On the blogs

Jean Tirole, A Practitioner Of New Industrial Organization -- Robert Vienneau discusses the new IO, based on game theory of the new 'Nobel' winner, and the old IO, which was based on the classical surplus approach and barriers to entry

Crony Capitalism, or Plain Old Capitalism? -- Arthur MacEwan dissects the right wing attack on the Export-Import Bank

These states, Part I and Part II -- Max Sawicky on how labor markets have done in States with gubernatorial elections

Solow on Greenspan's new book and the misrepresentation of the mainstream

Solow's review was published in the New Republic here (h/t Robert Vienneau). Solow has lost nothing of his ironic and acerbic style of criticism. As noted by Vienneau there is a great line at the end about Greenspan's mentor Ayn Rand:

"It is sometimes claimed that Alan Greenspan is a closet follower of Ayn Rand; he certainly had an early association with her circle. I got through maybe half of one of those fat paperbacks when I was young, the one about the architect. Since then I have found it impossible to take Ayn Rand seriously as a novelist or a thinker. In the past I have gone on the assumption that Greenspan’s ideas about economic life are his own, just what is contained in his writings, and the Ayn Rand question does not arise. But now there is this book, with its particular misinterpretation of mainstream economics, which might be thought to reopen the question if anyone is interested."

So basically he says Greenspan might be a crank after all. Yet, Solow has actually a couple of nice things to say about the old 'maestro.' For him, the injection of liquidity after the 1987 crash, and allowing the unemployment rate to fall below 6% or so (what most considered the natural rate) suggest that "it is only fair to say that he was a very good chairman of the Fed."

This in spite of his "two big mistakes." One mistake was allowing (I would say almost promoting) the housing bubble. The other, the relevant one for Solow, was his:

"deep-seated conviction that the unregulated financial system was self-stabilizing, that the self-interest of all those clever and experienced participants with a lot of their wealth at stake would keep the accumulation of risk within tolerable bounds. So he promoted deregulation and financial consolidation (as did others, of course) and, when this simple faith proved wrong, allowed disaster to strike."

If  being a monetary crank that shares responsibility for the deregulation of the financial sector and the current global crisis (let alone his role in the Bush tax cuts, or his promotion of cutting Social Security benefits) does not make him a terrible Fed chairman, I don't know what would.

Also, I think Solow is right, Greenspan does not represent well the more moderate New Keynesian mainstream. Yet, in many respects his sort of fringe radical right wing Ayn Rand version of the mainstream, like supply side and Austrian economics, is also part of the mainstream and shares several crucial elements. I would argue that the problem with Greenspan is NOT that he misrepresents the mainstream, but that his deregulation mantra is perfectly compatible with the mainstream. Lets not forget that Larry Summers (a New Keynesian that favors fiscal expansion and is concerned about the possibility of secular stagnation now) was during the Clinton era presiding over deregulation.

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.

Human Development Index: now and then

The new Human Development Report is out. It compares the 2012 Human Development Index (HDI) with the initial one, from 1990. Norway at the top, and Congo at the bottom of the list. As it turns out, only two countries, Zimbabwe and Lesotho, have seen their index scores fall. The chart below shows several countries (h/t The Economist).

The additional red dot, is the Inequality adjusted HDI (IHDI). Note also that in the case of Western European countries (Norway, Germany, Sweden, France, Italy, Britain) the IHDI is in between the 1990 and the 2012 HDI. So adjusted to inequality the HDI now is better than in 1990. That is not the case for the US. For the methodology for including inequality in the HDI go here.

The largest improvements in the index are Afghnistan (ravaged by a 10 year war with Russia when it started to be measured; and with significant transfers from the US now), China, Iran, India, and Egypt. Left of center countries in Latin America did reasonably well in the last 10 years.

The report suggests that: "the state of affairs in 2013 may appear as a tale of two worlds: a resurgent South—most visibly countries such as China and India, where there is much human development progress, growth appears to remain robust and the prospects for poverty reduction are encouraging—and a North in crisis—where austerity policies and the absence of economic growth are imposing hardship on millions of unemployed people and people deprived of benefits as social compacts come under intense pressure." Further, it argues that the number one driver of improvement in the Global South is a: "strong, proactive and responsible state [that] develops policies for both public and private sectors", since "governments can nurture industries that would not otherwise emerge."

