Two letters to The Economist about Donald Harris and what they reveal about ideology

 

Spaghetti economics: Shootout at Harvard Square

There were two letters about the poorly written (not the English, always impeccable, contrasting to my spaghetti English, which is always slightly off, like the Westerns) piece that The Economist had on Donald Harris. One by Robert Blecker, Steve Fazzari and Peter Ho, setting the record straight on the breadth and depth of Harris' contributions to economics. On this, they echo what the Post said about Harris' policy advice in his native Jamaica. The subtitle of the Post piece said: "An unconventional economist at Stanford, Donald J. Harris pushed strikingly nonideological economic solutions to the nation of his birth." Harris was (and still is, from what I can assume) a reasonable man, both as a scholar concerned with knowledge, and as a policy advisor. Nonideological being the key word.

The other one, that I reproduce in full, is by Professor Avinash Dixit, who says:

"You say that Mr Harris 'proposed that firms must choose from a 'book of blueprints', which need different capital goods' in his book published in 1978. Alas, that had been proposed more thoroughly and rigorously in 1953 in a brilliant paper by Edmond Malinvaud, for which he should have won a Nobel prize. And Robert Dorfman, Paul Samuelson, and yes, Robert Solow, whom you cite as author of the aggregate capital-growth model, covered it more comprehensively in a book from 1958. Perhaps the mathematics of all this were beyond the capacity of the so-called Marxists of Cambridge."

This, and The Economist piece itself, confirms the high degree of confusion about the meaning of the capital debates. The problem is not so much the lack of mathematical savvy of the Cambridge, UK, economists, Marxists or otherwise, but the lack of understanding of theory, by some very serious and important mainstream economists, and mainstream magazines (they do think they are a newspaper too, btw).

The Economist piece, commits the mistake that I suggested (see my old post on the Capital Controversies here) was typical of most incorrect views on the debates between the two Cambridges, and suggests, essentially, that it was an aggregation problem, and that:

"Mr Harris did not move on. In his 1978 book he developed a model of growth without an aggregate capital stock. Rather than the smooth 'production function' of Solow, in which the rate of saving and population growth determines capital per worker, Mr Harris instead proposed that firms must choose from a 'book of blueprints', which need different capital goods. Capitalists will compete to ensure the rate of profit is consistent across different industries, picking a blueprint based on the level of wages and profits in the economy."

That's why Dixit suggests that the choice of technique models in Malinvaud, and in Dorfman, Samuelson and Solow, using disaggregated notions of capital would avoid the circularity of the aggregative model. It is always the case that firms will choose, given distribution, the technique that minimizes costs. Of course, that's not the issue. The problem is that one cannot obtain a measure of capital that is independent of distribution, and hence, the idea that supply and demand in factor markets can determine the remuneration of capital and labor cannot stand. The classical concern with distributive conflict, both of Marx, but also of bourgeois economists, as he called them, Smith and Ricardo, becomes relevant again [meaning, if I need to clarify, the notion of conflict in the distribution arena was held both by critics of capitalism, and defenders of what Smith referred to as commercial societies].

Disaggregation does little to solve the problem. First, as noted by Garegnani, long ago, the abandonment of the notion of aggregate capital, and the notion of factors of production, came together with the view that means of production got their own rate of return, but also with the disappearance of the notion that the forces of competition lead to a normal and uniform rate of profit. The traditional long run method of economics, that was the theoretical foundation of the discipline, was abandoned. Further, it is still the case that, even with a disaggregated set of means of production, in the the aggregate, savings must be equalized to investment, and some process for that has to be used. That is why some notion of the quantity of capital was necessary for the mainstream [in recent times, mainstream economists and policy makers have started talking of the natural rate of interest again, a notion that had vanished more or less, and about very simplistic negative relations between investment and interest rates, w/o even knowing the logical problems associated with that, reinforcing problematic views about distribution].

In other words, forget the notion that firms actually face a book of blueprints, and that they can substitute and change the structure of production with relative ease, according to changes in relative prices, and that somehow that, by affecting the relative supply and demand for capital (many capital goods) and labor, would determine distribution, since that is obviously highly improbable in reality. Choices are more limited, and substitution irrelevant, at best. The Cambridge, UK, economists (and not only the Marxists; most were some kind of Post Keynesian, as The Economist notes) and Harris knew better. Distribution is determined by the relative bargaining power of workers and capitalists.

Samuelson knew enough, math and theory, to know when he was wrong. Mr. Dixit thinks his mathematical knowledge puts him above the rabble [the so-called Marxists of Cambridge, and Mr. Harris]. But what his letter [and the piece by The Economist] actually shows is lack of engagement with the theoretical argument, and, in contrast with Mr. Harris, an incredible amount of ideological bias. After all, the idea that distribution is according to effort, and that markets produce optimal outcomes is at play. It shouldn't be. He raised Malinvaud, I counter with Smith, which knew way less math than he does, for sure, but whose book is still worth reading.

Luigi Pasinetti (1930-2023)

Pasinetti, Garegnani and the president of Italy in 2010

Last week, in my senior seminar on the history of economic thought, I made the kids read a paper by Pasinetti on "Progress in Economic Science", which was published in a book edited by Boehm, Gehrke, Kurz and Sturn. It's a short defense of pluralism in economics on the basis of the co-existence of Kuhnian paradigms, with a relatively optimistic view of the possibility of progress, in a discipline in which, as he noted, the object of analysis is changing continually, the ideas of the researchers might affect the functioning of the object of study, and value judgments cannot be avoided, in part because they affect everyday material conditions. As he said: "It is enough to think of the devaluation of a currency, or of the movements of wages and salaries, to realize how deeply these phenomena affect everybody’s pocket."

Sadly Pasinetti has died yesterday. He was perhaps the last great name of the Anglo-Italian Cambridge School, that tried to put the works of the classical authors and Marx and the Keynesian Revolution together, and intimately associated with the work of Piero Sraffa. I remember reading a paper on how the school could be divided in a more Marxian strand (with Pierangelo Garegnani as the main author) and a Ricardian one, around Pasinetti. This also had political implications with Pasinetti representing the center right Christian Democrats, and Garegnani on the left, linked to the Communist Party. I once told that to Garegnani, who dismissed the idea of Sraffian schools.*

Pasinetti will be remembered for his work on the Cambridge distribution models, the famous Kaldor-Pasinetti model, the participation in the capital debates, and his work on a classical model of structural growth. Personally, his book on the theory of production (Lectures on the Theory of Production) and his discussion and critique of the Maastricht fiscal limits remain the two of his contributions that influenced me the most.

I should note that this comes after a series of deaths in the profession that have significantly affected the heterodox community, and me personally. Vicky Chick, with whom I was supposed to work for my PhD, and Jim Crotty, two of the more creative thinkers within Post Keynesian economics have passed. Also, on a personal note, Nilüfer Çagatay, my colleague in Utah, and Barkley Rosser, the co-editor of the New Palgrave passed away this month. The heterodox community is in mourning.

* The other would be the Smithian one, with Sylos-Labini as the main leader, and a Socialist bent in politics.

The end of Friedmanomics?

