Classical Political Economy or the Surplus Approach

Here our other conversation with LP Rochon, about the chapter on Classical or Surplus approach authors. My co-author, Suranjana Nabar-Bhaduri and I talk about the Real Bills Doctrine, Bullionism, Say's Law the implications for theories of crisis. And about several authors, Smith, Ricardo, Tooke and more.

Why do we need a theory of value?

The theory of value and distribution is at the heart of economics. To be clear, when I say that it is at the center, it means that discussions of almost any topic in economics, in one way or another, depend on a certain theoretical position about the theory of value and distribution. However, most economists have no clue about it, about the centrality of value. Not only they don't understand the original and now infamous labor theory of value (LTV), that dominated between Petty and Ricardo (and Adam Smith too, even though that tends to surprise and puzzle most economists),* but also they misunderstand the dominant marginalist paradigm. Some economists actually think that you don't need a theory of value at all, and some don't even understand that they use a conventional (some vulgar form of supply and demand) theory of value. Hence, the reason of this post is to try to help clarify some very basic issues related to the necessity of a theory of value for proper theorizing in economics.

In a sense, this topic was discussed here before, in my post on Sraffa, Marx and the LTV. But it is worth revisiting, and thinking in broader terms, beyond the LTV, to understand why a theory of relative prices is needed in general, to understand almost everything in economics.

Let me start with the authors of the surplus approach. In fact, a bit earlier with the economists that would eventually be known as Mercantilists (if you can talk about a school). If we are allowed to generalize and simplify, the latter believed that the wealth of nations depended essentially on maintaining trade surpluses, and accumulating precious metals. Profits were essentially the result of buying cheap and selling dear, or profits upon alienation, which indicates that, for Mercantilists, profits were generated in the exchange process.

Classical political economy authors, starting with William Petty, emphasize the determination of profits in the process of production, as a residual of output, once the conditions for the reproduction of the productive system were satisfied. So profits are not the result of selling high and buying low, something that could result from the mere fluctuation of market prices, but from the ability to produce beyond what was needed for the simple material reproduction of society. Note that to obtain profits, part of the residual, the surplus over and beyond reproduction requirements, one needs to know the prices of the means of production. That is, one needs to be able to account for the normal prices of the goods that went into the production of all commodities. And these prices would include a normal profit. Again, not the extra gain that might occur from a high market price. So the normal rate of profit is needed to determine prices, and prices are needed to determine the normal rate of profit. This was well understood by both Ricardo and Marx.

Value (the relative prices of commodities) and distribution (the normal rate of profit) are intertwined. Smith knew that the simple LTV (amounts of labor incorporated) was not correct other than in very rudimentary economic systems, with essentially no produced means of production. His solution was to adopt the idea of labor commanded (more on that on my post on Sraffa, and the one on the standard commodity). Ricardo solved this problem, in his corn essay, by assuming that the surplus and the means of production advanced to produce output where all in physical quantities of corn, hence profits could be determined independently from relative prices, as a physical quantity. And Marx adopted the simple labor theory of value in volume one of Capital. Both believed, for slightly different reasons, that their main arguments would hold even if the LTV was not precisely correct.

I am not concerned with the problems with the LVT in Ricardo and Marx (worth noticing that the mathematical solution was not known in their time, and was essentially developed in the late 19th and early 20th centuries) or Sraffa's solution. It is worth insisting that the LTV does have an analytical solution that is unique, and stable (see my post on the standard commodity for the former, which suggests a Smithian, i.e. labor commanded, version of the LTV is perfectly fine).** That's good, btw. It suggests that the classical political economy notion that there are prices that guarantee the reproduction, and, beyond the the expansion (or accumulation), of the economic system do exist.

Here I want to emphasize the importance of the LTV for the analysis of other aspects of the economy. Ricardo saw the problems of the Smithian adding up theory. That's the notion that prices were composed by the sum of natural wages, profits and rent and that prices would go up if one of its components went up.  In order to determine the rate of profit properly, Ricardo noted the explanation of value was essential. The rate of profit was central because in his view the processes of accumulation depended on the rate of profit. Hence, proper discussion of accumulation and growth depends on a proper theory of value and distribution. Btw, all classical authors assumed that real wages were exogenously determined by institutional and historical circumstances (so there was a role for history and institutions in their theory; also, for accumulation that was seen as too complex to be theorized in the same level of abstraction that value). But even if one is less keen than Ricardo on the role of profits in accumulation, it is undeniable that distribution affects accumulation, and, hence, a proper theory of value and distribution is needed.

Note also, that other things that depend on relative prices are crucially affected by the theory of value and distribution. Classical authors assumed that the process of competition, by which they meant only free entry and not the size or the number of firms in an industry, would lead to a uniform rate of profit. In that sense, the forces of competition were central in forging the structure of production, and, hence, the determination of technological change or to understand the patterns of trade specialization, which cannot be understood without the determination of relative prices. In fact, perhaps the most famous and the most controversial issues coming out of Ricardian economics dealt with international trade and the effects of technical change (the so-called machinery question), and are directly connected to the theory of value.

Even the most crucial macroeconomic problem, the question of output determination (and employment, for a given technique) is affected by the theory of value. Note that classical political economists assumed output as given for the determination of the surplus. And Ricardo accepted Say's Law as a way of determining output and employment (not Marx, btw, so it's NOT a requirement of the surplus approach). But as much as for accumulation understanding of distribution is central for the determination of the level of output, as it is explicit in the Kaleckian effective demand model. the classical long term prices are compatible with levels of output that do not guarantee full employment. And the parametric role of distribution in affecting the size of the multiplier is crucial for output and employment determination. So unemployment is possible in the long run, as a regularity of market economies.

In other words, for a coherent theory of output, accumulation, international trade, technological change and more (taxation, etc.) you need a theory of value and distribution. That is also the case in the mainstream. Marginalism developed in the last quarter of the 19th century, both as a result of the lack of analytical solution in that period for the problems of the LTV and as a reaction to radical revival of the theory (Marxism). The important distinction is that while classical political economy authors dealt only with objective factors, and considered demand as given when determined value and distribution, marginalism incorporated subjective preferences as central for the explanation of long term normal prices, and prices and quantities were determined simultaneously.

Beyond the problems with the marginalist solution for the existence of long term prices (see this on the capital debates) and their switch to the intertemporal approach, which basically only deals with short term prices, their theory is also central for almost everything in economics. In a sense, given that in marginalist analysis distribution is determined by supply and demand, and by the relative scarcity of factors of production, the theory of value and distribution is even more central for other parts of their theory than in the surplus approach. Here the theory of distribution does not affect indirectly the level of output and the process of accumulation. Here the level of employment and, for a given technology, output determination is the same as the theory of distribution. Real wages and the level of employment are determined in the labor market simultaneously. Everything derives from that.

Before getting to the reason why the theory of value and distribution, central for everything, is often ignored, let me note briefly the possibility of a third alternative to value and distribution, beyond the surplus approach and marginalism. That would be the markup theories of pricing. Note that theories of markup pricing essentially describe how firms determine prices. Most of these theories were developed as a result of the imperfect competition literature sparked by Sraffa's famous (1926) critique of Marshallian price theory (see an old post on that here).

First, as it would be known for the readers of this blog (at least the ones that have been reading for a long while), markup pricing is actually dealing with a different set of issues, and Franklin Serrano suggested here that they are different than the classical political economy normal long term prices (the Marxist prices of production or Sraffa's prices), and that Fred Lee and Marc Lavoie were right about that. He argued that some Sraffians (I won't name names), and I would add probably Fred too, thought that Sraffian prices were compatible with the full cost pricing tradition, and I could have included myself in this group.*** Note that what I mean by that is simply that the behavior of firms must be compatible in the real world with the logic of gravitation in classical analysis. In other words, if prices of production imply a normal profit over the full cost for a given technique, then firms somehow must be trying to do that.

But it is clear that the full cost pricing of a particular firm might not be the long run equilibrium price around which market prices gravitate, with free mobility, that is, with competition in the classical sense. In a way, the same circularity suggested above reapers, costs depend on prices (and that involves the profit related to the markup), and prices depend on costs. The firm's individual prices might not be the prices that are required for the reproduction of the economy as a whole. In that sense, markup theories must be grounded on some surplus approach understanding of value and distribution, and they are essentially theories about market prices, meaning short run behavior. In that sense, they run into the same problem than the intertemporal marginalist models, the Arrow-Debreu type, that became more popular after the capital debates, and that led to what Garegnani famously referred to as the change in the notion of equilibrium (that is the abandonment by the mainstream of the notion of long run equilibrium). Some heterodox groups see this as a positive development, but again it implies that they cannot say anything clear about distribution and relative prices, and that has implications for almost any other theory.

