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The Cambridge Controversy – a fundamental refutation of orthodox economic theory – Part 1

Some years ago, I promised to write about the – Cambridge capital controversy – which saw economists associated with Cambridge University in England and MIT in Cambridge, Massachusetts argue about the validity of neoclassical distribution theory. I never wrote the blog posts because I considered the material was a little difficult for a blog audience. Also, while of great interest to me, the topic was not necessarily compulsory reading for those trying to come to terms with Modern Monetary Theory (MMT). But today, I relent. For two reasons. First, I think my readership has reached much higher levels of economic literacy over the last 15 years and can handle a challenge. But, more importantly, there are times when the mainstream characters, who have been claiming that there is nothing new in MMT and that they knew it all along and all the important results can be explained within an orthodox New Keynesian approach, reveal their true colours. Their hubris sees them get ahead of themselves and they show they never really understood the basics that undermine their own approach. Such was the case this week when Paul Krugman declared the Controversy “a huge intellectual muddle” and “a tortured debate that illuminated nothing much”. Well, that just goes to show how the mainstream denial functions. A body of work comes along and blows the dominant paradigm out of the water, and the response is to ignore it as a meaningless muddle. Their current attacks on MMT are just another application of that approach, which I first encountered as a student while studying the capital debates. Given the complexity of this issue and the amount of material, this will be a two-part series. Today, we learn the historical context, which will convince you that this was not idle or arcane discussion. This was a debate that went to the heart of the existence of capitalism and the defenders of that system – the mainstream economists did everything they could to defend the myths that they had erected to make the system look fair. They failed but went on anyway. Here is Part 1.

Krugman on Joan Robinson

Commenting on an interesting article in the New York Times last week (April 24, 2021) about the late Cambridge (UK) academic Joan Robinson – The Woman Who Shattered the Myth of the Free Market – Krugman tweeted three times on the issue:

Nice appreciation of Joan Robinson, although no mention of her later role. Sad to say, as a student I mainly encountered her through the “Cambridge capital controversy,” a huge intellectual muddle 1/

Somehow Robinson and others managed to convince themselves that the moral legitimacy of capitalism rested on the existence of a well-defined measure of “capital” that had a well-defined marginal product 2/

What followed was a tortured debate that illuminated nothing much, and eventually just faded away. Oh well. But Zach Carter is right: we value thinkers for their best work, not their detours, and Robinson made a huge contribution 3/

Zach Carter was the author of the NYT article.

To suggest that the Cambridge debates, which were categorically won by the British side (with Joan Robinson, Pierro Sraffa, Luigi Pasinetti, Nicholas Kaldor, Geoff Harcourt) leading the way, didn’t illuminate much, suggests that Paul Krugman is either a liar or didn’t really get the point, or both.

The Cambridge controversy was very important part of my own undergraduate and post-graduate education.

For those who were coming into mainstream economics after reading Marx and like extensively, the Controversy had great meaning.

As an academic, I later went on an taught capital theory as one of my electives (in addition to macroeconomics, labour economics, and econometrics).

So what was it all about?

A brief history lesson

First, you have to understand some history.

Marginal productivity theory emerged in the second-half of the C19th as the conservatives became scared of the growing popularity of Marxism. Industrialists hired economists to develop theories that made capitalism appear to be fair.

That appears to be what Krugman is referring to above when he talks about the “moral legitimacy of capitalism”.

The major insight provided by Marx’s theory of surplus-value was that capitalist profits are sourced in the production of surplus-value. In turn, surplus-value is produced by unpaid labour and so under capitalism workers remain exploited (as they were under previous modes of production).

Exploitation takes on the meaning that workers do ‘free’ labour for the owners of capital as a result of the unequal power relations in the labour exchange and that labour is expropriated as the return to capital.

It is clear that the return of profits is the reward for ownership per se.

And that insight suggested that if ownership changed so would the distribution of income.

That threatened the hegemony of the owners of the material means of production – the capitalists and became an existential threat to the entire system.

The interesting part of Marx’s analysis of capitalism is that the exploitation is hidden in what he called the ‘wage form’.

Under previous modes of production the exploitation was obvious and built into the norms of the system.

So under feudalism, workers produced surplus labour for part of the week on the feudal lord’s land and for the rest of the week produced their own means of subsistence on their own land allocated to them by the feudal lord.

In the capitalist labour market, the wage form is such that it appears that equals are being exchanged – the wage for the supply of labour-power (the capacity to work) usually specified as a given number of hours of work per day.

So it looks like the worker is being paid for the entire day.

But the labour contract is more complex than a normal exchange of commodities where the parties agree on an exchange price (which reflects their assessments of the use value they will get from the swap and then after the contract is finalised they enjoy the use value of the exchange independently.

In the labour contract, the use value to the capitalist is the labour emanating from the labour-power and the capitalist “consumes” that during the production process which sees the worker producing more than they are paid.

The point is that the worker has to be on the job while the capitalist consumes the use value of the labour power.

So exploitation to Marx related to this inequality in the labour contract which meant workers had to work longer hours than necessary (for their survival) as a result of the unequal ownership of the productive capital.

The important point of Marx’s theory of exploitation for the subsequent developments in economic theory is that it exposed the capitalist system as being unfair.

Any notion that a person gets back out of production what they put in is rendered false.

The workers clearly do not.

And the capitalists are seen to put nothing in (ownership is not a productive input) yet get back the surplus-value which is then realised in the goods market as profit.

With social and political unrest increasing in Europe in the mid-C19th, a major effort was undertaken to produce a theory of income distribution which demonstrated that all owners of productive inputs get back in the form of income payments what they put into the production process.

So the ideological push to make capitalism appear to be fair led to the development of Marginal productivity theory.

According to this theory workers are paid according to their contribution to production.

Moreover, the other productive inputs, land and capital (equipment etc) generated returns that were also commensurate with their ‘marginal’ contribution to production.

Accordingly, the theeory asserted that every factor of production received what it contributed to the overall pie.

That was then represented as a fair system and was used politically to negate the claims that workers were being exploited.

Marginal productivity theory both explained but also justified the outcomes that the capitalist system produced.

All was fair.

If you wanted higher wages you had to invest in skills to generate higher marginal products

Someone who had invested more in skill development would get a higher return.

But then it was observed that persistent differentials in wage outcomes remained that could not be explained in terms of productivity differentials.

Enter another piece of mainstream ad hocery – the theory of compensating wage differentials.

The basic idea is that wage differentials compensate for differences in the nonpecuniary characteristics of alternative jobs.

This dates back to the Wealth of Nations (Book I: Chapter X).

So you have two occupations which are similar in every way but one – danger of work.

The more dangerous job will attract a higher wage to compensate for the danger.

The general conclusion is that where jobs are boring, dangerous, dirty, more stressful – that is, are generally less desirable – the market will reward them with higher wages than otherwise.

So more pleasant and interesting jobs will offer lower wages than other jobs with less favourable characteristics.

Workers are then seen to shop around for different ‘utilities’ (levels of satisfaction) rather different wages per se when choosing employment.

The segmented labour market theory provides a devastating critique of the mainstream approach to wages. There are good jobs and bad jobs and they pay accordingly.

The bad jobs are typically dangerous, boring, unstable, and pay low wages.

The opposite is the case for good jobs. The resulting wage outcomes cannot be explained using the mainstream theories.

There was another theoretical development that also destroyed the mainstream approach to income distribution and concentrated on the return to capital – profits.

Can we really conclude that profits reflect the marginal product of capital?

To relate this question to the Tweets by Paul Krugman , note that in his own textbook – Microeconomics – I have the Second Edition (2009) – Part 9, Chapter 20 considers “Factor Markets and the Distribution of Income”.