Friedman's advisees

Zachary Carter, of Price of Peace fame (a good book that I recommend, btw), wrote an interesting piece on Milton Friedman's legacy, which I think is, as Hyman Minsky said of Joan Robinson's work, wrong in incisive ways. But even before we get to his main point, that the era of Friedmanomics is gone, it is worth thinking a bit about the way he approaches the history of ideas. This is clearly a moral tale for Carter, with good guys and bad guys. Gunfight at high noon. It is more about vision than analysis, in the terminology of Schumpeter.

He starts, like Nancy MacLean in her Democracy in Chains -- I discussed only tangentially

the issue here -- with Brown v. Board of Education, and Friedman's, rather than Buchanan's, insidious behavior favoring policies that allowed the persistence of segregation. He tells us that: "it is hard to believe Friedman was merely naïve and not breathtakingly cynical about these political judgments, particularly given the extreme rhetoric he used to attack anti-discrimination efforts." Yet, as he continues he seems to change his mind and argue that: "yet he appears to have genuinely believed what he said about markets eliminating racism." So it seems he was naïve after all, according to Carter.

Of course, to determine whether Friedman was cynical or naïve is a thankless task and somewhat besides the point. Friedman was analytically wrong. There is a reason Schumpeter's monumental book is A History of Economic Analysis, and not of economic ideology. And Carter argument is built on moral, ideological grounds. Friedman is the bad guy. He tells us that: "[t]he chief political disputes of the 1950s and 1960s, as today, really were about moral values, not technical predictions." Don't get me wrong, vision matters, and it's hard to disentangle from analysis, but it is clear that Friedman's views differed analytically from the ones discussed by the Keynesian disciples at Cambridge (less so in the case of some of the Neoclassical Synthesis Keynesians that came to accept Friedman's notion of a natural rate of unemployment by the late 1960s). But it is hard to say that Friedman was for segregation, when he explicitly says he was against, and Carter himself thinks that he might have been sincere about that. Other than finding archival material that shows that Friedman knew better we are left with conjecture and guess work.

The key analytical differences between Friedman and the more heterodox Keynesians I alluded above, were not so much in his classic book on monetary history with Anna Schwartz, cited by Carter, but in his AEA presidential address from 1968. The return of the natural rate was the foundation that allowed, once the political circumstances were ripe for the demise of the Golden Age, for the return of marginalist analysis. In a sense, the notion of a natural rate of unemployment went full circle and added to the Neoclassical Synthesis notion that Keynes was fundamentally about wage rigidities or other imperfections. Note that this happened after the capital debates, when the logical foundations of the neoclassical theory was in shambles. In favor of Friedman, I might add, he did write the analytical model down in the debate with his critics, in contrast with Hayek, that after abandoning economics in the 1940s dedicated himself to ideological discussions without any analysis. Vision without analysis as my good friend Fabio Freitas poignantly says.

Carter is on firmer ground when he argues that Friedman was not a classical liberal, and had little in common with Adam Smith, although Friedman himself might have thought so; understanding of history of ideas is sadly vey uncommon among economists. Carter tells us that: "Friedman preferred to be identified as either a 'neoliberal' or a 'classical liberal,' invoking the prestige of the great eighteenth- and nineteenth-century economists—while conveniently gliding past their often profound differences with his political project. (John Stuart Mill, for instance, identified as a 'socialist,' while Adam Smith supported a variety of incursions against laissez-faire in the name of the public interest)." The differences with Smith were not fundamentally political though, but analytical (Stuart Mill is a more complicated transition author). Markets did not produce efficient allocation of resources or full employment of labor for Smith, as in the Marshallian world of Friedman and the Chicago School.

At any rate, the notion that Friedmanomics (or Neoliberalism for that matter; on that here) is dead is at best an exaggeration. In part, the misdiagnosis results from Carter's view according to which: "Friedman’s major theoretical contribution to economics—the belief that prices rose or fell depending on the money supply— simply fell apart during the crash of 2008." That's definitely not the main lesson from Friedmanomics. The quantity theory was never particularly dominant. It was a return to the simple notions of marginalism, of the theory of value, that suggests that supply and demand produce optimal outcomes, that lead to full employment, and that can fix all sort of social maladies (including racism, as Carter notes correctly) that was central to Friedmanomics, and neoliberalism.

In other words, his main legacy was the idea that the market society is a panacea. That free markets are prerequisite for a democratic society (Hayek was more forceful in that argument, without even trying to provide the analytical foundations). Something used cynically to favor the interests of a narrow group by the politicians Friedman advised (the three on top, for example). And while it is true that the last financial crisis (the 2008 one) has led to a reassessment of the role of government, and more so with the pandemic, as I discussed here, the notion that Friedmanomics is gone is wishful thinking.

Even though the profession has abandoned Friedman's Marshallian version of marginalism, his notion that markets do produce optimal outcomes has received no serious challenge within academia, and, in policy circles, interventions follow a pragmatic notion that market imperfections are worse than government imperfections. But that could change rapidly, like Larry Summers support for expansionary fiscal policies. Friedmanomics will certainly make a come back.

A primer on the economics of immigration: a surplus approach perspective

This is definitely not my topic of research. So you may very well ask why would I venture to write about it, beyond the obvious reason that it is probably one of the most debated issues these days in the US, with the government shutdown being related to the now infamous wall. I am myself twice an immigrant, I descend from immigrants (my parents returned to their country of origin, but had emigrated, and on my mother side my grandfather was also an immigrant, and the same goes on my father's side a few generations before), I might add. But that is not the whole, or the most relevant, reason.

Most debates about immigration center on labor market issues, and discuss the issue analytically with the tools of marginalism. The conclusions, by definition, are the logical consequence of the assumptions in that model, and the reading of the evidence is biased by those theoretical concepts. Here is a place were the capital debates (go read this very old post) might be important for a policy issue that is in the news constantly and that should concern economists. Being in favor of a return to the old and forgotten method of classical political economy, or the surplus approach, and not having seen any discussion of the issue along those lines is what led me to write this brief post.

Let me start with a very simple representation of the conventional argument. In the conventional story, you have a market for factors of production (labor in this case), and equilibrium is obtained when the marginal productivity of labor equals the marginal disutility of labor, where firms maximizing profits and individual workers maximizing utility find the optimal solution, shown in point C in the figure below (with variables with their traditional meanings; note I use N for labor, since I leave L, for liquidity; yep, I still teach the ISLM with that pesky L in there).

In this case, the effects of immigration are relatively simple to understand. Mainstream economics suggests that immigrants would add to the labor force, increase the labor supply, reduce the real wage, and lead to firms hiring more workers and increasing production. Output and employment should go up, while real wages would go down. The effect on the wage bill (W/p * N) depends on certain assumptions, but certainly native workers lose to the extent that their real wages go down. Hence, a backlash against immigration by working class native groups should be expected.

This simple analysis abstracts lots of things, of course. Differences in the quality (skills) of workers, and immigrants, and what would happen in the presence of capital mobility (with profits going up, with lower real wages, and capital mobility, then new factories should move into the country to take advantage of lower wages and increase the demand for labor, eliminating any initial effects on real wages). A lot of the academic debate has been based on arguments along these lines (see, for example, the Card and Borjas debate on the effects of the Marielitos Cuban immigrants in Miami real wages in this nice Vox post). Note, also, that the evidence suggests that the effects of immigration on real wages of unskilled workers are relatively small (if you believe Card).