PS: The HDI was developed by Amartya Sen, who also got the Sveriges Riksbank Prize. His work on the capabilities approach is based on social welfare theory and, while critical of the idea of rationality, in some aspects it remains founded in mainstream analysis. For a discussion of his critique of the mainstream and its relation to the one based on the surplus approach see the references provided by Robert Vienneau here. I remain skeptical about the compatibility of Sen's analysis with the old and forgotten classical tradition.

Confusion and the Failure of Marginalism

In my last post I briefly discussed the Austrian approach. One interesting point, discussed in more detail in the comments, is that several Austrians do not understand that they are neoclassical. Note that the core of neoclassical economics is the determination of prices, initially at least it was long-term prices, by the interaction of supply and demand.

I find a bit surprised that several neoclassical or marginalist economists do not understand the basics of their own theory. This confusion is compounded by the fact that several heterodox economists do not understand it either, and tend to be confused, as a result, on how they depart (when they do) from the mainstream.

I'll give you an example. If you think that prices (long-term normal prices, for those that think that these are analytically important) are determined by supply and demand, then you basically must believe that (with the exception of rigidities and other imperfections) full employment is the natural tendency of the system. Note that if prices are determined by supply and demand, the real wage in the long run would be determined by the supply and demand in that market, and given productivity and preferences you get full employment at the equilibrium real wage.

The failure of some mainstream and heterodox economists to understand the neoclassical approach, in my view, stems from the collapse of the marginalist project after the capital debates (not of its dominance, but the ability to provide coherent responses to the critics). Robert Vienneau has a very good post on the failure of neoclassical economics. Worth reading.

Nick Rowe on Reswitching and the Capital Debates

Nick Rowe gives a shot to the capital debates, which is a nice development indeed. [Robert Vienneau has a lenghty reply here.] In spite of the importance of the topic, and the previous engaging of mainstream economists like Samuelson, Solow – to cite two prominent ones – the topic has all but vanished from modern mainstream economics, with a consequent loss of understanding.

Let me clarify a few things before we get to Nick’s post. As I argued in a previous post, classical authors (e.g. Smith, Ricardo and Marx) understood that they needed to determine the rate of profit independently from relative prices to avoid circular reasoning. The Labor Theory of Value (LTV) provided a solution. Prices were determined by labor incorporated (or commanded for Smith) and profits, and the surplus, were determined on that basis [Sraffa’s solution to the problems with the LTV build on Ricardo’s use of a commodity, corn, to measure the profit rate as a ratio of two physical quantities]. However, most neoclassical/marginalist authors today are completely oblivious to the fact that their theory too must deal with the independent determination of the rate of profit and relative prices, and that this is problematic if you also accept the notion of a uniform rate of profit (a natural rate of interest).

Also, and before I show why the problem is a general one, that any theory has to deal with it is essential to note that the rate of profit and the rate of interest must be in the proverbial long run (when everything is flexible and there is no ceteris paribus) in equilibrium. That is, either the rate of interest adjusts to the rate of profit (the position taken by Ricardo and Wicksell, which called the real variable the natural rate of interest), or vice versa (as Tooke and Sraffa believed; Marx and Keynes pose more problems to be clearly defined, but I would put them in this camp too).

In the case of neoclassical economics, if you want to determine the natural rate of interest by the interaction of the discounted profitability of investment and the intertemporal savings (i.e. consumption) decisions of agents, you must be able to bring the gains to present value (as in the examples provided by Nick). That means that the discount rate (to bring the investment schedule to present value) must be known, while the rate of interest you want to determine requires knowing the value of investment (the demand for capital goods). Thus, we encounter the circularity of the determination of the natural rate of interest in the Loanable Funds Theory, noted by Joan Robinson long ago.