From Page 518, Krugman and his co-author discuss “The Marginal Productivity Theory of Income Distribution” and state:

We’ve now seen that each perfectly competitive producer in a perfectly competitive factor market maximizes profit by hiring labor up to the point at which its value of the marginal product is equal to its price – in the case of labor, to the point where VMPL = W. What does this tell us about labor’s share in the factor distribution of income? To answer that question, we need to examine equilibrium in the labor market. From that vantage point we will go on to learn about the markets for land and capital, and how they also influence the factor distribution of income … the result that we derived for the labor market also applies to other factors of production …

The same is true for capital. The explicit or implicit cost of using a unit of land or capital for a set period of time is called its rental rate. In general, a unit of land or capital is employed up to the point at which that unit’s value of the marginal prod- uct is equal to its rental rate over that time period …

Using the present value method … we can convert the value of the marginal product stream that the parcel of land or machine generates today and in the future into its present value. Thus, a producer will purchase parcels of land or pieces of machinery up to the point at which the present value of its current and future stream of the value of the marginal product is equal to its factor price.

This is very clear.

There is a symmetry in neoclassical theory across all productive inputs in terms of the relationship between their ‘price’ and the quantity demanded.

And the return a ‘factor’ receives is in line with its marginal contribution to production.

But note also, which will become important soon, the reference to the “present value method”, which is about the use of – Discounted cash flow – analysis, where monetary streams across different periods are compared by discounting them back to the present.

That is, allowing monetary values that have different future values because of interest rate compounding effects to be compared in a common unit – dollars now!

This arises because a ‘dollar today is worth more than a dollar tomorrow’.

To understand this point you need to appreciate the – Time value of money.

When we decide on whether to spend now or later, we are making a decision about what the benefits we get today versus the benefits we get later by deferring our consumption.

The reason interest is paid is because we will only sacrifice consumption today in order to get more later.

So $10 now might deliver $11 in a year’s time, if we can invest it at 10 per cent (ignoring inflation).

So we in appraising income flows, we can convert $11 that we might anticipate receiving in a year’s time to be equivalent to $10 now, if the interest rate is 10 per cent.

If the interest rate was higher than that then $11 next year is worth less than $10 now.

Now the relevance of all that to this blog series is that we cannot calculate a present value without reference to a discount rate.

Which means we cannot define a marginal product for capital independently of the profit rate.

Which means (and I will explain below) that we cannot claim the marginal product generates the return.

Which means there is no aggregate distribution theory provided by marginal productivity theory.

The Cambridge Controversies

The Cambridge Capital Controversies of the 1960s demolished the foundations of marginal productivity theory.

There were several elements to the debates:

1. The capital debate – what is capital and how do you calculate a return.

2. The reswitching debate – there is no unique ordering of capital to labour relative to the relative prices of each.

Conclusion

I hope Part 1 has helped you understand the importance of this debate.

In Part 2, I will try to elucidate you of some of the key points, which Paul Krugman is keen to ignore, assuming he understood them.

That is enough for today!

(c) Copyright 2021 William Mitchell. All Rights Reserved.

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    This Post Has 70 Comments
    1. Great to have blogs like this.
      I was following until final paragraphs.
      Profit rate vs discount rate etc.
      Look forward to reading more in part 2.
      Thank you for this!

    2. Bill wrote:

      “Now the relevance of all that to this blog series is that we cannot calculate a present value without reference to a discount rate.
      Which means we cannot define a marginal product for capital independently of the profit rate. Which means (and I will explain below) that we cannot claim the marginal product generates the return. Which means there is no aggregate distribution theory provided by marginal productivity theory.”

      I appreciate the pithiness of this setup of the problem addressed in the Cambridge Controversies. I was a graduate student in the Political Economy program at the New School for Social Research in the mid-1970s. The main foci of that program were Marx and Keynes. To pass your M.A. level exam in macroeconomics, you had to master Geoffrey Harcourt’s account of the controversies, “Some Cambridge Controversies in the Theory of Capital,” and P. Garegnani’s 1970 article, “Heterogeneous Capital, the Production Function and the Theory of Distribution.” As someone who had not studied economics as an undergraduate, this was quite challenging. I wish that I had had Bill’s setup of the problem way back then!

    3. Bill,

      Surely the way it has ended Krugman must know he is wrong. He has to and this is the guy that thought banks lent out reserves. The evidence is all around him.

      1. Gift exchange in a system of reciprocity.

      2. Redistributive exchange at allocated prices.

      3. Flexible price-setting markets.

      Probably the 3 different types of market economy.

      With number 3 being the choice of the anti government brigade claiming that attempts to regulate prices are are a waste of time. The belief that the optimum common interest is only achievable through a market equilibrium resulting from individual decisions by market participants seeking to maximise their own private gains = Thatcherism and Regan there is no such thing as society.

      Krugman must know the rentier class has taken over and thus the distribution theory must be wrong. Which is what Monetarism was really all about. Set up to serve the rent seekers and their class.

      Basically that of David Ricardo and the “banking school,” so called because their views were useful to bankers who claimed that only those with hard money – the banks – should create the currency credit, not the government.

      I don’t think Krugman recognises the type of economy we live in today. Never mind any idea how to fix it.

    4. Thank you for this informative post. I feel most MMT economists “show their work” and are not afraid to explain their views in a way that is grounded in the real world. I appreciate your willingness to reach out with a complete explanation and to link that to Twitter.

      Reading this is so much more satisfying than PK’s tweets and the hot takes that followed and I hoped at the time that someone would help fill in the gaps for me. Thanks again for doing that.

    5. Krugman’s idea of fixing the economy we live in today.

      The famous Labour roads to no where.

      Instead of creating jobs like the JG and reigning in the rent seekers.

      Krugman : ” Prime the pump ” so you have all these fancy new industrial sites around every town and village that lay empty for years creating no jobs as they hit the supply side shortages and run out of things to build. Expecting a HUGE increase in aggregate demand.

      Thinking that by simply moving the interest rate they can get these industrial sites working at full capacity after they have built them.

      What’s the problem guys that will work right ?

      Krugman’s the problem…. He is the chosen voice of the rent seeker…

    6. I love this post. Using it to tease a georgist who believes, as do they all, that the return to capital is earned. Capital, like land, is inanimate and passive. How can it earn anything? Georgists love the marginalists. I never could understand all that bunkum. So pleased that Steve Keen showed me I wasn’t just stupid.

    7. Derek suggests we should be about the business of “creating jobs like the JG and reigning in the rent seekers.” I like that. We talk a lot about the stunning clarity of the MMT lens, perhaps not enough about the elegant simplicity of the view from it.

    8. I certainly appreciate your confidence in your readers’ economic literacy but I am probably going to shake that confidence with my summary of this post here. I will start out confessing that, like Krugman, I have never really understood this affair and it is definitely a muddled mess in my mind to say the least.

      So summary of today’s post-

      Krugman wrong again and doesn’t even realize it. Not unusual.

      Marginal productivity hypothesis is stupid. It is obvious there are good jobs and bad jobs, and it is obvious that many of the bad jobs are “dangerous, boring, unstable, and pay low wages” and that the opposite is true for ‘good’ jobs. Which I think anybody who thinks about it for a minute will recognize as mostly true. Aside from some jobs that are put outside the ‘market system’ because they are paid by governments or well represented by decent unions. Often both.

      So under capitalism, workers remain exploited. Just as they more obviously were under feudalism.

