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.

On Sraffa and the History of Economic Thought

Mongiovi, Girardi, McColloch and Vernengo

Bill McColloch, Keene State College (Guest Blogger)

Opening comments, "Roundtable on Sraffian Economics as Part of the Radical Political Economics Tradition," URPE 50th Anniversary Conference, September 28th, 2018.

What should the purpose of studying the history of economic thought be? That purpose doesn't, of course, have to be singular, but it's a question that I regularly feel pushed to answer as I often find myself teaching undergraduate courses in the history of economic thought, as I'm sure many of us do. At one level I feel fortunate to find myself in a heterodox program that welcomes the study of the history of economic thought, and in fact requires our undergraduates to take a course in it. But I also feel the need to justify the course's place in the curriculum. Indeed I normally spend the first day of class questioning, with students the larger purpose of the course. Some arguments seemed destined to fall on deaf ears. As Sraffa suggested of the Classical economists at the outset of his lectures on the advanced theory of value, “the best thing would be to read them in the original – I'm sure you would find them more readable and less abstruse than the modern economists, but I suppose there's very little chance of inducing anyone to read them” (Sraffa Papers, D2/4). Certainly we ought to reject the old claim of Pigou that the HoT is little more than a litany of “the wrong ideas of dead,” but what can we say in its place? Some heterodox historiography exhibits an understandable tendency to treat the history of economic thought as a genealogical project. We want to feel rooted in the past, to feel that we're not quite so alone, or that we were not always so isolated from mainstream discourse. In some cases then, HoT therefore becomes a search for this or that prescient and neglected thinker to remind us that once, is some far off and idealized past there was a more open, more pluralist economics. Thus we tell stories about the heyday of old Institutionalism or of the historical schools and recall times when, to borrow Keynes' phrase, “the weather was delightful and the mind free to be fertile of new ideas.” I worry not only that such an appeal in likely to be entirely lost upon students, but also that this renders it even easier for the mainstream to dismiss or marginalize the history of thought as a pursuit for indulgent specialists.

Already in 1929 Sraffa plainly expressed disdain for these approaches. In his view we must not overlook “the fact that economic theories, whether ancient or modern, do not arise out of simple intellectual curiosity of finding out the reasons for what is observed to happen in the factory or in the marketplace. They arise out of practical problems that present themselves to the community and which must be solved. There are opposite interests which support either one solution or the other and they find theoretical, that is universal, arguments in order to prove that the solution they advocate is conformable to natural laws, or to the public interest, or to the interest of the ruling class or to whatever is the ideology that at the present moment is dominating.” He goes on to suggest that it is only later, as theories undergo some evolutionary process, that they come to be regarded as the outcome of impartial inquiry, and comparatively unassailable for that reason. Sraffa's work is thus a reminder that economic theory is both infused with ideology, and that it is contestable. It is a reminder that the study of the history of thought should not offer a picture of the smooth and orderly ascendance of incontestable truths, but of the rifts, ruptures, and debates that continue to animate the discipline.

Sraffa also suggests that the outcome of our study of the history of thought should not be absolute fealty to the ideas of any one thinker. He rightly suggests that in our study of Ricardo we should recall the it was the distribution of the total product between landowners and the remainder of society that was his principal focus, not the division between wages and profits. Ricardo's own views changed over his lifetime, but as Sraffa suggested, “however the historical point as to the interpretation of Ricardo is settled...it's true to say that Ricardo's views on this point are not very important” (Sraffa Papers, D2/4). Though the question may be central to our own historical moment, it was less so for Ricardo, and played only a minor role in his theory.

In Sraffa's mind Marx's great victory was to have rediscovered the essential meaning of the classical system in an era in which it was increasingly lost to all observers. On Marx's basic triumph, he notes that it was “[s]till more terrific [that] in the middle of the 19th century, a man succeeds, either by accident or by superhuman effort, in getting again hold of the classical theory: he improves it, and draws its practical consequences from it” (Sraffa Papers, D2/4). We might appreciate then that Sraffa's achievement was to draw out a few of the essential elements of classical political economy, and of Marx. What then should be regarded as essential in our own age from Marx? It seems to me that the correct thesis is that capitalism rest upon exploitation, an exploitation of human beings and of nature, and that is remains the task of economics today to speak to this reality and its consequences. Whether Marx's own proof of exploitation can be shown to be true is perhaps of negligible importance. The central suggestion of Sraffa's work, that profits are not the reward of abstinence, or a payment according with the illusory marginal productivity of capital, but instead the portion of the surplus product extracted from those that “concur in its formation”