Note also that the process implies that the rate of interest (which in equilibrium is equal to the rate of profit) is a variable that is determined by intertemporal decisions, which must equalize the rate of profit associated with the production of capital goods (i.e. produced means of production). What happens if, as Nick suggests, “There isn’t just one future period; there are many future periods.” Nothing much really happens, since for all those possible future periods, there must be a uniform rate of profit. For several different capital endowments, or several different sets of preferences (which seems to be what Nick has in mind), the interaction of investment and savings will solve for the rate of interest. But the inconsistency is still there.

But really what Nick is suggesting is that one might have a multitude of interest rates (which he refers to as the term structure, but think more of a term structure of interest rates associated with different capital goods, rather than financial ones, even if you do have monetary rates too). In fact, that is exactly what the mainstream did, when they changed the notion of equilibrium, as noted by Garegnani in his 1976 paper. It was only then, after the capital debates, that the Arrow-Debreu (AD; not Anno Domini) intertemporal general equilibrium notion became dominant. In that case you must give up the notion of a uniform rate of profit. Note that you cannot have both (in his replies to my comments Nick seems to believe that you can have it both ways; scroll down for the various comments which are worth reading I might add).

Nick says:

“I hadn't realised, until I read your comment just now, that *maybe*, when some people talk about “uniform rate of profit”, they mean something very different to what I thought they meant. I thought they meant: A uniform rate of profit across different industries (adjusting for or ignoring risk). But you seem to mean: A uniform rate of profit across different periods of time (i.e. a flat term structure). I would say that arbitrage is what creates a uniform rate of profit across different industries (or different assets). I would say that *nothing* creates a uniform rate of profit across different periods of time. The term structure is not (in general) flat. It could slope either up or down, or wiggle around. Even if we are talking about Wicksellian “natural” rates of interest. E.g., if everyone wants to go on a big consumption binge every 7 years, and fast for the remaining 6 years, (and if everyone knows about this), we are in general going to see a big spike in the term structure at 7 year terms.”

So let me clarify what I mean. Capital goods, the produced means of production, are an heterogeneous set of goods, but if one believes in competition (in the classical sense of free entry) then one must believe that a uniform rate of profit on the supply price of those goods will be established (not as a real world phenomena, but as a tendency; the long run is a theoretical construct). So what is established by free entry (and not arbitrage, which would be associated with the equalization of prices in an exchange economy) is a uniform rate of profit across sectors.

So what does that mean about the term structure? First, the term structure of monetary rates (i.e. the Fed Funds versus the ten year Treasury bonds) depends on the actions of the central bank, among other things (and I’ll let that for another post; mind you as you see I tend to think the monetary rates rule the roost, as Tooke and Sraffa). Nick is talking about the real or natural rate, having for reasons associated with the demand (the preferences about consumption in the future) different levels. That is, there would be more than one natural rate, associated with different preferences regarding consumption [echoes of the Sraffa-Hayek debate about the existence of several own rates of interest perhaps].

Yet, the point still is whether you have competition (free entry) or not. So if more people, as in Nick’s example, want to consume more in 7 years, wouldn’t the supply of capital adjust, to provide more in that year allowing for the consumption binge, and reduce the gains associated with providing more goods in that period? After all there is no reason for profitable opportunities, unless there are imperfections (e.g. lack of capital mobility or lack of information, which does not seem to be what Nick is arguing, since he says that "everybody knows"), to be left unfulfilled. The intertemporal nature of the decisions, meaning the decisions are being made now with all the information available about the future, does not affect the equalization of the rate of profit (interest). So competition should also lead to a uniform rate of profit not across different periods of time, but now for different states of preferences and the capital endowments (and technology of course).

Hence, the existence of a myriad of capital goods, or changing preferences (or technological change, which used to be the one that the capital debates concentrated more), do not per se justify abandoning the notion of a long term uniform rate of profit. That is what the AD model does. In the process it abandons the classical notion of competition (free entry) for one that has less meaning from the point of view of understanding capitalism (atomistic agents that are price takers; both links to the New Palgrave require subscription I'm afraid).