      Something about the time value of money. Which is an idea that the opportunity to consume today is always worth more than consuming tomorrow or something like that. Which is certainly debatable. But I don’t know where this part fits in the Cambridge Controversy thing. Maybe it will become clear in part 2?

      Well that is my summary. Any help pointing out things I missed or got wrong would be appreciated.

    9. This is fantastic. Really look forward to part 2.

      Krugman’s second tweet is revealing to me. Because if marginal productivity is wrong then capitalists and landlords are robbers so the entire system is based on naked exploitation, which therefore has no legitimacy.

      How is that NOT an important debate in Krugman’s mind?

      On the point of wage form, Marx wrote that the it looked as if the slaves in slavery do not work for themselves even though they do (a portion of the day they work for their own sustenance). On the other hand, as professor wrote here, because of the wage-form, it looks as if workers get paid for all the hours he/she worked.

      And I struggle to write that last sentence because how can our university amass such huge fortunes today if our lecturers get their respectable pay!? What Marx says is just so obvious when one is involved in working class struggle.

      Where even does profit come from in mainstream theory?

      Another point: In mainstream economics, its almost as if NOBODY tries to hoodwink another person. Landlords capitalists contribute more than workers in this parallel universe.

    10. Bill wrote:

      “And the capitalists are seen to put nothing in (ownership is not a productive input) yet get back the surplus-value which is then realised in the goods market as profit.”

      Ownership is not a productive asset – but capital is and capital is scarce, that’s the point.

      When I was taught microeconomics almost 50 years ago, economic rent was defined as a return over opportunity cost. Monopolists and oligopolists and the like were seen as earning economic rent.

      In the model of perfect competition, capital would earn a “normal” profit. This normal profit reflected the scarcity value of capital. Normal profit is included in opportunity cost.

      If there was no return to capital, capital would not be forthcoming. There would be no organized productive process, there would be no organized employment.

      The Marxist concept of surplus is nonsense.

      Even the socialist economies that arose in the 20th century found they had to ascribe a return to capital so that decisions could be made as to its allocation to varying uses. That is, even socialists recognized capital’s scarcity value.

    11. Why is the Marxist concept of surplus nonsense Henry? That statement is not supported by the rest of your comment as far as I can tell.

    12. Jerry,

      You probably know this already from 1997. So I don’t know if it will help much.

      https://michael-hudson.com/1997/05/theories-of-economic-obsolescence-revisited/

      A very brief history of the whole debate over a hundred years and more all On one page.

      After Bills part 2 figuring out how the Cambridge debate fits into that entire history. How thinking changed after that not based On facts but On geopolitical reasons and who called the shots. Who held the real power in the US. Which Zach Carter highlighted in his book the price of peace. If you have not read that book I recommend it. With the evidence of what happened because of those decisions made in the past all around us today.

      As Groucho Marx once said ” who do you believe me or your own eyes”

    13. Jerry,

      Marx had it that all surplus value should belong to labour and that any surplus value not accruing to labour was expropriation. He made no account of the productivity of capital and the scarcity value of capital.

    14. The term ‘capital’ as used in economics has always been somewhat confusing to me. Sometimes it seems as though it is tools and machinery used to produce things, but sometimes it seems to be money or wealth in general. What is ‘capital’?

      So I have been a construction contractor and have lots of tools used to make and repair buildings- these would all be capital right? Or is it only if I am currently using them? And what are my skills and knowledge in construction that I have developed over the years- human capital? And my actual physical body- I have always been fairly strong and have some dexterity- is that some kind of ‘capital’?

      Sometimes I would be constructing things like medical clinics, or retail space, or office space. Most times housing, either owner occupied or rental. Does that have anything to do with anything as far as ‘capital’?

      And I also am a ‘landlord’- or I provide housing services for a fee as I would rather call it. Is the building I own ‘capital’? It is on a small piece of land and obviously land is land- but in this case is it also capital?

      Henry mentioned he was taught microeconomics almost 50 years ago. What they tried to teach me about it would have been around 35 years ago. If I wasn’t sleeping I was wishing that I was… Either way, it seems I have either forgotten it or it wasn’t ever clear. Probably the latter.

    15. Henry, did Marx really say that? I mean surplus value could just be that which the capitalist took in excess of the costs or reasonable returns on ‘capital’. Marx was no dumbass even if you disagree with him. I can’t believe he would not have understood that tools, for example, are costly to provide and maintain and that the provision of such tools is a type of labor all in itself that needs to be compensated for.

    16. Jerry,

      From Vitaly Vygodsky – “Surplus Value”:

      …….https://www.marxists.org/archive/vygodsky/unknown/surplus_value.htm……

      “Surplus value is defined by Marx as the difference between the value that living labor creates in production and value paid by the capitalist to the worker in the form of wages. “Surplus value is nothing but the excess amount of labor the worker gives over, above the amount of materialized labor that he receives in his own wages as the value of his labor power” (Marx)”

      I believe Marx also considered capital itself to be embodied labour value (capital has to be manufactured).

    17. Jerry,

      Why do you think most of the socialist economies that arose during the 20th century, now mostly totalitarian regimes, reverted to adopting capitalist “reforms”?

    18. Jerry,

      Why do you think socialist planners of the 20th century had to find a way of pricing and valuing capital?

      (In my third year I took a unit titled “Comparative Economic Systems”. This theme kept re-occurring.)

    19. So I already asked what ‘capital’ is and therefore am not in a great position to give you answers Henry. But it is obvious to me as a carpenter that I can produce far more with tools than without them given the same labor time and effort. In any construction scenario, my labor with the tools I have is hundreds of time more valuable to anyone than my labor without tools would be.

      But the tools cost. You need to acquire or make them. Store them. They get lost and stolen and they wear out and break. And generally, nobody sits around admiring a circular saw not in use as if it was a piece of art. So they are mostly useless except when in use producing something for someone else. I think Marx understood this part of it and that he must have understood that there are costs to capital goods and that some return for providing them would be expected.

      Well actually, I have no idea what Marx understood beyond what I have read and been told. And one of the things I’ve been told is that many of the socialist economies that you mention did not really arise from capitalist economies as Marx envisioned (I think). So he got that part wrong .

    20. It seems obvious to me that, if every worker was paid according to his marginal productivity, a firm could make no profit. But in general firms do make a profit and therefore workers must be paid less and owners who do not work in the firm are being paid more than their productivity.

      This leads to the fundamental paradox of capitalism. In aggregate over the economy, workers are not paid enough to purchase what they produce without reducing their wealth, and non-working owners are receiving income to which they have not contributed so that wealth is continually being transferred from the workers to the owners, which is not sustainable in the long term.

      There are two possible resolutions to this paradox. One is that the owners spend their wealth rather than accumulate it (there is a paper by Mankiw along these lines but I don’t have the reference to hand). This would be inequitable but sustainable.

      The other is that all the wealth gained by the owners is invested to increase the total production. This leads to the idea that capitalism can work only if there is continual growth, which is not desirable on other grounds.

    21. Jerry,
      There shouldn’t be any confusion over the term capital once you specify the context in which it is used. In neoclassical economics capital is one of the four factors of production (including entrepreneurship), which is used as input by firms to turn out commodities. In this respect, it is productive or real capital that fits in this category, for instance machines, buildings, tools, equipment etc. It’s price is defined to be the profit rate, which is equal to its VMP. Financial capital, on the other hand, is not included since it becomes the means by which to acquire real capital. However, in Marx’s theoretical framework capital is defined as a social relation, in which the bourgeoisie confronts the proletariat in a struggle over the distribution of product. With this in mind, the tools used by a technician working for himself become capital only in the mainstream paradigm but not in Marxian terminology because no surplus value is extracted.