Archival efforts to more clearly reveal the genesis of Sraffa's own ideas are laudable, and testify to the importance of Sraffa's engagement with Marx as a sustaining motive force in the work that culminated in the Production of Commodities by Means of Commodities. But is it important to ask if Sraffa was ‘really’ a Marxist? I would suggest not. Similarly, Sraffa's well-reasoned and foundational criticisms of neoclassical theory have been rehearsed and staged for nearly six decades, to no great destructive effect. In Sraffa's own spirit it seems more important to ask what what “practical consequences” we can draw from this work today. One simple suggestion is that our theory of the functional distribution of income must be institutional and sociological. Insofar as the pace of accumulation is understood to depend on this functional distribution of income, or on the sources of autonomous demand, any non-neoclassical growth model is, at its foundation, an institutional theory of growth. Thus rather rather binding ourselves to a singular approach we might recall Sraffa's suggestion that “[o]ur metaphysics is in fact embodied in our technique; the danger lies in this, that when we have succeeded in thoroughly mastering a technique, we are very liable to be mastered by her” (Sraffa Papers, D3/12/4).

Sraffa and the Marshallian system

(Sraffa circa 1976)

G. L. S. Shackle argues in The Years of High Theory that ‘there began in the mid-1920s an immense creative spasm, lasting for fourteen years until the Second World War, and yielding six or seven major innovations of theory, which together have completely altered the orientation and character of economics’ (Shackle, 1967, p. 5). However, by 1967, the two most important developments of this period—Keynes’s principle of effective demand and Sraffa’s criticism of the marginalist theory of value—were rapidly fading from the main corpus of mainstream theory.

The relative ease with which neoclassical economics reasserted its main conclusions is, in fact, explained by Shackle’s account of those years. First, Sraffa’s critique of the Marshallian theory of value is seen only as a step in the development of the theories of imperfect competition by Joan Robinson and Edward Chamberlin. Second, Keynes’s General Theory is seen as stating that unemployment results from the existence of uncertainty and irrational expectations (Shackle, 1967, p. 129). Both developments can be interpreted as asserting that market imperfections render neoclassical theory, although internally coherent, irrelevant for the analysis of the real world.

Also Shackle’s failure in 1967 — well after the publication of Production of Commodities — to acknowledge the importance of the revival of classical political economy to the debates of the 1930s represents a serious inadequacy of his interpretation of ‘the years of high theory’.

Before getting into Sraffa's critique of Marshall, it is worth noticing that Sraffa came to economics via monetary economics, like Ricardo and Keynes. His dissertation for the Law Degree, L’Inflazione Monetaria in Italia Durante e Dopo la Guerra (subscription required), dealt with postwar inflation and the return to the Gold Standard, the same topic of Keynes’s Tract on Monetary Reform. According to Eatwell and Panico (subscription required), in the analysis of the asymmetric effects of inflation and deflation Sraffa reveals the heterodox character of his position, more akin with the works of the classical authors and Marx than the conventional marginalist analysis. The notion that social conflicts and monetary factors determine the normal real wage was part of Sraffa’s analysis, although several elements of his analysis were still conventional, e.g. the acceptance of the Quantity Theory and of the Purchasing Power Parity theory.

Sraffa’s criticism of the Marshallian theory of supply represents an analogous situation, in the sense that some elements of the conventional marginalist views were still present. Marshall’s or Sraffa’s dilemma (which appears in Sraffa's 1926 paper) refers to the incompatibility between increasing returns and perfect competition. It is a long period problem. Sraffa’s critique can be summarized in the following way. First, rising costs derive from diminishing returns to substitution, and, therefore, in the general case where there are no fixed factors, increasing costs do not seem to exist. Secondly, increasing returns are incompatible with perfect competition. In the long period, when the firm cannot experience marginal costs arising from the existence of some fixed input, there can be no diminishing returns. Replication is always possible, except for the case of indivisibilities. In addition, Sraffa showed that increasing returns to scale are inconsistent with the notion of perfect competition.