In this view, then, there are some acceptable reasons for workers to be concerned with immigration. Note that this says nothing about fiscal issues, which many conservatives also use against immigration, suggesting incorrectly that they do not pay taxes (they certainly pay sales taxes, and other local taxes, and given the low incomes of most unskilled workers, would not qualify for income tax anyway), and take advantage of public goods. However, there are many analytical problems with the assumptions of the model above.

Note that the basis of the marginalist (or neoclassical) model presented above is the principle of substitution. In other words, as labor becomes cheaper than capital, that is by assumption fully utilized, then firms hire more labor. So the lower wages guarantee the full utilization of labor. The intensity of labor increases as its remuneration falls, and the price of labor, as any other price in marginalist theories (Austrian too, although they sometimes confuse this) reflects the relative scarcity of the factor of production. Note that for classical political economy authors (including Adam Smith) real wages resulted from historical and institutional factors, and supply and demand were only one of the factors affecting them. Under the conditions they analyzed the economies of their time they assumed that real wages were essentially at subsistence level.

The capital debates become relevant because they essentially show that the substitution principle has logical problems, and they open the possibility to a return of the sort of historical and institutional analysis of the labor market of classical political economics. I will not discuss the whole issue here again (check that post linked above), but the essence of the argument is that sometimes when real wages go down instead of leading to firms hiring more workers, the opposite might occur. Think of a situation in which real wages fall, and as a result, there is less demand for the goods produced by the firm. Perhaps the firms goods are bought by workers themselves.  Even though labor is cheaper, there is no reason for the firm to hire more workers if they cannot sell their goods, and the income effect overwhelms the substitution effect (the capital debates suggest that the substitution effect may go in the wrong direction, on top of that). That's essentially what Keynes said on chapter 19 of the General Theory (in chapter 2 he basically accepts the marginalist demand curve above, which is problematic, and shows the limitations of the supply curve; my paper on reading Keynes after Sraffa, the key author of the capital controversy, here).

The point is that it cannot be guaranteed that immigration would lead to a reduction of real wages, at least not on the basis of the logic of the model above. The actual result is ambiguous. Classical political economy provides an alternative framework to look at the labor market effects of immigration. It is clear that an increase of the labor supply might affect negatively the bargaining power of the established workers. But note that this is not always necessarily the case. Arguably, in the case of many immigrants in the so-called first globalization (late 19th to early 20th century), in which significant amounts of Socialists and Anarchists from Eastern and Southern Europe came to the US (and other parts of the Americas), the effect was to raise the class consciousness and the combativeness of the working class, helping strengthen some unions.

And the reverse is true, a country that experiences emigration might actually lose key workers, and unionization rates might decrease. In the last 30 years or so, the US has experienced an increase in the population of immigrants, many came from Mexico of course, and yet both countries have experienced a decrease in unionization rates (see here for Mexico). This suggests that other forces are in action, and that wage stagnation might be related to those policies, and not just, or not even fundamentally, as a result of the flows of workers from one country to the other.

Note also that classical political economy authors assumed that output was given in their discussion of distribution, and that separation of the theories of output and employment (dominated by Ricardian Say's Law, that was not a necessary feature of classical thinking, and that can be superseded by the Keynesian Principle of Effective Demand) allows us to understand other aspects of immigration. In other words, the level of output and employment would depend on autonomous spending (demand), and immigrants can easily be accommodated in society without displacing the native workers. Of course that would depend to a great extent on the government macroeconomic policies (not just fiscal and monetary policy, but also the setting of minimum wages, industrial and trade policy and so on).

In this view, it is less the effects of immigration on the labor market (along neoclassical lines of reducing real wages and increasing employment) that matter. It has been the policies that actually led to lower growth, lower union participation, trade policies that favored the loss of manufacturing jobs that have created the conditions for real wage stagnation. In that sense, it is those policies that are responsible for the backlash against immigrants among large groups of resident (native) workers, that could be exploited politically by right-wing populists, often with fascistic and authoritarian tendencies (not just in the US). Immigrants are actually escaping from similar neoliberal policies in their countries of origin.

And all of these points are just about the most direct economic consequences of immigration. There are other issues that are as relevant beyond economics. And it goes without saying that both immigrants and refugees (in particular those that result from US direct or indirect intervention abroad) deserve humane treatment, even if the conventional mainstream story was correct and immigration did cause inequality.

On the AS/AD model and the micro/macro relation

I promised to discuss Nick Rowe's claim that one must start with Aggregate Demand and Supply (AS/AD) to explain macroeconomics. Nick's argument is that the AS/AD model is useful to analyze monetary economies, and he quite correctly points out that money must be part of the discussion from the start. In his words:

And if you don't start with money, monetary exchange, and AD and AS, you are doing macro wrong. Because the only thing that makes macro different from micro general equilibrium theory is the fact that macro incorporates the fact of monetary exchange, which microeconomists ignore.

While I tend to agree that macro should deal directly with monetary economies, it's far from clear that the only difference between macro and General Equilibrium (GE) micro is the existence of money. But before I get to that a few things about the AS/AD model in general and Nick's suggestions.

Sure money matters, but it's worth remembering that the basic macro principle, the idea of effective demand and the multiplier can be described without directly discussing money. Sure, Keynes noted that effective demand works in a monetary economy of production, and suggested that it was similar to Marx's capitalism (M-C-M') in the drafts of the General Theory (GT). But that was just to note that that the process of production is not about consumption, but about accumulation, something relevant for debunking Say's Law.

But the idea that investment (in this case as a proxy for autonomous spending) determines savings, and the adjustment process results from increases in income, does not require a previous discussion of money. So much so that Keynes himself suggests that he only came up with the theory of liquidity preference, and the monetary rate of interest, after the development of the multiplier (and his version the psychological law, and the propensity to consume below one; Kalecki does it by the share of income going to wages below one, and with workers consuming all their income).

So why is AS/AD important in my view, you may ask. I actually start with the Quantity Theory of Money to provide an AD curve (as suggested by Nick; but he prefers to make M endogenous as in a Wicksellian model), and a simple production function and labor market story for a vertical AS at the natural level of output to describe the neoclassical model. Exactly to show that in this case output is supply constrained and money does not matter. And that would contrast with the Keynesian view of a demand determined level of income and employment, and a world in which money matters.*

The worst part of using the AS/AD framework is that most students will mechanically believe in something along those lines, and in particular the notion that the two curves are independent. And even though by the end of the course I try to emphasize that the AS (potential output) can be moved by changes in the AD, along the lines of the Kaldor-Verdoorn, it is harder once they have been using both curves independently.

That leaves the issue of the micro/macro relations and Nick's notion that money, which he sees as a medium of exchange in typical neoclassical fashion rather than as a unit of account that represents the power of the State, is the main difference with micro. In my course, the first thing I discuss is the different views of what macroeconomics is, simply the aggregation of individual rational behavior, or as in Keynes' notion of the fallacy of composition something beyond simple aggregation. One example I use is Keynes' notion of financial markets as a beauty contest, that is, the idea that agents in financial markets are concerned with the average view of where the markets should be. So the behavior of one agent affects the behavior of others.

But the main problem with the notion of conventional neoclassical micro is more complicated than the lack of interdependence of preferences, or the lack of money for that matter, but the very core notion of the principle of substitution. I only discuss this in my course, briefly when I have to deal with investment behavior and Keynes' acceptance of the marginal efficiency of capital. And yes, that requires some understanding of the capital debates.

