine, as they each emphasise different stages of the trade-liberalisation process. Also, both leave out aspects of the story inconsistent with their preferred narratives. Ukraine may have more options for dealing with intensified competition than suggested by Russia, but implementation of EU business rules in Ukraine is likely to prove tougher than implied by the EU.

 

Ukraine is set to be admitted to the EU's so-called deep and comprehensive free trade area (DCFTA) at the end of November, after more than five years of negotiations. This is an integral part, and perhaps for Ukraine the key attraction, of the country's fast-developing integration into the EU. There are two main aspects to the deal. The first removes most trade tariffs and quotas for imports and exports between the two sides, while allowing Ukraine a more gradual elimination of trade restrictions in some "sensitive" Ukrainian segments in industry and agriculture to give local producers more time to adapt to the step-up in competition. The second is the reform of commercial laws and regulations to bring them into line with EU norms. Besides these, the DCFTA should chip away at non-tariff barriers, improve food safety and animal welfare, simplify trade administration and develop mechanisms for solving trade disputes. The deal will permit the extension of the liberal trade regime to new businesses and provides for the gradual incorporation of public procurement into the arrangement. These last are among the "unprecedented" measures behind the EU's use of the "deep and comprehensive" label.

 

Divergent visions

While trying to tug Ukraine into their respective economic blocs, the opinions of the EU and Russia differ on what Ukraine might expect from the opening of its markets and harmonisation with EU rules. For the EU, the DCFTA sets a framework for the modernisation of Ukraine's trade and economic development, which will boost real GDP and the population's buying power. It points, for example, to an immediate yearly net gain of €100m for Ukraine from the elimination of trade duties alone. Russia, by contrast, following a recent step-up in its efforts to block the westward drift of a number of former Soviet states, has issued dire warnings about the destructive economic and political impact that the DCFTA will inevitably have on Ukraine, leading　Sergei Glazyev, a Russian presidential aide, to label the step "suicidal". As Ukraine's poor-quality products will fail to compete on EU markets, Russia's argument goes, its exports will fall and its large external deficit expand. With funds scarce and reserves low, this could trigger a currency crisis and macroeconomic destabilisation, leading to financial catastrophe and perhaps even, it has been suggested, the collapse of the Ukrainian state. Russian officials have made it clear that inauguration of the EU FTA may not only lead to a more permanent disruption of Ukrainian exports to Russia, but may also render void their existing border treaties. By highlighting the potential political and social costs for Ukraine, Russia has implied that it might stir up unrest, and perhaps separatist sentiment, in areas of Ukraine dominated by ethnic Russians, such as Crimea and the Donbas.

Under the weather

The Ukrainian economy is certainly in bad shape. Because of this, it remains vulnerable to external shocks and destabilisation. In April-June 2013 real GDP fell year on year for a fourth successive quarter. In July and August, industrial output and exports continued to decline. In these months, the current-account deficit widened markedly, taking it to US$10.2bn in January-August, only a little down from US$10.5bn in the same period of 2012, a year in which the largest imbalance in the post-Soviet era was recorded. Reflecting these developments, the rise in international borrowing costs to emerging markets, following indications in May of a possible wind-down　of the US Fed's bond-buying programme, has been especially sharp for Ukraine. This forced the central bank to use its own reserves to meet a series of substantial debt repayments. By August, foreign-exchange reserves had dropped by US$3.7bn compared with April, to US$19.8bn. This was probably one factor behind a rise in devaluation expectations and an increase in foreign-currency demand among the Ukrainian population, prompting a return to intervention in currency markets in September. As a result, reserves climbed only modestly in that month, despite the receipt of a cheap loan from Russia's Sberbank.

The long and the short of it

Both the EU and Russian narratives about the DCFTA's impact on Ukraine have some truth to them, but look at different time frames. Over the longer term, by encouraging specialisation in areas in which Ukraine is least inefficient compared with the EU, Ukraine should make economic gains—gains maximised by the status of the EU as the world's largest single market. The Ukrainian population should also benefit from a wider range of products of better average quality, lower prices and, eventually, through a degree of wage convergence, higher living standards. Moreover, the quality of the country's own products should increase, sharpening their competitiveness in non-EU markets. The harmonisation of business rules should attract greater levels of foreign investment.

However,　in the short run, as competition diverts resources to stronger sectors, Ukraine could again be subject to another period of disruptive economic adjustment, involving business closures and job losses. In Poland and Croatia, for example, the shipyards were hit under similar circumstances, and many of Latvia's engineering business suffered a similar fate. Further, the groups of people who lose out in the short run may not be the same ones　that benefit eventually, owing to skills mismatches. Finally, greater adherence to EU norms of trade administration, safety and labour conditions is likely to be more costly than　maintaining　the status quo.

 

Off the radar

At the same time, there are important considerations missing from either scenario. Although Russia is keen to emphasise the precariousness of Ukraine's external-trade position, it does not mention that a key reason for this is the high price that it charges Ukraine for gas. Moreover, Ukraine still has the option of currency devaluation, which should discourage imports and boost foreign sales, narrowing the trade gap. On financing, large loans are likely to be forthcoming from Western institutions as long as Ukraine is able to agree—as seems prudent—to a new programme with the IMF. As for the ideal scenario of trade liberalisation on which the EU's promises depend, it is likely to come up against the hard reality of Ukraine's political economy, as it has developed since independence. This has seen a weak state gradually overcome by business-political associations whose typical modus operandi is to sustain profits by preventing market entry of competitors (rent-seeking). In principle, the provisions of the DCFTA on competition, public procurement and　working conditions promise fundamental challenges to this system. It will be interesting over the next few years to see how they fare.

Medium-term political outlook in Ukraine

The international situation of Ukraine in 2013

Early March 2013

Ukraine finds itself in a tug of war between the countries of the liberal-democratic West and Russia. The geo-political choices made by Ukrainian leaders in 2013 will set the broad course of the country’s political development over the medium term.

The main attraction of closer association with Russia is the prospect of cheaper Russian gas, on which swathes of Ukrainian heavy industry and most Ukrainian households depend. However, this would be offered only in return for joining the Russian-dominated customs union or ceding control of at least some of Ukraine’s gas pipeline network, which connects Russian suppliers with lucrative energy markets in Western Europe. These are both outcomes that most Ukrainian political leaders would resist.