I might add here, which is more concerning for some heterodox groups, is that many of these theories are also compatible with marginalist interpretations of the theory of value and distribution. Many imperfect competition theories just suggest simple inverse relations between markups and the price elasticity of demand. This again fall into the type of situation I discussed recently regarding Karl Polanyi, of well-meaning critics of the marginalist mainstream, using marginalist or neoclassical concepts w/o knowing they are doing it (if it's conscious acceptance of the mainstream model, then it's something different).

One last thing in this regard, while markup theories must be grounded on some theory of value and distribution, and my take is that the surplus approach is where it would make sense, the opposite is not true. There is no need for a theory of the firm, of individual behavior, to understand long term prices. Classical political economists certainly discussed behavior, but that essentially entailed some notion related to class, to general social norms, not about what is going on in someone's brain. Even Smith that was certainly concerned with the issue of the role of self-interest in determining the equilibrium outcomes in the market, cannot be assumed to be a precursor of the rational maximizing agents of the mainstream, or of methodological individualism. The same could be said of utilitarian views and Ricardo, who was, to some degree, close to many utilitarians including Bentham. Here too, many heterodox economists think that an alternative theory of behavior is central for economics, and that is why many see behavioral economics as somewhat heterodox.

Finally, getting, even if briefly, to the point of why most economists remain oblivious to the relevance of value and distribution. I would suggest that this is a recent phenomenon. It is the result of what I have discussed here before, the return of vulgar economics (for example, here or here), and that the mainstream has abandoned the long run, and provides only a theory of short run prices. But at the same time the mainstream must revert to the old model in order to promote economic policy. Note that only in that model you can guarantee that markets provide efficient allocation of resources (w/o imperfections), and the price system signals the direction of adjustment. It is often missed by the heterodox groups that resist old classical political economy (often for incorrectly assuming that it is a precursor of marginalism) that their theory of value and their long term prices provide something completely different, an understanding of the conditions for the reproduction of society. That notion, btw, is alive and well in other social sciences (see here or here). Not in economics.

* It survived in the fringes and it was rediscovered by Marx and then much later Sraffa, who actually provided a coherent solution to some of its logical limitations. But after Ricardo, the LTV was never dominant again.

** On the gravitation of market prices towards normal prices see the work by Bellino and Serrano here.

*** My fondness for the subject in part derived from having worked for Wynne Godley at the Levy for two years, who was a disciple of P. S. W. Andrews one of the key authors of the Oxford Economists' Research Group (OERG) behind full cost pricing theories.

Cohen and DeLong on Hamilton's Report on Manufactures

Hamilton's Reports, posthumous 1821 edition

Stephen Cohen* and Brad DeLong, in their highly readable book Concrete Economics: The Hamilton Approach to Economic Growth and Policy (if you haven't, go buy a copy now), argue that “Alexander Hamilton [was a] major economic theorist. His theory of economic development, first set out in his famous Report on Manufactures (1791), not only reshaped America’s economy but was channeled by Frederich List half a century later to play a central role in Germany’s rapid industrialization, and still later became a canonical text in Japan." Further they suggest that: “This Hamiltonian project was contrary to Ricardo’s canons of comparative advantage as well as Smith’s free markets. It was bold. The direction of economic activity was not commanded, but it was not left unguided either."

While I generally agree with the main points of the book (my major issues are with the notion that technical change was driven by scarcity of labor, and the need to economize labor along marginalist lines), I would qualify a bit the argument on the break with the Smithian/Ricardian classical political economy (or surplus) approach to economics.

Certainly Hamilton is not Ricardian in the sense that he suggests that the pattern of specialization should not follow comparative advantage (a notion not fully developed until Ricardo's own work a few years later, and simultaneously and independently by Robert Torrens). But note that for Ricardo Free Trade was part of a strategy of reducing the rent of landlords, which resulted from the use of lands of lower quality which were the consequence of the embargo first, and then the Corn Laws. In that sense, Ricardian Free Trade was a strategy of industrialization for England (as much as Hamilton's project was for industrialization in the US). It is also true that Hamilton was breaking with the laissez faire tradition of Smith and classical authors in general. But he was not precisely Mercantilist or Cameralist, in the sense that a reading of the Report clearly shows he understood that the wealth of nations derived from the division of labor, and not from the accumulation of bullion and trade surpluses.++

Hamilton believed, not unreasonably, that manufactures were more prone to the adoption of machinery, and indicates that manufacturing countries are more opulent than merely agricultural countries. In other words, he seemed to believe that what is produced matters, and that manufacturing would further the division of labor that was at the heart of the wealth of nations. That is why there is some importance in the Cohen and DeLong book emphasis on Hamiltonian trade management, and the willingness to use tariffs and bounties (subsidies). Note that the conventional view among economists increasingly tries to deny that this was central for Hamilton. For example, Douglas Irwin argues that: "Although the report is often associated with protectionist trade policies, Hamilton’s proposed tariffs were quite modest, particularly in light of later experience. This reflected his emphasis on using tariffs to generate fiscal revenue to fund the public debt; indeed, the country’s finances were his top priority, not discouraging imports for the sake of domestic manufacturers."

However, the Report itself seems pretty concerned with the differences between agricultural societies and manufacturing ones, arguing that: "nations merely agricultural would not enjoy the same degree of opulence, in proportion to their numbers, as those which united manufactures with agriculture." He cites England and the Cotton Mill developed there as something to be emulated, and that it can only be done with a certain degree of trade management (on free trade versus managed trade see this).

Hamilton is explicit on a strategy that we would call today as import substitution industrialization, and argues that: “The substitution of foreign for domestic manufactures is a transfer to foreign nations of the advantages accruing from the employment of machinery, in the modes in which it is capable of being employed, with most utility and to the greatest extent. The cotton mill invented in England, within the last twenty years, is a signal illustration of the general proposition, which has been just advanced.” Interestingly, he does not cite the use of steam engines, which was still not prevalent, but notes the use of the water wheel, and the extensive use of female and child labor (the latter as a positive development). In this regard, he seems more au courant than Adam Smith, with his pin factory, about what would later be termed the Industrial Revolution.

Moreover, Hamilton suggest that manufacturing and agriculture should be complementary, and argues that manufacturers would provide an outlet for the production of the agricultural sector. The Smithian notion of a vent for surplus, but a domestic one is utilized by him. He argues that: “It is evident, that the exertions of the husbandman will be steady or fluctuating, vigorous or feeble, in proportion to the steadiness or fluctuation, adequateness, or inadequateness of the markets on which he must depend, for the vent of the surplus, which may be produced by his labor; and that such surplus in the ordinary course of things will be greater or less in the same proportion. For the purpose of this vent, a domestic market is greatly to be preferred to a foreign one; because it is in the nature of things, far more to be relied upon.”

The relevance of the ideas related to managed trade seem to be again on the agenda with the rise of right wing populist governments, in particular here in the United States, and the skepticism about Free Trade and Globalization.

* Stephen Cohen was the co-author with John Zysman of a very influential book in the 1980s called Manufacturing matters: the myth of the post-industrial economy which is also still worth reading.

++ In the Report on a National Bank he explicitly says that: “it is immaterial what serves the purpose of money, whether paper or gold and silver; that the effect of both upon industry is the same; and that the intrinsic wealth of a nation is to be measured, not by the abundance of the precious metals, contained in it, but by the quantity of the productions of its labor and industry.”

Ricardo's Principles turns 200!

On Saturday, April 19th 1817 , David Ricardo published The Principles of Political Economy and Taxation (price was 14s, and 700 copies were printed; later editions had 1000 copies each; my copy above is of the 3rd and definite edition published in 1821, and had at least two previous owners, a college and someone in Philly that signed it in 1901). Most comments on the book tend to emphasize things like rent theory and comparative advantage, but those are not central to the main point of the book (the Wikipedia entry is specially bad). The central question in the book, which follows Ricardo's Corn Essay of 1815 (An Essay On the Influence of a Low Price of Corn on the Profits of the Stock), is that there is an inverse relation between wages and profits, and, distribution is conflictive. That is the essence of the Ricardian theory, and the reason why Marx was a Ricardian, not a minor one as suggested by Samuelson though.