* I should add that I make the distinction that you could have short run effects of money in the simple neoclassical story, but not in the long run, in which cycles are dominated by technological shocks (phlogiston as Romer would aptly call them). In my view, in the long run the main effect of money would be on the level of the normal rate of interest, and it's impact on income distribution and the dynamics of debt. But those are discussed only cursorily in the undergraduate course.

On the return of the natural rate of interest

The natural rate is an old concept, well explained in Wicksell, that almost vanished (Keynes was explicitly against it, even though he partially failed to get rid of it), and has made a come back with the Neo-Wicksellian model that dominates macro today (misnamed New Keynesianism). Below the estimates published in the speech by John Williams.

Note that what seems to drive the natural rate of interest is the basic rate determined by the central bank. Either the fall of the natural rate caused the crisis, or more plausibly, the crisis forced the central banks to reduce the basic rates, and the average of the fed funds rate (which is essentially how they get the natural rate) has subsequently fallen. The same goes for the twin concept of the natural rate of unemployment that keeps falling.

Interesting thing is that for a while the very concept had lost some of its prominence. After the Keynesian Revolution, and particularly after the capital debates, mainstream economists were more cautious about bringing up the natural rate of interest. Friedman used a subterfuge to bring it back with the idea of the natural rate of unemployment. In part because of that, as it can be seen below, the use of the term natural rate of interest in four of the central mainstream journals (American Economic Review, Economic Journal, Journal of Political Economy and Quarterly Journal of Economics) fell in the 1970s, 80s and 90s.

Since the 2000s, there seems to be an increase in the use of the term (in my JSTOR search; note we have a few more years left in the last decade), and if Ngram viewer is correct, a decline in the use of natural rate of unemployment (although the increase in natural rate of interest is not visible in Ngram; one was a limited search in academic journals and the other is a very broad search in books, which may explain the different results). I might be wrong, but my guess is that the natural rate of interest, now that the capital debates are long forgotten, is being rehabilitated.

PS: First paper in 1913 by Irving Fisher, in the JSTOR search.  Roy Harrod is the one with the most papers using the term natural rate of interest, followed by Dennis Robertson. In recent times the one with more papers is Michael Woodford. I excluded papers that were about history of thought, rather than about theory (very few anyway).

Dvoskin and Petri on the relevance of the capital debates

Ariel Dvoskin and Fabio Petri just got their paper published in Metroeconomica. From the abstract:

Among the recent interventions in the capital controversy, the debate between Paola Potestio and Kurz & Salvadori has raised important issues. We agree with Potestio's rejection of the legitimacy of a value endowment of capital but we disagree with her dismissal of the relevance of reswitching and reverse capital deepening: these phenomena are very important because they undermine the demand-side role of the conception of capital as a single factor. For the marginal approach to be plausible, this demand-side role had to imply the stability of the savings-investment market even in shorter time frames than those required by a complete adaptation of the ‘form’ of capital; this was taken by Marshall to authorize doing without a given endowment of value capital, which opened the door to the shift to the modern neo-Walrasian versions of the marginal approach. With proof from Hayek, Hicks, Malinvaud, and Lucas we argue that a continuing belief in traditional time-consuming marginalist disequilibrium adjustments based on capital-labour substitution is the hidden reason why the claim often made by contemporary marginalist economists, that the economy can be assumed to be all the time on the equilibrium-growth path, is not found patently unacceptable. The true microfoundation of DSGE macromodels is not intertemporal equilibrium theory, but the time-consuming adjustment mechanisms on whose basis the marginal approach was born and accepted, and on whose basis monetarism was then able to re-assert a pre-Keynesian view of the working of the economy.

You can read the preliminary version at the Siena working paper series here. The idea that the capital debates is a central issue in macroeconomics has been discussed recurrently in this blog.

Petri on Say's Law

Profs. Serrano and Petri

I somehow missed this paper so far. It explain the several additional problems with Say's Law even if one does not rely on the capital debates to show the limitations of the downward-sloping investment curve.

From the abstract:

Neoclassical capital-labour substitution correctly understood is unable to prove a tendency toward the full employment of resources because it leaves investment indeterminate if the full employment of labour is not assumed to start with; then Say's Law loses plausibility because of the inevitable presence of accelerator-type influences on investment, even neglecting the inconsistencies of neoclassical capital theory; and wage decreases cause a decrease of investment, undermining the 'neoclassical synthesis' criticism of Keynes. The way a negatively interest-elastic investment function is obtained by Romer without assuming the full employment of labour, that is through adjustment costs, relies on several grave mistakes. The recent DSGE models which directly assume that investment equals savings are not supported by general equilibrium theory because the latter theory is admitted by the specialists not to be a positive theory, nor can those models rely on the neoclassical synthesis or monetarism because of the critique of this paper (besides the capital critique), so they must be discarded too.

Read rest here.

Lazzarini on the second phase of the Cambridge-Cambridge capital theory controversies

A new paper by Andrés Lazzarini on the second phase of the capital debates, from 1971 to 1976, when the intertemporal Walrasian model had become the norm within the mainstream. From the abstract:

The aim of this paper is to clear up some issues in a second phase of the Cambridge-Cambridge capital theory controversies, when the neoclassical argument was chiefly conducted in terms of the Walrasian specification of capital in intertemporal and temporary general equilibrium models. It is held that the response by the neoclassical side in that phase has not been as satisfactory to rebut the implications of reswitchingand capital reversing as some neoclassical scholars have argued. The reason for this can be traced in the overlooking of the implications of the redefinition of equilibrium implied in those models.

Read full paper here (subscription required). I think this might be an earlier version here. 

Special Real-World Economics Review Issue on Thomas Piketty's 'Capital'

Special Real World Economics Review issue on Thomas Piketty’s Capital, featuring authors James K. Galbraith, Dean Baker, Jayati Ghosh, Michael Hudson, David Colander, Robert Hunter Wade, Lars Syll, to name a few.

See whole issue here.

For a recent debate at the New School between Anwar Shaikh, Heather Boushey, and Thomas Piketty, himself, see here.

History versus equilibrium: a false dichotomy

The title comes from Joan Robinson's famous essay. However, the motivation is to clarify some comments on a previous post on what Keynes meant by unemployment equilibrium (sent to me, but not published). There is a relatively widespread notion among some post-Keynesians that neoclassical economics assumes always a single unique equilibrium, and that Keynes, or at least his closer followers like Robinson, believed in multiple equilibria. The idea is that post-Keynesians believe in an unstable, uncertain capitalist system in which full employment is only one possibility.

Beyond what one may think about equilibrium, there is no basis in the history of economic ideas for that view. Keynes was a Marshallian, and as such did believe in the notion of a single stable long run equilibrium of the system. The radical element in Keynes analysis is that such equilibrium might be suboptimal, that is, one in which resources are not fully utilized. He is very clear when he says in the General Theory that:

"it is an outstanding characteristic of the economic system in which we live that, whilst it is subject to severe fluctuations in respect of output and employment, it is not violently unstable. Indeed it seems capable of remaining in a chronic condition of sub-normal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse. Moreover, the evidence indicates that full, or even approximately full, employment is of rare and short-lived occurrence. Fluctuations may start briskly but seem to wear themselves out before they have proceeded to great extremes, and an intermediate situation which is neither desperate nor satisfactory is our normal lot."