    22. “but capital is and capital is scarce, that’s the point.”

      Financial capital isn’t scarce. Neither is physical capital in a modern world. We can produce more than enough stuff for everybody with what we have and we get better at it all the time.

      What is scarce is labour hours, with which we create capital items (particularly in service economies where the capital is largely human capital), yet we waste millions of labour hours every day.

      The mainstream view of what capital is and how it comes about is misguided and muddled, which is what Part 2 will no doubt explain.

    23. “This leads to the fundamental paradox of capitalism. In aggregate over the economy, workers are not paid enough to purchase what they produce without reducing their wealth”

      That wealth word again. God knows why that shows up and why people put so much store in it.

      Profit is the wages of capitalists and interest is the wages of bankers. Everybody spends their wages on the output of workers in firms – mostly on consumption items, some on capital items that increase the amount that can be consumed. Economies of scale kick in due to that and prices fall so that people can consume more with the same wage. That circuit is perfectly balanced in that configuration.

      The problem happens when somebody decides to save, not spend. Then the circuit is disrupted and it heads towards depression. MMT policies offset that desire to save maintaining the circuit in balance – thereby fixing the ‘paradox of capitalism’. Much to the chagrin of the average Marxist.

    24. Neil,

      “Neither is physical capital in a modern world.”

      Shear nonsense.

      I suppose lathes and power saws and cranes etc. grow on trees in the village common?

      I suppose if I open your garage door there will be a D8 bulldozer parked in there (it just appeared one day), perhaps a tractor or two and perhaps a Boeing 737?

    25. Neil,

      “The problem happens when somebody decides to save, not spend.”

      If a certain amount of productive capacity is not set aside for capital goods then society will slide backwards.

    26. Thank you Demetrios. There are factors of production in providing services also though. What counts as capital if you are a medical doctor? Absolutely there shouldn’t be any confusion but I am confused and want a definition that works enough so that the term has some meaning. If it only applies to the manufacture of commodities in a factory setting, that would be fine – but I need to know that is the scope of what capital is. I need some understanding of whether a doctor’s stethoscope is capital or the MRI machine at the hospital is capital or none of it is capital. I wouldn’t know how to classify either the simple piece of equipment or the very complicated piece right now.

    27. Neil,

      “If a certain amount of productive capacity is not set aside for capital goods then society will slide backwards.”

      I should also have mentioned that socialist planners know this as well as anyone.

    28. tonyw,

      “It seems obvious to me that, if every worker was paid according to his marginal productivity, a firm could make no profit.”

      Can you prove that?

    29. Henry: “If there was no return to capital, capital would not be forthcoming.” (Physical) capital, like land, should belong to the users (workers) – worker co-ops. As Neil says: “Financial capital isn’t scarce” – that’s loans to you and me.

      Demetrios, ‘entrepreneurship’ is not a factor of production. An entrepreneur provides work and capital.

    30. Carol,

      In the first instance, I am talking about physical capital. To argue that it is not scarce is crazy.

      “Physical) capital, like land, should belong to the users (workers) – worker co-ops. ”

      Who SHOULD own it is a matter of opinion.

      Financial capital is another matter. That’s a tricky one. Some people have no problems getting their hands on it but it still has a price (which currently is historically low for a bunch of reasons). Others, like the poor, can get it but invariably pay a higher price for it.

    31. Henry, all factors of production are scarce.
      Lionel Robbins LSE 1932:
      “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.” Dispute ‘science’.

    32. Jerry,
      Regarding capital the same “stuff” could be capital or not depending on the economic school of thought. Let’s use as an example a radiologist with her own fully equipped medical office that includes the most sophisticated MRI. In this case we say that she owns all factors of production, that is labor, land (the plot on which her office is built), and capital in the form of the building and everything located in the office. To exaggerate a little, even her video games, which she uses to relax during a break is considered capital since it increases the productivity of her labor! Now, the Neoclassical school of thought or mainstream economics considers the entire content of the office capital and there’s not doubt about that. However, according to Marxian paradigm this very same content is NOT capital because the radiologist doesn’t sell her labor power to any capitalist and thus there isn’t any surplus labor extraction. In the latter case the social relations don’t create the conditions for exploitation, since ownership of labor AND capital coincide on the same person. Changing scenario now, let’s suppose that after 25 years of working for herself she decides to sell the business in order to work for a large private hospital in the department of radiology having exactly the same equipment as her former private office. The difference now is that she’s been alienated from the ownership of capital, she only owns her labor and sells labor power to the capitalist hospital owner according to the terms of her contract. Obviously in this case the social relations of production are entirely different, nevertheless a Neoclassical economist would argue that because this doctor’s remuneration reflects the value of her marginal product, she gets exactly what she contributes to production of medical services and consequently there is no exploitation. In juxtaposition, a Marxist economist would argue that although this radiologist is paid according to marginal productivity theory, the fact that the capitalist extracts all surplus value there is a clear cut case of exploitation. In conclusion, what constitutes capital strictly depends on the social relations of production.

    33. Carol,
      Firstly, one of the aims of this blog is to help us detach ourselves from neoliberal thinking. The definition of economics by Lionel Robins you cite is at the core of Neoclassical economics. If you read Mitchell et al “Macroeconomics” textbook, you’ll find a totally different definition. Secondly, regarding what constitutes factors of production you use an outdated definition that was used until WWII. However, after the War the creation of Neoclassical Synthesis by Paul Samuelson expanded the number of factors of production by including Entrepreneurship as the fourth one. In this regard, the entrepreneur is the driving force in capitalist economies, that talented individual who will combine the other three classical factors of production in the most efficient way in order to maximize profit. The entrepreneur also has a central place in the writings of Joseph Schumpeter.

    34. Demetrios, yes that’s the definition current when I studied economics and entrepreneurship was suggested as possibly an extra one. Steve Keen considers that ‘energy’ should be included with land, labour and capital. Actually there are only 2 primary factors of production: land (which includes natural resources – in fact the environment) and labour, that is human beings and the rest. Capital is produced by labour using land. Energy is capital – Keen is thinking physics here, not economics. Most of what I was taught was rubbish but I knew that land was important and should be taxed.
      I consider that ‘land’ and ‘rent’ are macro, but MMTers say otherwise. Still learning…

    35. “There is also the problem of the relative levels of different types of earned income. Here we have the famous marginal productivity theory.

      In perfect competition an employer is supposed to take on such a number of men that the money value of the marginal product to him, taking account of the price of his output and the cost of his plant, is equal to the money wage he has to pay. Then the real wage of each type of labour is believed to measure its marginal product to society. The salary of a professor of economics measures his contribution to society and the wage of a garbage collector measures his contribution. Of course, this is a very comforting doctrine for professors of economics, but I fear that once more the argument is circular. There is not any measure of marginal products except the wages themselves. In short, we have not got a theory of distribution.

      We have nothing to say on the subject which above all others occupies the minds of the people whom economics is supposed to enlighten.”

      – Joan Robinson, The Second Crisis Of Economic Theory, 1972

      From Inequality and Unearned Income Kills the Economy article in Evonomics by Joe Stiglitz.

      “The trickle-down notion— along with its theoretical justification, marginal productivity theory— needs urgent rethinking. That theory attempts both to explain inequality— why it occurs— and to justify it— why it would be beneficial for the economy as a whole. This essay looks critically at both claims. It argues in favour of alternative explanations of inequality, with particular reference to the theory of rent-seeking and to the influence of institutional and political factors, which have shaped labour markets and patterns of remuneration. And it shows that, far from being either necessary or good for economic growth, excessive inequality tends to lead to weaker economic performance. In light of this, it argues for a range of policies that would increase both equity and economic well-being.

