What is heterodox economics? Some clarifications

Long ago I wrote on the meaning of heterodox economics. I suggested that it should be defined in its own terms, not as a reaction to the mainstream or orthodox approach, and as a unified set of propositions.[1] In other words, heterodox economics would be a set of principles that would be backed by a certain community. Of course, the sociology of that community would lead to some degree of debate and dissent within heterodoxy, as it is in fact the case within the mainstream. There is, one might add, significant confusion about the meaning of marginalist and neoclassical economics, and also there is no monolithic and consensual approach within the orthodoxy. The mainstream is somewhat fragmented, and there are more than a few neoclassical or marginalist schools. Some, like the Austrians, tend to think of themselves as heterodox, and evident confusion.

My preoccupation when I first wrote about this topic had been related to the argument by Colander, Holt and Rosser that heterodox economics should be abandoned, or that the labels orthodox/heterodox themselves meant little or nothing. For them, the mainstream itself was moving on, and that the best within the mainstream, the cutting edge as they called them, were breaking away with traditional neoclassical views. In my reply to them, I suggested that the mainstream was doing fine, and that it was not being abandoned by the best and the brightest. I argued that the mainstream had for a while a dual strategy. It maintained certain principles that purported to show that markets produce efficient outcomes, even if a significant part of the profession does not believe it is true in practice, and then proceeded to discuss a series of imperfections that are better suited for the complexities of the real world.

Read rest here.

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.

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* 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.

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.

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.

Lars P. Syll: Piketty and the Cambridge capital controversy

 

By Lars P. Syll

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

Read rest here.

On Marginalism Versus Neoclassical Economics

In a recent post by NK, (see here), it was mentioned that when teaching macroeconomics, especially from a heterodox perspective, "one and has to deal, as always, with the confusion generated by all manuals (to a great extent Keynes' fault for using the term classical for everybody that came before him) between the old classical political economy tradition and the marginalist (or neoclassical, other misnomer, this one Veblen's fault) school." Perhaps the paper by Tony Lawson, "What is this 'school' called neoclassical economics" (see here, subsciption required), and "Sraffa and his arguments against marginism," by Maria Christina Marcuzzo and Annalisa Roselli (see here, subscription required), can be of assistance... 

Bortis on the Classical-Keynesian Approach and the limits of neoclassical-Walrasian economics

The paper Prof. Bortis presented at the 1st World Keynes Conference at Izmir University in Turkey is here. From the intro:

The paper starts with considering the domination of the neoclassical exchange paradigm since the Marginalist Revolution 1870-1890, brought about by Alfred Marshall’s Principles of Economics. The inability of neoclassical theory to properly explain the formation of the fundamental prices prevailing in modern monetary production economy, the prices of production to wit, through the mechanism of supply and demand and to cope with the deep depression of the 1930s initiated a classical-Keynesian counterrevolution in the course of Shackle’s Years of High Theory 1926–1939 (Shackle 1967), a counterrevolution which was accomplished in 1960 through Sraffa’s Production of Commodities by Means of Commodities (section 2). However, as is alluded to in section (3), a wide gap existed between Keynes’s General Theory and Sraffa (1960), Keynes emphasising uncertainty about the future associated with the various investment projects, Sraffa putting determinism to the fore with the prices of production being governed by technology and distributional institutions. Section four deals with Pasinetti’s effort to close the gap between Keynes and Sraffa, which opens the way to the classical-Keynesian synthesis of Keynes and Sraffa, set out in the central section (5). In the following section (6) the classical-Keynesian system of political economy is compared with neoclassical-Walrasian economics made operational by Marshall; here we also ask the question as to which of the two theoretical systems is more plausible. In section (7) classical-Keynesian economic policies are set out. Some implications of classical-Keynesian political economy for political philosophy and the associated political system are exhibited in section (8). The concluding remarks emphasise the necessity for a new economic, financial and political world order.

Very similar to the ideas developed in my old graduate history of thought course.

PS: Geoff Harcourt's book on Post Keynesian economics, which also tries to put together the old classical political economists and Marx with Keynes, is available here.

Neoliberalism, neoclassical economics and the return of vulgar economics

The term Neoliberalism has been used with increasing frequency over the last few decades. But is often a confusing term, also used interchangeably with neoclassical economics by some authors (in fact if you look at the graph below you can see that as the use of neoliberalism increased, the use of neoclassical went down). I'm not necessarily against the use of the term, but I do think that semantic clarity is needed if the term is to be used with any propriety. I discussed some of these issues in my review of Masters of the Universe: Hayek, Friedman, and the Birth of Neoliberal Politics, by Stedman Jones here.