So what Keynes said is pretty clear, fluctuations around a normal equilibrium. Unemployment is the normal position, the long run equilibrium around which the system fluctuates. Like the old classical political economists (e.g. Smith, Ricardo, and Marx) and the marginalists of his time (e.g. Pigou, and Marshall) Keynes believed in a single stable long run equilibrium position. Note that nothing in Keynes analysis implies that the long run equilibrium is ever attained, or that it cannot be affected by the process by which it is approached, and, hence that it would be path-dependent [the supermultiplier story with a Kaldor-Verdoorn process is path dependent and is still a long run equilibrium position].

The problems associated to the negative impact of uncertainty, and failed expectations, and the institutions and conventions that are relevant in a certain historical context to minimize the effects of instability are all part of the normal operation of the economy for Keynes, and not, like in neoclassical models, superimposed on an essentially stable system. In other words, Keynes equilibrium theory is not a-historical, and hence does not require the addition of more realistic (historical?) elements to provide explanation of say why the system is stuck below full employment equilibrium.

For example, lack of demand (caused by stagnant wages and not enough fiscal stimulus) means that the US economy will the near future fluctuate around levels of unemployment that are above the previous normal levels. In the graph below (source) that is visible in a trend that was lower in the 1950s and 1960s, and goes up in the 1970s and 1980s, only to go down (as a result of a series of bubbles) in the 1990s, and, as I suggested, is likely to go up again. This trend represents the normal position to which Keynes alluded in the passage cited above. Unemployment fluctuates, but is not violently unstable (sometimes it might be; asks the Greeks). In the neoclassical model, in contrast, without imperfections, be that price rigidities or lack of information or any other kind, the system would move to full employment. That's why they often resort to change what the meaning of full employment is (the natural rate goes up; nudge, nudge; wink wink).

However, the interesting thing is that while the old neoclassical authors shared the classical political economists and Keynes notion of a stable long run equilibrium (optimal for the neoclassical, and not so for Keynes and the classical authors), they have departed from that view after the capital debates. In fact, it is in the Walrasian world of Arrow-Debreu's intertemporal equilibrium, that the notion of multiple equilibria becomes relevant (for the reasons why the mainstream changed their views on equilibrium go here; Garegnani classic paper titled "On a Change in the Notion of Equilibrium in Recent Work on Value" is the source of this idea). But in that world, anything could happen, it is wildly unstable and there no forces bringing the economy back to its normal position. Certainly not what Keynes thought, and also not an accurate description of the graph above.

More importantly, the very idea of long run equilibrium is central to our ability to theorize about the functioning of real, historically and institutionally specific economies. It is the fact that there are persistent forces, with regularities, which allows to say something meaningful about the functioning of the economy. If uncertainty rendered economic calculation impossible, then even Keynes' theory about how effective (autonomous) demand determines income, would be irrelevant, and in that case post-Keynesians would have (notice I said would have, since I don't think this is the right way to describe post-Keynesian economics) more in common with the modern neoclassical economists that have embraced multiple equilibria and all sorts of imperfections.

Robert Murphy, the Austrian theory of the rate of interest and Piketty's 'Capital'

In the comments to another post it was suggested that I checked Robert Murphy's discussion of the relevance of the capital debates for Austrian economics.* The basis for my comments is Murphy's recent post on the topic here. It seems that the capital debates are somehow connected to a critique of Piketty's views on inequality from an Austrian point of view, but the post here, which was also linked in the comments, is less than clear about that.

The question is why would the capital debates, which basically criticize the main tenets of marginalism, be relevant for a marginalist school of thought like the Austrians. Shouldn't the logical flaws of marginalism affect Austrians too? [The answer is yes, by the way, but we'll get to that].

First of all, Murphy gets the main point of the capital debates wrong. He seems to think that the lack of a natural rate of interest results from the difference between aggregate capital, which must be measured in monetary terms (which he refers to as financial capital), and physical capital (which he, interestingly, refers to in the Sraffian terminology of Marx and the classical political economy authors as produced means of production). Note that it does NOT matter whether capital is in aggregative (monetary) form or if you have an array of physical capital goods, as I explained before, it is still necessary to equate aggregate investment to savings.

In Keynesian economics the equalization of investment to savings is done by the multiplier process and by variations of the level of income leaving space for a monetary story for the rate of interest. In all neoclassical (marginalist) models, including the Austrian, it is the rate of interest that equilibrates investment to full employment savings. That rate of interest is the natural rate of interest.

Murphy seems to think rather confusedly, that the idea of disaggregated capital implies that Austrian (really it would be the case for any model without aggregative measures of capital, like the Arrow-Debreu General Equilibrium too, which is hardly an Austrian model) models do not have a natural rate.** Let me repeat it then, any model with disaggregated means of production (capital goods) still requires for the equilibration of aggregate investment to full employment savings, it requires a measure of the quantity of capital that corresponds to aggregate investment, and that means, by necessity, a rate of interest that equilibrates investment and savings. The point of the capital debates is that there is no direct relationship between the intensity of the use of capital and its remuneration, that is, no guarantee that at lower rates of interest more capital would be used, and full utilization of resources would be produced by the free interplay of market forces (something that Murphy, as an Austrian, believes in).

Worst, Murphy seems to think that the capital debates applies only to the capital market. He says: "the relationship between the productivity of capital and the interest rate is not directly analogous to the relationship between the productivity of labor and the wage rate." As it turns, the point of the capital debates is that if you reduce the wage rate, there is also no guarantee that more labor would be utilized, and there is no necessary relationship between marginal productivity of labor and real wages (and the evidence in favor of that is also flimsy, to say the least). In other words, the capital debates apply to the marginalist labor market too. No 'factor of production' is remunerated according to marginal productivities (Samuelson got that right, all the neoclassical parables are problematic, and it is a bit surprising to find this amount of confusion so long after the capital debates have been resolved).

So its seems that it is not just Piketty that "has no clue about Capital." The fascinating thing about Murphy's critique of Piketty's lack of knowledge about capital, is that for him this suggests that Piketty's  wealth tax would be a bad idea (note that critiques from the left, like Galbraith or Palley are not against a wealth tax, but suggest that inequality must be combated in other ways too, with stronger unions, more regulated capital, full employment policies, etc.). Here Murphy seems to think, like Tyler Cowen, that taxes would punish entrepreneurs and reduce the dynamism of capitalism. Because, you know (wink wink nudge nudge, say no more), without taxes, and other impediments, capital would be more efficiently utilized. So here is an economist that criticizes higher taxes as the solution for inequality, by suggesting that the notion of capital used to defend a wealth tax is flawed, and uses that very same flawed notion of capital (without even getting it) to defend a laissez-faire solution.

* By the way, not the first time I'm asked to comment on Austrians (see here and here). Austrians stand for economics like Libertarians for politics, and they are a militant group, which would be my guess of why there are so many people concerned with Austrian theory. Love for Hayek and Ayn Rand are highly correlated among teenage students, in my experience. And that's not very good company for Hayek.

** The fact that Murphy does think the capital debates are about aggregation is clear when he asks: "Does anyone know, does Piketty’s book elsewhere deal with the problem of aggregating capital?"

Radical and Heterodox Economics

Radical economics, the term as much as the theories behind it, is fundamentally a phenomenon of the 1960s and the academia in the United States, intrinsically tied to the upheavals of that transformative decade, in particular the Civil Rights movement and the war in Vietnam. The Union for Radical Political Economics (URPE) was the result of that boom in interest for alternative approaches to the mainstream. I don’t intend to write a history of URPE, in this brief post, but I want to contrast Radical Economics with the term Heterodox Economics, which has gained traction more recently (see Ngram viewer figure).