The inverse relation between wages and profits is what led Ricardo to criticize Adam Smith's problematic adding up theory of prices, and abandon the notion of labor commanded for the concept of labor incorporated (to keep the labor theory of value), which then led to the search for absolute value. The solution of the problem was elusive and was only provided by Piero Sraffa, the editor of his Works. For more read this entry on the Labor Theory of Value and this one on Sraffa's Standard Commodity.

Free trade and Portuguese decline

Last weekend, as a result of Brad DeLong's post on free trade, we had a brief Twitter exchange. He had suggested that the Heckscher-Ohlin (HO) model* implies gains from trade associated to comparative advantage. He went further and suggested, after I implied that the Methuen Treaty between England and Portugal had not been favorable to the latter, that Portugal had indeed benefited greatly from free trade.

It is important to note, before we get to Portugal, that the HO model, which is a direct application of marginalist theory of value to international trade, arguing that specialization depends on relative scarcity, with countries exporting the goods that use intensively the factor of production that is abundant, is open to the capital debates critique, as shown by Ian Steedman long ago. So the HO model results lack generality, and it is NOT possible to guarantee gains of trade, as suggested by Brad. Actually, there should be no surprise that one finds paradoxes and problems, like the famous Leontief Paradox.

That does not mean that comparative advantage is conceptually wrong. The old Ricardian model does not have the problems of the HO model (Brad would have been on more solid logical grounds using this model). It is open to critiques of its use of the labor theory of value (LTV), but those can be dealt by the Sraffian reinterpretation of the LTV (for that, although not related to trade, go here). Note, however, that Ricardo's model presumes fixed levels of employment (not full employment, but given or constant) and no capital mobility. Anthony Brewer showed (subscription required) that in the Ricardian model, with capital mobility, producers would move to the country with lower costs, basically lower wages (exogenously given by classical authors), and absolute advantage would dominate trade patterns.

So what about trade between England and Portugal, you may ask. In part, the reason why Ricardo, a descendant of Portuguese jews that emigrated to Italy, the Netherlands and then to England, used the cloth-wine/England-Portugal example in his Principles, is because of the Methuen Treaty of 1703, a sort of free trade agreement. If one looks at income per capita (Table below using the Maddison data), one finds that Portugal was, by the time that follows its control of the trade routes to Asia (after Vasco da Gama reached India in 1498), slightly ahead of England, but by 1700, on the eve of the Treaty, it was considerably behind. Yet, by 1750, it seems that Portugal caugth up a bit, only to fall inexorably behind after that. By 1820, the income per capita in Portugal is less than half of the English.

So is there any truth to Brad's view that Portugal benefited from the free trade agreement, you may ask again. The point is that, the Iberian Union (1580-1640), when Portugal was governed by Spanish kings, and the loss of the Asian Empire (but not Brazil) was behind the Portuguese long term decline, which started way before the Methuen Treaty. Guns (and sails, Carlo Cipolla would add), not comparative advantage, were behind the rise and fall of the Portuguese empire in Asia.  The Dutch and then the English would come to dominate those trade routes. And the improvement in income per capita in the 18th century in Portugal can be ascribed to the discovery of gold in Brazil (a little aside, it is the combination of Brazilian gold, the Methuen Treaty, and the infamous mistake in the pricing of silver by Sir Isaac Newton that, arguably, put England on a Gold Standard). Free trade did not explain that.

So the Methuen Treaty by itself did not cause the ruin of Portugal. But it added to the problems associated to the loss of the Asian empire, and created patterns of specialization that did not lead to further technical change and economic development. Trade matters, because what one country produces and exports matters. Complex products with higher value added are more likely to lead to the incremental innovations that are behind the wealth of nations. You may call that increasing returns or cumulative causation. Trade agreements that ossify the production structure in sectors with low levels of technological dynamism lead to lower growth, and, as in any process with path dependency, failure breeds failure. Portugal, like England, needed managed trade, not 'free' trade.

* The model is often referred to as Heckscher-Ohlin-Samuelson (HOS), since Paul Samuelson was instrumental in formalizing the HO theorem and extending some of its results. Also, less frequently the model is referred to as Heckscher-Ohlin-Vanek (HOV), as done by Brad, since Jaroslav Vanek noted that trade of goods is indirect trade of factors of production, providing further extensions to the model.

Comparative Advantage and Capitalism

From CAPITALISM the documentary by Ilan Ziv. In this short clip a discussion of comparative advantage and its limitations, with Pascal Lamy, Robert Boyer and yours truly (many others in this chapter, including Geoff Hodgson and Ha-Joon Chang).

The Mexican secretary of finance that appears in the video is actually NOT talking about the Ricardian model of trade, which at least given its assumptions is logically correct, but about the neoclassical or Heckscher-Ohlin-Samuelson (HOS) model that has significant problems (see here).

I should note also that in my view Ricardo should not be seen as Robert Boyer suggests (not shown in the video above) as a precursor of mainstream neoclassical economics for his role in the development of formal models. Formal models can be marginalist or not, and actually Ricardo's ideas led to Marx. As I noted in my interview (in parts that do not appear in he documentary), Ricardo was the first economist to formalize the idea of a distributive conflict between capital and labor, once the Smithian notion of the adding up theory was criticized. I joke that contrary to Samuelson's view according to which Marx was a minor Ricardian, one should think of him as a major Ricardian. And in many other ways Ricardo's legacy has been misunderstood (without even discussing  Barro's Ricardian Equivalence).

Samuelson as a historian of economic thought

Steven Medema, together with Anthony Waterman, has published a series of papers by the late Paul Samuelson on the history of economic thought. Note that the scale and the range is more impressive than I expected. As they say in the intro:

"Paul Samuelson once referred, self-disparagingly, to 'the 5 per cent of my published papers that deal with the history of economic science' (54, 3). But D.P. O’Brien (2007, 336) regards this as a 'significant underestimate.' Nearly 140 articles, essays, or memoirs listed at the end of this volume, appearing over a period of forty-four years from 1946 to 2009 and comprising perhaps 20 percent of his scholarly publications, are clearly identifiable as studies of the history of economic thought."

I only know a bit of his writings on the Keynesian Revolution, and on Marx, who he famously, and incorrectly in my view, labeled as a "minor post-Ricardian." Now I learn that Samuelson thought also that Ricardo, in his estimation, was "the most overrated of economists."

I suppose that his views on Ricardo help understand his reservations about Marx. Also, and so far I have read the introduction (so I am relying on the editors), he seems to side with Malthus in his debate with Ricardo. Again, that makes sense. At any rate, worth reading and more to follow.

PS: It occurs to me that Samuelson's interest in Sraffa (he wrote an entry for the 1987 edition of the Palgrave, and according to Eatwell, wanted to write the main entry), who is cited profusely in the volume, the ultimate interpreter of Ricardo (and for me of Marx too), is no coincidence. 

Quotes

 

"Of the tendencies that are harmful to sound economics, the most seductive and, in my opinion the most poisonous, is to focus on questions of distribution." Robert Lucas Jr. (see here, last paragraph).

"Political Economy you [Malthus] think is an enquiry into the nature and causes of wealth; I think it should rather be called an enquiry into the laws which determine the division of the produce of industry amongst the classes who concur in its formation." David Ricardo (see here).

Both cannot be right.

Capitalism, Episode 3

Episode 3 of Capitalism, in French though. English version coming soon.

Jan Toporowski: Michał Kalecki and Oskar Lange in the 21st Century

It is possible to identify in The General Theory and Kalecki's work key ideas that they had in common.  The first is that in a capitalist economy output and employment are determined by business investment, so unless investment is high enough the economy is unlikely to be at full employment.  Secondly that investment determines saving, rather than the other way around.  Both men denounced the doctrine of the social value of thrift that so comforted the complacent Victorian bourgeoisie and that just made such a comeback today.  Finally, contrary to the Neoclassical and the Ricardian-Marxist view both men argued that wage rises would increase employment rather than decreasing it.  Underlying this commonality of view on how the capitalist economy works was a fundamental principle of the economic method that Kalecki explicitly employed to great effect and Keynes in a somewhat more haphazard way: the principle of the circular flow of income.  This is the idea that incomes are determined by expenditure decisions, rather than being decided in complex games of exchanging resources, capital or labor.  The principle goes back to the work of the French Physiocrat François Quesnay but had been lost to political economy by the 19th century with the ascendency of the idea that prices integrate individual exchange decisions, so all you need is correct prices.  Nevertheless, a hundred years ago the great Joseph Schumpeter recognized the importance of the circular flow of income...

