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.

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.

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

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

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

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

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

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

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

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

In his words:

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

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

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

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

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

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

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

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

Sraffa's contributions to economics: a crash course

So a friend asked what to read in order to understand Sraffa's contributions to economics. For some reason the Production of Commodities by Means of Commodities is considered a very difficult book to read. I find that a strange argument. It is similar to the notion that the General Theory is a badly written book, as in difficult to follow (not necessarily the content, but the style), since supposedly Keynes was not a good writer (he actually was a bestseller author, at least his Economic Consequences of the Peace, and a prolific writer for the general public, meaning clear and popular).

Sraffa's book explains in plain English most of the essential concepts in his book. I would suggest the reading Part I as one that can be taken without any problem for those with some basic training in linear algebra. In addition, below I'm posting the links to 7 previous posts on Sraffa's contributions to economics, which might be helpful for some.

1. Sraffa and the Marshallian System
2. Sraffa, Marx and the Labor Theory of Value (LTV)
3. Sraffa, Ricardo and Marx
4. The Standard Commodity and the LTV
5. The Capital Debates
6. Microfoundations of Macroeconomics and the Capital Debates
7. Free Trade and the Capital Debates

Note that these posts were not written to provide a didactic introduction to Sraffa's economics. Yet, one can follow from them Sraffa's critique of marginalist economics (in the Marshallian tradition) in 1, the relevance of his contribution for the revival of Marx and of a modified Labor Theory of Value in 2, and how that does not make him Ricardian (meaning anti-Marxist) in 3, how he solves the limitations of the LTV and provides a version of it with the Standard Commodity in 4, how his contributions undermine the internal logic of marginalist (supply and demand) arguments in the capital debates in 5, how the capital debates are central for macroeconomics in 6, and how the capital debates have direct relevance for a simple policy issue like free trade in 7 (for those that think that Sraffians don't care about economic policy).

If I had to suggest books to read on Sraffa's contributions, I would say that Pasinetti's Lectures on Theory of Production, and Kurz and Salvadori's Theory of Production are the essential books. For a more macroeconomic oriented book the one would be Bortis' Institutions, Behaviour and Economic Theory.

On Karl Polanyi and the labor theory of value

The other great transformation

I have discussed Polanyi on the blog before, but not in great detail (see this video posted a few years back from Fred Block for a more in depth discussion). However, writing about Bob Heilbroner's views of economics, and in particular the labor theory of value, reminded me why I have reservations about Polanyi, something that often surprises my friends, since I often cite some of his ideas, and I did put his book on the Top 10 list.

Polanyi has been, indeed, one of the most influential social scientists of the 20th century, even if economists never read him. His notion that markets are embedded in society has been used by political scientists and sociologists to understand the rise of neoliberalism, and the policies of austerity that have had incredible social costs (e.g. Mark Blyth's book Great Transformations). In part, the increasing formalization of economics made his work less popular among economists, proving that Boulding was right when he said that math brought rigor to economics, but it also brought rigor mortis.

The main thesis that free market capitalism leads to unstable political situations, and that this, in turn, would lead to coalitions that restraint and regulate markets, seems to have been vindicated, even if he did not get much recognition when the book was originally published. However, in spite of being a central an relevant author, many of his conclusions suffer from accepting an incorrect view of classical political economy, and ultimately his support for the mainstream (marginalist) theory of value.

He clearly believed, as did many, if not most, economists before the re-edition of Ricardo's works by Sraffa and his later rehabilitation of a version of the Labor Theory of Value (LTV), that classical authors were confused, and were essentially precursors of the neoclassical mainstream. He tells us:

"Apart from some special theories like that of rent, taxation, and foreign trade, where deep insights were gained, the theory consisted of the hopeless attempt to arrive at categorical conclusions about loosely defined terms purporting to explain the behavior of prices, the formation of incomes, the process of production, the influence of costs on prices, the level of profits, wages, and interest, most of which remained as obscure as before."

