Institutions produce social effects, and one vocabulary for thinking about these effects derives from economics and focuses on efficiency and inefficiency. Neoclassical economics held little space for institutions, beyond the sparest notion of uncoerced market exchange. Over the course of the twentieth century, problems associates with transaction costs, bounded rationality, strategic interaction, and puzzles of macroeconomic growth called forth welfare-impacting institutions. Beyond merely impacting incentives (e.g., by economizing on transaction costs), institutions came to play a central role in explaining thorny problems such as collective action and credible commitment. We survey a range of applications in economics or working broadly within its rational choice framework which speak to the increasing centrality of theories of institutions in explaining central social outcomes such as development. Efficiency approaches to institutional origins are superficially attractive, modeling them as choice outcomes, but can slip easily into problematic post hoc ergo propter hoc functionalism. By contrast, they show real comparative strength in accounting for institutional stability and change.

In this introductory chapter, we will discuss some methodological issues that will prepare us for the study of Marx's economics. We will begin by acquainting ourselves with Marx's life in general and, in particular, understanding Marx's route to the study of political economy. This will allow us to grasp the motivations that propelled Marx to the study of political economy. On the way we will engage with two important ideas: dialectical method and historical materialism. In the second part of this chapter, we will study the logic behind the structure of his mature work, Capital. The structure of Marx's presentation in Capital reflects his understanding of some important aspects of the methodology of social sciences. A proper understanding of the structure of Capital can potentially prevent us from misunderstanding some of Marx's economic arguments.

Marx's Route to Political Economy

How and why did Karl Marx come to the study of political economy? In this section, we look, very briefly, at the life and times of Karl Marx and try to understand the motivations that underlay his lifelong study of political economy.

First Phase of Studies

Marx came to the study of economics via jurisprudence, philosophy, history and journalism. After completing his PhD in philosophy from the Universityof Jena in 1841, he quickly gave up hopes of an academic position. He realized that there was no real prospect of an academic job materializing in Germany due to his radical political views. So he turned to journalism, writing for and then becoming the editor of a radical democratic newspaper Rheinische Zeitung (Rhineland Gazette). As editor of the newspaper, he found himself ill prepared to deal with issues of what he called ‘material interest’.

In section 5.2, we had studied the issue of technical change, and we now revisit the issue to deal with it in greater detail. In particular, two questions related to technical change will be addressed in this chapter. We will first make precise the definition of technical change, relate it to capitalist decision-making and then ask the following question: Does technical change adopted by capitalist firms coincide with what is best from a social perspective? The second question we will investigate relates to the relationship between technical change and the rate of profit. When does technical change in capitalist economies lead to a fall in the rate of profit?

The second question derives its importance from a long and distinguished Marxist literature on tendencies of economic crisis in capitalist economies. From a Marxist perspective, an economic crisis in a capitalist economy is a deep and prolonged interruption of the economy-wide circuit of capital. The proximate cause of an economic crisis is a decline in the average rate of profit. The rate of profit can fall in two different, and mutually exclusive, ways, which suggest a typology of economic crises in capitalism. The first way in which the average rate of profit can fall is when the economy is marked by a chronic insufficiency of aggregate demand, so that commodities are sold at prices that are below their value (or price of production). Hence, in this case, the sale of the commodity does not realize the full surplus value (or the average rate of profit), and the realized rate of profit falls below the ‘normal’ rate of profit (which prevailed previously). We can refer to this as a ‘crisis of excess surplus value’ (because more surplus value was produced than could be realized through sale). The second way in which the average rate of profit can fall is when, despite the commodity selling at its full value (or price of production), the realized rate of profit declines. Thus, in this case, the problem is not one of realization of the surplus value embedded in commodities, but rather points to the production of insufficient surplus value itself. We can refer to this as a ‘crisis of deficient surplus value’ (because the system produces less surplus value than is necessary to ensure a ‘normal’ rate of profit).

The nature of capital investment is that an upfront expenditure is made with the hope of producing a stream of benefits over time that more than pay for the initial expenditure. Capital investments are thus risky, because that stream of benefits may not materialize. The economic environment may deteriorate, induced by new patterns of trade or a technological advancement creating fresh competition. Or the legal environment may darken, if it is later discovered that the production process is harmful, or if product is harmful in a way that was unknown at the time of investment. When those economic or legal threats present themselves, owners of capital rally to preserve the value of their capital. The bigger the capital, the stronger the rally. When capital owners attempt, through legal, political, or extra-legal means to protect their capital from these changes, they are said to engage in rent-preserving activities. The result is a costly policy conflict.