As I noted before, in my exchange with Noah Smith, the term neoclassical is a bit of a misnomer. The term presupposes a continuity between the old classical political economy authors of the surplus approach -- the authors from Petty to Marx, including Quesnay, Smith and Ricardo, that assumed that real wages (distribution) were exogenously given -- and marginalists (the neoclassical ones), which assumed that real wages (equilibrium ones in the long run) are determined by supply and demand (endogenously) like any other price.

In that sense, Smith (Ricardo was a radical and his classification is more complicated, and Marx was a critical revolutionary socialist) was a liberal in the sense of wanting Laissez-Faire, but his theoretical framework was very different from neoclassical authors like Friedman, a modern champion of free markets. In other words, the policy stance in favor of non-intervention and freedom of markets is a poor guide for the underlying theoretical framework or the political views of the author.

The liberalism of the classical authors was based on the notion that the rising bourgeoisie had a revolutionary role (something noted by Marx in his Communist Manifesto), and was a reaction against Mercantilism and the remnants of the Ancien Régime. Neoliberalism, in contrast, should be seen as the resurgence of a free market ideology, after the onsloghut on neoclassical economics by the Keynesian Revolution. It was the ideology of the anti-New Deal, anti-Keynesian conservatives, which was finally victorious in the 1970s, when the marginalist ideas had already proven to be either incoherent or/and irrelevant by the capital debates.

In other words, while the old liberalism was a progressive ideology at the service of the nascent capitalist system radical transformation of the structure of production and the social relations associated with it, the modern resurgence of neoliberalism is a conservative ideology at the service of the maintenance of the status quo. It is fundamentally what I referred before as the return of vulgar economics.

PS: Note that many neoclassical economists are not neoliberals in the sense of radical defenders of the free market ideology. In fact, the majority, the so-called New Keynesians, are willing to accept significant amounts of government intervention to deal with market failures, even if by the 1990s they had accepted much of the more radical stuff (think of Larry Summers, which last week quite correctly noted that more government spending is needed to get us out of the recession, but back in the 1990s believed in expansionary fiscal contractions and financial deregulation. On the latter no word).

Confusion and the Failure of Marginalism

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

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

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

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

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).

A Note on the Concept of Vulgar Economics

The concept of vulgar economics, developed by Karl Marx, is often cited, but seldom properly used or understood. In the preface to the second German edition to Capital Marx said that:

"[The] period, from 1820 to 1830, was notable in England for scientific activity in the domain of Political Economy. It was the time as well of the vulgarising and extending of Ricardo’s theory, as of the contest of that theory with the old school."

It is important to note that Marx clearly knew that "the theory of Ricardo already serves, in exceptional cases, as a weapon of attack upon bourgeois economy," in particular, because Ricardo was the first to show conclusively the necessary oposition between wages and profits, and the conflictive nature of the capitalist system. The problem with post-Ricardian economics was that it could not claim to be scientific and at the same time argue that the capitalist system was harmonious. For him:

"Men who still claimed some scientific standing and aspired to be something more than mere sophists and sycophants of the ruling classes tried to harmonise the Political Economy of capital with the claims, no longer to be ignored, of the proletariat. Hence a shallow syncretism of which John Stuart Mill is the best representative. It is a declaration of bankruptcy by bourgeois economy."

So vulgar economics was the dominant, or common, view of Political Economy after Ricardo, which was fundamentally apologetic and dismissed the Ricardian conflictive view of capitalist economies.

Also, it is important to note that, although critical of bourgeois economics (Quesnay, Smith, Ricardo), Marx knew his theory built on their analysis. He says:

"As early as 1871, N. Sieber, Professor of Political Economy in the University of Kiev, in his work 'David Ricardo’s Theory of Value and of Capital,' referred to my theory of value, of money and of capital, as in its fundamentals a necessary sequel to the teaching of Smith and Ricardo. That which astonishes the Western European in the reading of this excellent work, is the author’s consistent and firm grasp of the purely theoretical position."

So the excellent work of Professor Sieber correctly grasps Marx's theoretical position, according to Marx, and says that it is "a necessary sequel to the teaching of Smith and Ricardo." I'll leave for another post the discussion of the current state of economics, and in what sense one can talk of a return of vulgar economics.