Home > The Economics Profession > A funny thing happened on the way to the teaching of neoclassical economics

A funny thing happened on the way to the teaching of neoclassical economics

from David Ruccio

I often explain to students that the most controversial topic in the history of economics is the theory of capital.

It’s controversial because a theory of capital is also a theory of profits—and, therefore, what explains the existence of profits, who gets the profits, whether or not they deserve to get the profits, and so on. And different economic theories, historically and today, have offered different answers to those questions.

The issues surrounding capital are important not only because they are central to any theory of capitalism (in which profit—money begetting more money—plays a key role) but also because they inevitably arise in political discourse, especially in a presidential election year (and especially when one of the candidates has received preferential treatment on his “capital income” via the tax code and most people pay a much higher rate on their “labor income”) and when, in the midst of the Second Great Depression, labor income is declining, capital income is becoming more concentrated, and the overall distribution of income is becoming more unequal. 

So, I was dismayed yesterday when, in an attempt to respond to student questions concerning Marx’s theory of surplus-value, I compared Marx’s approach with the neoclassical theory of profits as a return to capital. In Marx’s theory, profits are based on exploitation; while in neoclassical theory, profits are equal to the marginal productivity of capital.

The problem was, the students had never learned the neoclassical theory of capital and profits—even after multiple courses in neoclassical microeconomics, and many other neoclassical-based courses. How am I supposed to teach the Marxian critique of mainstream economics if the students haven’t even learned mainstream economics?

As it turns out, as Fred Moseley [pdf] explains, “the marginal productivity theory of distribution is quietly disappearing from microeconomic textbooks, both undergraduate and graduate, without mentioning to students this important omission.” Moseley suggests the theory has been dropped because of its many “fundamental and insoluble logical problems.” I don’t have a good explanation as to why it’s been dropped. But I do know that the effect of not explicitly treating the theory of capital (and therefore profits) is to leave students unaware of those problems. It also means students walk away with a business-school definition of profits (as total revenue minus total costs) and have no way of squaring that definition with the role of capital (as one of the factor services in a neoclassical production function whose return is determined in a supply-and-demand market). They don’t, therefore, know how capital fits into the larger neoclassical theory of capitalism and they’re not able to think through the various issues—theoretical, political, and ethical—concerning capital and profits.*

Since I’m a teacher, I end up teaching both theories—both the neoclassical theory of profits as the return to renting capital from households and the Marxian theory of profits as surplus-value. That way, the students know both theories, as well as their implications for economic theory and for public policy.

*It also means that someone like Matthew Yglesias can, with all seriousness, attempt to argue that Romney’s tax rate should be low by using the example of two doctors, one of whom “spends a lot of his money on hiring people to build buildings around town. Those buildings become houses, offices, retail stores, factories, etc. In other words, they’re capital. And capital earns a return, so over time the second doctor comes to have a much higher income than the first doctor.” Yes, money begets more money but Yglesias is unable to offer any explanation as to where that “return” on capital comes from.

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  1. Alice
    September 27, 2012 at 10:34 am

    Good

    The accountimng dfefinmition of profit as revenue minus costs seems eminently more practicable for now than teaching students the mumbo jumbo of economic theory of capital only to have them critique it with Marx theory of capital.

    Jeez the accounting version will do nicely and its a lot less F***ed up.

  2. Alice
    September 27, 2012 at 10:43 am

    and re this comment
    *It also means that someone like Matthew Yglesias can, with all seriousness, attempt to argue that Romney’s tax rate should be low by using the example of two doctors, one of
    whom “spends a lot of his money on hiring people to build buildings around town. Those buildings become houses, offices, retail stores, factories, etc. In other words, they’re capital. And capital earns a return, so over time the second doctor comes to have a much higher income than the first doctor.”

    Yes if only the good low tax reciients did actuallly invest in hiring people around town to build buildings instead of squirreling it away in some tax haven where it sits idle

    like Romney does

  3. September 27, 2012 at 10:53 am

    The basic confusion is perhaps to equate capital (which is inanimate and passive) with the owners of capital who are animate but not active in the sense that their decisions do not affect production. Even real investors, unless they are also managers, do not determine which capital is employed. And, of course, neoclassical economics completely ignores the nature of land, conflating it with capital.

  4. Cengiz
    September 27, 2012 at 12:39 pm

    Instead of lowering the tax on capital revenue which could be used for personal consumption shouldn’t VAT be spplied to capital expenditure at a lower rate than consumption so that the price of k is subsidised to ensure investment. is this too crazy an idea to work?

  5. September 28, 2012 at 11:53 am

    One of the key problems is that we are talking about two different things re capital – a rental return on money lent to purchase any factor of production; and total profits after accounting for all costs including cost of capital used up in production including the cost of depreciated fixed capital. The two are equalised through arbitrage, for example people would buy ice cream vans if the rate of return was far higher than loaning out money and vice versa.