See rest here

Say's Law of Markets: Classical and Neoclassical versions

Teaching macroeconomics, and having to deal, as always with the confusion generated by all manuals (to a great extent Keynes' fault for using the term classical for everybody that came before him) between the old classical political economy tradition and the marginalist (or neoclassical, other misnomer, this one Veblen's fault) school.

Not all classical authors accepted Say's Law, to which Keynes' Principle of Effective Demand (PED) was contrasted, but all neoclassical authors do accept it (last week the Societies for the History of Economics, aka SHOE, had a very confusing discussion on Say's Law, in which this simple fact got completely lost by a few debaters). Marx certainly was critical of Say's Law.

Ricardo in chapter XXI of his Principles famously says:

"M. Say has, however, most satisfactorily shewn, that there is no amount of capital which may not be employed in a country, because demand is only limited by production. No man produces, but with a view to consume or sell, and he never sells, but with an intention to purchase some other commodity, which may be immediately useful to him, or which may contribute to future production. By producing, then, he necessarily becomes either the consumer of his own goods, or the purchaser and consumer of the goods of some other person. It is not to be supposed that he should, for any length of time, be ill-informed of the commodities which he can most advantageously produce, to attain the object which he has in view, namely, the possession of other goods; and, therefore, it is not probable that he will continually produce a commodity for which there is no demand."

The Ricardian notion is relatively simple. It suggests that the objective of production is consumption (what Marx would call later the "simplest form of the circulation of commodities," or simple exchange, where commodities are produced for exchange for commodities, with money being just an intermediary, C-M-C'). Further, Ricardo suggests that nobody would continue to produce something for which there is no demand over the long run. Yes there might be mistakes and excess production, but over time producers learn from their mistakes. In this simple story if a capitalist saves, it is by definition because he intends to invest and be able to produce more in the future. Think of the corn model; the corn not consumed, for wages (for the reproduction of the system), goes by definition into expanded reproduction.

The Ricardian model has no adjusting mechanism between investment and savings, which are by definition one and the same. Also, there is no guarantee that the system fully utilizes labor resources, or that the system would be at full employment. The rate of interest was regulated by the rate of profit, and adjusted to its level in the long run, but it did not adjust savings and investment.

This is, in fact, the main difference between the old classical version of Say's Law when compared to the marginalist or neoclassical one. In the neoclassical version the rate of interest (the natural rate of interest indeed) becomes the adjusting mechanism in what is often referred to as the Loanable Funds Theory (LFT) of the Rate of Interest (for a simple discussion of Wicksell's version of the LFT go here). Now an excess supply of funds (savings) for investment would be eliminated by the tendency of the monetary rate of interest to equilibrate with the natural rate, guaranteeing that investment is at the level of full employment savings. Investment can deviate from the equilibrium level of savings only in the short run, and neoclassical theory (including Wicksell of course; a few in the SHOE discussion seemed confused about this) would accept Say's Law in this new version in the long run. Note that in order for a rate of interest to lead to increasing investment demand, it must be the case that labor is fully utilized, and firms decide to substitute labor for capital. In the marginalist version Say's Law implies full employment in the labor market.

Keynes' Principle of Effective Demand, by suggesting that savings were simply a residual (income not spent), famously argued that, instead of supply creating its own demand, it was autonomous spending decisions (which Keynes associated with investment) generated income and, hence, made the supply effective. It was the variations of the level of income that made the adjustment of savings to investment possible, and there was no guarantee that autonomous spending would provide for the full utilization of resources.

For a thorough analysis of Keynes' PED, this book remains in my view one of the best around.

Demographic transitions, Malthusian traps and supply constrained growth

Gregory Clark's book The Farewell to Alms re-popularized the Malthusian model (for the relevant chapter go here). The basic idea is that population dynamics and the so-called demographic transition do have an important impact on economic growth. Robert Malthus' idea is relatively well known, even if there is an incredible amount of confusion in the way it is explained by modern neoclassical authors.

As all classical authors, Malthus assumed that real wages tended to be at subsistence levels. He emphasized more than others, eg. Smith or Marx, the physiological elements associated to subsistence, and his theory of population influenced David Ricardo (friends sometimes will push you in the wrong direction, but this should not be exaggerated; Ricardo was no Malthus). And this has nothing to do with some Iron Law of Wages (again this reflects the fact that mainstream authors like Clark have limited, to say the least, understanding of the surplus approach; for Ricardo and other classical authors on real wages see Stirati here).*

At any rate, Malthus notion was that if wages increased, population growth would ensue and bring them back to subsistence levels, hence real wages could not grow. In the mainstream story this is connected with lack of growth of income per capita. The economy would be in a Malthusian trap.** Population growth is bad in this Malthusian world, that is why the good reverend, like modern Republicans (and I would assume more than a few neoclassical economists), was for abstinence and delayed marriages.

The idea is that higher population, for a given technology, leads to more mouths to feed. Classical ideas that suggest that the extent of the market (and, hence, population) might have a positive impact on the division of labor (who said that?) are not discussed by modern neoclassical authors (also explains their dislike of Kaldor-Verdoorn Law). At any rate, the modern theory of economic growth is still dominated by supply-side explanations, in which technological progress is either exogenous (Solow) or endogenously determined by spending on education (or some variation of the topic in the endogenous growth literature).

Demographic transitions, in which the rates of mortality and fertility decline have in this view particular effects on growth. The notion is that the initial fall in fertility leads to a lower youth dependency ratio (less youngsters to feed), and is growth enhancing. Further, mainstream authors assume that workers in the labor force would have a higher savings rate (given life cycle hypothesis arguments) and that would lead to investment (yes, Say's Law). Jeff Williamson suggests (see here) that this, the so-called demographic dividend, in part explains the Economic Miracle in parts of Asia.

On the other hand, the same population dynamics leads to higher old age dependency ratio, and that should have (even if evidence is mixed on that) a negative impact on growth. Note that Eichengreen and his co-authors, suggest that slowdowns in growth are associated to falling productivity (not population dynamics), even if they measure that using Total Factor Productivity (which is not a measure of productivity, but of the changing patterns of functional income distribution; see here).

Mind you there is a more reasonable, demand-led, explanation for why population transitions might have an impact on growth. As the process of structural transformation from agricultural to industrial societies continues, more workers are incorporated in industrial jobs with higher pay, and even if income distribution might worsen, the expansion of urban population (and higher real wages) means an expansion of demand. Obviously once the transition is done, the expansion of real wages (not just from the rural workers moving into cities) must continue. In this case, the main cause for the limits to real wage expansion (demand expansion), and continued growth, come from the balance of payments, since higher wages and consumption lead to increasing imports.

There are many more limitations in the resurgence of Malthusian views in the mainstream. Including the Social Darwinist flavor of Clark's ideas, as noted by Deirdre McCloskey (here). But I'll leave those for another post.

* The main point that mainstream intepretations of classical authors miss is that there is no systematic decreasing relation between real wages and employment in Ricardo and other classical economists, something that Stirati makes clear.

** Note also that some authors suggest that this is the basis for Carlyle's epithet the 'dismal science' for Political Economy. As noted before by Vienneau (see here): "Thomas Carlyle did not coin the phrase 'The dismal science' to refer to Thomas Malthus's anti-utopian theory of population."

Garegnani on Sraffa, Ricardo and Marx

I was going to write something about the Ricardian roots of Marx, but in all fairness a lot of ink has already been spilled on the subject. Here is the reply to the question about the relation between Sraffa and Marx, given by Garegnani in 1978 (here for the whole interview; subscription required):

"The conception which some people have of this relationship [Sraffa and Marx] seems to me quite misleading. And in order to reach a correct understanding of it, we first have to grasp the true relationship between Marx and Ricardo. I have argued elsewhere that this latter relationship should be seen in terms of a strict continuity at the level of economic analysis. Of course, unlike Ricardo and the classical economists, Marx sought to show that the capitalist mode of production is no more permanent than the modes which came before it. But this does not contradict my previous point, since it is perfectly normal that a given theoretical approach should reveal to one author a series of consequences that were not brought to light by his predecessors. That was precisely the relationship, for Marx, between his ‘critique of political economy’ (that is, his demonstration of the transitory character of capitalism) and the work of Ricardo. In fact, Marx deduces the transitory character of capitalism from a kernel of analyses whose object is what he often called ‘the inner nexus of bourgeois economic relations’—essentially, the antagonistic relationship between wages and profits. Now, as Marx himself repeatedly stated, this ‘inner nexus’ was discovered by the classical economists, and analysed especially in Ricardo’s theory of surplus-value and profits. It was precisely this theory which he took up and developed in his ‘critique’. Once this continuity between the classical economists and Marx has been understood, it is easy to grasp the true relationship between Sraffa and Marx. For a revival of the classical approach is possible only if it starts from the highest point of development attained in the past—that is to say, the point at which we find it in Marx’s work."