And there should be no doubt that to a great extent the mistakes of classical authors, in Polanyi's view, were associated with the LTV. He says just before the above passage that:

"Although Adam Smith had followed Locke’s false start on the labor origins of value, his sense of realism saved him from being consistent. Hence he had confused views on the elements of price, while justly insisting that no society can flourish, the members of which, in their great majority, are poor and miserable." [Italics added]

And it is also clear that he adhered to some vulgar version of the marginalist supply and demand story for value. Again in his words, from the his classic book, The Great Transformation:

"Economic value ensures the usefulness of the goods produced; it must exist prior to the decision to produce them; it is a seal set on the division of labor. Its source is human wants and scarcity." [Italics added]

In other words, relative value depends on demand (human wants) and their limited supply (scarcity). Given his background, and the mainstream authors he quotes, Polanyi basically believed in some version of marginalism, perhaps with Austrian undertones.

His bias in favor of neoclassical economics is also evident in his insistence that the beginning of capitalism* can be associated with the organization of the three markets that correspond to the factors of production, namely: labor, land and money (capital), and the implicit notion that the production is a linear process that goes from the factors to final output, in contrast with the classical view of a circular process, in which commodities where produced by means of commodities.

Polanyi was certainly sympathetic to Marx, but he clearly missed a lot, given the marginalist foundations of his analysis. He associated classical political economics with a naturalistic philosophy that tried to explain human behavior in terms of natural causes, and that imposed an extraneous logic to social relations. In view:

"naturalism haunted the science of man, and the reintegration of society into the human world became the persistently sought aim of the evolution of social thought. Marxian economics—in this line of argument—was an essentially unsuccessful attempt to achieve that aim, a failure due to Marx's too close adherence to Ricardo and the traditions of liberal economics."

So Marx wasn't a minor Ricardian, as Samuelson later famously put it (perhaps he was a major one for Polanyi), but his problem was the adherence to the Ricardian LTV.

I should note that Polanyi tends to think and judge classical and neoclassical economics from the point of view their economic policy prescriptions, and the idea of laissez faire, or what is referred to as liberalism in Europe. That is probably also the reason why Veblen coined the term neoclassical, which also gives the incorrect impression of continuity between both schools.

There is a lot that is valuable in Polanyi's analysis, but the problem is that he accepts the notion that prices are determined by supply and demand, and that implies that markets produce efficient outcomes in the marginalist sense of efficient allocation of resources (on the problems of the marginalist theory of value see this post on the capital debates). He does not seem to grasp that the classical notion of competition and long term equilibrium prices did not require optimality in the allocation of resources. Even if Polanyi is critical of the idea that in reality a pure market economy is stable, and even if he insists that free market policies led to a backlash from the losers that required a safety net to reduce the negative impact of market outcomes on society, it is still true that markets are about efficient allocation of resources in his view.

For classical political economists markets were an institutional framework for the reproduction of the material conditions of society, and for the process of accumulation. In the classical framework, equilibrium prices are not the ones that show the relative scarcity of goods and services on the basis of preferences, and limited resources. Normal (natural in Smith and Ricardo, production in Marx) prices are the ones needed to reproduce society. The overall state of preferences were taken as given, something determined by broad institutional and historical circumstances and not something to be formalized.

This matters exactly because the classical long term prices require that one distributive variable be determined beforehand. In other words, with real wages set at the subsistence level, something that was seen as historically and institutionally established in their time, the technical conditions of production (amounts of labor needed to produce, in the simplest version) were sufficient to determine normal prices. This view is actually perfectly compatible with Polanyi's notion of the embeddedness of markets, the idea that labor markets are social constructs and that rules, regulations and other institutional features are central for the creation of markets. In a sense, markets do not just appear out of thin air, in self-organizing fashion.

In other words, what Polanyi documents with this discussion of the expansion of the franchise in Britain in 1832, and the new Poor Laws established in 1834, is not the creation of the labor market as described by neoclassical theory (and that's exactly and incorrectly what he suggests). The institutional changes describe the full and final move from one set of regulations, still resulting from the more paternalistic system that came from pre-capitalist times, to a more punitive system for the working class. What was planned was not laissez faire in the labor market, but less protections to reduce the workers bargaining power. Workers resisted, but only much later, when their voice had a stronger political outlet (mostly with the rise of Labour), they could push back and regain some degree of bargaining power. Polanyi was partially correct, in saying that: "While laissez-faire economy was the product of deliberate State action, subsequent restrictions on laissez-faire started in a spontaneous way." However, it required taking over, to some degree, the State to bring about the Welfare State. Laissez-faire was planned, for sure, but planning was too.

