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Cambridge Debates

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While the aggregation literature deals with the question of whether a well-behaved aggregate production function can be generated from micro production functions for the purpose of building theoretical models and for empirical testing, the Cambridge-Cambridge debates were about the measurement of capital as it relates to the interdependence of prices and distribution. Both problems can be present at once, but they are not the same issues. The discussions took place during the 1950s, 1960s and 1970s between Joan Robinson and her colleagues at Cambridge, UK, and Paul Samuelson and Robert Solow at Cambridge, USA. The debates were, in the final analysis, about different value theories, the classical versus the neoclassical, and how these theories explain prices and distribution. The debates centered around the question of whether one can use an aggregate measure of capital (Joan Robinson’s 1953-54 famous question “in what unit is ‘capital’ to be measured?”) in a macroeconomic production function without running into apparently paradoxical phenomena (e.g., reswitching and reverse capital deepening). It was concluded that the notion of an aggregate production function is more than dubious. In a widely cited paper, Paul Samuelson (1961-1962) showed that under some admittedly strict conditions, one could think of an aggregate production function as a parable. However, a few years later, Garegnani (1970) showed that Samuelson’s neoclassical aggregate production function, supposedly the antithesis of the classical approach, was theoretically valid only if Ricardo’s labor theory of value, which neoclassical economics contemptuously rejects, is strictly true. What a cold shower!

See the paper by Cohen and Harcourt in the Winter issue of the Journal of Economic Perspectives (2003) and the comments on this paper in the Fall 2004 issue of the same journal.

Classical Economists

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Classical economists of the 18th and early 19th century (Smith, Ricardo, Malthus, Marx) were mostly concerned with the analysis and implications of long-run growth, its causes and consequences. This is in sharp contrast with the two schools of thought that followed the classical, the neoclassical and Keynesian. The former was more concerned with issues of equilibrium, while the latter was concerned with short-run instability problems. For this reason, those interested in the study of the developing economies have, one way or another, to understand the message of the classical economists in order to find an appropriate framework to study the problem of growth in these countries. The classical economists had such a deep understanding of the economy (e.g., they were perfectly aware that unexpected shocks occurred periodically, giving rise to market turbulence that accentuated the systemic imbalances out of which central tendencies emerged; trade; the role of technical change), and in particular of the incipient economic and social system being developed at the time they wrote, that much of their message is still alive and constitutes a useful reference in order to understand the problems of the developing economies. Many developing countries today are, to a large degree, pre-capitalist societies and economies, or have traces of it.

As the Spanish economist Manuel Roman indicates in “Heterodox Views of Finance and Cycles in the Spanish Economy”, the classical economists took growth for granted as long as structural barriers did not hamper the extraction of the economic surplus form productive investment. The consumption of workers in this pursuit was a cost of production to capitalist firms advancing circulating capital. Capitalist consumption of goods or the services of unproductive labor was viewed as a subtraction from business savings. Internal finance was sufficient to sustain capital accumulation and no stimulus form government deficits or bank lending was essential for its growth.

Abstracting from differences in the works of Smith, Ricardo, Malthus and Marx, classical growth models share as a basic assumption the recognition that accumulation and productive investment of a part of the social product is the main driving force behind economic growth, and that in a modern market capitalist economy, this takes the form of the reinvestment of profits. For the classical economists profits were assumed to be largely saved and invested, while wages were consumed. The share of profits in income determined the share of investment in total production and the rate of accumulation. Business practice alone should suffice to shed light on the significance of profits for capital accumulation and output growth. One would expect that because the pursuit of profits by business enterprise is paramount, the growth of output must be closely related to the dynamics of the profit rate.

Adam Smith
 possessed a deep understanding of the hidden power of market forces and saw technical change fostering the division of labor, raising labor productivity and expanding both employment and the surplus since population expansion would in due course put a lid on the growth of wage rates. Higher productivity leading to expanding profits would promote higher accumulation and a growing demand for labor, but wage rates would only rise temporarily because if wages went up, net birth rates would increase and population growth would surpass the labor demand.