This is why in the forthcoming documentary on Capitalism, written and directed by documentary filmmaker Ilan Ziv and organized around key historical debates and thinkers, I argued that Marx should be, contra-Samuleson, be seen as a major Ricardian.

On Sraffa and the labor theory of value this is what Garegnani had to say:

"This brings us back to the second of the three aspects of Sraffa’s work: namely, his proposed solution to the problem of value based on more general hypotheses than those which assert that commodities exchange in accordance with the labour embodied in them. Solving this problem and abandoning the labour theory of value are, in reality, two sides of the same coin: any living theoretical approach has to develop, undergoing modification and modifying its own propositions. Now, it is indeed sometimes said that Sraffa has thrown Marx’s economic theory into crisis. But in order to understand this point of view, we must recall the significance attached to the labour theory of value by that Marxist tradition which arose at the end of the nineteenth century, following the marginalist attack on Marx. I have argued elsewhere that the positions developed at that time were of an essentially defensive character; and that they reflected a temporary state of theoretical weakness which is now, largely thanks to Sraffa, in the process of being overcome.

This being said, however, it is important to remember that Sraffa created only the premises for a revival of the classical and Marxist theoretical approach. He did this by clarifying anew the basic elements of that approach, and by providing a solution to the problems of value-theory that had remained unanswered. It would thus be a mistake to seek in Production of Commodities what is not actually there: to seek, that is, a theory of capital accumulation and crises, or even a theory of the way in which relations between the two social classes determine the division of the product between wages and profits. I would maintain that, so far as all these problems are concerned, Sraffa refers us to the place where they receive the most advanced treatment in the framework of this theoretical approach—essentially to Marx’s Capital, and to all the work which has to be done in order to develop Marx’s ideas in conformity with the present state of reality and economic knowledge."

Note that Sraffa suggested that his solution, based on the standard commodity, could be interpreted as akin to Smith's labor commanded theory of value, and as such could (and I would say should) be seen as a logically coherent version of the labor theory of value (discussed in this previous post).

PS: As I was writing this I saw that Robert Vienneau has just posted on the same topic here.

The Marxologiosity of TSSI

Lately, I have been delving into the debate on the supposed logical consistency of Andrew Kliman's Temporal Single-System Interpretation of Marxian Economics (see here). After reviewing the relevant literature, I am of the disposition to suggest that the supposed solution to Marx's problem of perceived incoherence in Das Kapital is indeted suspect (see here). More generally, I am a bit perturbed by the way in which TSSI advocators, in particular Kliman, promote the approach with such religiosity. For an outstanding refutation of TSSI, see Gary Mongiovi's Vulgar Economy in Marxian Garb (subscription required):

"Although Marx did make a number of errors in elaborating his theory of value and the profit rate, these missteps do not undermine his larger scientific project. Far greater damage has been inflicted by his would-be Temporal Single System defenders, who camouflage Marx's errors by detaching him from his Ricardian roots; in the process they redefine value in a way that trivializes its function in Marx's system."

Marx on Absolute and Relative Wages and the Modern Theory of Distribution

Given recent reconsiderations of the Marxian 'falling rate of profit' hypothesis, I reckon it be of readers' interest to consider this article by Enrico Sergio Levrero (see here).

From the abstract:

"This paper aims at clarifying some aspects of Marx’s analysis of the determinants of wages and of the peculiarity of labour as a commodity, focusing on three related issues. The first is that of Marx’s notion of the subsistence (or natural) wage rate: the subsistence wage will be shown to stem, according to Marx, from socially determined conditions of reproduction of an efficient labouring class. The second issue refers to the distinction between the natural and the market wage rate that can be found in Marx, and his critique of Ricardo’s analysis of the determinants of the price of labour. Here the ‘law of population peculiar to the capitalist mode of production’ (that is, Marx’s industrial reserve army mechanism) will be considered both with respect to cyclical fluctuations of wages and to their trend over time. Moreover, a classification of the social and institutional factors affecting the average wage rate will be advanced. Finally, the last issue concerns Marx’s analysis of the effects of technical progress on both absolute and relative wages (that is, the wage share). It will also be discussed by relating it back to the longstanding debate on the Marxian law of the falling rate of profit, and addressing some possible scenarios of the trend of wages and distribution."

When Karl, Rosa, Michal and Maynard met in London

Sergio Cesaratto[1]
(Guest Blogger)

In a previous post I argued that if one wants to be convinced of the Classical and Sraffian surplus approach, she should read Jared Diamond. I would add now Jack London’s The Iron Heel (1908) to the list. Although Jack London is a figure with some ambiguities, this book is prescient of the bellicose and authoritarian tendencies of capitalism. Orwell considered it an inspiration for 1984. The book sounds as a militant, didactic introduction to a Marxist interpretation of capitalism. In this capacity it uses the surplus approach, but not in its Marxian version that employs the labour theory of value – pregnant of moralist meanings -, that Marx received from Ricardo’s Principles, but the more terse, so to speak, material version of Ricardo’s Essay on Profits. The social surplus, that in a capitalist society is appropriated by capitalists, appears as the difference between the amount of commodities produced and the amount of them paid to worker as wages (we are talking of a novel, so I feel free not to be extremely rigorous; the interested reader can consult Garegnani 1984).

In Chapter 9 the hero of the novel (Ernest Everhard) tries to explain to a group of small capitalists (represented by Mr. Kawalt, Mr. Calvin and others) the structure of capitalism. The existence of a surplus of commodities seized as profits is straightforwardly linked by London to the question of finding a market to them. Foreign markets, including those in underdeveloped countries, are one possible debouche, as later Rosa (Luxemburg) and Michal (Kalecki) suggested, but once more and more countries develop, the difficulty to find a debouche in the “external markets” markets become more difficult So, either we luddistically destroy productive capacity by going back to antediluvian methods of production, that is we escape “the problem of the surplus by not producing any surplus”, or through a more “equitable distribution of the products of the wonderful machines” we avoid any “unconsumed surplus”. Oligopoly capitalism might however react with repression and authoritarianism.

(From Chapter 9): <<"And now we come to the point. Four billion dollars of wealth is produced in one year in the United States. Labor buys back and consumes two billions. Capital does not consume the remaining two billions. There is a large balance left over unconsumed. What is done with this balance? What can be done with it? Labor cannot consume any of it, for labor has already spent all its wages. Capital will not consume this balance, because, already, according to its nature, it has consumed all it can. And still remains the balance. What can be done with it? What is done with it?"

"It is sold abroad," Mr. Kowalt volunteered.

"The very thing," Ernest agreed. "Because of this balance arises our need for a foreign market. This is sold abroad. It has to be sold abroad. There is no other way of getting rid of it. And that unconsumed surplus, sold abroad, becomes what we call our favorable balance of trade. Are we all agreed so far?"

"Surely it is a waste of time to elaborate these A B C's of commerce," Mr. Calvin said tartly. "We all understand them."

"And it is by these A B C's I have so carefully elaborated that I shall confound you," Ernest retorted. "There's the beauty of it. And I'm going to confound you with them right now. Here goes.

"The United States is a capitalist country that has developed its resources. According to its capitalist system of industry, it has an unconsumed surplus that must be got rid of, and that must be got rid of abroad. What is true of the United States is true of every other capitalist country with developed resources. Every one of such countries has an unconsumed surplus. Don't forget that they have already traded with one another, and that these surpluses yet remain. Labor in all these countries has spent it wages, and cannot buy any of the surpluses. Capital in all these countries has already consumed all it is able according to its nature. And still remain the surpluses. They cannot dispose of these surpluses to one another. How are they going to get rid of them?"

"Sell them to countries with undeveloped resources," Mr. Kowalt suggested.