Against this, the pull of closer integration with Western structures is twofold. The first is the prospect of finally ratifying an EU association agreement at the EU’s Eastern Partnership summit in Vilnius, Lithuania, in November 2013, and the “deep and comprehensive” free-trade agreement (FTA) that goes with it. Following the 16th EU-Ukraine summit in Brussels at the end of February, José Manuel Barroso, the president of the European Commission, stressed that a boost to trade, investment and economic modernisation were among the benefits that Ukraine could expect from such a development. In addition, greater integration into the EU’s energy system could shore up Ukraine's energy security. For many of the politically well-connected business groups that dominate Ukrainian politics, this could offer considerable opportunities to expand their business empires by offering privileged access to the single market—the world’s largest in terms of GDP. In addition, in 2013 the government faces sizeable debt repayments, as well as clear signs of mounting domestic financial strains. A second attraction of the West is, therefore, the prospect of a large loan from the IMF. Another visit by the Fund to Ukraine for negotiations on this issue got under way in late March. The agreement of a loan with the IMF would provide the funds needed to address the country’s financial problems directly, while boosting market confidence about the direction of economic policy, and helping to steer the economy away from a full-blown financial crisis. However, from the point of view of Ukraine’s leaders, clinching an association agreement will depend upon addressing EU concerns about the politicisation of the judiciary and the imprisonment of opposition political leaders during Mr Yanukovych’s presidency. If this means having to free Ms Tymoshenko, the most prominent opposition politician, the governing group will be wary of a conflict with their overriding goal of winning re-election for Mr Yanukovych in 2015. In respect to a borrowing deal with the IMF, the Ukrainian administration will be afraid that the economic reforms demanded in return for a loan—especially increasing gas tariffs to the population and easing the fixed exchange rate—will damage the living standards of key political constituencies (thereby further undermining its political support), and exacerbate the strains on public finances and on the banking system. These fears will have been stoked by the recent mass protests against high energy bills that swept Bulgaria in late February, leading to the resignation of the Bulgarian government.

Scenarios for Ukraine’s political development

In this context, a number of political scenarios are possible. The Economist Intelligence Unit’s main scenario is that Ukraine makes a tentative move towards greater integration with the West. However, recent political events have made a second scenario—maintenance of the status quo between Western and Eastern political blocs—an increasing possibility. This nevertheless comes with a high risk of financial destabilisation. It is possible that a financial crisis of this kind could be averted by a turn back towards Russia (the third scenario), but it could easily merge into our fourth scenario, by triggering another outbreak of mass social unrest at home. At the moment, we consider the third and fourth scenarios as less likely than either of the first two.

Main scenario: “Unconditional” Western integration, but with certain conditions

Caught between an urgent desire for external funds to avert an economic crisis and the goal of securing the presidency in 2015, the ruling group around Mr Yanukovych and his PoR tries to pursue a creative middle course.

In negotiations with the IMF, the government underscores the dangers of a "Bulgarian scenario"—that is, of politically destabilising popular protests against increases in fuel prices. As a result, the government achieves compromise deals on key reforms—an agreement to limit the impact on the general population of domestic gas price rises, and to devalue the hryvnya only partly. A deal on programme lending is signed in mid-April. Ahead of the EU’s May deadline for “tangible” evidence of movement on the association agenda, this contributes to the sense that Ukraine is making progress on the necessary economic reforms. The government tries to meet most of the EU’s economic and trade requirements. To address the issue of “selective justice”, some of the less prominent opposition figures are released, perhaps including Mr Lutsenko, a former interior minister in Ms Tymoshenko’s government. Promises are made that the case against Ms Tymoshenko will be reviewed with all possible haste—but that, in view of the seriousness of the charge (she is a suspect in the murder of a business rival in 1996), no country in the world could be expected to dismiss such charges out of hand. The authorities hope that the release of the first few tranches of the IMF loan is enough to get them past the immediate threat of an economic crisis. They bank on achieving sufficient progress in most economic and financial areas to convince the EU to compromise, on the assumption that the EU is eager to demonstrate a definite success story at its Eastern Partnership summit in Lithuania in November, and that it sees Ukraine as too valuable a prize to lose to Russia.

Ukraine signs its EU association agreement in November. However, the case of Ms Tymoshenko is dragged out for as long as possible, perhaps right up until the 2015 presidential election. Meanwhile, the short-term negative economic impact of raising gas tariffs and loosening the hryvnya peg—on consumer spending and bank lending, for example—erodes government support still further. The positive impact of the same measures—in terms of boosting exports and hence economic growth, and taming the signs of macroeconomic destabilisation—occur too late and too weakly to boost the government’s electoral prospects in time for the 2015 presidential vote. The government pulls out all the stops to hold on to the presidency, employing (for example) a mix of administrative resources and intimidation at the local level; heavy propaganda campaigns on the national TV stations owned by pro-government oligarchs; threats of “investigation” by the tax authorities against the business holdings of non-compliant business leaders; large-scale spending sprees on wages and public relations (PR) campaigns; creation of “clone” candidates (either with the same or similar names as opposition candidates, or with a similar policy offering) in order to split and confuse the opposition vote. Some creative new scams are implemented, as yet not invented.

The conduct of the election and its outcome—the re-election of Mr Yanukovych as president—are condemned by international observers as a backward step in democracy. Ukrainian leaders say that they are ready to make amends by moving unconditionally towards democratic norms and against corruption. At the same time—not wishing in practice to be held to their democratic promises—it is made clear that Ukraine remains interested in joining Russian economic structures.

Second scenario: Neither Brussels nor Moscow, but political stagnation and an economic crisis

It proves simply beyond the capacity or inclination of the groups that compose the Yanukovych regime to fulfil the political demands of the IMF and the EU. The regime stays put between political blocs and attempts to “muddle through”. It decides to content itself with plundering the domestic economy, as per usual. However, this has some very serious economic consequences.