Read rest here.

PS: I started blogging at the URPE blog too. Check it out here.

More on flimflam and lack of understanding of the capital debates

Paul Krugman has responded to Tom's article and here is his reply. Let me just add my two cents. Krugman says that:

New Keynesians assert — as Keynes did, although I don’t think it matters for this debate what he said — that both liquidity preference and loanable funds are true. There are conditions under which one or the other is the main one to focus on — at full employment, loanable funds are crucial, in a liquidity trap, liquidity preference.

Oh Lord. Paul can you send us the quote were Keynes says that Loanable Funds is correct? And again this is NOT about irrelevant exegesis. If you do have that Investment and Savings are equilibrated by a natural rate of interest, then that means that you must, with interest rate flexibility, reach a point at which investment would equate the full employment level of savings. Krugman and other New Keynesians argue then for a version of what they call a Liquidity Trap (actually a zero lower bound problem), in which the monetary rate of interest (of the Liquidity Preference Theory) is not capable of equating the natural rate (of the Loanable Funds Theory).

Note that here Keynes has a problem. Although Keynes clearly rejected the concept of a natural rate of interest (Keynes, 1936, pp. 242-4), and said very clearly that savings are equated to investment by changes in the level of activity (Effective Demand), his acceptance of the notion of the marginal efficiency of capital implies that there is a sufficiently low interest rate that would be associated with an investment that would produce the full employment level of savings, very much like Krugman. Excluding imperfectionist arguments related to the downward rigidity of the interest rate, or the possibility that a negative interest rate would be required to increase investment to its full employment savings level, it would seem that the acceptance of the marginal efficiency of capital is in contradiction with the notion of a “highly conventional” rate of interest (ibid., p. 203).*

So as noted here you do need to abandon the notion of a natural rate of interest and the marginalist theory of distribution (besides the evidence is that investment does not react to cost of capital, but it does to expected sales, that is expected demand). Here Krugman's comments are disingenous at best. He says:

I think, is a fairly desperate attempt to claim that the Great Recession and its aftermath somehow prove that Joan Robinson and Nicholas Kaldor were right in the Cambridge controversies of the 1960s.

As I noted it is logically required to get rid of the idea of the natural rate, and there is no need to argue that in the 1960s capital debates Robinson and Kaldor (Sraffa really, dude) were right, since Samuelson (1966; subscription required) already did.

* The capital debates show that there is no correspondence between the intensity of the use of capital and its remuneration. No natural rate of interest that would lead to more intensive use (full utilization) of capital. And that's what Samuelson admited. To understand the capital debates go here, and to get its relation to Keynes' theory go here.

PS: Krugman also gets a bit testy suggesting that: "as for wage and price inflexibility as the cause of unemployment — grrr. I’ve written again and again on this subject, pointing out that in a liquidity trap price flexibility probably makes things worse, not better." Yes, grr. Dude, first it's not a liquidity trap that you're talking about, but a lower limit to nominal rates of interest. And debt-deflation and negative effects of income distribution discussed in chapter 19 of the GT occur even if you are not at the lower bound (or the real liquidity trap). And Keynes said that the liquidity trap was irrelevant to explain the Great Depression, it's worth noticing, since really it seems you never read the GT (even though you wrote a preface to one edition). So price flexibility in a world with extensive debt contracts and where income distribution affects spending is always kind of bad. That's Keynes' message. Tom is correct on that one too.

Lars P. Syll: Piketty and the Cambridge capital controversy

 

By Lars P. Syll

Piketty wants to provide a theory relevant to growth, which requires physical capital as its input. And yet he deploys an empirical measure that is unrelated to productive physical capital and whose dollar value depends, in part, on the return on capital. Where does the rate of return come from? Piketty never says. He merely asserts that the return on capital has usually averaged a certain value, say 5 percent on land in the nineteenth century, and higher in the twentieth.  The basic neoclassical theory holds that the rate of return on capital depends on its (marginal) productivity. In that case, we must be thinking of physical capital—and this (again) appears to be Piketty’s view. But the effort to build a theory of physical capital with a technological rate-of-return collapsed long ago, under a withering challenge from critics based in Cambridge, England in the 1950s and 1960s, notably Joan Robinson, Piero Sraffa, and Luigi Pasinetti.

Read rest here.

Was Marx right? Nice of you to ask, but...

The New York Times asked five economists whether Marx's economics was right, even if his politics was all wrong. By the way, the latter would be unquestionably true as a result of the collapse of the Soviet bloc. I am no Marx scholar, but I'll try to give my two cents on this debate. At any rate, it seems I read more of Marx's works than most of the commentators in the Times.

It is a bit disingenuous to suggest that Marxist economics, or classical political economy for that matter, since Marx was building on the work of the surplus approach authors, stands or falls with the Soviet Union [for a discussion of the causes of the Soviet collapse go here]. In fact, Marx has very little to say about communism, and many of the 10 policy proposals in the Communist Manifesto are now well-established consensual views in civilized societies, like the idea of a "heavy progressive or graduated income tax" ... or the provision of "free education for all children in public schools" and the "abolition of children’s factory labor."

Even if some of Marx's propositions are less well viewed in today's political climate, like the "abolition of private property," or the expansion of the "factories and instruments of production owned by the State," or the "centralization of credit in the hands of the state, by means of a national bank," these were instruments used to some degree by almost all successful experiences of industrialization in the world. One might as well suggest that the accomplishments of the Welfare State, in Western Europe and in the US (yes, even here), and some of the successful experiences in the developing world, are associated to Marx ideas. In fact, without the unity that he recommended to the working men of all countries, none of the advantages of the Welfare State would have taken place. The success of Sweden, so to speak, is as much a measure of the success of Marx's political ideas as the failures of the Soviet Union would be of his intellectual failure.

But, be that as it may, it is the actual economic thinking of Marx, about the functioning of capitalism, a mode of production, that he was the first to define and to try to explain its origins from a previous mode of production (feudalism), that matters in order to understand whether his contributions are relevant or not. The comments by the two academic economists in the New York Times, Brad DeLong and Tyler Cowen, are poor at best. Their views reveal, no surprise here, that their contact with Marx's works is minimal, if any, and that what they do know is some form of pop Marxism, filled with naïve simplifications of what Marx actually said.

Brad suggests that Marx was a second rate theorist. Why? In his words: "Marx's fixation on the labor theory of value made his technical economic analyses of little worth." I've already dealt significantly with the question of the labor theory of value (LTV) here, but it's worth remembering that while Sraffa provided a coherent solution for the labor theory of value's problems, in which long term normal prices can be determined as proportional to the labor commanded by the standard commodity (for the latter go here), the neoclassical problems to show that prices in the long term are determined by supply and demand, forced them to abandon the traditional method of economics, and embrace the intertemporal General Equilibrium model, in which all prices are short run ones, and there is no tendency to a uniform rate of profit. In other words, the LTV (or at least a version of it) theoretically stands on firmer ground than the neoclassical supply and demand theory. That is one of the results of the capital debates.