"The very thing. You see, my argument is so clear and simple that in your own minds you carry it on for me. And now for the next step. Suppose the United States disposes of its surplus to a country with undeveloped resources like, say, Brazil. Remember this surplus is over and above trade, which articles of trade have been consumed. What, then, does the United States get in return from Brazil?"

"Gold," said Mr. Kowalt.

"But there is only so much gold, and not much of it, in the world," Ernest objected.

"Gold in the form of securities and bonds and so forth," Mr. Kowalt amended.

"Now you've struck it," Ernest said. "From Brazil the United States, in return for her surplus, gets bonds and securities. And what does that mean? It means that the United States is coming to own railroads in Brazil, factories, mines, and lands in Brazil. And what is the meaning of that in turn?"

Mr. Kowalt pondered and shook his head.

"I'll tell you," Ernest continued. "It means that the resources of Brazil are being developed. And now, the next point. When Brazil, under the capitalist system, has developed her resources, she will herself have an unconsumed surplus. Can she get rid of this surplus to the United States? No, because the United States has herself a surplus. Can the United States do what she previously did—get rid of her surplus to Brazil? No, for Brazil now has a surplus, too.

"What happens? The United States and Brazil must both seek out other countries with undeveloped resources, in order to unload the surpluses on them. But by the very process of unloading the surpluses, the resources of those countries are in turn developed. Soon they have surpluses, and are seeking other countries on which to unload. Now, gentlemen, follow me. The planet is only so large. There are only so many countries in the world. What will happen when every country in the world, down to the smallest and last, with a surplus in its hands, stands confronting every other country with surpluses in their hands?"

He paused and regarded his listeners. The bepuzzlement in their faces was delicious. Also, there was awe in their faces. Out of abstractions Ernest had conjured a vision and made them see it. They were seeing it then, as they sat there, and they were frightened by it.

"We started with A B C, Mr. Calvin," Ernest said slyly. "I have now given you the rest of the alphabet. It is very simple. That is the beauty of it. You surely have the answer forthcoming. What, then, when every country in the world has an unconsumed surplus? Where will your capitalist system be then?"

But Mr. Calvin shook a troubled head. He was obviously questing back through Ernest's reasoning in search of an error.

"Let me briefly go over the ground with you again," Ernest said. "We began with a particular industrial process, the shoe factory. We found that the division of the joint product that took place there was similar to the division that took place in the sum total of all industrial processes. We found that labor could buy back with its wages only so much of the product, and that capital did not consume all of the remainder of the product. We found that when labor had consumed to the full extent of its wages, and when capital had consumed all it wanted, there was still left an unconsumed surplus. We agreed that this surplus could only be disposed of abroad. We agreed, also, that the effect of unloading this surplus on another country would be to develop the resources of that country, and that in a short time that country would have an unconsumed surplus. We extended this process to all the countries on the planet, till every country was producing every year, and every day, an unconsumed surplus, which it could dispose of to no other country. And now I ask you again, what are we going to do with those surpluses?"

Still no one answered.

"Mr. Calvin?" Ernest queried.

"It beats me," Mr. Calvin confessed.

"I never dreamed of such a thing," Mr. Asmunsen said. "And yet it does seem clear as print."

It was the first time I had ever heard Karl Marx's doctrine of surplus value elaborated, and Ernest had done it so simply that I, too, sat puzzled and dumbfounded.

"I'll tell you a way to get rid of the surplus," Ernest said. "Throw it into the sea. Throw every year hundreds of millions of dollars' worth of shoes and wheat and clothing and all the commodities of commerce into the sea. Won't that fix it?"

"It will certainly fix it," Mr. Calvin answered. "But it is absurd for you to talk that way."

Ernest was upon him like a flash.

"Is it a bit more absurd than what you advocate, you machine-breaker, returning to the antediluvian ways of your forefathers? What do you propose in order to get rid of the surplus? You would escape the problem of the surplus by not producing any surplus. And how do you propose to avoid producing a surplus? By returning to a primitive method of production, so confused and disorderly and irrational, so wasteful and costly, that it will be impossible to produce a surplus."

Mr. Calvin swallowed. The point had been driven home. He swallowed again and cleared his throat.

"You are right," he said. "I stand convicted. It is absurd. But we've got to do something. It is a case of life and death for us of the middle class. We refuse to perish. We elect to be absurd and to return to the truly crude and wasteful methods of our forefathers. We will put back industry to its pre-trust stage. We will break the machines. And what are you going to do about it?"

"But you can't break the machines," Ernest replied. "You cannot make the tide of evolution flow backward. Opposed to you are two great forces, each of which is more powerful than you of the middle class. The large capitalists, the trusts, in short, will not let you turn back. They don't want the machines destroyed. And greater than the trusts, and more powerful, is labor. It will not let you destroy the machines. The ownership of the world, along with the machines, lies between the trusts and labor. That is the battle alignment. Neither side wants the destruction of the machines. But each side wants to possess the machines. In this battle the middle class has no place. The middle class is a pygmy between two giants. Don't you see, you poor perishing middle class, you are caught between the upper and nether millstones, and even now has the grinding begun.

"I have demonstrated to you mathematically the inevitable breakdown of the capitalist system. When every country stands with an unconsumed and unsalable surplus on its hands, the capitalist system will break down under the terrific structure of profits that it itself has reared. And in that day there won't be any destruction of the machines. The struggle then will be for the ownership of the machines. If labor wins, your way will be easy. The United States, and the whole world for that matter, will enter upon a new and tremendous era. Instead of being crushed by the machines, life will be made fairer, and happier, and nobler by them. You of the destroyed middle class, along with labor—there will be nothing but labor then; so you, and all the rest of labor, will participate in the equitable distribution of the products of the wonderful machines. And we, all of us, will make new and more wonderful machines. And there won't be any unconsumed surplus, because there won't be any profits."

"But suppose the trusts win in this battle over the ownership of the machines and the world?" Mr. Kowalt asked.

"Then," Ernest answered, "you, and labor, and all of us, will be crushed under the iron heel of a despotism as relentless and terrible as any despotism that has blackened the pages of the history of man. That will be a good name for that despotism, the Iron Heel.">>

Still, how can an authoritarian capitalism solve the question of the realization of the capitalists’ surplus. Well, the same way the Egyptian ruling class solved the question of spending the social surplus, by building pyramids or other magnificent public works. And, of course, anybody would wonder at this point if it was Jack London that inspired Maynard’s famous passages of the General Theory on the pyramids. Capitalists’ autonomous consumption is therefore another “external market” that can provide a debouche to capitalists’ surplus. Notably “external markets”, or “non capacity-creating autonomous-components” of aggregate demand do not play a relevant role in so-called neo-Kaleckian growth models that should more aptly be defined as neo-Harrodian models. Moreover, by using odd arguments about a variable normal degree of capacity utilization, these models also abandon the conflict view of distribution proper to the Classical economists and Marx.
From Chapter 14:

<<"But if the Oligarchy persists," I asked him that evening, "what will become of the great surpluses that will fall to its share every year?"

"The surpluses will have to be expended somehow," he answered; "and trust the oligarchs to find a way. Magnificent roads will be built. There will be great achievements in science, and especially in art. When the oligarchs have completely mastered the people, they will have time to spare for other things. They will become worshippers of beauty. They will become art-lovers. And under their direction and generously rewarded, will toil the artists. The result will be great art; for no longer, as up to yesterday, will the artists pander to the bourgeois taste of the middle class. It will be great art, I tell you, and wonder cities will arise that will make tawdry and cheap the cities of old time. And in these cities will the oligarchs dwell and worship beauty.*

"Thus will the surplus be constantly expended while labor does the work. The building of these great works and cities will give a starvation ration to millions of common laborers, for the enormous bulk of the surplus will compel an equally enormous expenditure, and the oligarchs will build for a thousand years—ay, for ten thousand years. They will build as the Egyptians and the Babylonians never dreamed of building; and when the oligarchs have passed away, their great roads and their wonder cities will remain for the brotherhood of labor to tread upon and dwell within.