In the case of increasing returns, the average cost is decreasing, implying that the marginal cost is below average variable cost, and, hence, there is no infinite, non-zero solution for the profit maximization problem. In other words, there is a tendency for the firm to expand to infinite size. Sraffa’s argument proves the failure of perfectly competitive assumptions to determine any equilibrium of the individual firm. Two alternatives are opened by Sraffa’s critique of Marshallian theory. If it is not legitimate to treat average cost as either increasing or decreasing within the framework of perfect competition, we are left with the result that the only satisfactory assumption is that of constant returns. On the other hand, ‘everyday experience shows that a very large number of undertakings work under conditions of individual diminishing costs’ (Sraffa, 1926, p. 543), which suggests that we should instead abandon the notion of perfect competition.

Sraffa considered the imperfect competition approach to be the only logical way to develop the theory of value along Marshallian lines. However, he showed no inclination to pursue this solution, and he appears to have already been working toward the revival of the classical approach. The origins of this project can be traced back to his early draft of the opening propositions of the Production of Commodities, which he asked Keynes to read in 1928 (Sraffa, 1960, p. vi). The reasons for not pursuing imperfect competition were never quite explained by Sraffa, but are fairly reasonable to infer (note that in Cambridge it was two of his students, Richard Kahn and Joan Robinson, that developed the imperfect competition theory).

Note that in order to obtain partial equilibrium, which is what the Marshallian model presumes, one must assume that prices in a particular industry are not affected by and do not affect the prices in other industries. Hence, externalities have to be internal to the industry, since otherwise production in one sector would affect the prices in other industries [perfect competition in partial equilibrium, the U-shaped cost curves and the equilibrium at the minimum with marginal cost equal marginal revenue, require also that externalities are external to the firm, since if they weren't the firm would became a monopolist; of course externalities that are internal to an industry and external to firms are an empty set]. That seems to be a dead end. Sraffa was already interested in the determination of long term prices. By this time, the summer of 1927 when he was preparing his ‘Lectures on Advanced Value Theory’ that he gave from 1928 until 1930, it was already clear to him that he needed to start from classical preocupation of determining relative prices and one of the distributive variables (the rate of profits or wages) strictly in material terms, that is, the quantities of labor and commodities needed to produce commodities.

For further on Sraffa's critique of Marshall see Gary Mongiovi's paper here (subscription required). For a general critique of Shackle's stance in the history of 'the years of high theory' read this one. For the implications of Sraffa's 1960 book for economics go to this old post (yes on the capital debates!).

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.

Nick Rowe's misconceptions about Sraffians I

Nick Rowe continues his very welcome discussion of the issues related to the capital debates in a recent post (see also the reply by Unlearning Economics). However, there are several misconceptions in his post that are worth clarifying. I'm going to deal with his first four assumptions (1 and 2 in this post, and 3 and 4 in a subsequent one), which are the more substantial from a theoretical point of view, namely:

1. Some economists in Cambridge UK wanted to explain prices without talking about preferences. I don't know why they didn't want to talk about preferences;

2. They made some special assumptions that helped them explain prices from technology alone, without talking about preferences. Like: all labour is identical; all technology is linear; prices never change over time;

3. But they still couldn't explain the rate of interest. Because it's hard to explain the rate of interest if you don't want to talk about time preferences. And all the other prices depend on the rate of interest, as well as on technology. So they assumed the rate of interest was exogenous;

4. Some economists in Cambridge US made a very special assumption that let them explain the rate of interest without talking about time preferences. They assumed that there was only one good, and it could be converted back and forth between the consumption good and the capital good by waving a wand.

The Cambridge economists are, of course, Sraffa and his followers. First, one of the most frequent confusions about Sraffa was that he assumed that demand, and, as a result, preferences were irrelevant. Before I tackle the issue per se, it is worth quoting this phrase, brought to my attention in Robert Vienneau’s blog:

"I am sorry to have kept your MS so long - and with so little result. The fact is that your opening sentence is for me an obstacle which I am unable to get over. You write: 'It is a basic proposition of the Sraffa theory that prices are determined exclusively by the physical requirements of production and the social wage-profit division with consumers demand playing a purely passive role.' Never have I said this: certainly not in the two places to which you refer in your note 2. Nothing, in my view, could be more suicidal than to make such a statement. You are asking me to put my head on the block so that the first fool who comes along can cut it off neatly. Whatever you do, please do not represent me as saying such a thing." -- Piero Sraffa (1964). Letter to Arun Bose (italics added).

