Saturday, April 26, 2014

Krugman and the neoclassical theory of distribution: will he recant on the natural rate of interest

In the previous post I noted that Krugman suggests incoherently that: "saying that capital gets its marginal product in no way says that the people who own that capital deserve what they get." The point is exactly that if you receive according to productivity, it cannot be blamed on exploitation or other social factors. Capital gets higher profits because it is productive, and unskilled labor does not for the reverse reason.

If we do not mince words about the meaning of deserve, 'to be worthy' in my dictionary, by the way, it is evident that a theory that says that remuneration is accrued according to productive capacity, and again we take productive to mean, using the same dictionary, doing or achieving a lot: working hard and getting good results, then you have that those that work hard are worthy of their remuneration. But does Krugman believe in the notion that productivity determines pay you, enlightened reader, might ask.

From the 2014 3rd edition of Krugman's Essentials of Economics:
The factor market most of us know best is the labor market, in which workers are paid for their time. Besides labor, we can think of households as owning and selling the other factors of production to firms. For example, when a corporation pays dividends to its stockholders, who are members of households, it is in effect paying them for the use of the machines and buildings that ultimately belong to those investors. In this case, the transactions are occurring in the capital market, the market in which capital is bought and sold. As we’ll examine in detail later, factor markets ultimately determine an economy’s income distribution, how the total income created in an economy is allocated between less skilled workers, highly skilled workers, and the owners of capital and land [italics added].
Fair enough, Krugman said back in 2007 in his book The Conscience of a Liberal that: "there is something wrong with textbook economics." Apparently he has not read his textbook.

So, yes Galbraith, Palley, Syll, and others that have pointed out the connection of neoclassical economics with the specific idea that inequality results from market forces, and represent what people deserve are correct. That is why this blog has insisted that Krugman's notion of a natural rate of interest undermines his own policy views on the need for social policies to redress inequality.


  1. The theory says more precisely that income is determined by the marginal value product of labor, which has nothing to do with the common sense notion of productivity.
    If a factor is scarce it will command a high price but scarcity doesn't imply at all hard work or merit.

    It's true however that saying income is determined by marginal productivity is misleading, and right wing economists, starting with J.B Clark, have often taken advantage of this ambiguity to assert that it implies a fair distribution of income.

    1. Hi Ric:
      The marginal productivity of labor is the increase in output brought by the last unit of labor. That is, the marginal unit of output per worker, which is the common sense notion of productivity. Not really a controversial issue, and not really something that is denied by most neoclassical economists. Krugman is trying some impossible intellectual gymnastics.

  2. Krugman explicitly denies there's a tight ink between A (marginal product income distribution) and B (fairness). Your insistence that anybody who believes A must believe also B is thus kind of silly. If not for anything else, competitive equilibrium and income distribution depends on initial endowments, and there's no guarantee those must be fair.

    And by the way, that textbook quote merely says that renumeration for factors of production is determined in factor markets (no marginal products are mentioned). This is trivially true - where else should it be determined?

    1. Second part first. The fact that remuneration of factors of production is given by supply and demand in the factor markets implies by definition that it is the marginal productivity of labor and capital that determines the remuneration. Anything but trivial proposition. In fact, it involves unsurmountable problems, as the capital debates demonstrated. The remuneration of labor is given, for classical authors, by the several social and historical forces that determine the relative strength of the labor force. They suggested it was at subsistence levels, which was probably appropriate given their historical circumstances. Sraffa and others suggest that the rate of interest is determined, in Keynesian fashion (in particular the Keynesian notion of a normal rate of interest), by the exogenously by the monetary authority. Here again, institutions and history matter. Conflict is at the center of distribution. Once one of the distributive variables is determined, either one, the other must be determined for the given long term prices. The disappearance of the old classical tradition is so strong that the incorrect marginalist notion has become a naturalized as if evident, when it is simply logically wrong.

      On part one, is not an insistence, it is fact. Productivity means that you get according to what you put in the productive system. Not fair, but according to effort. Fair is a value judgment, not used in my post. Also, yes it is well known that in neoclassical theory endowments, technology, and preferences determine prices, including those of the factors of production. And yes they do mean that they receive according to productivity which is what the quote says, and that DOES mean according to contribution.

      The fact, that you have certainty about this logically incorrect theory, and no knowledge of the existence of alternative theories of distribution, implies minimal contact with the works of classical authors (Smith, Ricardo and Marx). You should probably read on them Ivan.

    2. Competitive equilibrium is just one kind of a market structure. In markets with monopsony or bargaining, wage doesn't have to equal marginal product of labor. If I'm not mistaken (I have access only to an older edition), that quote you pulled from Krugman's textbook comes from chapter on national income, discussing the circular flow diagram - a basic description of flow of funds in the economy, without any assumptions about whether factor markets are competitive. So I don't think it proves what you claim. As for "according to contribution" vs. fairness - now you're just arguing semantics. It's clear that Krugman referred to normative, value judgments - so repeating the definition of marginal product (on which we all agree) is beside the point.

      Although it has really nothing to do with my post, I'm aware that Sraffian authors reject marginalism (well, the basic idea, at least). Aware and unconvinced. I don't see any evidence that disaggregated general equilibrium models suffer from logical inconsistency, just because Sraffa wrote down a model where prices are indeterminate - if you ignore demand and preferences, then of course you'll find you have more unknowns than equations, and Sraffian models can be recast as special cases of GE anyway (Hahn, Cambridge J. Econ. 1982; Mandler, Rev. Econ. Stud. 1999). But I guess that as a rhetorical strategy for those already convinced, a blanket dismissal of neoclassical theory as a way to avoid engaging any arguments of substance, it works quite well.

    3. The simple fact is that if you take as your "base case" a perfectly competitive model and then add in frictions (monopsony and bargaining) you give the student a distinct impression that we would be far better off without the frictions. This leads to the policy conclusion that labour markets should be flexible.

      All the distribution models are garbage. They're just sophisticated myths that economists -- Sraffian or marginalist -- tell themselves. You work through them and explore their logical ramifications largely as an exercise in intellectual masturbation. But the myths carry with them very real messages about how the world kind-of-sort-of works. The Sraffian myth is far closer to the truth of the matter than the marginalist myth because it is (a) more in line with how firms set prices which is via costs of inputs and a mark-up and (b) it recognises that distribution of income is logically prior to price/demand formation which is how things work in the real economy.

  3. Doesn't James K. Galbraith make the beginnings of an argument against the every ontology of a "labor market" in 'Created Unequal'?


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