“The Wealth of Nations” has rightly earned its reputation as the founding work of modern economics. As Alan B. Krueger indicates in a recently published edition of the masterpiece, Adam Smith was a great synthesizer, great observer, and great storyteller. But above all, Adam Smith was a great economic theorist. He saw economic behavior as primarily guided by the fundamental force of self-interest, and he conceived of the economy as a system in which regular patterns emerged form people interacting in markets on their own accord, without interference from outside authorities. Order, not chaos, would result if individuals were left to their own devices in Smith’s conception of the economy. Interestingly, he was not nearly as doctrinaire a defender of unfettered free enterprise as many of his late twentieth-century followers have made him out to be. Many liberal and conservative economists have interpreted Smith’s reference to the invisible hand broadly, as indicating his commitment to the idea that individual exchange in the marketplace inexorably leads to the greatest good for society. This view is most likely incorrect, a distortion and exaggeration of Smith’s reference to the invisible hand: interpreted in the context of the late eighteenth century and Smith’s other writings, he would probably be skeptical of the elevation by modern commentators of the invisible hand to the central concept of his thinking.

Adam Smith worried about the encroachment of government on economic activity However, he was very tolerant of government intervention when the aim was to reduce poverty. Moreover, he argued that when labor regulation is in support of the workers, it is always just and equitable. Smith always saw a tacit conspiracy on the part of employers to keep wages as low as possible. He was also pro progressive taxation, and supported universal government-financed education because he believed the division of labor destined people to perform monotonous, mind-numbing tasks that eroded their intelligence. At times these issues were dilemmas for Adam Smith (how much efficiency should be sacrificed to improve the lot of those who feed and lodge the rest of society, if that is a goal of economic policy).

Smith viewed competition as economically efficient: “Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society.” Central to Smith’s thinking was the notion of equilibrium, according to which the economy would reach a balance in which buyers and sellers, workers and firms, would have no incentive to change their economic behavior in light of the set of prices and wages that would be grounded out in the market by the pursuit of individuals’ self-interest.

A large part of post-war economics can be thought of as an effort to determine theoretically and empirically when, and under what conditions, Adam Smith’s invisible hand turns out to be all thumbs.

David Ricardo’s analysis of the laws of political economy is outstanding. He brought up the link between accumulation and the class distribution of income. He examined how structural changes in the class distribution of the surplus between productive capitalists and landowners could slowdown or even bring to a halt accumulation altogether. Initially accepting Smith’s view of growing employment with rising accumulation, Ricardo saw the secular rise in wage rates coming about as a result of expanding accumulation. As cultivations bumped against the boundaries of he best soil for growing food, capitalist farmers would be forced to cultivate progressively lower grade areas. The rising cost of food at the margins would push wage rates higher, thus allowing the landowners of the better lands to capture an increasing share of the surplus in the guise of differential rents. Ricardo then argued that if the surplus retained by capitalists declined, so would accumulation. Finally, Ricardo allowed that labor saving technical progress and declining accumulation would reduce the demand for labor, harming employment.

THE PERILS AND PITFALLS OF THE THEORY OF COMPARATIVE ADVANTAGE: SOME ECONOMIC MYTHS THAT EVERYBODY SHOULD BE AWARE OF.

Thomas Malthus questioned the viability of exuberant accumulation in the absence of external sources of effective demand, thus anticipating Keynes. If workers consumption demand was limited by subsistence wages and capitalist consumption was constrained by competition and the drive to accumulate, where would the final demand for the growing output to be found? This question led Malthus to theorize the necessity of cycles as an organic feature of secular growth. For Malthus the accumulation drive would widen the gap between the growing capacity to produce commodities and the insufficient growth of final consumption demand. Hence periodic slumps would punctuate this growing imbalance and their destructive force would temporarily reduce the existing gap.

Karl Marx provided the deepest and most comprehensive analysis of how capitalism works. In fact, very few thinkers in history have formulated ideas that have had an impact comparable to those of Karl Marx. However, unfortunatley, Marx’s work is largely misunderstood and distorted and much of the compulsive overreaction againsts his work and ideas steams from fear and ignorance. Most people (economists included) do not have a clear idea of what Marx had to say about inequality, economics, and the role of social classes in society. Some people would find it surprising that Karl Marx admired many aspects of capitalism in the modern nations of the mid 1800s, when he wrote. Heargued that capitalism was a truly dynamic system, a powerful modernizing force. Marx thought that capitalism would wipe out the older, rigid, autocratic systems of inequality. Capitalism meant doom for the nobility of the aristocracy of feudal regimes. He saw the technology of capitalism as far superior to, and more efficient than, the way work had previously been organized. Marx wrote admiringly of the many ways in which capitalism tended to organize and improve industry. But it always ended up with periodic gluts of overproduction, which then led to economic downturns. It was this very efficiency that led capitalist industries to expand in an insatiable search for new markets to sell their goods, which in turm led to greater profits for their owners. This, in turn, led such owners to invest in even more productive facilities. But Marx foresaw only collapse. In the long-run, overproduction would lead to a satiation of markets. Slack demand for goods, less need for manufacturing, an increase in unemployment, further poverty, and eventual violence would well up within a sinking economy.