Following a high-profile meeting with Mr Yanukovych in Brussels at the end of February, EU leaders called for “tangible progress” from Ukraine in three areas by early May, if the Ukrainian government hopes to proceed with ratification of its EU association agreement this year. The three areas specified are a clarification of electoral rules; implementation of the judicial and economic reforms required for association; and movement on “selective justice”, which alludes to the use of the courts to sideline opposition political leaders. For many observers, the absence of any progress on these criteria since previous high level meetings with the EU in May 2012 or December 2012 strongly favours a “staying put” scenario. Recent supporting evidence for this would include the flawed conduct of the 2012 parliamentary election, as well as the launch in January of a fresh investigation—this time as a suspect in a murder case—against Ms Tymoshenko. The latest move against the jailed former prime minister seems designed to prevent her from running against Mr Yanukovych in the 2015 presidential election, should forthcoming rulings by the European Court of Human Rights make it difficult to keep her locked up on the current charges.

However, in the current difficult economic situation, attempting to keep things as they are—with Ukraine positioned advantageously between rival political blocs, playing them off against one another—is unlikely to be cost-free. From the perspective of the current administration, it could even be more dangerous than the first scenario, because it implies greater risk of a loss of economic control and, perhaps, a more rapid and extensive loss of political support. This is the scenario of a full-blown financial crisis, which could pan out as outlined below.

Ukraine is unable to agree a programme loan with the IMF, but announces that it can go it alone, as it did in 2011-12. However, following an inconclusive election in Italy in late February and the threat in March to expropriate Cypriot bank deposits as part of the country's EU bail-out, this happens just as uncertainty over the fate of the Euro area intensifies again on international financial markets, causing investor sentiment to sour towards emerging markets. Together with clear indications of serious strains in Ukraine’s finances—economic recession, wide budget and current-account deficits, low official reserves, and low levels of foreign direct investment (FDI)—the government’s access to international capital markets is affected. This takes the form of a considerable constriction in access to borrowing and at a higher cost. Concerns grow that the government might be unable to borrow sufficient funds cheaply enough to meet its short-term debt repayment schedule, estimated at around US$9bn for 2013 as a whole. The prospect of a sovereign debt default looms.

Fear that the government might increase taxes to address its poor financial position encourages capital flight. This is the link with a second aspect of the emerging financial crisis, as capital flight greatly increases downward pressure on the hryvnya. However, the fixed exchange rate to the US dollar is maintained by the authorities for fear of increasing the debt burden on public and private holders of foreign loans, in this way exacerbating recession and aggravating the deterioration in public finances. Further unorthodox administrative measures are brought in to try to restrict demand for hard currency and, perhaps, to restrict imports, encouraging the development of a black market and concerns abroad of protectionism. Despite these measures, the deficit on the current account, already at its highest level in the post-Soviet era, continues to deteriorate, increasing downward pressure on the currency and stoking expectations of a devaluation. Official reserves fall to an unsustainable level. In these circumstances, the conduct of an orderly devaluation or depreciation becomes much more tricky, but either this or a disorderly fall in the currency nevertheless ensues. This weighs heavily on banks’ foreign-currency balance sheets, possibly threatening a banking crisis.

Politically, the multiple financial crises damage Ukraine’s already poor prospects for economic growth and therefore also the government’s electoral support. Following the high cost to exports and private investment of maintaining the fixed exchange rate, the spectre of a debt crisis dampens private investment still further. The fixed exchange rate has already hit livelihoods in the government’s heartland in eastern Ukraine. The rapid boost to inflation from soaring import prices undermines them still further. An invigorated anti-government popular mood boosts the public support and optimism of the opposition. Key business leaders who have been alienated from the regime step in with finances, media campaigns and political networks to back a credible candidate of the unified opposition in the 2015 election. The chances of Mr Yanukovych being re-elected, even with the enormous state and financial resources that he has at his disposal, become ever slimmer. It is possible that an intensification of political conflict along these lines is faced down by the regime using a mix of political and security measures—more or less as in the first scenario, but with more force. The stark choice of a decisive move back towards democracy or towards outright authoritarianism again presents itself.

Other scenarios

Other possibilities are that the situation is resolved before it gets out of hand by resorting to closer ties to Russia in return for economic relief (the third scenario), or that it escalates from a political into a social crisis, of large-scale popular unrest, which tests the oligarchic political system (the fourth scenario). At the moment, however, a return to the Russian fold does not seem likely, because Ukrainian oligarchs do not want to see Russian businesses with strong political backing enter the Ukrainian market as their competitors. Neither do they want to see what happened to their Russian counterparts under the current Russian president, Vladimir Putin—a re-subordination of the oligarchs to the state, as symbolised by the incarceration of the head of the giant Yukos oil firm, Mikhail Khodorkovsky, in 2005—happen to them. Also, an outbreak of spontaneous nationwide anti-government protests, in the manner of those that swept Bulgaria in late February, does not seem to be on the cards. This is because, with the broad failure of the Orange Revolution of 2005-10 still a recent memory, the population will probably be wary of backing a similar movement again so soon. In addition, the organised opposition is weak. The networks and resources that it would need to channel and promote such an episode of unrest have been systematically chipped away under the Yanukovych administration.

Poor country macro

Some features of emerging market and developing economies (from Montiel) that affect the way their economies work, and to which textbook macroeconomic models for advanced economies should be adpated.

1. Lower income per head: implies different spending behaviour, different institutional quality, different interest rates and exchange rate policies.

2. Small economies: specialised and open.

3. Structures of trade and production are different from advanced economies.

4. Specific parts of the balance of payments more important: eg concessional loans and remittances.

5. Less financial integration internationally

6. Underdeveloped domestic financial sector that inhibits international integration.

7. Fiscal policy conducted in different conditions: eg greater government role in production and higher non-tax revenue. Greater tendency to deficit and printing money reduces confidence of private creditors and so lowers level of sustainable debt.

8. Monetary policy less independent and more subordinate to fiscal policy. Because financial systems underdeveloped and dominated by banks, these economies tend to have different, more direct instruments of monetary policy for different kinds of targets: eg CB supplies credit to banks with specific target for money supply or stock of domestic credit in mind.

9. Exchange rates tend to be "determined": towards the more rigid end of regime spectrum because of greater intervention. Exchange rate targets vs inflation targets.

10. In labour markets, nominal wages are less "sticky" to price shocks in the short run. Nominal wage adjustment minimises impact of prices shocks on employment and so output. Therefore, less "Keynesian unemployment" in deflationary period?