Classical political economy actually allows one to understand that, since in the surplus approach there is no labor market that is regulated by supply and demand and determines both the real wage and the quantity of employment. Polanyi would have been under much stronger foundation if he understood the role of institutional and historical factors in classical political economy.** The reason that there was a backlash about laissez faire policies is that markets do not produce efficient allocation of resources, something Smith, Ricardo and Marx understood. Keynes' tried to explain why the neoclassical labor market theory was incorrect too. And here too Polanyi, writing just eight years after the publication of the General Theory, has nothing to say about it.

But as much as Polanyi neglected and misinterpreted the works of classical political economy, the same is true of heterodox groups that have brought back the ideas of the surplus approach. And heterodox economists should pay more attention to Polanyi's work and the idea of the embeddedness of markets on a broader social framework.

* To be precise he suggests approvingly that “the Reform Bill of 1832 and the Poor Law Amendment of 1834 were commonly regarded as the starting point of modern capitalism.” In other words, the labor market is at the center of his view of capitalism. Compare this with a Marxist discussion of modes of production that also puts labor relations at the center.

** Polanyi incorrectly suggests that Smith accepts the wage-fund doctrine, a precursor of supply and demand theories, which certainly was developed much later, with Stuart Mill, a transition author, that had already departed from Ricardian economics.

60 Years of Sraffa's Production of Commodities by Means of Commodities/ROKE Webinar

Tomorrow we will talk about this book that is the Rosetta Stone of the history of economic ideas (read post 6 below for more on that). I'm happy to have a great panel to discuss it. In the meantime below 7 previous posts on Sraffa's contributions to economics, which might be helpful for some.

1. Sraffa and the Marshallian System
2. Sraffa, Marx and the Labor Theory of Value (LTV)
3. Sraffa, Ricardo and Marx
4. The Standard Commodity and the LTV
5. The Capital Debates
6. Microfoundations of Macroeconomics and the Capital Debates
7. Free Trade and the Capital Debates

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.

On the blogs - Labor Theory of Value (LTV) Edition

Marx’s Refusal of the Labour Theory of Value-- David Harvey on Marx and the LTV

Marx’s law of value: a debate between David Harvey and Michael Roberts-- Michael Roberts reply to the post above (Harvey's further response is also linked)

Sraffa and Marxism or the Labor Theory of Value, what is it good for?-- old post by yours truly, which I offer (for now) in lieu of an actual post on the above debate, since I think there are problems with both views

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.

Economics without Gaps: on Ibn Khaldun and non-Western traditions in the history of ideas

Ibn Khaldun, Arab scholar

A piece* from a few years ago, has again become somewhat popular and it has been making the rounds. It suggests that the Arab scholar Ibn Khaldun developed the ideas of classical political economics in the late XIV century, about half a millennia before Adam Smith, often seen as the father of classical economics, and of modern economics. Some would suggest that Khaldun was the real father of economics (or stepfather in the first essay on top). To a great extent, the discussion of the role of non-western scholars tries to show that an Eurocentric bias has dominated the history of economic thought. This discussion goes hand in hand with the notion that the Rise of the West and the so-called Great Divergence are relatively recent phenomena.

There are many elements in that assessment that are correct. Schumpeter's massive History of Economic Analysis does mention Khaldun in passing on his discussion of historical sociology, but he also argues that between the ideas of classical antiquity and scholastic thinking there was a great gap.** In his words: "So far as our subject is concerned we may safely leap over 500 years to the epoch of St. Thomas Aquinas (1225–74), whose Summa Theologica is in the history of thought what the south-western spire of the Cathedral of Chartres is in the history of architecture." There is little recognition of the role of Arab scholars in maintaining and expanding the knowledge of classical antiquity in almost all fields. And in the field that eventually would be associated with political economy, Khaldun's Muqaddimah, or Introduction (or Prolegomena), does indeed provide significant progress over the work of classical antiquity.