While it would be impractical to try and regulate capital investment, it is still surprising that there is so little to deter risky investments. It is still easy to invest in capital equipment that produces harmful effects or products. The reasoning would seem to be the notion that capital investments are purely private decisions. We leave it to the private investor to consider the private benefits. As to the potential for public harm, a dual system of ex post and ex ante disincentives are supposed to send a signal to prospective investors. Ex post, liability could be costly, and could serve as a deterrent for engaging in potentially harmful behavior, by investing in harmful capital. Ex ante, a regulatory state is supposed to intercept the most dangerous industrial practices, and should disincentivize the capital investments that enable them. These dual disincentives have been insufficient in stemming the investment in harmful capital.

Capitalism is not the reason that humankind has so badly mistreated its environment. It is true that capitalism has taken a very wrong turn, and having gone down this route, it is difficult to change it. But there is nothing about capitalism preordaining it to produce environmental destruction. Capitalism has taken on a malignant form, but it has been steered by mistaken political choices, born of political failures, greed, tribalism, and that toxic cocktail of human arrogance mixed with abject ignorance.

In May 2020, during the COVID-19 crisis, which pummeled markets and industries of almost all types, fourteen Republican senators and two Republican congressmen wrote to the President, urging him to “use every administrative and regulatory tool at your disposal to prevent America’s financial institutions from discriminating against America’s energy sector … .”

The section ‘The Benefits and Costs of EPZs and SEZs’ in Chapter 5 made a case that what is happening in China, particularly Western China, is of crucial importance to the likely impact of the CPEC on Pakistan. While the CPEC is about infrastructure and FDI, these processes are influenced by overall trade relations between China and Pakistan. Infrastructure links that open up trade between China and Pakistan will make little difference if the two countries charge high tariffs on trade. This chapter outlines the emerging patterns of trade between Pakistan and China, particularly in relation to the signing of the 2006 FTA.

THE CHINA IMPACT ON WORLD TRADE: THE IMPLICATIONS FOR PAKISTAN

In 1979 China had a mix of land shortages and an abundant and reasonably well-educated labour force. The entry of China onto world markets after 1979 from a position of near autarchy had a global impact on relative factor endowments and thereby the comparative advantage of other countries (Wood and Mayer 2011). The value of having a great deal of available land to produce agricultural products, natural endowments of oil, metals and industrial inputs such as cotton, or the ability to produce skill-intensive manufacturing and services in other countries increased as China sought more imports (Renard 2011). Those countries exporting low-skill labour-intensive manufactured goods were set to face the brunt of Chinese competition in export markets.

Chinese potential was realised in the massive surge of Chinese exports. China's exports of manufactures increased from $48 billion in 1990 to $303.5 billion in 2002, from a 3 per cent share of world manufactures in 1995 to 11 per cent in 2006. These exports were initially concentrated in labour-intensive sectors such as textiles, clothing and wood products. Between 1990 and 2006, China's exports of clothing increased from $9.7 billion to $95.4 billion and its world market share from 9 to 31 per cent, with an extra 9 per cent when including Hong Kong (Wood and Mayer 2011). In many cases, this had a devastating impact on other exporters of textile products.

The value of clothing exports from sub-Saharan Africa (SSA) to the US dropped by 25 per cent between 2004 and 2006. For Lesotho, the fall in export value was 15 per cent, mostly in 2005, but exports did stabilise in 2006.

The relationship between ‘value’ and ‘price’ of commodities has been an important issue of investigation in the classical-Marxian tradition for more than two centuries. By ‘value’ we mean, as in the previous chapters, the socially necessary abstract simple labour directly and indirectly needed to produce a commodity, and by ‘price’ we mean prices of production, that is, the set of prices that can ensure a uniform rate of profit in all industries (see section 5.1). The transformation problem refers to attempts to offer consistent conceptualizations of the relationship between value and price, as defined here.

Along with the literature on the impact of technical change on the rate of profit, which we discussed in the previous chapter, the literature on the transformation problem is arguably one of the largest in Marxist political economy. In this chapter, I reinterpret the vast literature on the transformation problem as consisting of attempts to provide meaningful answers to two questions.

• • Can a set of prices of production be calculated consistently that avoids mistakes made by Marx?

• • If a consistent set of prices of production can be calculated, is there any role left for value magnitudes? Are value magnitudes redundant?

The first question relates to the computation of a set of prices of production that avoids some mistakes Marx made. The second question relates to the nature of possible relationships between value and price magnitudes, given that the latter can be calculated in a consistent manner. In this chapter, I provide both a brief survey of the existing literature on, and detailed treatments of two approaches to, the transformation problem by organizing the discussion around these two questions. I will discuss how these two questions emerged and how the Marxist tradition addressed the questions.

The two approaches I take up for detailed treatment are the Standard Interpretation (SI) and the New Interpretation (NI). The SI was the traditional approach to the transformation problem until the 1970s. It emerged in the early 1900s in the work of the German statistician-economist Ladislaus von Bortkiewicz, and was popularized by Paul Sweezy and beautifully formalized by scholars like Nobuo Okishio, Michio Morishima and John Roemer.