Practical philosophy

“The naively metaphysical standpoint of sound bourgeois common sense considers thought independent of being and defines truth as the correspondence of thought to an object that is external to it and ‘mirrored’ by it. It is only this outlook that can sustain the view that all forms of economic consciousness (the economic conceptions of a pre-scientific and unscientific consciousness, as well as scientific economics itself) have an objective meaning because they correspond to a reality (the material relations of production which they comprehend)”

Karl Korsch, Marxism and Philosophy, 1923

I’m thinking of writing a textbook, perhaps called How to Learn Marx’s Theory and Apply it for Yourself to the Contemporary World. It would have to involve i) a short history of dialectics; ii) an outline of, perhaps, The Phenomenology of Spirit, The Philosophy of History and perhaps The Logic (if I could manage that); iii) a short history of political economy, focusing on labour theories of value; iv) an outline of Smith and Ricardo in respect to this question in particular v) Marx’s philosophy of the interaction of the subject and the object, as originally formulated in the Theses on Feuerbach vi) Marx’s philosophy in practice, as he applied to concrete analyses of historical and contemporary history and journalism; vii) Marx’s philosophy/ methodology in practice, as he applied it to economic analysis; viii) the relevance or otherwise of any of his tools to understanding the contemporary world, especially the specific nature of contemporary imperialism and the ongoing crisis of global capitalism; ix) Marx’s theory of colonialism and Marxist theories of imperialism; x) the theoretical and organisational degeneration of anti-imperialism and the Western left as a large-scale modern socio-historical phenomenon, that can only be explained by a careful and judicious application of Marx’s philosophical and social scientific method of the interaction of the subject, ala Karl Korsh in Marxism and Philosophy; and xi) ongoing problems with Marxist philosophy, social theory and economics, and possible answers to them.

Some quick points about Marx's philosophy and economics.

 1. Objectivity is distinguished by Marx in two ways i) material objectivity (eg use-values and wealth) and ii) social objectivity (in economics, exchange-values, or the quantities of abstract or homogenised labour). So both use values and exchange values are, in Marx’s theory, supposed to be objective, but in different ways. Many mix up the two, and, with regard to marginalism, mix up the perception of values of goods and services (a subjective, individual-psychological question) with use values, which can never be subjective.

2. The subject-object thing runs right through Marx from beginning to end, from the architecture of Capital—which begins with the general abstract conclusions on the nature of wealth in the capitalist mode of production and descends to the concrete evidence from which the general categories are derived—down to the detailed concrete passages detailing, say, the process of increasing subordination of the worker amid the process of development of manufacture. This is because Marx knows that all theory is inescapably subjective—but not only in the sense of being individually subjective,but also socially subjective, from a group point of view. However, he believes that the objective position of wage-labour in opposition to capital (again, the two form an inseparable mutually defining "unity") gives it a unique vantage point in the social structure. Hence the crucial distinction between a class in itself (an objective social-structural position in relation to property [land, labour and capital]) and a class for itself (a subjective awareness of position, interests and capabilities that informs social and political action). One reason why "subjective" in Marxism is not synonymous with "bias" in the everyday sense is that, once the accumulation of capital is seen to result from the labour process, as the product of dead labour, the subjective view from the objective position of the working class—that it is the class responsible for wealth creation—is seen to be objectively correct. That is, the subject and the object re-emerge as a unified whole, a unity. And in fact, the same thing is right there in the Theses on Feuerbach, as it is in The 18th Brumaire and the Civil War in France. Because one of the things that Marx is saying (or rather illustrating) in the quote from the Critique of the Gotha Programme is that wealth has a passive as well as an active side, a material as well as a social, an objective as well as a subjective. It is not possible to be a Marxist and not grasp that Marx's methodology—which conceives of reality as sensuous human activity, as political and social practice—is at base a conception of social change as the mutually determining relation subjective and objective factors at various levels. Because this is the very core of Marx's innovation, his specific philosophical advance over both mechanical pre-Marxist materialism (say, of Holbach or Feuerbach), which conceives of reality as an external object, and idealism, for which reality and contemplation are one and the same. That's more or less point one in Marxism, and if you haven't got that, nothing else is really available to you, and you are forced merely to decry it as "pseudo philosophical claptrap", in the manner typical of today's anti-intellectualism—essentially revelling in its own ignorance. "The chief defect of all hitherto existing materialism—that of Feuerbach included—is that the thing, reality, sensuousness, is conceived only in the form of the object or of contemplation, but not as sensuous human activity, practice, not subjectively".

3. Marxist objectivity, Marx's version of realist method—and so Rosdolsky's version of realist method—is always an everywhere understood as a mutually determining process between subjective and objective factors.

4. Without use value, there can be no exchange value, because any labour that goes into a product that no one wants is socially unnecessary. 

5. Another reason why abstracting from use values can't mean excluding them from the value equation, or separating them from exchange value, in Marx's system: because the use value of labour power treated as a commodity is the source of fresh value when it is turned into labour during production. Therefore, the lines of manufactured trousers hung up for sale in Marks and Sparks imply the class struggle!

6. It is some time since I studied the question, but some common objections to the LTV are as follows: i) scarcity is also a feature common to commodities that gives them value (Austrian School); ii) in an economy in which food or energy are commonly part of the production of commodities (whether as imputs for the worker or for production), then the same relation applies as it does for labour, and we have a food or energy theory of value (neo-Ricardians, the most important of whom is Sraffa); iii) even if there is then a food or energy theory of value, can we talk of exploitation of food or energy? Technically, yes; but morally, no. Marx aims for a dispassionate account of exploitation as a technical relation, but it has an irreducibly human-centred moral component: normative ethics vs scientific socialism. iv) Most of the classical economists, including Marx, assumed a falling rate of profit, but it is unclear whether there is strong empirical evidence for this on a worldwide scale over time. v) Marx's theory of the falling rate of profit is based on the idea that, because labour power is the sole source of fresh value, as the capitalist invests in new machinery (dead labour) to give them a competitive advantage, this may raise individual profits in the short run, but, as capitalists as a whole adopt the new technology, over the long run, the ratio of fresh value-creating labour (variable capital) to constant capital (machinery) falls, and with it surplus value (the relation between value and prices is that value is something like the long-term equilibrium price around which prices fluctuate because of variations in supply and demand), the source of profits. But what about new lines of industry, which are being developed all the time, will they not offset the overall declining tendency? But what if the productivity increase delivered by the new capital offsets the falling tendency? This development is not specified in detail, ie there is no integrated theory of it.