"These things the oligarchs will do because they cannot help doing them. These great works will be the form their expenditure of the surplus will take, and in the same way that the ruling classes of Egypt of long ago expended the surplus they robbed from the people by the building of temples and pyramids. Under the oligarchs will flourish, not a priest class, but an artist class. And in place of the merchant class of bourgeoisie will be the labor castes. And beneath will be the abyss, wherein will fester and starve and rot, and ever renew itself, the common people, the great bulk of the population. And in the end, who knows in what day, the common people will rise up out of the abyss; the labor castes and the Oligarchy will crumble away; and then, at last, after the travail of the centuries, will it be the day of the common man. I had thought to see that day; but now I know that I shall never see it." >>

As a reminder, here is Keynes:

<<Ancient Egypt was doubly fortunate and doubtless owed to this its fabled wealth, in that it possessed two activities, namely pyramid building as well as the search for precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance. The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York.>> (131)

<< In so far as millionaires find their satisfaction in building mighty mansions to contain their bodies when alive and pyramids to shelter them after death, or, repenting of their sins, erect cathedrals and endow monasteries or foreign missions, the day when abundance of capital will interfere with abundance of output may be postponed. 'To dig holes in the ground', paid for out of savings, will increase, not only employment, but the real national dividend of useful goods and services. It is not reasonable, however, that a sensible community should be content to remain dependent on such fortuitous and often wasteful mitigations when once we understand the influences upon which effective demand depends.>> (220)

Even the outrage, Keynes seems to have got from London.

Yet crisis are still possible, as in the years the novel takes place, and a conflict can erupt between the mercantilist countries that struggle to control the external markets (in this regard this post argues that mercantilism is a constant characteristic of capitalism and advocates that mercantilism is given its proper place in the Classical surplus approach). Moreover, wars are another important debouche for capitalists’ surplus, as Michal later suggested. In the novel the working class of the two mercantilist countries, the U.S. and (easy guess) Germany, succeed in stopping the world war – unfortunately socialists failed seven year later in this regard. In the novel German socialists even succeed in a socialist revolution, also attempted by the American workers. Unfortunately this attempt failed and was followed by repression and by three centuries of authoritarian regime, later followed by the eventual victory of the resilient socialists. Well, socialist actually tried a failed revolution in post-WWI Germany (led by Rosa), followed (although not immediately) by an authoritarian regime. Unfortunately after one century later we have not a full socialist regime, but horrible Angela. Cesaratto’s dream is of course a final (for Germany) like that in the novel:

“By the very nature of the socialist state, the German population would consume all that it produced. Of course, it would trade abroad certain things it produced for things it did not produce; but this would be quite different from an unconsumable surplus.”

In the novel, indeed, the outcome is less positive for American workers: the withdraw from the external markets of the main mercantilist competitor (the by now socialist Germany) provided even more justification for the American capitalism to repress internal demand and wages so to increase the exportable surplus.

From Chapter 13:

<<The hard times at home had caused an immense decrease in consumption. Labor, out of work, had no wages with which to buy. The result was that the Plutocracy found a greater surplus than ever on its hands. This surplus it was compelled to dispose of abroad, and, what of its colossal plans, it needed money. Because of its strenuous efforts to dispose of the surplus in the world market, the Plutocracy clashed with Germany. Economic clashes were usually succeeded by wars, and this particular clash was no exception. The great German war-lord prepared, and so did the United States prepare.

The war-cloud hovered dark and ominous. The stage was set for a world-catastrophe, for in all the world were hard times, labor troubles, perishing middle classes, armies of unemployed, clashes of economic interests in the world-market, and mutterings and rumblings of the socialist revolution.

The Oligarchy wanted the war with Germany. And it wanted the war for a dozen reasons. In the juggling of events such a war would cause, in the reshuffling of the international cards and the making of new treaties and alliances, the Oligarchy had much to gain. And, furthermore, the war would consume many national surpluses, reduce the armies of unemployed that menaced all countries, and give the Oligarchy a breathing space in which to perfect its plans and carry them out. Such a war would virtually put the Oligarchy in possession of the world-market. Also, such a war would create a large standing army that need never be disbanded, while in the minds of the people would be substituted the issue, "America versus Germany," in place of "Socialism versus Oligarchy."

And truly the war would have done all these things had it not been for the socialists. A secret meeting of the Western leaders was held in our four tiny rooms in Pell Street. Here was first considered the stand the socialists were to take. It was not the first time we had put our foot down upon war,* but it was the first time we had done so in the United States. After our secret meeting we got in touch with the national organization, and soon our code cables were passing back and forth across the Atlantic between us and the International Bureau.

The German socialists were ready to act with us. There were over five million of them, many of them in the standing army, and, in addition, they were on friendly terms with the labor unions. In both countries the socialists came out in bold declaration against the war and threatened the general strike. And in the meantime they made preparation for the general strike. Furthermore, the revolutionary parties in all countries gave public utterance to the socialist principle of international peace that must be preserved at all hazards, even to the extent of revolt and revolution at home.

The general strike was the one great victory we American socialists won. On the 4th of December the American minister was withdrawn from the German capital. That night a German fleet made a dash on Honolulu, sinking three American cruisers and a revenue cutter, and bombarding the city. Next day both Germany and the United States declared war, and within an hour the socialists called the general strike in both countries.

For the first time the German war-lord faced the men of his empire who made his empire go. Without them he could not run his empire. The novelty of the situation lay in that their revolt was passive. They did not fight. They did nothing. And by doing nothing they tied their war-lord's hands. He would have asked for nothing better than an opportunity to loose his war-dogs on his rebellious proletariat. But this was denied him. He could not loose his war-dogs. Neither could he mobilize his army to go forth to war, nor could he punish his recalcitrant subjects. Not a wheel moved in his empire. Not a train ran, not a telegraphic message went over the wires, for the telegraphers and railroad men had ceased work along with the rest of the population.

And as it was in Germany, so it was in the United States. At last organized labor had learned its lesson. Beaten decisively on its own chosen field, it had abandoned that field and come over to the political field of the socialists; for the general strike was a political strike. Besides, organized labor had been so badly beaten that it did not care. It joined in the general strike out of sheer desperation. The workers threw down their tools and left their tasks by the millions. Especially notable were the machinists. Their heads were bloody, their organization had apparently been destroyed, yet out they came, along with their allies in the metal-working trades.

Even the common laborers and all unorganized labor ceased work. The strike had tied everything up so that nobody could work. Besides, the women proved to be the strongest promoters of the strike. They set their faces against the war. They did not want their men to go forth to die. Then, also, the idea of the general strike caught the mood of the people. It struck their sense of humor. The idea was infectious. The children struck in all the schools, and such teachers as came, went home again from deserted class rooms. The general strike took the form of a great national picnic. And the idea of the solidarity of labor, so evidenced, appealed to the imagination of all. And, finally, there was no danger to be incurred by the colossal frolic. When everybody was guilty, how was anybody to be punished?

The United States was paralyzed. No one knew what was happening. There were no newspapers, no letters, no despatches. Every community was as completely isolated as though ten thousand miles of primeval wilderness stretched between it and the rest of the world. For that matter, the world had ceased to exist. And for a week this state of affairs was maintained.

In San Francisco we did not know what was happening even across the bay in Oakland or Berkeley. The effect on one's sensibilities was weird, depressing. It seemed as though some great cosmic thing lay dead. The pulse of the land had ceased to beat. Of a truth the nation had died. There were no wagons rumbling on the streets, no factory whistles, no hum of electricity in the air, no passing of street cars, no cries of news-boys—nothing but persons who at rare intervals went by like furtive ghosts, themselves oppressed and made unreal by the silence.

And during that week of silence the Oligarchy was taught its lesson. And well it learned the lesson. The general strike was a warning. It should never occur again. The Oligarchy would see to that.

At the end of the week, as had been prearranged, the telegraphers of Germany and the United States returned to their posts. Through them the socialist leaders of both countries presented their ultimatum to the rulers. The war should be called off, or the general strike would continue. It did not take long to come to an understanding. The war was declared off, and the populations of both countries returned to their tasks.

It was this renewal of peace that brought about the alliance between Germany and the United States. In reality, this was an alliance between the Emperor and the Oligarchy, for the purpose of meeting their common foe, the revolutionary proletariat of both countries. And it was this alliance that the Oligarchy afterward so treacherously broke when the German socialists rose and drove the war-lord from his throne. It was the very thing the Oligarchy had played for—the destruction of its great rival in the world-market. With the German Emperor out of the way, Germany would have no surplus to sell abroad. By the very nature of the socialist state, the German population would consume all that it produced. Of course, it would trade abroad certain things it produced for things it did not produce; but this would be quite different from an unconsumable surplus.

"I'll wager the Oligarchy finds justification," Ernest said, when its treachery to the German Emperor became known. "As usual, the Oligarchy will believe it has done right."