Note that the centrality of the results of the capital debates is that one cannot say that changes in relative prices govern decisions about the allocation of resources in any clear way. Not only capital will not be used more intensively with lower rates of interest (even if lower rates of interest may stimulate other forms of demand, not capital, and eventually lead to more demand for means of production), but also lower real wages (the relative price of labor force) might not lead to higher employment. Think of the policy implications of this result for Europe now.

But let me finish saying that beyond the differences we might have, real or of interpretation (and I think both things play a role), I think it is important to thank Nick for thinking about the relevance of these issues and taking them seriously, which can only lead to clarify differences and provide a better understanding, if not of the real world, about what economists think about the real world. And that is a step in the right direction.

More on Sraffa and the theory of value and distribution

Two posts by Alejandro Fiorito, at the Revista Circus blog, and Robert Vienneau follow up my previous post on Sraffa and the Labor Theory of Value (LTV). The former is on the debate between Garegnani and Samuelson, just published in a book edited by Heinz Kurz. Garegnani, who debated with Samuelson since the latter's seminal paper on the production function as a parable back in the early 1960s, basically argued against the notion that Sraffa's system can be seen as a special case of Walrasian General Equilibrium, which was ultimately Samuelson's position.

Vienneau discusses several issues. One that I think it's particularly relevant is Steedman's view that one might have a positive profit rate and negative aggregate surplus value. Serrano and Lucas (not that Lucas!) have written a paper on the subject which suggests that Steedman's counterintuitive results are basically irrelevant. At any rate, as noted by Robert, "Marxist political economy should remain a live and exciting field of scholarly research," and this is to a great extent possible because of Sraffa's legacy.

Sraffa and Marxism or the Labor Theory of Value, what is it good for?

An old, but not completely closed, debate revolves around whether Sraffa was a Marxist or instead he should be seen as Ricardian, hence the term Neo-Ricardian used derisively by Bob Rowthorn (subscription required) and other Marxists authors (and also by Frank Hahn, again subscription required). From a personal point of view there is little doubt that Sraffa identified with Marxism, and close friends like Antonio Gramsci and Maurice Dobb would agree. But the important question is whether his contributions in Production of Commodities by Means of Commodities (PCMC) should be seen as a development or a criticism of Marx's theoretical tradition.

For the most part the question revolves around the relation between Sraffa's prices and the labor theory of value. Several authors tend to believe that the latter theory is central for Marx's theory of exploitation. Recent interpretations such as the so-called New Interpretation (NI) and the Temporal Single System (TSS) would agree on that point.

For example, Foley and Duménil (2008; subscription required) argue that:

"Central to Marx's framework of analysis in Capital is the labour theory of value (LTV), which defines the value of a commodity as the ‘socially necessary’ labour time required by its production, that is, the labour time required by average available techniques of production for workers of average skill. 

The LTV is central to Marx's theory of exploitation, a term he uses to describe a situation in which one individual or group lives on the product of the labour of others."

On the similar claims by the TSS Marxism see Mongiovi (2002; subscription required). [Vienneau provides a list of readings on the TSS topic here.]

The question then is what was the role of the labor theory of value in Marx and the classical authors, i.e. for the surplus approach. The initial problem that Smith was trying to deal with the LTV was to determine the rate of profits independently of prices, since profits were considered essential for capital accumulation. Note that one needs the prices to determine profits, in particular the price of the means of production advanced for production, but one needs the rate of profit (the normal uniform rate of profit) to determine long term normal (or production) prices.

Smith (1776, book I, chapter 6) makes the value of commodities depend on the quantity of labor required to produce them is where there has been no accumulation of capital or land. In his words:

"In that early and rude state of society which precedes both the accumulation of stock and the appropriation of land, the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another."

But when profit and rent make their appearance alongside the worker's income, the rule is no longer applicable. The price of a commodity is then obtained by 'adding up' its component parts, namely: wage, profit and rent. The adding up theory implied that profits and wages had an independent determination. Hence, if profits went up, and prices too, real wages might not decrease. As a result, one cannot determine profits independently of prices.

Ricardo saw the limitations of the adding up theory. In his early writings he solved the problem by presuming that the economy produced corn (grain) with corn and labor, and the surplus was a physical amount of corn, so the rate of profit could be measured as ratio of corn (the surplus) to corn (the means of production advanced for production). He, then used, the labor theory of value as an approximation to the solution in his Principles, knowing that prices were not exactly proportional to the amounts of labor directly and indirectly used in production.