      … Neoclassical economists developed the marginal productivity theory, which argued that compensation more broadly reflected different individuals’ contributions to society.”

      – Joseph Stiglitz Sept 9th 2016.

      If course Krugman denies all of it in his piece – Frustrations of the Heterdox in the New York Times after his debate with Thomas Palley about the issue.

      “But doesn’t that show that conventional economics is indeed capable of accommodating big concerns about inequality? You fairly often find heterodox economists insisting that to accept the idea that capital and labor are paid their marginal products, even as a working hypothesis to be modified when you address things like executive pay, is to accept that high inequality is morally justified. But that’s obviously not the case: there are plenty of economists who are willing to use marginal-product models (as gadgets, not as fundamental truth) who don’t at all accept the sanctity of the market distribution of income.”

      – Paul Krugman The New York Times, Krugman April 2014

    36. So personally, I am relieved that ‘capital’ means a whole lot of different things depending on who is talking about it. I was always afraid I had skipped the relevant class back in school and that was why I didn’t understand it.

      Sort of concerned that Neil Wilson might have a 737 and a bunch of tractors in his garage though. Those jet airplanes can always be used for nefarious purposes. But if John Travolta can have one I guess it is ok that Neil could have one too. But if it was sitting in his garage behind a bunch of tractors- well is it really capital?

      Did the Cambridge Capital Controversies start out with so much controversy about the definition of capital?

    37. Derek,
      When Joan Robinson says “. . . but I fear that once more the argument is circular. There is not any measure of marginal products except the wages themselves. In short, we have not got a theory of distribution.”, what does she really mean?
      To answer my own question, she means that using marginal productivity theory to justify the price of capital and land (profit and rent, respectively) is circular reasoning and thus absurd. Because using discounting method to find the present value of these resources, a discounting factor must be employed that reflects their opportunity cost in production, which is nothing else . . . than their prices, which is exactly what we’re searching for! It’s a version of chicken and egg analogy. But in the case of labor there isn’t any such problem because the extra output of an additional worker is directly identified and measurable. Therefore, the marginal productivity theory of income distribution breaks down.
      Notwithstanding the above, when dealing with employment Robinson considered capitalism as a necessary evil when she said that:
      “It’s a terrible thing to be a worker exploited in the capitalist system. The only worse thing is to be a worker unable to find anyone to exploit you.”

    38. For the vast majority of the world real and financial capital is scarce.
      Comes down to power and the will to wield it.

    39. Henry Rech,

      “”It seems obvious to me that, if every worker was paid according to his marginal productivity, a firm could make no profit.”

      Can you prove that?”

      Here goes:

      Suppose a firm makes widgets which it sells for $10 each. The firm employs me and I am responsible for an increase in production of 100 more widgets a day. If I was paid according to my contribution to the increase in production, I would receive $1,000 per day. The firm then receives an additional $1,000 in sales but it pays me the same amount, so that its increase in profit is zero. If the same applies to every worker, the firm does not make any profit. Q.E.D.

    40. Demetrious,

      You have a nice way with words. To make a difficult subject understandable.

      I’m interested in what Bill has to say in part 2 to get some historical context to the debate.

      I’m more interested and wanting to see what the sectoral balances are looking like with all this net saving and deleveraging going on by households. Borrowing going on by businesses during the pandemic. What the response is going to be.

      Godley’s work made Samuelson and Friedman look like an amateurs.

      Domestic Private Sector Net Saving + Capital Account Balance = Government Sector Deficit (at full employment.) Interests me. Will it work if you are determined to run a certain type of trade policy ?

      Especially when you can’t control the external sector that much apart from running a tight fiscal policy to dampen down demand to try and reduce imports. Can’t stop companies from exporting. What that might look like with full employment and thinking about how it will adjust. Once the exporters to your country realise they are getting the short end of the stick.

      For the domestic private sector to net save, the government sector’s deficit must be larger than any current account deficit.

      I’m trying to imagine what the sectoral balances might look like with a job guarentee in place. When you add nice things to have onto the job guarentee from the bottom up and you have full employment domestically. How that full employment will effect the trade balance and thus effect the sectoral balances and then the government balance. Is it achievable if inflation takes hold.

      The income/ expenditure flows such as consumption, taxes and investment and the financing flows, loans, deposits and equities. Income/expenditure flows affect financing flows which then affect balance sheets.

      Most of the Sectoral balances analysis I’ve seen is based on government’s who support the NAIRU and keeping a pool of unemployed human beings to control inflation and with countries having unemployment. Not interested in creating full employment by introducing a Job guarentee.

      I’ve only started thinking about it recently and need to start reading some of Marc Lavoie books. How will full employment affect the sectoral balances ? How different will they look compared to what they look like under austerity policies and monetarism and how will it effect the external sector? How will it restrict or make easier to implement the public purpose nice things to have that we would all like to see and affect households net saving? Is household net saving always the first thing to get punished at full employment in order to manage inflation?

      You can look at historical sectoral balances charts to when they did have full employment policies in place and they look different to what they today. When you read the Australian white paper from 1945 On full employment. The interactions between the 3 sectors are at the forefront of their minds. It is all in that white paper.

      So for the next couple of years I’m going to be knee deep in Godley, Lavoie and Cripps work. To get a better understanding of how full employment will effect the sectoral balances. What you have to look out for to get a healthy deleveraged household sector and what it means for the trade balance to introduce public purpose and nice things to have.

      Read some MMT papers on it and compare the findings.

      I just feel a basic understanding of the sectoral balances is not enough to get a deep understanding of what is going on. More importantly I’m convinced the sectoral balances are set On Geopolitical terms today. A tool that is used for geopolitical reasons that feeds expansion abroad and greed. Instead of what they could be used for and benefit the domestic population within your own borders.

      So if there is a shift in the geopolitical landscape and MMT is accepted in the west. I’ll have a better understanding of what is actually going on in the different sectors.

    41. tonyw,

      “If I was paid according to my contribution to the increase in production, I would receive $1,000 per day. ”

      “If” is the operative word.

    42. Dear tonyw (at 2021/04/29 at 7:54 am)

      Your reasoning is incorrect and I guess it is because you don’t understand the marginal concept in neoclassical theory.

      1. Marginal productivity theory says that if you add more labour to a fixed existing stock of capital, the extra output gained declines at some rate. So each successive worker is less productive than the last. This is their so-called law of diminishing returns (which has little empirical foundation).

      2. Competitive forces then mean that the firm maximises profits by paying the marginal worker a wage exactly equal to what that worker contributes to revenue by way of their marginal product. That is, they break even on the last worker.

      3. But as all the previous workers employed were contributing higher marginal products, the firm has made a profit on them.

      I hope that helps you.

      best wishes
      bill

    43. @’Jerry Brown’ (April 28, 2021 at 6:30):
      There is also the issue of how exactly employers set wages. It is similar to the findings of Alan Blinder on price setting. They will pay wages just sufficient to attract hires. That is basically set by the monopolist wage rate (public sector salaries) and the labour market can do little but apply fluctuations about the public sector wage rate according to scarcity of the skilled labour they seek plus psychology (executive pay rates being obscene psychology). No employer I’ve ever known values labour by actual energy and living expense demand of labour time. They just try to get away by pay the bare minimum going rate a worker will accept upon first hire.

      But subsequently surveys show they are prepared to pay for salary rises to retain skilled workers, rather than hire the cheaper unemployed, regardless of any computation of the real labour-time value of the employee. They simply never make those calculations, and they would not know how to anyway, and “the market” doesn’t make such a computation either (contrary to what Hayekians might think about the magical computational powers of “the all-knowing market”).

