Monday, August 28, 2006

Foley On Incoherence Of Marginalist Project

Here are two long quotations from Duncan K. Foley, "Value, Distribution and Capital: A Review Essay", Review of Political Economy, V. 13, N. 3, 2001.
"The strongest and most important point that has come out of the classical critique of marginalism and neoclassical economics is its refutation of the capital scarcity theory of the rate of profit.

The notion that the profit rate can be coherently viewed as being determined by a 'marginal product of capital' given by technology and input availabilities is one of the more confused and ideologically muddied chapters in the history of economics. A cost-minimizing firm facing a wage, cost of capital, and prices of capital goods determined by markets will adapt its relative use of labor and capital to those prices. The value of capital goods is a rational and appropriate measure of capital input to the firm when the prices of capital goods are determined by market forces outside the firm's control. When a cost-minimizing firm faces a range of technical methods of production that approximate a smooth continuum of capital-labor ratios, cost-minimization entails setting the marginal value product of each input equal to its price. (There is, of course, vigorous debate in all schools of economic thought over how well the assumptions of a cost-minimizing firm facing market prices for inputs fits the behavior of real capitalist firms.) In this scenario, however, it is the wage and the cost of capital that determine the marginal value products of labor and capital, not the other way around.

The vision of the marginalists and their neoclassical followers was that this uncontroversial theorem of cost minimization could somehow be transformed into a theory of the wage and profit rate, and hence into a theory of distribution. Their hopes of accomplishing this transformation stemmed from their anthropomorphic vision of the economy and its markets as analogous to the allocation of scarce resources by a single decision maker with a well-defined objective function, who, at least under the assumptions of concavity of the objective function and convexity of resource constraints, can impute shadow prices (Lagrange multipliers) to the resources. This program, despite firing the imaginations of many talented economists, has never managed to disentangle the problems of aggregation of disparate preferences, treatment of time and information, definition of resource limitations, and dynamic stability of market clearing that are inherent in carrying it out to arrive at the robust, unified, and transparent account of distribution it sought. Economics owes a particular debt of gratitude (which it shows precious few signs of recognizing, to tell the truth) to Sraffa and his followers for their dogged insistence on bringing to light the ramifying incoherence of this marginalist project...

...The Cambridge capital debate centered initially on one aspect of this tangle of confusions, the neoclassical hope that the value of capital goods would somehow behave like a single scarce input in equilibrium. The interchanges of this debate, including an important paper by Garegnani (1970), showed unambiguously that the neoclassical construction would work in general only under assumptions on production so stringent as to amount to the assumption of a single capital good. Other work related to the Cambridge debate, for example that of Luigi Pasinetti (1974) and Stephen Marglin (1984), also underlined the other side of Sraffa's critique, the necessity of taking some distributional variable, either the wage or profit rate, as the boundary condition in production models, rather than stocks of individual capital goods. This path clarifies the real relationship between input prices and marginal productivities (if indeed they exist), which is that input prices determine marginal productivities through the cost-minimizing choice of technology.

Neoclassical economists have a hard time keeping their minds clear on this point. They are distracted by the fact that it is possible to embed a Sraffian production system in a general equilibrium model with given stocks of inputs and calculate equilibrium prices and rates of return without any reference to the value of capital goods. They read this model as supporting the scarcity theory of profit rates, although it fact it only reproduces its own assumption of the full employment of all inputs except those that have zero prices in equilibrium. The equilibrium allocation can equally well be viewed as one in which given input prices determine cost-minimizing choices of technique that happen to be compatible with arbitrarily given supplies of inputs. In the absence of a compelling dynamic theory that shows how the market might find these prices, which neoclassical theory has pretty well given up hope for, Sraffa's critique carries the day.

It would have been a good thing if the Cambridge capital controversy had managed to drive a stake through the heart of the scarcity theory of the rate of profit, but it hasn't. I think this has been because the classical critique tells economists what they shouldn't do (assume full employment and market clearing in order to determine prices) but doesn't tell them very clearly what they should do as an alternative, either at the purely theoretical level or in econometric studies."
Those who have followed this series of posts with attention will understand, to some extent, Foley's statement that "input prices determine marginal productivities through the cost-minimizing choice of technology."

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