His work essentially deals with the cyclical rise and fall of caliphates, and analyzes the material conditions for these historical circumstances. Robert Irwin in his intellectual biography of Khaldun, reminds us that: “Arnold Toynbee, who produced a twelve-volume study of the rise and fall of civilizations, described Ibn Khaldun’s theoretical treatise on history, the Muqaddima, as 'undoubtedly the greatest work of its kind that has ever been created by any mind in any time or place'.”

However, while all of that is correct, and should lead to a more encompassing understanding of the role of non-western economic thinking, it is also important to bear in mind what was the contribution of Ibn Khaldun, how it fits in the history of ideas, and also in what sense classical political economy authors have an original theoretical framework. That tradition, it is worth noticing starts really with Sir William Petty, not Smith, as noted by whom I would suggest is the first serious historian of economic ideas, Karl Marx, in his Theories of Surplus Value. Furthermore, it is important to be careful and avoid the normal confusion of seeing Adam Smith as the father of modern, meaning marginalist (or neoclassical), economics. As a general principle, I would also be critical of the notion that the history of economic ideas is the repository of old versions of modern economic theory, that have to be deciphered and understood in modern guise. It was exactly this kind of thinking that led many marginalists, like Alfred Marshall, to suggest that they were expanding on the ideas of classical authors like David Ricardo, when in fact they were subverting them.***

I would suggest that there are two important differences between Ibn Khaldun and the Anglo-French tradition of the surplus approach, associated with the Petty-Cantillon-Quesnay-Smith-Ricardo (and I would add Marx; on the first three that form the basis for the work of the surplus approach see this chapter by Tony Aspromourgos) line of evolution. First, while Khaldun is interested in the cyclical rise and fall of civilizations, associated to the sedentary, urban, mercantile caliphates bordered by nomadic, desert populations, Smith developed at the same time and independently from Turgot (on that see Ronald Meek), a linear four stage theory of economic development, from hunting (and gathering), to pastoral, then agricultural, and finally commercial societies, which is the term he used for societies like the England of the time, were manufacturing activities and financial relations were significantly developed. These ideas would lead to Marx's materialist conception of history based on the notion of modes of production, evolving from ancient slavery and feudalism to capitalism.

It seems that while a perception that, what we now call, the social sciences are historical in nature was clearly in Khaldun's writings, the conception of history, and the scope of the analysis was different than the one in Smith. The reason is not only related to the fact that Khaldun was writing in the Middle Ages, before the rise of capitalism, but also, and more importantly it seems, Khaldun was looking at the specific circumstances of Arab societies, even if there were universal lessons in his analysis. The evolution from hunter-gathering to agriculture and to manufacturing are more universal. Further, Marx's conception of modes of production emphasizes the method and the social relations of production by which surplus is extracted from workers. Command and coercion in the context of slave and feudal societies, and market relations in the case of capitalism.

The second difference is related to the notion of surplus, and the source of value. It is true that there was a notion of a surplus beyond what is needed for survival in Khaldun's work, and that it allowed in his view for crafts and division of labor, or specialization, as would be discussed by classical authors much later. And there was also a clear sense that labor was the source of value, and that a producer must cover the costs of production. Some have argued that one can see the labor theory of value (LTV) in Khaldun's writings. However, it is clear that the conception of profits and of prices in Khaldun was not in conformity with the LTV.

He argues in chapter 5 of the Muqaddimah that: "Commerce is a natural way of making profits. However, most of its practices and methods are tricky and designed to obtain the (profit) margin between purchase prices and sales prices. This surplus makes it possible to earn a profit." In other words, the surplus results from selling at a higher price than purchased in the process of exchange. Profits were not a residual obtained in the process of production for Khaldun, after the conditions for reproduction of society, in particular the subsistence of the labor force, was obtained. This is, of course, the whole point of classical political economy. The understanding of the objective, material conditions for the reproduction of society. Profits were obtained in the process of production, and that would allow to understand accumulation, since the surplus was the basis for economic growth. Accumulation and not the cyclical fluctuations of civilizations were at the center of classical political economy analysis, reflecting, perhaps, the dynamic nature of capitalist societies.