    I should stress marginal returns only work here when labour, rent and cpital are considered together. for example you can run an ice cream van without an ice cream maker

    I have a nice digram of this in a article attacking the Bohm Bewerk/Fisher approach to interest which also visually explains the Sraffa/Bose approach to calculating factor returns.

    http://andrewlainton.wordpress.com/2012/09/25/the-real-cost-of-waiting-and-debt-interest-in-cost-of-production-theories-of-value/

  6. September 28, 2012 at 2:55 pm

    Yet to overcome that behavior and all its costly social consequences, we will need people with knowledge and skill in economic analysis. That too is an important consideration for you, notwithstanding today’s realities of higher education in economics in the US.

  7. Nell
    September 28, 2012 at 9:19 pm

    Sometimes it seems like the only reason why you would ever teach neoclassical theory is to laugh at its ‘scientific’ assumptions on human behaviour – in aggregate or at the individual level. Bit of sweeping statement – no doubt there is some good stuff in there somewhere. But while that paradigm dominates the discipline it feels like there is little hope for actual living human beings escaping from the harsh consequences of neoliberal economic prescriptions.
    TINA sucks.

    • David F. Ruccio
      September 28, 2012 at 9:26 pm

      The good thing, Nell, is there ARE alternatives—alternative economic theories and alternative economic arrangements. So, we have two tasks: to criticize neoclassical economics and the economic and social arrangements neoclassical economists celebrate, and to develop radically different theories and arrangements. Otherwise, as you say, we’re stick with TINA.

      • Nell
        September 28, 2012 at 10:55 pm

        Yes you are right – and thanks to some economic teachers like yourself and others on this blog lay people like me can learn about the alternatives. I do my best to spread the word -linking back to this blog and others like Keen’s, but sometimes its seems like a hopeless task. All you get back in return is – but where is the money going to come from?, or governments have to pay down the deficit because out of control spending is the cause of the recession (somehow private sector debt is sacrosanct). And god help the UK, we are sitting on a private sector debt of 427% of GDP and no-one with any power to make decisions is showing the least bit of concern.

  8. paolo leon
    September 29, 2012 at 6:31 am

    I am rather flabbergasted: never heard of Sraffa, Kaldor, J.Robinson,L.Pasinetti or the debate between the two Cambridge (Mass. and England)?

  9. Alice
    September 29, 2012 at 9:52 am

    There is also the pure joy of being engaged to teach neoclassical economics but in also teaching where the fractures are in this fractured fairy tale.

  10. DRONGO
    September 29, 2012 at 12:17 pm

    It is like what is “good” cannot be explained without category “evil”. Under the mask of teaching “good” we teach about “evil”. Lets not teach about “evil”, lets not teach neoclassical economics.
    I think anyway teaching economics is tend to be dogmatic. We must teach students about pluralism of views. The goal of mainstream economics is to create army of brainwashed zombies, who can not explain reality, but knows only textbooks. That army will never say that capitalism is bad and government is good.
    The goal of economics is to teach not different schools, but teach ways of thinking, help students develop own abilities to explain reality.

  11. October 2, 2012 at 1:53 am

    In response to David Ruccio’s “..there ARE alternatives—alternative economic theories and alternative economic arrangements. So, we have two tasks: to criticize neoclassical economics and the economic and social arrangements neoclassical economists celebrate, and to develop radically different theories and arrangements. Otherwise, as you say, we’re stuck with TINA.” —

    Regarding “we’re stuck with TINA”, it could be concluded that the world is at least starting to turn from individualistic free markets, free trade and capitalist globalization. In any case, for a better world we certainly need to replace time-incomplete and (accordingly) fallacious neoclassical orthodoxy in our universities. Here it may be that “starting from scratch”—as seems to have been occasionally suggested in the posts—is probably not an option: many decades would be required to create the entirely new approach. Meanwhile, growth of the serious threats before us could become insurmountable.

    Were we to start from the present state of our authoritative knowledge (i.e., in our universities) we could proceed in a pluralist manner, integrating ideas that have been substantially ignored by the mainstream (like Hermann Gossen’s explicit activity-time on the consumption side, and his “recurrence of wants” over intertemporal time). The diverse set of heterodox schools should certainly participate. In this regard, I believe no single school of economic thought can by itself cover all domains and aspects of economic function—just as fluid mechanics is made up of various subjects (e.g., Stokes/Oseen flow, continuum subsonic/supersonic/hypersonic flows; real gas effects, rarefied gas dynamics, etc.), each with its own domain of expertise and authority.

    As some of the present readers may know I have previously advocated an extension/completion of the neoclassical micro-economic paradigm at the marginal-utility foundation (this extension/completion defined by a unification [after the 135 year divide] of the Gossenian and neoclassical utility theories). Whether this is a “radically different [theory]” or something corrective of mainstream economics may be considered semantic. But it is an alternative to the “start over” approach that might not change things soon enough.

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