7. Only exchange vales can represent values, because they are the form that value takes in capitalist society and value is the content. In contrast, use values are the bearers of exchange value. Represent and bear do not mean the same thing.

8. A use value cannot be subjective. This is because it is the quality of the commodity that allows it to fulfil some socially mediated human need. It is the quality, the socially mediated human appeal, that allows it to enter exchange in the first place. Without it, no equivalence of, say 2 shirts for 1 exquisite tie, on the basis of their containing the same amount of abstract human labour, could take place.

9. The marginalists start with scarcity and find the explanation in variations in value in individual psychology, in individual tastes. For them the external world of material things and the subjective world of the mind (ie of individual tastes) are radically separate. For Marx, on the other hand, the two are inseparably part of the same whole, the same totality.

10. "It is in the various use values that value is expressed". No, value is expressed as exchange value. Use values are carriers of exchange value. These are two ideas that are fundamental to understanding the LVT, before you decide whether the the criticism of it are true or false.

11. The secret of Marx's analysis, as he used it, is that socially objective factors—such as exchange value—are themselves the outcome of previous clashes of subjective and objective factors. That's why the subject-object formulation holds. In practice, it is not a theoretical question, but a scholarly-practical question, the end result of scrupulous and detailed investigation at more and more concrete levels of social reality, at lower and lower levels of social reality, spiralling downwards to follow the inner relations (not causative relations!) of the mutually conditioning sides. Thus, even if the LTV aims at social scientific objectivity, it does not aim at class objectivity. On the contrary, it aims to punch a series of holes in classical political economy, in this way placing itself wholeheartedly in the service of achieving working class power.

12. On the Jewish Question.  Marx, in his argument with Bauer on the insufficiency of mere religious emancipation, adopts—mock-naively and for (heavy handed) satirical purposes—the characteristic denigrating epithets commonly heaped on Jews to suggest that they would be more appropriately heaped on the chief denigrators, the respectable bourgeoisie. Also, he's just emerging from pure Hegelianism (I think he's 25) so that the language makes it difficult for the casual reader to grasp what he's saying. He's saying social emancipation should be the revolutionary democratic goal.

13. The two basic point where today's "anti-imperialists" go wrong, is that, on some occasions, in relation to some kinds of regime, some forms of western Imperialism are relatively progressive; the partial advances in democratic and social control, though insufficient, are not illusory, but are real. This leads them into all kinds of reactionary contortions.

14. Marx never repudiates the idea that capitalism is progressive relative to some kinds of social formation. He certainly uses some of the (to us) loaded phrases of the day. He is also inevitably Eurocentric, despite his very serious attempts to get to grips with other cultures (on India, he probably read as much as was available in the day, even if this wasn't very much or very good). But "progressive" and "civilising" do not mean the same thing. The earlier passages on India merely note that, despite all the human horrors and destruction wreaked by colonial domination, at the same time the social basis of a stultifying social form, of "oriental despotism" is shattered. In a way, he is arguing against the romanticisation of social forms that severely check human development. The later passages on the Russian mir is not about changing his mind on the accidentally progressive aspect of colonialism (I don't think he had a fully-worked out view on what we would call imperialism, just hints here and there), but on there being the possibility of multiple trajectories towards social advance, rather than a single one suitable for all times and places.

15. The point about Marx's earlier quote about India and the one about the mir is his ability to see alternative potential futures immanent in existing social structures—notwithstanding that, based on the inadequate sources of the day, his picture of pre-colonial India has since been superseded. In contrast, the dogmatist sees only one possible path—whether that be inevitably positive or negative. But both are attempts at "a general historico-philosophical theory, the supreme virtue of which consists in being super-historical", but neither are really much to do with Marx's Marxism—ie, Marxism at its most powerful. That's why the "bleeding dry" of the later Marx fits perfectly well with, and is not cancelled out by, the earlier argument of progressive potential of destruction of repressive social and or state structures—whether we wish to apply it to historical societies or Saddam's Iraq—because in between the two are the actions of the main actors, the oppressor and the oppressed, which fulfil or nullify possibilities that were previously present. That's why Marx's views on the mir wasn't cancelled, in this sense, by the actual history of the development of capitalism in Russia.

16. Just as he saw the potential for the break up from the outside of social relations restrictive of human developments—but perhaps thought this potential closed off following the Indian mutiny—so he saw the potential for social progress on the basis of the Russian commune in a context of globalising capitalism. Ie neither of the potentialities he thought he saw materialised and, in fact, both have had to undergo full scale capitalisation or recapitalisation—in India's case, in part owing not just to transfers of technology and knowhow, but more importantly to the transformation in social relations, of the dominant property form, the precise trajectory of which owes in part to the imperial inheritance.

17. No expurgation of the possibility of Indian agency from the dynamic political picture:
"All the English bourgeoisie may be forced to do will neither emancipate nor materially mend the social condition of the mass of the people, depending not only on the development of the productive powers, but on their appropriation by the people. But what they will not fail to do is to lay down the material premises for both. Has the bourgeoisie ever done more? Has it ever effected a progress without dragging individuals and people through blood and dirt, through misery and degradation? The Indians will not reap the fruits of the new elements of society scattered among them by the British bourgeoisie, till in Great Britain itself the now ruling classes shall have been supplanted by the industrial proletariat, or till the Hindoos themselves shall have grown strong enough to throw off the English yoke altogether. "
O yes, and tell us, clever clogs, by what processes do you propose might lead to the Indians being able to throw off the English yoke themselves?
"The political unity of India, more consolidated, and extending farther than it ever did under the Great Moguls, was the first condition of its regeneration. That unity, imposed by the British sword, will now be strengthened and perpetuated by the electric telegraph. The native army, organized and trained by the British drill-sergeant, was the sine qua non of Indian self-emancipation, and of India ceasing to be the prey of the first foreign intruder. The free press, introduced for the first time into Asiatic society, and managed principally by the common offspring of Hindoos and Europeans, is a new and powerful agent of reconstruction. The Zemindari and Ryotwar themselves, abominable as they are, involve two distinct forms of private property in land — the great desideratum of Asiatic society. From the Indian natives, reluctantly and sparingly educated at Calcutta, under English superintendence, a fresh class is springing up, endowed with the requirements for government and imbued with European science. Steam has brought India into regular and rapid communication with Europe, has connected its chief ports with those of the whole south-eastern ocean, and has revindicated it from the isolated position which was the prime law of its stagnation."