These differences suggest that Khaldun was, most likely, an important source for scholastic, and mercantilist/cameralist authors to which classical authors were to some extent responding in their own writings. Mercantilists authors also thought in terms of profits in the process of exchange, which was to some extent to be expected in pre-capitalist societies with a large mercantile sector. These were essentially agrarian societies, and the transformation of the structure of production was not yet significant.  Recognizing the role of Arab scholars in preserving the texts and the knowledge of ancient scholars, and their ability to move beyond the ancients is crucial for the proper understanding of the evolution of economic ideas. But it is important understand their actual contributions to avoid more confusion in the history of ideas.

-------------------

* In this piece it is suggested that the history of thought textbooks by Screpanti and Zamagni and by Roncaglia are mainstream texts, and put in the same category with Blaug's book. That is of course a misconception. The former differentiate between classical and marginalist traditions, and do not argue for the continuity, as Blaug does, and can be seen as clearly heterodox in nature.

** Spengler (1964) is the classic study on Khaldun by western historians of economic thought. Although his essay is careful about Khaldun's contribution it might give to much credence to the notion that the "economic literature of Islam can be traced to the Economics of Bryson", for the ancient Greek philosopher. 

** It is worth noticing that the piece cited at the beginning suggests that Khaldun is a precursor of Smith, presumably because of the division of labor, but without a distinction of productive and unproductive activities, but also of Alfred Marshall. We are told that Khaldun "analyzed markets which arise based on the division of labor and examined market forces in a simple didactic way which is very similar to the attitude of Alfred Marshall. The invention of supply and demand analysis wasn’t invented in the 19th century: the islamic scholar also described the relationship of demand and supply." Supply and demand forces were well-known before Khaldun. Marginalism suggested that long-term prices, what Smith called natural prices, were determined by those forces.

What's the deal with The Smiths

 

 

With friends like this...

This is NOT a review of the Smiths (the band), and neither of (or at least not a full one) of Glory M. Liu's (relatively) new book Adam Smith's America: How a Scottish Philosopher Became An Icon of American Capitalism. For a proper review go read Kim Phillips-Fein's one. In a sense, the book remind me of Bernard Shaw's famous saying that UK and the US were two countries divided by the same language. Here the gap is between fields, and there are two gaps, one within economics, modern mainstream economics and old classical political economy. Liu is a political scientist by training, and what she takes as economists views, including the understanding of the history of the discipline, are fundamentally from a mainstream perspective.

The phrase by Sraffa, that I have cited before fully applies here. He said:

"The classical economists said things which were perfectly true, even according to our standards of truth: they expressed them very clearly, in terse and unambiguous language, as is proved by the fact that they perfectly understood each other. We don’t understand a word of what they said: has their language been lost? Obviously not, as the English of Adam Smith is what people talk today in this country. What has happened then?" [Sraffa, Nov. 1927, D3-12-4, front page, 14]

In particular, the continuity in what has been aptly referred to as the surplus approach from William Petty to Smith, and the well documented trajectory from the ideas of Petty to Cantillon, to Quesnay, and then to Smith is lost in her relatively thin discussion of political economy aspects of Smith. The book by Tony Aspromourgos, On the Origins of Classical Economics: Distribution and value from William Petty to Adam Smith, is required reading on this subject. Smith clearly builds upon the core of the surplus approach, as developed by Petty-Cantillon-Quesnay, in particular on the question of the notion that manufacturing activities are productive. That is certainly an important aspect associated to the disputes between agrarian and industrial views of society.

But while there are differences in their views with respect to what might be termed the model of development (agrarian vs manufacturing), there is clear analytical continuity between Smith and the Physiocrats. They are all concerned with the material reproduction of society, in which the surplus (and, hence, profits and distribution) is a residual, and wages are at the level of the socially and institutionally determined (not merely physiologically) by the needs of survival of the working class. Smith saw distribution as conflictive. That's an analytical point that cannot be dismissed, and is not discussed in Liu's book at all.