Clearly Sraffa says that demand plays a role. However, the role is not the same as in marginalist theory. One has to understand what role demand played in the surplus approach in the determination of relative prices to get what Sraffa is saying.

Classical authors, in particular Adam Smith and David Ricardo (and certainly not Marx), did not think in terms of individual utility. When they talk about utility they are referring to social utility. Hence, commodities to be produced must be socially useful, otherwise they would not be produced, since nobody would buy them, but their price, their exchange value, is not based or connected with their use value. For example, Smith in his discussion of the diamond/water paradox (Wealth of Nations, Book I, ch. IV) argues that things with a high use value often have little or no exchange value, since things that are not costly to produce will command no price, even if they are useful. It is only with Thomas De Quincey, after Ricardo and the demise of classical economics, that the notion that utility (and use value) had a functional relation to exchange value becomes entrenched in economics, an idea that was picked up by Stuart Mill, and through him by Marshall (marginalism or neoclassical economics), as it is well documented by Krishna Bharadwaj (subscription required).

As Bharadwaj says of the Quincey/Mill/Marshall notion:

"This was a different notion of use-value than that accepted by Smith and Ricardo, for whom use-value was a necessary condition for a commodity to possess in order to be an object of exchange, but referred to the physical properties socially known to belong to a commodity, and not dependent upon the individual's estimation of its capacity to gratify subjective inclinations, measured in quantitative terms. In fact, use-value and exchange-value were incomparable in so far as the former covered the qualitative aspect and the latter was a quantitative notion. In De Quincey and Mill, the two notions had become quantitatively comparable (one acting as an extreme limit upon another) and this was only a step towards the later resolution of the paradox in terms of 'total' and 'marginal' utility."

In other words, social utility not individual estimation is behind the classical notion of preferences. The point then is that social utility and, as a result, demand considerations are essential for the determination of long term prices. However, these preferences are not the subjective preferences of individuals, about which nothing scientific can be said, since there are no regularities and they can change for irrational and circumstantial reasons.

The utility that society attaches to a particular good, say a car, however, can be taken as given at a particular point in time. The reasons are not only directly connected to objective characteristics, like the fact that a car is a means of transportation or negatively that they worsen environmental conditions, but also that cars socially may be a source of status, as Veblen later suggested. In other words, preferences (and demand) are socially determined and taken as given for the determination of relative prices, but there is a role for historical and institutional analysis in understanding why and how demand and preferences change over time. The idea was, also, that social preferences are relatively slow to change, and for that reason one can take them as given.

Thus, in the surplus approach there is a role for historical/institutional analysis (not just social preferences, but income distribution too, e.g. the discussion of the determination of the exogenous real wage), and a different role for theoretical analysis (the determination of exchange value). Note that the assumption of given social preferences, as correctly noted by Unlearning Economics, can be seen as a ceteris paribus clause. So Nick is right that there is no reason not to talk about preferences. However, it is far from clear that knowledge has been advanced by the marginalist treatment of individual subjective preferences. As I noted in my comments to his post, the reasons for convex, homothetic preferences is not dictated by knowledge about a regularity about people’s behavior, but simply by the teleological need of finding a solution to the maximization problem. I would say rather that there is no reason to talk about individual preferences. Social utility is fine.

Point 2 is just a poorly built straw man of the Sraffian/surplus approach model. There is no assumption of a linear technology. In fact, that’s typical of the neoclassical aggregative models. The only situation in which a linear relation between wages and profits in the Sraffian model is in the case of the standard commodity [I still owe you all a post on that topic; didn't forget], if this is what Nick means by linearity, which would be the only relevant case (unless he is against input-output models). The input-output framework of any system in which production is done by using commodities to produce commodities (a feature of the real world, by the way), does not imply that there is no technical change either. Technical input-output coefficients can change.

Note that any theory has to say something about the determination of relative prices for a given technology anyway. By the way, in this case Sraffa assumes, like the classical authors, a given level of output (again is a ceteris paribus condition, and a different theory of the determination of output is needed; we know through Garegnani, Sraffa’s disciple, that effective demand is what Sraffa had in mind, and not some version of Say’s Law). That does not imply, hence, constant returns to scale, since that would require an increase in output proportional to the increase in inputs, something that cannot happen when output is given. Remember that output is given for the theory of long term prices only.