That was, also, essentially the role of the LTV in Marx's volume I of his masterpiece Capital. That is, the LTV allows Marx to determine the rate of profit independently of prices. Note that Marx was also aware that relative prices determined by the amounts of labor directly and indirectly incorporated are incorrect once you have produced means of production. However, Marx thought that embodied labor redistributed by the process of competition meant that in the aggregate total surplus value  corresponded to total profits, even if prices of production deviated from embodied labor. As a result, on the basis of the LTV it was still possible to obtain the correct rate of profit. As it turns out, there is no reason for positive and negative deviations of prices of production from the labor values to cancel out. You cannot argue with the algebra.

Marx had no way of knowing this. Only with Bortkiewicz, Dimitriev and Tugan-Baranovsky's work, early in the 20th century, this was clearly understood. If in general commodities do not exchange at labor values, then there is no reason why that should be correct for two composite commodities that make the total physical surplus and the physical advanced means of production.

Sraffa's solution, based on the standard commodity (to be discussed in another post), shares with Ricardo's corn model the idea that one can measure the rate of profit as a share of a particular commodity (Sraffa's being a composite commodity, that is, composed of several goods). It also shares with Ricardo the fact that only basics (commodities that enter the production of all goods including their own production), which for simplicity can be related to subsistence goods, affect the rate of profit, while non-basics, or luxury goods, are not relevant. Further, as noted by Sraffa too, his solution resembles Smith's since the standard commodity can be seen as akin to the former's idea of labor commanded, that is relative prices are proportional to the amount of labor that they can command (buy). In that sense, Sraffa's prices are firmly based on a certain notion of the labor theory of value.

Mind you, in the central issues Marx's theory was correct. Once you determined exogenously the real wage, and the technical coefficients of production are given, one can determine the rate of profit, and it is inversely related, everything else constant, with the real wage. Hence, the theory of distribution based on class conflict which is the central element of the surplus approach, including Marx, is logically consistent [which is more that can be said about marginalism, as showed by the capital debates].

But does the Sraffian system mean that exploitation as interpreted by Marx is not valid anymore, since, as noted above, some Marxist authors think that the LTV (narrowly interpreted as prices of production proportional to embodied labor) is essential for that part of the Marxian project? Petri (2012)* has published an excellent review of the limitations of the NI and TSS. He clearly states (p. 3) that:

"The proof that labour is exploited, in particular, does not lie in the validity of a quantitative correspondence of surplus exchange value with surplus labour time; this is a misconception that derives from a mistaken acceptance of the argument that the inability to prove such a correspondence might mean that the capitalists contribute to production, that profits reflect their contribution, and that this is the reason why commodities do not exchange in proportion to labours embodied – the argument of the ‘vulgar’ economists and then of the marginalist critics of Marx" (emphasis added).

Why is that the case that there is no correspondence between the LTV and whether labor is exploited or not? Note that for Marxists this is a necessary condition because workers work more time than what is needed for their reproduction, and that is the supposed basis for exploitation. It is worth quoting Petri at length here:

"Imagine an isolated market economy where production is carried out by self-employed artisans and cooperatives, and the rate of profit is zero: prices of production are proportional to labours embodied. One day Gengis Khan’s army invades this community, but instead of killing everybody Gengis Khan announces that he will be content with collecting a yearly monetary tax at a rate r=20% on the value of the capital employed in each productive activity, a tax he will then use to buy goods on the market. The community is obliged to accept, and prices of production come to include a 20% tax on the value of capital which has the same effect on relative prices, and on real wages, as a 20% rate of profit. Relative prices are no longer proportional to labours embodied, Marx’s r=S/(C+V) does not work, but production is still performed by the same labourers, and the goods appropriated each year by Gengis Khan with the income deriving from the tax do not reflect any productive contribution of the oppressors. One would have little hesitation, it would seem, to say that Gengis Khan is exploiting this community. But if Gengis Khan had imposed the tax as a given percentage of wages, with the rate of profit remaining zero, then relative prices would have remained proportional to labours embodied, but exploitation would be still there. On the other hand, imagine that the 20% tax rate on the value of capital is imposed not by Gengis Khan but by unanimous popular vote because it is decided to use it to help for some years another community struck by an earthquake: in this case the surplus product would again be associated with an impossibility to explain prices with the labour theory of value, but few would call the surplus product the fruit of labour exploitation. All this shows that the proportionality or non-proportionality between exchange values and labours embodied reflects, not the absence or presence of other productive contributions besides that of labour, but only the specific way the mode of appropriation of the surplus product affects relative prices; the origin of the surplus remains to be ascertained" (emphasis added).