Also, note just for the sake of the argument, that while Brad dismisses Marx as a second rate theorist, he embraces Adam Smith (e.g. he says: "Adam Smith is the founder of economics because he has a great and extraordinary insight: that the competitive market system is a remarkably powerful social calculating and organizing mechanism"). And yet Adam Smith did use the labor theory of value, which should make his analysis of little worth, one would imagine. Mind you, for Smith, as much as for Marx, the competitive market system led prices to their long run equilibrium determined by the labor theory of value (labor commanded in Smith, incorporated in Marx). One is forced to assume that the reasons for dismissing Marx are not related to the LTV, and are political, or are based in a misunderstanding of the LTV, which would include the work of Smith (my history of thought students in Utah had a t-shirt that read: "I've read Smith and understood it.")

Brad then moves on to discuss Marx's predictions, which he suggest are somehow connected to Marx's confusion between real and nominal values. It is clear that Marx's immiseration hypothesis, the notion that the conditions of workers worsen as capital accumulation proceeds, is not based on some simplistic confusion between real measures of well being and nominal remuneration. For Marx the determination of the real wage, as it was for all the classical authors (Smith and Ricardo included) was exogenous, and at the subsistence level, but that did not mean that wages were determined physiologically, but by historical and institutional standards instead. In other words, the subsistence level would change in time and space. Why did Marx believe that the labor class would be worse off with the development of capitalism? Basically because he thought that the reserve army of unemployed would increase reducing the bargaining power of workers.

In his words:

"The greater the social wealth, the functioning capital, the extent and energy of its growth, and, therefore, also the absolute mass of the proletariat and the productiveness of its labour, the greater is the industrial reserve army. The same causes which develop the expansive power of capital, develop also the labour power at its disposal. The relative mass of the industrial reserve army increases therefore with the potential energy of wealth. But the greater this reserve army in proportion to the active labour army, the greater is the mass of a consolidated surplus population, whose misery is in inverse ratio to its torment of labour. The more extensive, finally, the lazarus layers of the working class, and the industrial reserve army, the greater is official pauperism. This is the absolute general law of capitalist accumulation. Like all other laws it is modified in its working by many circumstances, the analysis of which does not concern us here."

It is worth noticing that Marx's Laws, for all the criticism about their determinism, allow for countervailing forces, and suggest tendencies, rather than mechanical relations. Marx suggested in the same chapter (linked above) that:

"within the capitalist system all methods for raising the social productiveness of labour are brought about at the cost of the individual labourer; all means for the development of production transform themselves into means of domination over, and exploitation of, the producers; they mutilate the labourer into a fragment of a man, degrade him to the level of an appendage of a machine, destroy every remnant of charm in his work and turn it into a hated toil; they estrange from him the intellectual potentialities of the labour process in the same proportion as science is incorporated in it as an independent power; they distort the conditions under which he works, subject him during the labour process to a despotism the more hateful for its meanness; they transform his life-time into working-time, and drag his wife and child beneath the wheels of the Juggernaut of capital. But all methods for the production of surplus value are at the same time methods of accumulation; and every extension of accumulation becomes again a means for the development of those methods. It follows therefore that in proportion as capital accumulates, the lot of the labourer, be his payment high or low, must grow worse."

It is not just the payment, which could be high or low, but the alienation, and exploitation that made the labor force worse off. It is also far from clear that Marx is suggesting absolute immiseration rather than relative in his writings. Brad, it seems, thinks that Marx somehow thought that workers would be in absolute terms worse off with the development of capitalism. He suggests that that extreme pessimism might not be guaranteed. Another reading would be that Marx thought that workers would be relatively worse off, and that the recurrent crisis of the system (realization crisis, financial crisis, of which Marx is among the first to discuss in a systematic way), would undermine the social basis of the system.

Tyler Cowen, the other academic economist in the NYTimes bunch, has no understanding of Marx and of the current problems of capitalism. For him the quesion is whether: "does Marx provide a very good guide to understanding all of those problems?" And his answer: "mostly not. Neoclassical microeconomics explains why some of our services are low quality and high cost, namely too much third party payment through insurance companies, too much regulation of the wrong kinds, and the difficulties consumers face in judging quality." In other words, for him our problems are caused by a collapse of supply, with high prices (and low quality) associated to too much regulation, or as he suggests, imperfect institutions. The notion that the instability of capitalism, or for that matter, the normal functioning of market economies is well explained by the neoclassical supply and demand story is hard to defend. There are too many problems with this kind of view. The lack of understanding of the limitations of the neoclassical paradigm by mainstream authors is probably one the worst problems of the profession at this point. And just to show the degree of confusion, he claims that Marx understood Public Choice theory (what passes for political economy at George Mason University)!

Michael Strain, who has been mostly an economist in government bureaucracies, including the Fed, suggests that: "Marx believed that the free enterprise system required the exploitation of workers," and for him "it is hard to see why anyone would believe that today." Sure poverty in the world has declined, depending on the measure you use (he uses the World Bank's one dollar a day). But the lack of understanding about the extension of capitalist exploitation associated with globalization, and the increase in inequality in many of the countries in which economic growth has accelerated in the last three decades seems misguided at best.

The last two commentators are more favorable to the Old Moor. Yves Smith, of the great blog Naked Capitalism, suggests an old theme among Marxists scholars. Even though Marx was aware of the destructive elements of financial crisis, he did not think that finance would be the main cause of the collapse of the system. Echoes of Rudolf Hilferding can be distinguished in her piece. Doug Henwood, a journalist with his Left Business Observer, is the only openly Marxist one to appear in the Times. He basically argues in favor of the old profit squeeze view of the demise of the Golden Age, and the beginning of the Conservative Era. And he does say, correctly, that we cannot understand our current problems without "some sort of Marx-inspired analysis."

Beyond the simplistic notions of whether Marx was a right about the Soviet Union [e.g. Strain tells us that Marx was: "devastatingly wrong ... about the most important questions he tried to tackle (see also: Union, Soviet)"; yep, Marx did not foresee the rise and fall of the Soviet Union, what a moron!], or about the collapse of capitalism, what is missed in this discussion is that Marx's method, which harks back to the old surplus approach, in which distribution is exogenous, and determined by social and institutional factors, and is open to Keynes effective demand to complement the theory of output and accumulation, and which can include all sorts of financial instability notions, provides a far more fertile ground to rebuild the edifice of economics than the illogical neoclassical paradigm. But even if some of the contributions were not great, we should still thank the New York Times for asking.

Galbraith on Piketty's Capital

I'm still reading the book, so I will not say much at this point. The history of ideas at the beginning of the book is just embarrassingly bad, and suggests that mainstream economists do not have the faintest idea about the history of their own discipline. Just a short example would suffice to show what I mean. Piketty says: “Marx totally neglected the possibility of durable technological progress and steadily increasing productivity.” Note that the book is named Capital, and Piketty is quite critical of Marx. So you would expect some reasonable understanding of what is in the other Capital. If you open chapter XV of Marx's Capital, on Machinery and Modern Industry he tells you:

"Like every other increase in the productiveness of labour, machinery is intended to cheapen commodities, and, by shortening that portion of the working day, in which the labourer works for himself, to lengthen the other portion that he gives, without an equivalent, to the capitalist. In short, it is a means for producing surplus value."

So machinery and increasing productivity are essential for the production of surplus value and the explanation of profits. It is evident that if Piketty read Marx, he didn't understand much. And that is true of almost any citation that involves history of economic ideas (so Roncaglia, previous post, is right, Piketty should take a course in the history of economic thought).