Finally, there is enough literature showing that one can reduce, theoretically speaking, labor of different qualities to a uniform type. It is ironic that a neoclassical author would complain about this, since the production function, which is beset with unfathomable problems, also assumes identical labor, and in fact it also assumes a unique capital good (not many means of production) and is fundamentally a world of only one commodity (on this and point 4 by Nick, more on the following post).

TO BE CONTINUED

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.

The standard commodity and the labor theory of value

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

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

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

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

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

We have:

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

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

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

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

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

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

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

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

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

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

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

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.

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.

Ricardo's Principles turns 200!

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

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

Marx Capital turns 150

Marx's capital (Volume 1) was published September 14, 1867, exactly 150 years ago. Below a few links to posts on Marx written over the years.

What makes capitalism capitalism? (on the definitions of capitalism as a mode of production)

Sraffa and Marxism or the Labor Theory of Value, what is it good for? (on the labor theory of value)

Was Marx right? Nice of you to ask, but... (on common misconceptions about Marx)

A Note on the Concept of Vulgar Economics (an important idea, often neglected)

Garegnani on Sraffa, Ricardo and Marx (on the relation of Marx with classical economics)

The last Marxist? Or shortchanging Hobsbawm (a critique of The Economist's obituary)

And this one on why Marx and Keynes are essential for a coherent heterodox alternative to the mainstream:

The meaning of heterodox economics, and why it matters

Samuelson as a historian of economic thought

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

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

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

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

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

Robert Paul Wolff on Marx

Robert Paul Wolff always worth. Should read his Understanding Marx. He surprisingly says that Analytical Marxism has taken over Marxism. To get to Marxism he had to learn economics, the classical political economy of the Ricardian kind, and learn linear algebra. Hegelianism was not really central to the message (in my view, but he does say he hates Hegel). Labor Theory of Value explained, but he does not discuss Piero Sraffa's contributions directly here. There is no way to understand Marx without Sraffa. As he said in a paper in Social Research (subscription required) Sraffa "rescued [Smith, Ricardo, and Marx] from the trash heap of antique, outmoded ideas... [and provided] a serious alternative to marginalist theories."

Krugman on the meaning of neoclassical economics

So what is neoclassical economics? According to Krugman it is basically maximization and equilibrium. In his words, neoclassical or marginalist analysis is:

"economics based on maximization-with-equilibrium. We imagine an economy consisting of rational, self-interested players, and suppose that economic outcomes reflect a situation in which each player is doing the best he, she, or it can given the actions of all the other players. If nobody has market power, this comes down to the textbook picture of perfectly competitive markets with all the marginal whatevers equal."

This is clearly incorrect. First, classical authors, meaning those that followed the surplus approach (from Petty to Marx, including Quesnay, Smith and Ricardo) did assume that economic agents were rational and self-interested and they also believed that the economy could be represented by equilibrium outcomes. And they clearly were not neoclassical, meaning they did not believe that supply and demand determined long term prices (natural prices as Smith and Ricardo referred to them, or prices of production in Marx's terminology).

If profits were higher in a particular sector, capitalists would try to gain from those opportunities entering the industry, and in the process would lead to a uniform rate of profit. Market prices, determined by supply and demand, would gravitate around the long term equilibrium prices that were determined by the technical conditions of production, and the previously given real wage (by conflict), in modern parlance (on the issues raised by the Labor Theory of Value, and Sraffa’s solution just check other posts in this blog).

More importantly, there was no mechanism (even in the case of those classical authors, like Ricardo, that accepted Say’s Law) that implied full utilization of labor, capital or any particular means of production. Wage flexibility did not lead to full employment. The hallmark of marginalism is the notion that supply and demand determines simultaneously the equilibrium long term prices, and that price flexibility leads to full utilization of resources, something that the capital debates have demonstrated long ago it cannot be done. In this regard, Krugman decides (because it must be advantageous) to follow those that he criticizes, and remains oblivious to both logic and empirical evidence. If he wants to be coherent with his Keynesian ideas, he should get rid of the notion of a natural rate of unemployment (or and of interest).

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.