It is also true that Marx argued that like all previous societies, capitalism is a historically limited social system. Arguing this, however, is not a “sin”. Marx developed extensively this idea as part of an integrated intellectual system. Thus, no part of the system can be understood fully except by putting it in its proper context within the whole system. Moreover, Marx did not say much about what would happen after capitalism would collapse and communism would arrive. He preferred to dwell upon the more pronounced traits of capitalism in his day. Marx did not concern hiself with the possible internal modifications or reforms of the capitalist structure through persistent state interventions becasue he believed that the system would collapse and be abolished by the rise of the revolutionary proletariat. He was fully convinced that no reform of capitalism could alter its essential capital-labor relationship or the value character of its social production. Any reformed capitalism was bound to suffer the same fate that he predicted for the capitalism of his own time. It was the great mind of the first part of the twentieth century, Keynes, who sought to remedy the deficiencies of laissez faire capitalism through deliberate state action. In fact, as Joan Robison wrote: “Keynes had a ‘long struggle to escape’ from the neoclassical orthodox theory in which he had been brought up and there are some points at which the process was incomeplete. Only the contorsions of the neo-neoclassics, trying to reconstitute the old orthodoxy while accepting the main part of Keynes’s theory, have shown how radical his departure from orthodoxy really was. It has become clear that Keynes’s affinity in analysis.though not in ideology, is with the classical economists, and therefore with Marx, rather than with the tradition that he inherited from Marshall”.

Often one hears such simplistic comments as “he was wrong”, or “his analysis is outdated”, or “his predictions never materialized”. Nobody seems to show the same degree of contempt, however, about Smith’s invisible hand, about Ricardo’s principle of comparative advantage, about Friedman’s natural rate of unemployment, about Lucas’s rational expectations, or about Prescott’s real business cycles. Are they all “right”? The “celebrated failure” of Marxism is, to some degree, a failure of economic theory insofar as its application to reality led to an underestimation of the strength of capitalism’s adaptability to change. But it is more a failure of the social and poitical expectations based on it. One may disagree with Marx on many counts, but his insights about how capitalism functions are simply brilliant, and sometimes his views have merely been restated with a different terminolgy (e.g., Keynes view of the long-run trend of capital production: investments depend on profitability, current and expected, and investments tend to decline with a declining profitability). Moreover, as Paul Mattick put it: “no reasonable person would demand that Marx should foresee actual social and economic development in all its concrete manifestations. And to the extent that socio-economic development is predictable with some degree of of certainty, Marx did rather well, as is demonstrated by the rise of Keynesianism. In the Keynesian formulation, Marx’s findings are silently accepted and simultaneously “remedied” by conscious interventions in the market mechanism.”

I believe that the Marxist toolkit equips a social scientist mcuh better than standard orthodox (neoclassical) economic theory to understand and explain many aspects of the economic and social reality, especially those of the developing countries. We have been told many times that class confrontation is something of the past; that such a concept ended definitely with the fall of the Berlin Wall; and that the situation today is so different….Really? As Hernando de Soto indicates in “The Mystery of Capital”, class conflcict has not ended, in particualr in developig countries. This may be hard for a citizen in an advanced nation to understand because in the West those discontented with the system live in ‘pockets of poverty’. On the other hand, poverty in developing countries is the norm. In developing countries like the Philippines, people live divided into classes: those who have (and who live behind fortress-like walls), and those who do not have. As de Soto indicates: “The Cold War may have ended, but the old class arguments have not disappeared.” It is here that the Marxist toolkit can help a great deal in expaining class conflict questions, which are at the root of many of the problems, including economic, of these countries. Surely the social reality, even in developing countries, is not the same as that when Marx wrote about in the 19-th century. But Marx’s insights into the importance of capital accumulation for growth, or his understanding of the role of property, are outstanding

Marx agued that capitalism is subject to four laws of motion: 1. the law of the falling rate of profit; 2. the law of inceasing severity of the cyclical crises; 3. the law of concentration and centralization of capital; 4. the law of increasing misery of the working class. It is not about being “right” or “wrong”, but about providing a very useful framework to analyze many of the problems that developing countries suffer from. Prestigiuous economists like Joseph Stiglitz or Lester Thurow have claimed that financial crises in the third world come frequently and are increasingly severe. Marx had said that in the 19th century.