      Where is marginal productivity pricing theory here? It’s bleedin’ nowhere.

      I’d like to see a mainstreamer compute what wages should be based on MPL theory (it must be possible to do so if “the market” can do the computation), and then compare with the real world. My bet would be their computed wage rates are completely uncorrelated with the real world.

    44. Dear Bill,
      I think there is a caveat in tonyw’s statement that “. . . if every worker was paid according to his marginal productivity, a firm could make no profit.” If we consider each and every successive additional worker getting paid his VMP, then in a perfectly competitive market at equilibrium is there profit resulting from labor? And assuming that every other firm is just as generous as the representative what will happen to producer surplus? And given that the market price>ATC where does profit come from, if not from labor? Wouldn’t a mainstream economist point out that every other factor of production has its own marginal productivity? Therefore, although there is no profit resulting from labor wouldn’t there be profit emanating from capital and land provided that their VMPs exceeds their respective opportunity costs?
      Thanks for your time!

    45. replying to @’Henry Rech’ (April 28, 2021 at 8:18);
      I think Henry is missing the point, and so are those arguing with Henry. In fact Henry himself partly got closer to the pont when he noted Marx thought capital equipment to be “embodied labour,” which is partly true. But as Steve Keen constantly points out, the LTV is utterly flawed because a hell of a lot of exergy comes from nature (Sun and Earth’s gravity mainly). So there is surplus real value everywhere to be had for free. Capital merely helps harness this exergy, and labour adds to the inputs to create surplus value — the difference between the use-value of all the inputs and the exchange-value when sold to a buyer of the goods. Marx got it deliberately wrong in Capital Vol 1, because he was arguing in the abstract about “perfect capitalism,” i.e., perfect competition (a fiction) as well as using the concept of commodity money (gold standard). I think Marx knew he was arguing against a straw man (you can tell this from the Grundrisse) but he wanted to focus the minds of workers of how they are unfairly treated (he lived in Dickensian times) and wanted to foment revolt, which he managed to do, so “mission accomplished.” The exploitation of labour is very real, and palpable, so setting up a straw man to attack in order to energize socialists was a fair game to play. So you have to take Marx with a thousand grains of salt.

      But “social value” a highly nebulous quantity, is indeed extracted from labour. Passive machines contribute zero social value (some person has to push the buttons, to put it crudely). This is what capitalists exploit. They exploit the social relation, and realize it in a money form.

      As for Henry Rech on the value of capital equipment: sure. Equipment is scarce, and the capitalist pays for it. But they very rapidly recoup the costs in sales over a fairly short period, well before the equipment life expires typically. So from that point on they are pure rentiers, and Marx’s critique applies in a social setting. You have to be prepared to get in the uncomfortable frame of social relations to see why besides all of Steve Keen’s disagreements with LTV, nonetheless, labour is still exploited and can often be paid an unfair wage.

      But then turn that on its head: If we devoted the compute resources to estimate the real energy expenditures as Prof keen woould have us do, it would be possible to pay workers a fair wage, based on the labour power the firm demands from them, this includes the mental stress of intellectual endeavour which has computable costs to “knowledge” workers. (Talking here about highly uncertain computations, so there are massive error propagations to handle.)

      No one is ever going to be bothered to do this sort of analysis is my guess, the real costs of mental stress are far too uncertain, so fair wages need to simply be more democratized, and nationalized, as in worker cooperative models. People are “smarter” than machines, we know the stress of having intellectual work to do such as science research when you have no idea when a breakthrough will come, a huge stress, I can attest to, with enormous life costs. But I can have nurses measure these stresses, I just do not have personal nurses to do it. But socially people are capable of fairly accurately judging the social value of various forms of work.

      We all know janitors do critically necessary work, and are grossly underpaid — think of how wretched life would be at the office without them. We underpay them not just because there is plentiful supply of janitors in excess of demand (which is probably false), but because they are often vulnerable people who will simply accept low wages and have not even a thought of unionizing because they are already too troubled just surviving. It is within our collective power to make janitorial work of high rank and importance, reflected in high wages. Obviously this sort of reappraisal of the social value of labour will not happen under neoliberalism, but it can happen.

    46. Hah I just read your post “Why budget deficits drive private profits” from 10 years ago where you said you would (some day) write a post about the Cambridge controversies (something I stumbled upon elsewhere and wanted to learn more about) and — surprise! — only two days ago you did! What a coincidence, I feel very lucky. Thanks very much Bill.

    47. Bijou, Keen is badly mistaken about Marx. Let me try to explain:

      “But as Steve Keen constantly points out, the LTV is utterly flawed because a hell of a lot of exergy comes from nature (Sun and Earth’s gravity mainly). So there is surplus real value everywhere to be had for free” — this is not correct as, for Marx and for the classicals generally, “value” is definitionally human labor. Value is a way of accounting for human labor. That part of the claim is just tautological. The really interesting part, and Marx was right on this (and Keen was wrong), is that you cannot charge for cost-less use-values available to all, so things that have use-value may not have exchange-value. So, you inadvertently give an excellent example: no capitalist can mark up her products for the “value contributed” by the sun and Earth. This was well-understood by all of the classicals and it is frankly . No capitalist has ever successfully charged for the vibrant green color of a smoothie their workers make or the rich scent of a wooden chair. They assess a mark-up on *money costs paid*. Now, rent is an exception to that that has to be explained (and Marx does it well), but rent is a clear exception to the case you lay out (which is a very useful limit-case) because not-everyone has access to the unproduced natural wealth in the case of rent. The fact that some use-values *necessary* to production *cannot be charged for* in a competitive market is all the proof you need that there is a difference between use-value and exchange-value, and when you have use-value that has no exchange-value, it is because there is no *human* cost to produce it, only a natural “cost” (i.e., it requires some energy expended without human effort).

      I have a draft paper (that I’ve slowly been working on for a decade when I have time) showing how badly Keen misread Marx. And I started out in economics by reading Keen shortly after the GFC. A mentor of mine, a Marxist economist, challenged me to actually find the parts he cites in Marx and see if that’s what Marx meant. I accepted, assuming I would impress my mentor, and discovered that Keen was completely changing the meaning of Marx’s words. Of course, the main point is not so much about quotational scrutiny, just about whose logic makes sense — your chosen case is actually an excellent one. Happy to send the paper along.

    48. Dear Bill, (April 29, 2021 at 16:08)

      You have misconstrued what I have written.

      You said that my reasoning is incorrect but, in your point 3, you used the same reasoning and came to the same conclusion that I did. I fail to see what the argument is about.

      Regards,
      Tony

    49. tonyw
      Friday, April 30, 2021 at 10:24

      If I may play devils advocate, Bill is only explaining the Neoclassical theory of marginal productivity, which in a nutshell argues that for as long as an additional worker contributes more value than the wage paid to him he’ll be hired, and this process continues until the last worker (also known as the marginal worker), revenue wise, just pays for himself. However, because the nominal wage rate is set in competitive labor market the firm is going to pay ALL employed workers the same equilibrium wage (the one that clears the labor market). Now, diminishing labor productivity ensures the firm a positive differential between the value of marginal product and this fixed paid wage rate, except for the last worker (the marginal) for whom the firm breaks even. Therefore, profit results from labor due to the fact that for different marginal products the SAME money wage is paid.
      I interpreted your initial statement differently, and asked Bill what is it going to happen to profit in that (theoretical) case where EACH successive hired worker is paid a wage which is exactly equal to HIS value of marginal product.

    50. tonyw,

      “….in your point 3, you used the same reasoning and came to the same conclusion that I did.”