And sure enough. The Oligarchy's public defence for the act was that it had done it for the sake of the American people whose interests it was looking out for. It had flung its hated rival out of the world-market and enabled us to dispose of our surplus in that market.

"And the howling folly of it is that we are so helpless that such idiots really are managing our interests," was Ernest's comment. "They have enabled us to sell more abroad, which means that we'll be compelled to consume less at home.">>

As said, after a failed socialist coup, in the U.S. The Iron Heel prevailed (Chapter 14). Notably, the oligarchs coopted the skilled working class in the regime, assuring it higher wages and a good welfare state. The unskilled working class was reduced to semi-slave labour and all the universal welfare state institutions, including public education, were dismantled. To the discomfort of our neo-Keleckian friends, growth was not wage-led (how it can? wage-consumption is an induced component of aggregate demand, therefore it cannot drive growth), but it relied on the autonomous consumption of capitalists.

Note:

[1] These posts are divertissement; I do not pretend extreme rigour, but just to be suggestive. Hundreds of thousand become communists after having read The Iron Heel. Perhaps one or two guys will become Sraffian-Kaleckians after reading this post.

So? None of your conclusions follow from your arguments

Krugman has a post on the effects of technological change on employment. Here is a very illustrative case of the limitations of mainstream marginalist (neoclassical) economics, which leads a reasonable and intelligent economist to all sorts of mistakes. He says:

"start with the notion of an aggregate production function, which relates economy-wide output to economy-wide inputs of capital and labor. Yes, that sort of aggregation does violence to the complexity of reality. So?"

Implicit here is the incorrect notion that the problem with the aggregate production function is over-simplification. Nope, that is a feature of all theories of course. The problem is far worse; it is that it leads to logical mistakes.* So, as we will see, none of Krugman's conclusions follow from his analysis, and that is kind of a problem. Lack of logical coherence and empirical evidence are after all the two main criteria of demarcation between scientific knowledge and the half-baked notions of ideologues.

His first point, which is based on the marginalist theory of distribution**, is that:

"in competitive economy ..., we would expect the labor force to achieve full employment by accepting whatever real wage is consistent with said full employment."

In other words, wage flexibility guarantees the full utilization of labor. A reduction in the real wage in the case of unemployment would lead to full employment (yes, he actually does not defend this in policy discussions, because he thinks that nominal wage rigidities preclude adjustment; mind you his real preocupation is that the rate of interest of equilibrium is negative, precluding adjustment in capital markets).

Of course this is nonsense. A reduction in real wages, and I'm not even talking about the effects of deflation on demand which were discussed by Keynes in the chapter 19 of the General Theory, may not lead to an increase in the demand for labor. First, it must be noted that if wages go down, since wages are part of the cost of production of produced means of production (i.e. capital), the price of the latter also goes down. There is a priori no reason to say that firms will substitute labor for capital (on capital debates go here; really Krugman should read this stuff).

Second, once the idea that the intensity of the use of a 'factor of production' is inversely related with its remuneration is abandoned (by the way there is no evidence for the notion that real wages are inversely related to employment utilization, in fact, if anything, the evidence points in the other direction, with real wages being slightly pro-cyclical), there is no reason to believe that real wages are connected to productivity (and again there is no evidence for that relation either, which means that when Krugman asks "what is that real wage?" and replies that it is "the marginal product of labor at that point," he is also incorrect). Yes real wages have stagnated, since the bargaining power of the working class has deteriorated, with productivity still growing since the 1970s.

So, what is the problem Mr. Krugman? That your conclusion, that the effects of technical change on employment are ambiguous, does not follow logically from your arguments. Ricardo's discussion of the effects of technical change on employment, in his famous chapter on machinery, is far more interesting and coherent than Krugman's (see the paper here). Not just the idea of a natural rate has to be abandoned, but the essential principle of substitution, which allows for the natural rate, must be dropped too. Logical coherence and evidence require it.

* For a serious discussion of the limitations of the aggregate production function go this paper by Jesus Felipe and Franklin Fisher here.

** The quote of Hicks classic presentation of the marginalist theory of wages leaves little doubt of where Krugman stands, if you had any.

The standard commodity and the labor theory of value

In a previous post I promised to deal with Sraffa's standard commodity (chapter IV of his Production of Commodities by Means of Commodities, PCMC). So here is a brief and simple explanation of this somewhat arcane topic. The standard commodity is basically a more developed version of Ricardo's corn model.

Ricardo, remember, wanted to explain the rate of profit, to show that tariffs on corn (not corn, grain imports really) would reduce the rate of profit, and as a result would be detrimental for capital accumulation (which was based on profits for him). To determine the rate of profit he needed to obtain the prices at which commodities were bought and sold. Yet, to get the prices he needed the uniform rate of profit earned on the production of those commodities.

His solution in the Corn Essay of 1815 was brilliantly simple. Assume that the economy produces corn by means of corn seeds and labor. So the total output consisted of corn, the wages paid to workers were also in corn, and of course the means of production advanced to produce corn were corn seeds. So the profit rate could be measured as the surplus left over after wages were paid over the amount of corn advanced for production. A physical ratio that was independent of prices [Note that tariffs would increase the rents of landowners and reduce the profits left over for accumulation].

Malthus, Ricardo’s nagging friend, suggested that this would not be true in a world in which there are more goods than corn. This is, in fact, correct. Once you have that the means of production and the surplus are not a single commodity you need a numeraire to sort out the problem, which brings about the problem of determining profits (distribution) independently from relative prices (value).

Ricardo’s solution in his Principles was the Labor Theory of Value, meaning to assume that relative prices were proportional to the amounts of labor directly and indirectly used in production. Lets say we have two commodities i and j, produced with a homogenous type of labor that is paid w and a normal rate of profit is obtained.

We have:

p_i = wl_i(1+r)
p_j = wl_j(1+r)

where l is the amount of labor used in production. Hence, the relative prices are proportional to labor ratios, since:

p_i/p_j = [wl_i(1+r)]/[wl_j(1+r)] = l_i/l_j

But Ricardo knew that his solution had a fatal flaw (and so did Marx, by the way). The problem is that once you introduce produced means of production it is not possible anymore to assume that relative prices would be exactly proportional to the amounts of labor directly and indirectly used in production. If for simplicity we assume that it takes time to produce the means of production, then we can re-write the price equations as:

p_i = wl_i(1+r)^ti
p_j = wl_j(1+r)^tj

where the superscript ti and tj stand for the time it takes to produce the means of production in sector i and j. Clearly relative prices would be proportional to labor incorporated if r=0 or ti=tj [that is, in Marx’s terms, no means of production or same organic composition of capital].

In any other situation you would have that prices depend on the proportion of labor to means of production, but also retroactively on the proportions of labor to means of production with which the means of production have been produced, or in the example above the time it took for the means of production to be produced [see paragraph 20 in PCMC, pp. 16-17 in the linked edition].

In general, you would have that some commodities would have a higher proportion of labor to means of production and some would have a lower proportion of the same ratio. Or, in terms of the example, some commodities would be above and some below the average time that would make prices proportional to labor. So in general there are surplus and deficit industries, with higher and lower proportions of labor to means of production in their production [see paragraph 17, pp.14-15].

Sraffa’s standard commodity is based on the possibility of building a composite commodity that would be produced in such a way that it would have the same proportion of labor to means of production than the means of production used in its production, and would be in the exact threshold between surplus and deficit industries [the proof that all prices systems have such a standard commodity is provided in a simple thought experiment in paragraph 37, pp. 30-31].

Note that the proportion of labor to means of production in the production of the surplus product, and in the production of the means of production could be measured in terms of the standard commodity, and, hence, as in Ricardo’s corn model, as a physical ratio independently from relative prices. Like the Ricardian (and Marxist) theory, the standard commodity implies that the rate of profit is determined by the material conditions of production and the need of reproducing the system, including the labor force. The amount of the surplus, or what is kept by workers, is independent of the determination of relative prices.

Not only is distribution determined by conflict, and the remuneration of capital is NOT dependent on the services rendered by ‘capital’ (the means of production) in the productive process, but also exploitation is possible and likely, since it is a common way of extracting surplus from society. Further, the standard commodity is perfectly compatible with a notion of a labor theory of value. Note that the standard commodity may command a certain amount of labor and as a result prices could be determined as ratios of labor commanded in a Smithian way [see paragraph 2, Appendix D, pp. 112].