This matters to some extent, because the general argument in Liu's book -- which is for the most part correct, that Smith ideas have been used by different groups to promote agendas that were not originally part of Smith's arguments, and that he was a complex author with more depth than often transpires in these several versions of reinvented Smiths (hence, the Smiths) -- misses the actual point of the original Smith. In her view, the nuance is provided by the fact that Smith was a moral philosopher and that in his other major work (and in his Lectures on Jurisprudence, based on students notes, and published posthumously), The Theory of Moral Sentiments (TMS), a Smith different from the one of The Wealth of Nations (WN) appears. Smith cannot be seen as a defender of selfish behavior, since he is clearly critical on TMS (the so-called Das Adam Smith Problem, about which Liu makes more than one should), neither an unqualified supporter of unregulated capitalism, since he qualified it, including in the WN (for example, with his approval of the Navigation Acts; I would add of the Bank of England). That's fine, but displays a limited understanding of the relation of Smith's and the surplus approach with modern economics.

Smith is misread by modern economics NOT because he was not an unqualified defender of unmitigated, unregulated, laissez-faire capitalism (which he wasn't), but because theoretically his economic system did not imply that markets produced optimal outcomes. His defense of laissez-faire and of commercial societies was not based on the allocative efficiency of markets (neither then intervention could be supported as a way to preclude inefficiencies), but simply as needed break with the remnants of feudal institutions that hampered the process of accumulation. As Marx noted in his The Poverty of Philosophy (Works, vol. 6: 176): "The Classics, like Adam Smith and Ricardo, represent a bourgeoisie which, while still struggling with the relics of feudal society, works only to purge economic relations of feudal taints, to increase the productive forces and to give a new upsurge to industry and commerce."

Of course, to sort this out one has to get into the theory of value.* The labor theory of value (LTV) (in an early and rude state of society) meant that the long term (natural) prices were determined by the relative amounts of labor, and supply and demand only determined short term market prices. This theory implied that profits were determined as a residual, for a given level of output and with real wages given, for historical and institutional circumstances, at the level of subsistence. The implication is that the theory did not imply the full utilization of labor, and that distribution is conflictive. So Smith's policy defense of laissez-faire was not based, like modern neoclassical versions (in particular the Chicago School that Liu's discusses in more detail, including Stigler, pictured above), on markets producing the optimal allocation of resources, including the full utilization of labor.

It is clear that Smith is not a forerunner of Marx, something that the latter understood. Marx shared an analytical framework with the classical authors, but rejected their a-historical categories. He argued that:

"Economists like Adam Smith and Ricardo, who are the historians of this epoch, have no other mission than that of showing how wealth is acquired in bourgeois production relations, of formulating these relations into categories, into laws, and of showing how superior these laws, these categories, are for the production of wealth to the laws and categories of feudal society." (Ibid.).

But it is also clear that the theoretical foundations of his policy views was very different than those that were built from the developments of the Marginalist Revolution, and closer, in fact, to Marx's own analytical framework. On that Milgate and Stimson (2009), in their very useful After Adam Smith, are also clear. They say:

"Indeed, if the contemporary economic case for liberty is ultimately made in terms of the language of the market, which if left unimpeded by the state is capable of solving a static problem of allocating a fixed supply of resources, then we have moved well beyond these eighteenth-century thinkers such as Smith. In this sense it might be reasonable to ask whether what we understand today as free market theory—against which a modern form of nationalist- led trade policies might be said to operate—is different in important ways from the eighteenth-century political economy from which it is said to have originated. It might also be well to ask just how that transformation of the conceptual framework of political economy and its relationship to politics that came about after Smith took shape" (2009: 32).

Without an understanding of the changes in political economics (and its transition to economics) after Adam Smith, one is left with the puzzle noted by Sraffa almost a century ago.

* On the reasons for the need for a theory of value go here. For more on the limits and problems of the LTV see this and this.

PS: I should note that Liu tells the story of Stigler's T-Shirt that read Adam Smith Best Friend (Nathan Rosenberg's paper on that here). Back when, my PhD students in Utah, did a T-Shirt on my suggestion that there should be an alternative to Stigler's one. The Heterodox Students Association (HESA) T-Shirt read: I read Adam Smith and Understood it. Enough said. Old post on that. A recurring theme around here.