Hence, as the simple example shows one might have exploitation without the LTV, and no exploitation with the LTV, which should be a black swan for those that think that Marxism stands or falls with the narrow definition of the LTV. For our purposes what matters is that the correct solution of the problem of the determination of the rate of profit independently of prices, provided by Sraffa, actually strengthens and is a development of the theories of Marx and the other authors of the surplus approach. Sraffa is the author that makes Marx's conclusions possible.**

Notes:

* Petri provides a critique of NI and TSS solutions of the transformation problem too. A different solution, that is more Ricardian in assuming that embodied labor provides a good empirical approximation to production prices, is provided by Shaikh (1977).

** Interestingly Petri quotes several passages in which Foley tends to suggest that Marxism and marginalism are not necessarily incompatible.

References:

Foley, Duncan and Gérard Duménil (2008). "Marxian transformation problem." The New Palgrave Dictionary of Economics. Second Edition. Steven N. Durlauf and Lawrence E. Blume. (eds.), The New Palgrave Dictionary of Economics. Palgrave Macmillan.

Mongiovi, Gary (2002). "Vulgar Economy in Marxian Garb: A Critique of Temporal Single-System Marxism," Review of Radical Political Economics, 34(4), pp. 393-416.

Petri, Fabio (2012). "On Recent Reformulations of the Labour Theory of Value," Quaderni del Dipartamento di Economia Politica e Statistica, Università degli Studi di Siena, No. 643.

Shaikh, Anwar (1977). "Marx's Theory of Value and the Transformation Problem,"in Jesse Schwartz (ed.), The Subtle Anatomy of Capitalism. Goodyear Publ. Co.

Three things you thought you knew about economics

Great post by Robert Vienneau who correctly claims that the three propositions below are well-established, namely :

"1. Adam Smith did not use the phrase "The invisible hand" to refer to the optimality properties of a static general equilibrium supposedly brought about by the workings of competitive markets. 

2. Thomas Carlyle did not coin the phrase "The dismal science" to refer to Thomas Malthus's anti-utopian theory of population. According to that theory, human population responds endogenously to increased prosperity, thereby making impossible any rapidly established, long-lasting general rise in per capita income beyond the custom and habits of mankind. 

3. John Maynard Keynes, in The General Theory of Employment, Interest, and Money, did not explain widespread and persistent unemployment by sticky, rigid, or slowly adjusting money wages and prices - a pre-Keynesian theory that, in fact, he opposed. Many economists, I claim, teach the opposite of these propositions. 

(...) 

It seems to be a quixotic and never-ending task to oppose demonstrably false statements about economics, often made by economists."

It is absolutely true. I would even say the majority of economists teach the opposite. I have insisted more on 3 here, but 1 and 2 are equally true, and 1 at least as important as 3. I should probably use this in my history of thought lectures from now on.

Monetization of debt: what does it do? Krugman and Rognlie on MMT

Again in a previous post I suggested I would deal with the issue, which seems to be apropos, since there has been a certain discussion in the blogosphere about the so-called Modern Monetary Theory (MMT) approach (see here, here and here). First, I should clarify that the discussion to which I refer tends to conflate two different issues. One is the question that I will deal here, what are the constraints faced by the government in managing its budget, and the approach associated with MMT in this case is basically what used to be called functional finance, a tradition that harks back to Abba Lerner and Evsey Domar, and to which Keynes eventually agreed.