      I don’t think Bill is saying what you said.

      Have a think about the difference between marginal productivity and average productivity.

    51. Bijou,

      Surplus value is just something that Marx made up. He defined it to suit his purpose which was to emphasize the exploitation of labour by capitalists. Joan Robinson provided a stinging rebuke of Marx’s labour theory of value (from An Essay in Marxian Economics):

      “Voltaire remarked that it is possible to kill a flock of sheep by witchcraft if you give them plenty of arsenic at the same time. The sheep, in this figure, may well stand for the complacent apologists of capitalism; Marx’s penetrating insight and bitter hatred of oppression supply the arsenic, while the labour theory of value provides the incantations.”

      “We all know janitors do critically necessary work, and are grossly underpaid…….. It is within our collective power to make janitorial work of high rank and importance…………”

      There was a time when perhaps they were. The Chamberlain, a high ranking official, was, among other things, an attendant on a sovereign or lord in his bedchamber. I suppose we have to use our imagination as to the meaning of this. So there is hope yet.

    52. “… a hell of a lot of exergy comes from nature (Sun and Earth’s gravity mainly). So there is surplus real value everywhere to be had for free. Capital merely helps harness this exergy, and labour adds to the inputs to create surplus value”. This shows that Keen, like most economists, have no understanding of ‘land’ as a factor of production. The electromagnetic spectrum, the soil, the sea, the fish in the sea, virgin forest – they all have the unique feature that they have no cost of production.

      Wih regard to Marx’s ‘surplus value’, I understood from a communist friend that the correct term is ‘surplus labour’, at least that’s what he called it, and I think it’s more descriptive.

    53. Carol,
      These two terms aren’t synonymous although highly connected. Surplus value is the difference between the value of the commodity produced and the value of indirect and direct materials and subsistance wage.
      Surplus labor, on the other hand, is labor expanded in the creation of this surplus value.
      The first is expressed in money terms while the latter in labor time.

    54. “How will full employment affect the sectoral balances ?”

      One of the reasons for a Job Guarantee is to fully accommodate non-government sector savings desires, so I’d suggest they will rise to their indifference level. What the offset from private investment would be depends how much increasing spending to the correct level crowds in extra investment. (This is what creates the effect the right mistakenly call and mis-analyse as the ‘Laffer Curve’. When seen correctly from the MMT viewpoint it is the crowding in effect of sufficient, but not excessive, well targeted public spending. Nothing to do with tax rates).

      The Job Guarantee anchors true inflation in its own right by maintaining demand at the correct level at all times. Supply side semi-inflation is then tackled with anti-trust mechanisms – since price rises at that point necessarily mean there is insufficient competition in that market area. Since there are now always sufficient jobs you can break up the cartels with a degree of firmness hither to unseen.

    55. “I suppose lathes and power saws and cranes etc. grow on trees in the village common?”

      And I suppose in your world those things appear by magic once you way money around in a particular fashion rather than being created, like everything else, by the application of labour hours.

      What is capital and what is consumption is in the eye of the beholder. The classic case is a car which is purchased to drive in. That is a consumption good and is consumed by the user. Then they decide to become a travelling salesman for a week. All of a sudden the car becomes capital – for a week – before returning to its lowly status as a consumption unit.

      Economists have real trouble with capitalisation and their dividing lines are often laughable. They will classify a stapler as durable goods because it lasts more than a year, but training a helicopter pilot is consumption.

      At the base capital is produced with labour hours in multiple different forms and whether it is capital or becomes capital changes over time – often in interaction with other changes in state in the economy. (A particular way of thinking that was laughed at and ignored for generations suddenly becomes incredibly valuable because somebody else invented a computer – and that changes the entire political and economic landscape because suddenly geeks have money and power).

      This is why the capital debates still hold. Conceiving of capital as a single thing is as wrong as conceiving of money as a single thing. It is neither single, nor a thing.

    56. Further, Demetrios, my friend was concentrating on defining, and then proposing policies to minimise, the appropriation of surplus labour, which I think is still a very worthwhile pursuit. It is equivalent to economic rent (unearned income). I was able to help him to define the appropriation of surplus labour by the owners of land – and its simply solution: land value tax.

    57. Neil,

      “This is why the capital debates still hold.”

      I agree with most of what you said but can’t see it’s relevance to the point I was making.

    58. Dear Henry Rech,

      When talking about profits and surplus value, aren’t the neoclassicals redefining the terms in the way it suits them and then showing the supposed absurdity of Marx’s views? This method is based on an “informal fallacy” called equivocation (as described in Wikipedia). Another term for this is “twisting words”. They also use misdirection that is a technique of distracting the audience while performing a trick, commonly applied by street magicians.

      Regarding so-called profits they can be defined as the flow of revenue minus the flow of costs. In a neoclassical or New Keynesian model such as one described in “Recursive Macroeconomic Theory” by Ljungqvist and Sargent, costs of a representative firm consist of the costs of renting capital and labour. What remains are “profits” and these are assumed in the marginal theory of production to be equal to zero. This is what tonyw quoted. Yet using the language of finance, firms make “profits” which belong to the owners of capital, this is exactly what is redefined as the costs of renting capital in the neoclassical theory. Regarding the marginal productivity theory itself, the reasoning that profits are equal to the excess value brought to the production process by all the hired workers apart from the last one (these for whom marginal productivity was higher than the wage paid), is itself flawed. The productivity of all individual workers depends on the ratio of the number of hired workers to the value of the stock of capital. The productivity of all workers is assumed to be the same, so hiring extra workers diminishes the productivity of already hired ones. “At the margin” (when the hiring process stops) the productivity of all individual workers is equal to their wages. We cannot apply a concept similar to a “consumer surplus” here. The same reasoning applies to the process of renting the capital.

      Now the main point. The neoclassical production function has been defined in nominal not real terms. Labour time and quantity of capital are different categories. The only way one can measure the value (“exchange value” in Marx) is by finding a common unit – usually value is expressed in money units. We can define the production function in real units but then we still need to calculate the monetary values of flow of products and labour and the stock of capital. For simplicity we can talk about the Cobb-Douglas production function defined as
      P=b*L^k*C^(1-k)
      It is usually defined as a “real” production function. But the fallacy of neoclassicals is to skip the step of normalising the units by multiplying the volume of labour L by the unit wage “w” and the value of capital by the unit price “p_e”
      P_m=b*w*L^k*p_e*C^(1-k)
      It is nowhere seen that both w and p_e are constant. They may depend on the actual labour intensity and other factors. Going one step further, we can even assume that the production of all the commodities is described by Leontief real production functions of the form
      P=min(L/a,C/b)
      Anwar Shaikh in “Laws of Production and Laws of Algebra: The Humbug Production Function” has demonstrated that we will still get Cobb-Douglas as the aggregate nominal production function for the whole economy regardless of the form of real production function. The paper is available on his personal web site. We can claim that the neoclassical aggregate nominal production function is an artefact of income distribution between the owners of capital and workers.

      Now back to surplus value. This term has been defined by Marx as the part of the total exchange value of the products (equal to the amount of socially necessary labour expended in their production) which is allocated to landlords (in feudalism) or capitalists (in capitalism). We need to distinguish between the contribution of the factors of production to the value of the output and the allocation of the revenue of firms to workers and capitalists. Neoclassicals claim that the allocation of revenue (social income) between workers and capitalists is determined by the production function in the way described above. The rate of return of capital (equal to the rate of interests in an ideal case without frictions and productivity shocks) is determined by the discount factor (how less utility a representative agent will enjoy in the case of postponing consumption by a unit of time) and the rate of deprecation of capital. Unit wages can be set to unity and the whole model looks consistent – but the causality is reversed to what has been claimed by Marx and Neo-Ricardians. The whole point of having neoclassical economics is to “prove” that the distribution of social income is a result of objective, “natural” laws existing in the universe and no exploitation of labour exists.