So: some historical errors on the nature of Indian property systems, owing to inadequate sources, but no “imperiocentric” siding with the English against the Indians, or denying that they would have to be the agents of the own political destiny if they were to enjoy the benefits of the destructive and self-serving interference of the imperialists.

Neither Islington nor Scunthorpe, but a few modest steps towards international socialism!

On Ed Miliband's alleged swerve to the right on budget policy, I find myself in between the "Blairite neo-liberals", if I can combine familiar insults, and the old Labour stalwarts. First, this is because the longer-term question isn't really about fiscal policy. Fiscal policy can offset a slump in demand to some extent and for some time. If you cut too far and too fast, you risk tipping the economy back into recession. If you don't make the right noises and some progress on cutting the budget deficit, at some point borrowing costs will soar: even more so in the febrile atmosphere of today's international financial markets. That is, both positions are true, depending on the specific circumstances. Also, the level of spending that was affordable in the 2000-07 bubble (the greatest bubble in human history) is affordable no longer now that the bubble has burst. The system of private ownership and generalised commodity production is not neutral between possible solutions: it favours making working people rather than property owners pay. These are really technical questions about how capitalism works now.

But I think where the unions and the old Labourites—and those on the left of the party more generally—miss a trick against the "Blairite neo-liberals" is over the longer-term and ultimately more important questions of the kind of society we would like to live in: What kinds economic and social structures? Are any of these are plausible? If so, how might we practically develop them?

On this second set of questions of practical social and moral philosophy—which will be at the heart of what the Labour Party becomes, assuming it is capable of change in time—the old Left seems to have very few, new positive creative proposals, which is unfortunate.

As for Ed, I think that, for practical short-term political purposes, to keep the two main halves of the party on side, he needs to stick to "fiscal conservatism" (if that means addressing the structural budget deficit over the longer term)—especially as 2012 could well be a very bumpy year economically around the globe—while at the same time offering the unions and the old Labourites something positive and attractive and big on the practical social and moral front that they can hold on to. What that might be, I'll try to make some concrete suggestions later.

Model worker

While I remember, I want to jot down a couple of points about the two macroeconomic models I have found to be of the most practical use in looking at policy and performance in emerging economies: the full Keynesian domestic economy model, which brings in flexible prices and depends on particular view of how firms are likely to respond to changes set off by a change in demand; and the Keynesian open economy model in the short run, which is for economies in which international trade is significant component. It assesses the likely impact and effectiveness of monetary and fiscal policies—the two main levers of policy control—when the exchange rate of a country’s currency is kept artificially fixed against the currencies of the outside world and when it is allowed to float. These models are best "applied" separately, even to the same economy, in order to simplify the analysis of the expected lines of causation.

ISLMAS(K)AD. In contrast to the situation when we are looking at the knock-on effects of demand changes on the goods and financial markets of the domestic economy only, the introduction of the possibility of changes in the price level produces two new effects for policymakers to consider. In the first, [and in addition to the feedback loops set off between the goods and money markets through changes in interest rates and national income,] a price change caused by a rise in demand in the goods market, reflecting perhaps a fiscal expansion, erodes the real money supply, altering the equilibrium conditions in the money market—that is, its shifts the LM curve down, wiping out some or all of the gain in output from the original change in demand. The second is the effect of a change in the price level on the labour market, understood as working in a particular way. The key features of this model, which give rise to its distinctive results, are the assumptions of flexible prices in combination with "sticky wages"—that is, when nominal wages take time to adjust to changes in the price level, either up or down. Assuming that there is spare capacity in the economy, a boost in government spending or a cut is taxes will push up demand for goods and services, but it will also push up price growth. If the nominal wage fails to adjust upwards to compensate for inflation, the real wage falls, inducing a rise in labour demand (ie firms find it profitable to employ more staff) and a fall off in labour supply (people want on average to work less). This divergence of labour demand and supply temporarily boosts the level of employment and so, as conditioned by a definite level of technological development, economic output and income. At the same time, it reduces the level of involuntary unemployment. In modern economies, at least until the great economic crisis of 2007-09, this was the direction of price movements that interested economists, as it matched, for a time, the broad empirical trends of the economies in which they found themselves. However, I think I'm right in saying that Keynes emphasised the "downward stickiness" of wages, as, writing in the 1930s on the events of the Great Depression, what interested him was, understandably, the impact of deflation, which he identified as a trigger of the intractable and socially damaging problem of high and enduring unemployment. This was because institutional and legal factors prevented money wages from adjusting to a fall in prices by falling themselves, as predicted in classical economic theory. In turn, this tended to boost the real wage and so induce a fall in labour demand from firms and a rise in labour supply, at once reducing both employment and output, and amplifying "involuntary" unemployment.

Because the model sets out systematically the relationships between a large number of variables, it is a helpful framework for looking at a wide range of phenomena relevant to assessing the health and stability of economies, from demand-pull inflation and hyperinflation, overheating, soft and hard landings, to the co-ordination of policy with economic recoveries and slumps.

ISLMBOP. In an open economy, which incorporates the impact of inward and outward/net currency flows on the financial and goods markets, fiscal policy is powerful when the country’s currency is set at a specific rate, whereas monetary policy is relatively ineffective. If the authorities allow their currency to find its own level, however, without interfering by buying or selling on the currency market, then the reverse is true: the impact on monetary policy in enhanced and that of fiscal policy weakened. The reason for this is that

Looking both ways

Question: How does a closed economy adjust to shocks from the outside or to economic policy changes in the short run? Why is using the ISLM a more sophisticated and useful approach than looking at the real and financial sectors separately?