The other issue is related to the causality between money and economic activity, and is part of what in more modern times has been called endogenous money. The debates on this issue are older than the Bullionist/Anti-bullionist and Currency/Banking schools, and in modern times the endogenous money (anti-bullionist-banking) view was developed by Nicholas Kaldor and Basil Moore among other names. The reason the two issues tend to be conflated is that printing money is one way to finance government spending, and there is a traditional connection between sound finance and monetarist (exogenous money) views.

First, it is clear that if debt is denominated in domestic currency default per se is NOT possible, simply because the government can always monetize the debt. So the question is not whether the government has a budget constraint (what’s the meaning of a constraint if you can print money anyway), as Matt Rognlie says (he gets worked up by this, and affirms that: “MMT is wrong on money … The government does have a budget constraint”). Unless he denies monetization of debt is always possible (there might be political problems, but it is technically possible) in domestic currency, he needs to explain what is the constraint. Otherwise the question is really related to the consequences of monetization. By the way, that is the same confusion made by Krugman. He says:

“As I understand the MMT position, it is that the only thing we need to consider is whether the deficit creates excess demand to such an extent to be inflationary. The perceived future solvency of the government is not an issue.”

Again, what could be the solvency issue if the debt is denominated in a currency that the government controls? He may have issues with the consequences of printing money, but not with the fact that money can be printed. So solvency is NOT, and cannot be an issue. What are the consequences of monetizing debt then?

Long ago the authors of the Banking school (e.g. Thomas Tooke) noted that if more money is pumped into the system agents would spend the money or pay their debts (the second case is known as the reflux mechanism). If they pay previous debt, the money has no effect on the level of activity. On the other hand, if they spend and firms have extra capacity output must increase. Note that firms normally have extra capacity, and can produce more at the same price, contrary to the textbook (U-shaped) cost curves.

But what if the economy is at full capacity? Then it is clear that excess demand may have an impact on prices (or, if instead of monetization, the government prints more debt agents may demand higher rate of interest to hold it). The question then is whether the economy is at full employment and what determines full capacity, not whether monetization is always inflationary (which clearly would only be the case if the economy was always at full capacity; unless Krugman and Rognlie agree with Lucas, this could not be the case for them).

However, note that it has been accepted that the supply constraint is variable (the mainstream refers to it as the Time Varying Non Accelerating Inflation Rate of Unemployment or TV-NAIRU). The important question regarding monetization is what determines this supply constraint that imposes an inflation barrier to demand expansion, what Friedman referred to as the natural rate of unemployment (note that natural was meant to suggest that policy cannot affect it).

Here it is also important to note that one component of demand, investment, does have an impact on the supply side. In other words, investment has a dual effect, it is a component of demand (more sales of equipment) and it creates more supply capacity in the future (when the equipment is installed). So, as the economy grows, firms try to adjust their capacity to demand, so as to keep up with the economy, and avoid loosing market share to competition. This suggests that one of the reasons for the variation of the supply constraint is the expansion of demand itself.

It should be noted that this does not mean that the supply constraint is never reached, but it is clearly a rare phenomenon. The graph below shows unemployment in the United States from 1929 to 2011. Only in four occasions did the annual average unemployment fall below 4%, in the mid-1940s, the early 1950s, the late 1960s and the late 1990s (all during Democratic administrations, by the way, with the exception of 1953).

Inflation did accelerate in the first three, when the economy, because of war efforts (WW-II, Korea and Vietnam), was most likely close to full employment (I’m more skeptical about the 1960s, since inflation really picks up in the 1970s, and oil shocks where more important than full employment), but not in the last. Even in those cases, only in the first public debt was actually growing, and the size of the deficits (more than 20%) was incredibly large.  Interest rates did not increase significantly in any of these episodes either (this seems to be Rognlie bone with MMT).

This is the evidence that is used to suggest that governments have a constraint and beyond that inflation ensues? And that is taken as serious thinking on money and deficits! I would agree with Robert Vienneau that this is “unjustifiably arrogant” dismissal of MMT, to say the least.  Part of what I have referred to as the incredible persistency of monetarist views (even among more progressive economists).