Also, Piketty is in many passages clearly contradictory, taking positions that are not compatible with other assumptions made just before. These contradictions derive basically from his adherence to neoclassical theory, and his desire to transcend it, and say something relevant about inequality. In neoclassical theory inequality results from technical change, and different levels of skills, since workers and capital receive according to their productivity. Political factors should NOT play an important role. Other than the data on inequality, in the collecting of which he has been central together Emmanuel Saez, even if it is far from true that he is the only follower of Kuznets, there is little merit in this book it seems.

Jamie Galbraith provided a good review in Dissent (see here). An important point that Jamie makes is that Piketty botches the argument on the capital debates (again, given the title of the book, it is a bit ironic). Jamie notes: "Piketty devotes just three pages to the 'Cambridge-Cambridge' controversies, but they are important because they are wildly misleading..." and Piketty doesn't get that: "as the rate of interest falls, there is no systematic tendency to adopt a more 'capital-intensive' technology, as the neoclassical model supposed." The implications of the capital debates (for more on that go here) for understanding inequality are associated that once intensity and remuneration are not connected in the way neoclassical theory suggests the bare bones of the social conflicts that are behind income and wealth inequality are exposed.

An appreciation of the limitations of the neoclassical view of capital would lead, according to Galbraith, to a broader understanding of the policies needed to overcome inequality, beyond the tax on wealth proposed by Piketty, and a better understanding of how in a previous era -- of the New Deal and the Welfare State -- it was possible to reduce equally staggering inequities.

Two Cents on Birner's 'The Cambridge Controversies in Capital Theory'

I just finished perusing Jack Birner's "The Cambridge Controversies in Capital Theory" (see here). My brief take is that although the author provides a thorough and lucid analysis & exposé of the debates, I certainly do not agree with his assumption that the issues involved primarily dealt with a fundamental difference over research programmatic technique & methodology, with ideology being merely secondary, if not superfluous. This is quite untrue; ideology was at the very core! For more on this, I recommend G.C. Harcourt's "Some Cambridge Controversies in The Theory of Capital" (see here) and Andrés Lazzarini's "Revisiting the Cambridge Capital Theory Controversies: A Historical and Analytical Study" (see here).

More on wages and employment

So my last post has led to a few comments on the relation between changes in real wages and employment. As my students are probably tired to hear real wages tend to be pro-cyclical, a well established empirical regularity. This poses a problem, not only for mainstream accounts of the labor market (and hence for the conventional views on the minimum wage), but also for Keynes' own views.

Keynes was forced to deal with those issues early on, as a result of the empirical research by Dunlop and Tarshis, and his answer in his famous 1939 paper (often published together with the General Theory, GT) "Relative Movements of Real Wages and Output." He said then:

"The only solution was offered by Dr Kalecki in the brilliant article which has been published in Econometrica. Dr Kalecki here employs a highly original technique of analysis into the distributional problem between the factors of production in conditions of imperfect competition, which may prove to be an important piece of pioneer work."

In other words, he suggests that some sort of constant returns, or increasing returns to scale, and, hence a mildly positively sloped labor demand curve could possibly explain the empirical regularity. Note also that Keynes had already in chapter 2 of the GT argued that the labor supply curve made no sense (two reasons one fundamental, and the other non-fundamental; see here). He says:

"the contention that the unemployment which characterises a depression is due to a refusal by labour to accept a reduction of money-wages is not clearly supported by the facts... A fall in real wages due to a rise in prices, with money-wages unaltered, does not, as a rule, cause the supply of available labour on offer at the current wage to fall below the amount actually employed prior to the rise of prices."

However, even if one gets rid of the labor supply curve, and determines employment in the market for goods, as a function of demand, as Keynes does, as it is clear from his reply to Dunlop and Tarshis the real problem with the conventional marginalist story (and Keynes' own) is on the acceptance of the marginal productivity of labor (MPL) as the source for labor demand.

One possible neoclassical response would be to suggest that real (supply side) shocks, which change the MPL upwards and downwards, is the main cause of fluctuations in output and employment. So Real Business Cycles (RBC) is the solution. In this case, pro-cylcial real wages can be explained by the mainstream. The main critique coming from other mainstream authors about this possibility, is that, since the real wages are only mildly pro-cyclical, a shock to the MPL would lead to small changes in the real wage only if labor supply is very elastic. In other words, workers labor supply would have to be very sensitive to changes in real wages, and, yet, the empirical evidence is that the number of hours worked does not change much with variations of the real wage.

Besides, there is the question of whether one can really assume that business cycles are explained by real shocks. Note that Lucas, who has for the most accepted the RBC interpretation of the working of the economy, still argues that the Great Depression is most likely explained by a demand shock (for him a monetary contraction a la Friedman).

That is why the capital debates, which undermine the rationale for the marginalist labor demand curve, is relevant for solving the pro-cyclicality of real wages conundrum. The capital controversies suggest that there is no reason to expect that firms buy more of a relatively cheap 'factor of production,' implying an inverse relation between remuneration and intensity of use. Once this notion is rejected, the problem of pro-cyclicality is easy to explain.

Classical (not neoclassical, but the old classical political economists and Marx) presumed that the real wage was determined by the relative bargaining power of workers and capitalists, and it is expected that in a boom, with low unemployment, workers would have the upper hand, and would be able to demand higher wages. So there is no need to resort to real shocks to explain this empirical regularity.

What do mainstream economists think about the minimum wage?

A third think it's bad, while slightly less than a quarter think it's fine. Or so it seems according to David Colander. In the update of his 1987 analysis of "The Making of an Economist" (original one with Arjo Klamer; subscription required) David asked graduate students what did they think about several economic issues (a short version here; the book here). I have some doubts about David's new overall conclusion about the state of the profession, in particular his views on how the profession has changed (see for example my debate here), but there are several interesting points raised by the replies given by the graduate students of 6 mainstream programs. One is related to their views about the minimum wage.

The table (from the book) shows the views then (1987) and now (2005), by publication dates, on whether the minimum wage increases unemployment among young unskilled workers. The evidence seems to suggest overall there is not much of a change, with 34% back then and 33% now agreeing with the conventional neoclassical proposition. But a small change suggests that more economists believe that the minimum wage does NOT lead to unemployment now, from 18% to 23%. In Chicago the percentage of graduate students holding a conventional view fell from 70% to 56%. Only Harvard seems to go in the opposite direction. MIT shows the biggest increase among those that disagree with the conventional view (from 11% to 30%).

There are several problems with the conventional mainstream (marginalist) story about the effects of minimum wages. The capital debates actually are relevant here too. There is no reason to believe that firms will hire more workers when the price of labor falls, exactly for the same reasons that hold for capital. The principle of substitution does not necessarily work, and there is no relation between the intensity of the use of a factor of production (labor) and its remuneration (real wage). Put in simple terms, there is no reason to hire workers, even if their wages are lower, if there is no demand for your products.

But the reasons for the change in views, small as they are, are not related to the logical flaws of the mainstream model. I don't even think it is solely the increasing evidence since the publication of Card and Krueger's analysis (here; discussed here too), about the absence of a negative effect of minimum wage increases on employment, that has been the driving force in these changing views. My guess is that income inequality has played a role in the willingness of mainstream students to reject the conclusions of the theory they are taught. But in order to really know why, we would need another survey.