ISLM: internal macroeconomic adjustment in the short run

An alarming slowdown in economic growth gnaws away at business confidence, so that increasing numbers of firms lose faith in their ability to hit next year's sales targets, leading them to hold off on investments that would otherwise have gone ahead, depressing economic growth still further. Or instability in the financial markets sees more investors cashing in financial holdings so as to avoid the chance of a fall in their value. It is the macroeconomic implications of scenarios like these that the forbiddingly named ISLM framework helps us to analyse systematically. By selecting the most relevant economic indicators and sketching the expected relationships between them, this framework helps us to trace through the rest of the economy the knock-on effects of destabilising economic developments, such as the ones above, and to work out the kinds of results that we might expect from policy responses to them. The most important variables include the rates of growth of government spending, household consumption, private investment expenditure, and the national output of goods and services. Important, too, are changes in tax rates, money holdings and interest rates. Over a longer period, changes in the price level would be included on this list. When looking at imbalances in the goods and the money markets taken separately or together, the crucial difference is that, in the second case, there are feedback loops between them, going in both directions. The key link by which imbalances in the real economy are transmitted to the financial sector is between the economic activity (or output) and money demand. Imbalances originating in the money market affect the production of goods and services by way of changes in short-term interest rates. And just as we conventionally show the main relationship as between output (Y) and the price level (P) in graphical form when looking at aggregate demand (“PY space”), so it is useful to illustrate the two-way links between the goods and money markets as a relationship between output and short-term interest rates (“IY space”), because these, as I have said, are the main channels through which changes in one market are transmitted to the other. Thus, the IS schedule (the letters stand for “investment” and “savings”) is simply a graphical summary of all possible combinations of interest rates and national output in which goods demand and supply just balance. It incorporates much the same information as in the PY or aggregate demand diagram—since aggregate demand is affected by changes in both the goods and the money markets—but is examined from a different angle so as to bring out the interlinks between the domestic economy’s component markets. As lower interest rates encourage borrowing by firms and households for investment and consumer purchases—and thus also higher levels of economic output—the IS curve is negatively sloped: as interest rates rise, investment, and so economic output, falls. Likewise, the LM schedule (standing for “liquidity preference”, or money demand, and “money”, or money supply) represents all the combinations of interest rates and output in which money supply and demand are in balance. In contrast with the IS line, the LM schedule is positively sloped: as output rises, it takes higher interest rates at every level to equate money demand with a (nominal) money supply that is centrally fixed. Movement along the curve can be read as showing that higher money demand is associated with increased rates of growth in national income—that is, to facilitate the rise in the number of transactions—but that higher rates of interest are required to maintain balance with the fixed money supply. The point of crossover of the two schedules thus represents the unique rates of interest and output growth needed to keep both markets in balance at the same time.

By goods alone: IS

One way to proceed is to contrast the results to be expected following the combined and separate adjustment to developments that upset balance in either market. In the real domestic economy, the kinds of changes that could affect the level of demand for goods and services include alterations in the pace of growth of private investment, household disposable income or government spending. It would also include changes in tax or savings rates, or in the responsiveness of private investment to changes in interest rates. (Reforms of public spending or of the rates of taxation—fiscal policy—are the main policy instruments used by the government to influence activity in the real sector.) Changes in the first set of factors would affect the position of the IS curve, shifting it up or down, boosting or sapping demand for goods and services—and thus the growth rate of national output—at all interest rates. Changes in the second set would tilt the IS curve so that it becomes flatter or steeper. A flatter IS curve implies that only small changes in interest rates are needed to induce a relatively large increase in investment demand. A steeper curve means that even large changes in the interest rate are able to induce only a small change in desired investment. (The slope of the IS curve might be said to reflect the level of development or friendliness of the business environment.) In the short run, changes in domestic spending mean that some combination of firms, households and the government together plan to buy more or fewer goods and services than are currently being supplied. Such a change tells domestic producers whether to make more or fewer products. In this relatively simple model of the domestic economy, firms are assumed to be able to respond unproblematically to imbalances in the goods market by adjusting production for the inputs they need: they supply just as much or as little as is desired.

Money alone: LM

In the financial sector, three factors are typically cited as capable of igniting disturbances. In each case, any imbalance in the money market triggers changes in interest rates, which ensure that a new equilibrium level, higher or lower than the initial one, is achieved. The first factor is a change in the pace of growth of economic activity. For example, a splurge in consumer spending—say, in the run up to Christmas, or ahead of a rise in value-added tax (VAT)—boosts aggregate demand and hence the rate of growth of national income, simultaneously pushing up the demand for money to carry out these additional buys. The LM curve shifts up and left. A second important destabilising factor would be any trend towards holding more private wealth as money. Such a rise in "liquidity preference"—say, in response to high volatility in bond markets, as in my opening paragraph—would likewise shift the LM curve leftwards and up, also by setting off by unbalancing rise in monetary demand. A third important factor that can produce money market imbalance is a change in the growth of the real money supply. In the short run, when prices are fixed, this is identical with the growth or contraction of the nominal money stock, which is controlled by the central authorities as a tool of (monetary) policy to influence other economic indicators, such as the short-term interest rate, or, over the longer term, the pace of growth of the general price level. Typically, it does this by buying or selling government securities (bonds and bills), which increases or decreases amount of cash in the financial sector, pushing interest rates down or up. The excess money supply linked to faster growth in the stock of money in the economy disturbs equilibrium in the money market, triggering a shift in the LM curve, this time rightwards and down, so that money market balance is restored: a reduction in the interest rate induces a switch from less attractive interest-bearing bonds to cash, so that money demand rises to the point where it just offsets the increase in the money supply, restoring money market balance.

Both together: ISLM

Probably the clearest example of the distinct result of the interaction of the goods and money markets can be seen by working through the knock-on effects of a change in demand. From such a change, the main conclusion is that impact of the multiplier, whether positive or negative, is dampened by the interaction with the financial sector, because of the two-way feedback loops between the goods and money markets.

Causes. A rise in demand could be the result either of putting more money into the circular flow of income or of withdrawing less from it. In a closed economy, this might result, for instance, from an increase in government spending, or a tax cut (which would leave households with a larger slice of their income to divide between spending and saving, in this way, assuming that the ratio between them stays the same, boosting consumption demand). Such measures featured heavily in the many "fiscal stimulus packages" that have been implemented by governments around the world since 2008 in an attempt to counter the impact of a sharp drop in foreign demand set off by the global economic crisis. A boost to domestic demand might also stem from an improvement in business or consumer confidence, lifting investment and consumption demand, perhaps because the outlook for economic growth has substantially brightened, or because the latest figures show employment growing more briskly than expected.