      In Neo-Ricardian models such as ones presented by Pasinetti in “Lectures on the Theory of Production” the rate of profit is an exogenous parameter. It is one of the parameters determining the unit-pricing system for the whole economy (assuming perfect competition, implying cost-pricing). We can argue whether this parameter is exogenous or endogenous. But this does not help us answering the following question – what happens when we don’t change the prevailing rate of profit but just nationalise the whole industry and redistribute the “profits” (rents on capital) pro rata to the workers? Let us assume that the bundle of final goods demanded by the consumers does not initially change after the nationalisation, that the scale of production remains the same. The prices will remain the same as the rate of return on capital does not change in market socialism, compared with capitalism. We can then claim that the value of profits reclaimed by the workers in market socialism is equal to the value of surplus value harvested by capitalists (owners of capital) in capitalism prior to the nationalisation. Marx went from surplus value to profits, we are retracting his steps back from profits to surplus value. I strongly disagree with the statement that “Marxist concept of surplus is nonsense”.

      It looks like the question of allocation of social income is the question of ownership of the means of production, precisely what Marx has claimed. The thought experiment about creating market socialism with a non-zero rate of return on capital is not a theoretical one as this is what the Chinese are aiming for, allowing only limited private ownership of the means of production and creating an illusion of capitalism while maintaining a firm control of the Communist Party on the whole social income distribution system.

    59. Adam K,

      I have no interest in the line of argument in your post. I am not interested in being an apologist (your strawman) for neoclassical theory. I don’t care how you define the production function and what conclusions you draw from it.

      The simple fact is that Marx defined any return to capital as expropriation.

      To me this seems absurd.

      Capital is a scarce factor of production and requires a return otherwise it will not be forthcoming and will not be optimally deployed. Even socialist planners found they had to ascribe a value to it so that optimal resource allocations could be made.

      How that return to capital is derived, well that’s another matter. To me this is a red herring in this discussion.

      “..what the Chinese are aiming for, allowing only limited private ownership of the means of production and creating an illusion of capitalism ..”

      Almost fell off my chair laughing when I read this. It might be what they are aiming for but the reality is that the private sector produces well over 50% of Chinese GDP, probably close to 70%.

    60. Henry writes: “Marx had it that all surplus value should belong to labour and that any surplus value not accruing to labour was expropriation. He made no account of the productivity of capital and the scarcity value of capital.”

      This is not correct at all. It is crucially important to distinguish between the physical side of production and the social side. Marx freely admitted, indeed constantly discussed and saw as no challenge to his theory at all, the fact that a marginal addition of means of production a production process might have a positive impact on physical productivity and that capital might be relatively scarce.

      Here is how this works in practice. Assume a competitive market where some state-of-the-art technique prevails. This is a pretty reasonable assumption for a lot of industries, and it’s reasonable at the level of abstraction we want to work on. There is thus some capital-labor ratio (in physical terms) in that industry that minimizes unit costs, and so producers are driven to adopt that technique. Only then is the value of a product in that industry defined: it is (at the level of abstraction of Vol. I) the direct-price of the good (c + v + s), or at the level of abstraction of Vol. III, the cost-price plus the average rate of profit (k + k*p’). A producer who finds that adding one more machine increases productivity will simply define the new technical standard for the industry, and thus the actual (discovered) socially-necessary labor-time changes, changing the value of the product, while the producer who adds one more machine and sees an increase in unit costs will simply make below the average rate of profit (or try to sustain that rate of profit and have to charge higher prices), in either case being out-competed.

      So, you can see that the physical productivity of machinery and labor are incorporated into Marx’s analysis — and it’s really quite impossible to suggest otherwise — it shows an unfamiliarity with what his most basic arguments are.

      Incidentally, your point that because socialist planners assigned prices to physical means of production non sequitur. Marx never said that capital didn’t have a cost (to say otherwise indicates you haven’t read even the shortest summary of his work as he thought precisely the opposite). Further, because profit is surplus labor and surplus labor exists in almost all societies (including socialist ones), profit was simply a way of accounting for that surplus labor. The term is unfortunate and misleading to use in a socialist society, I suppose, but that’s a wholly secondary point. I’m not sure how you could possibly think that this is a “gotcha”.

    61. Physical capital is produced from labour using land (natural resources). There are only 2 primary factors of production. The return to capital is profit or interest. You can cut out the owner of capital by bank loans – which incur interest (you might say that banks are providing a service here). There is no need for capital to be owned by anyone other than those who use physical capital, i.e. labour. Equally there is no need for anyone to own land other than those who use it. That does not rule out the necessity for landlords who also own the physical capital on the land as that has to be maintained and renewed. However, land is permanent and does not need to be maintained or renewed. That is why LVT is necessary because the return to land is rent – unearned income. The tenant farmer pays LVT to the landlord, because agricultural land has little in the way of physical capital.

    62. Griffin,

      You have gone down the same path as Adam K, putting words in my mouth and then proceeding to explain production functions and the workings of labour value.

      As I said to Adam, this is all irrelevant to the discussion.

      The fact that Marx accepted the physical conditions of the production process is inconsequential (he was just accepting the blindingly obvious).

      The point is Marx considered that all surplus value was expropriation and exploitation of labour, the corollary being that the owners of capital are owed no reward.

      Good luck with running an economy on this basis – even the socialist managers recognized capital is owed a reward.

    63. ” even the socialist managers recognized capital is owed a reward.”

      You keep saying capital is a scarce resource, yet it isn’t. It is just labour hours. Why do you want to separate workers and capital? In a monetary economy, where money isn’t a scarce resources, the two are the same thing. So the return to ‘capital’ is just the wages of those workers who organise things and maintain things. There is a wage to a banker for assessing what is likely to deliver a return and providing the necessary liquidity. Any other return is merely ‘rent’ and should be eliminated by the effect of market competition in a system where the bankers do their job properly.

    64. Let me quote Keynes from Chapter 24 of “The General Theory…”.

      “I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work. And with the disappearance of its rentier aspect much else in it besides will suffer a sea-change. It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier, of the functionless investor, will be nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain, and will need no revolution.

      Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in the volume of capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus; and at a scheme of direct taxation which allows the intelligence and determination and executive skill of the financier, the entrepreneur et hoc genus omne (who are certainly so fond of their craft that their labour could be obtained much cheaper than at present), to be harnessed to the service of the community on reasonable terms of reward.”

    65. Keynes- ““I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work.”

      Adam, I think Keynes might have been overly optimistic if not altogether wrong about this. One thing is that it seems that governments like the US have actively extended the ‘rentier aspect’ through all kinds of protections on ‘intellectual property’ such as patents, copyrights, production processes, and even to the extent of enforcing ‘non-compete’ clauses in workers contracts. At a certain point all of that becomes ‘rentier aspect’. Not sure what that point is.

    66. “governments like the US have actively extended the ‘rentier aspect’ ”

      Michael Hudson, for one, has a great deal to say about this. Rentier-ism got a solid grip after World War I and has ruled since then. Counter-measures need to discourage pervasive borrowing: 1) stop treating debt service as a normal cost of doing business, so it isn’t deductable from taxable income; 2) tax capital gains at the same rate as business income. Both these policies would make it attractive for businesses to finance operations out of available cash, and avoid debt compounding and taking over the entire nation.

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