Mechanism. An increase in spending and/or confidence boosts aggregate demand, though the rise in output is larger than the original impetus because, along the way, the original sum becomes someone’s income and they, in turn, spend a proportion of it, creating additional goods demand. In the short run, however, with prices relatively rigid, the rise in demand induces only an increase in economic output and the IS curve shifts right: output is higher at all interest rates. But that's not the end of it because the expansion of economic activity shows up in the money market as an increase in demand for money, which is needed to cope with the increased number of transactions. With wealth split, for analytical purposes, between money and bonds, saying that there is an excess of demand for money is the same as saying that there is an excess supply of bonds. With bond offerings exceeding planned new bond purchases, bond prices fall and the yield on bonds moves in the opposite direction—ie the interest rate rises. (Another way or seeing it is that interest rates rise because, in the case of bond-financed government spending, government borrowing bids up the cost of borrowing by creating additional demand for the supply of loanable funds.) This restores balance in the money market by choking off the increase in money demand to equate it to the nominal money supply, which is fixed by the central monetary authorities. At the same time, some business projects are rendered unattractive by the rise in interest rates. This discourages some private investment demand ("crowding out"), reducing aggregate spending and shifting the IS curve somewhat back left. Thus the conclusion is that the full impact of the multiplier on national output is dampened by the feedback loop in the financial sector. This also works the other way, so that the same mechanism will ameliorate the impact on the real economy of a drop in demand. The result contrasts not only with the outcome expected in the goods market taken in isolation, where the impact on the multiplier unfolds fully, but also, looking ahead, with the expected outcome of macroeconomic adjustment over the longer term, once the effect of the inclusion of the domestic labour market is taken into account where fully flexible wages and prices ensure that a boost to government spending produces no increase in output or employment at all (at least, with the classical or monetarist versions of the supply curve). Instead, all of the adjustment takes place in the form of faster price growth and the complete crowding out of private investment. From the point of view of disturbances originating in the financial sector, such as a loosening of monetary policy to try to “jump start” the economy to offset an economic slowdown, or a change in the pattern of distributing assets between money and other forms of wealth, in the first case would see the LM curve shift right, reducing interest rates and pushing up investment demand, which in turn pushes the curve back in the direction it came from.

Practical application

Under what circumstances might such a model be of practical use? A practical use of such a model would be when the international context is either a small or negligible factor for the economy in question, or the international trading environment is stable. This would include countries with economies characterised by a relatively low level of trade of integration with international financial markets. In countries in which the capital or debt markets are underdeveloped, the feedback loop between goods and financial markets is inhibited and the financial sector is an ineffective medium for transmitting official interest rate policy.

AD-AS & IS-LM-BoP

The goods market
Mainstream macroeconomic models make simplifying assumptions to look at the behaviour of the participants in a number of markets, at first imagined and understood discretely. These are the goods market (in fact, the market for goods and services) and the factors market, the money market (representing the workings of the domestic financial sector), the foreign-exchange market, and the labour market. How they work in combination is then investigated systematically. One of the main purposes of this is to try to assess the likely impact of policies in addressing specific economic problems, such as unemployment, or inflation, or destabilising shocks to economic growth.
An important concept in mainstream economic modelling is that of aggregate demand (AD), which is a summation of the spending plans faced by firms, and is itself the outcome of the myriad spending decisions of different groups of "economic actors". When firms are willing to supply all the goods and services that households (C), other domestic companies (I), government institutions (G) and foreigners (X) want to buy, the goods market is said to be in balance. In short-run, demand-side models, this is assumed always to be the case—ie firms will always have spare capacity to raise production, or the freedom to cut it back, when faced with changes in aggregate demand.
However, market balance need not correspond to a level of sales that ensures that everyone who wants to work is employed. In fact, finding a way to close the gap between the two (the so-called deflationary gap) was the motivation for the generation of Keynes's economics as a whole, since mass unemployment was the specific problem that he set out to address in the 1930s. He thought that firms' production plans depended in large part on the demand they expect for their products, itself conditioned by their recent sales experience. In order to influence company behaviour, therefore—and so the level of aggregate supply and employment—it is necessary to understand both how aggregate demand is composed and what the knock-on effects of changes in the components of aggregate demand might be. These components, of consumer demand (goods and services wanted by households), investment demand (goods and services desired by domestic companies), government spending and net exports (foreign demand for domestic goods less domestic demand for foreign ones) are conventionally given the letters of C, I, G and (X – Z).

AD = C + I + G + X – Z

For the two most important components—consumer demand (C) and investment demand (I)—I'm going to start at the end result, missing out the stage of building them up from their simpler to their more complicated versions.
Consumer demand, often the largest demand component of any economy, is the only one that is held to be conditioned by changes in the income of the economy overall, whereas the factors affecting the other three lie outside the model of income determination. Not all of the income received by households (in the form of wages for labour, interest for capital and rent for land) is available for spending, since some portion of it will usually be saved. This portion tends to decline with rising individual household incomes. For economies as a whole, the share of an increase in income that goes on consumption spending (the marginal propensity to consume) is historically and culturally conditioned, slow to change, and can vary between groups, generations and regions. Since the share of income that households have available to spend—their disposable income—has the most bearing on buying decisions, this is what interests economists most. It is affected by the level of net taxes (taxes minus benefits), which is the link through which governments can influence the level of private consumption demand.
However, some part of consumer spending is taken to be independent of changes in income. This component, sometimes called autonomous consumption, takes account of the impact to changes in consumer preferences or taste, for example. Importantly, it is also taken as a proxy for consumer expectations and confidence, which can be lifted or depressed by perceptions of the economic outlook, or by more specific factors, such as the prospect of a tax increase or of rising unemployment.
One final factor that can help to explain changes in observed patterns of private consumption demand is changes in the value of household property or financial holdings—ie their wealth. The proportionate change in consumer spending linked to a change in wealth—the so called wealth effect—is usually much smaller than for the corresponding relation to income, perhaps because changes in wealth can vary. This is something to look at when property booms or busts are prominent features of the economic scene, or when economically significant numbers of households own stocks or shares.

C = a + bY +dW