Home > New vs. Old Paradigm > Krugman’s misleading trivialization of the capital controversy

Krugman’s misleading trivialization of the capital controversy

from Lars Syll

Paul Krugman today comments on some “leftist” critiques of Piketty:

(T)hey’re disappointed that Piketty’s book relies mainly on conventional, mainstream economics.

And it’s mostly true. For the most part Piketty works with an “aggregate production function” in which labor works with a stock of capital to produce output, and both labor and capital are paid their marginal product …

capital-gainsThere are a few economists on the left who seem to believe that:

1. You need to believe in the existence of a perfectly well-defined aggregate measure of capital to believe in the marginal productivity theory of income distribution;
2. If you believe in, or even use, marginal productivity theory, you are conceding that capitalists deserve their income.

Neither of these things are true. Nothing about marginal productivity theory depends on the exact truth of a simple aggregate production function with capital defined by a single number. And saying that capital gets its marginal product in no way says that the people who own that capital deserve what they get.

On the inequality issue, Krugman is absolutely right. It would be preposterous to allege that mainstream economics couldn’t explain it or consider it bad. And I doubt if any serious “leftist” economist really maintains such a view.

But — as so often — Krugman trivializes the more theoretical point. In this case it’s the concept of capital and the Cambridge controversy over it. As every mainstream textbook on growth theory and most neoclassical economists, Krugman just chooses to turn a blind eye to it and pretend it’s much fuss about nothing. But Krugman et consortes are wrong!

The production function has been a powerful instrument of miseducation. The student of economic theory is taught to write Q = f(L, K) where L is a quantity of labor, K a quantity of capital and Q a rate of output of commodities. He is instructed to assume all workers alike, and to measure L in man-hours of labor; he is told something about the index-number problem in choosing a unit of output; and then he is hurried on to the next question, in the hope that he will forget to ask in what units K is measured. Before he ever does ask, he has become a professor, and so sloppy habits of thought are handed on from one generation to the next.

Joan Robinson

And as Edwin Burmeister admitted already fifteen years ago:

It is important, for the record, to recognize that key participants in the debate openly admitted their mistakes. Samuelson’s seventh edition of Economics was purged of errors. Levhari and Samuelson published a paper which began, ‘We wish to make it clear for the record that the nonreswitching theorem associated with us is definitely false’ … Leland Yeager and I jointly published a note acknowledging his earlier error and attempting to resolve the conflict between our theoretical perspectives … However, the damage had been done, and Cambridge, UK, ‘declared victory’: Levhari was wrong, Samuelson was wrong, Solow was wrong, MIT was wrong and therefore neoclassical economics was wrong. As a result there are some groups of economists who have abandoned neoclassical economics for their own refinements of classical economics. In the United States, on the other hand, mainstream economics goes on as if the controversy had never occurred. Macroeconomics textbooks discuss ‘capital’ as if it were a well-defined concept — which it is not, except in a very special one-capital-good world (or under other unrealistically restrictive conditions). The problems of heterogeneous capital goods have also been ignored in the ‘rational expectations revolution’ and in virtually all econometric work.

Edwin Burmeister

  1. April 25, 2014 at 1:08 pm

    The Cambridge controversies in capital theory showed only some of the inconsistencies of the marginalist method. A look at Sraffa’s unpublished manuscripts shows that he had a more fundamental critique of the whole marginalist method. The marginal method, as differential calculus in general, presupposes infinitesimal changes that take place while everything else remains constant. But in open systems (and the socio-economic realm is an open system), you are not concerned with infinitesimal changes while everything else remains constant. So the problem is not limited to the aggregate production function, as Krugman seems to think. It is a much broader problem.

    The Cambridge controversies showed also that the classical method was much more consistent than the marginalist approach, and a more appropriate framework to be combined with the Keynesian principle of effective demand, as Joan Robinson suggested when advocating a reconstruction of economic theory. Of course, the classical method must be distinguished from what Marx and Sraffa called “vulgar” economy, which is the approach that Veblen and Keynes are really criticizing when they say they are criticizing what they call the “classical” approach

    In the classical approach, the central issue at stake is not the optimization given scarce resources, but rather the distribution of the surplus, constituted by rents, profits and interest. Part of the surplus is reinvested in productive activities, while another part is spent in luxury goods, as Quesnay noted long ago. The part which is reinvested in productive activities has a multiplier effect (which is higher when income equality is higher, as Keynes and Kalecki noted), while the part spent in luxury has no multiplier effect, and leads to the accumulation of wealth. The key is to look at the leakages in the circular flow of income, which depend on whether the surplus is kept or reinvested in productive activities.

    So using a classical-Keynesian framework you can explain quite easily that “r” (the surplus) is higher than “g” (growth),as Piketty noted, because part of the surplus “r” is used in luxury “l” rather than in investment aimed at growth “g”, leading to the accumulation of wealth in a stock of luxuries. But all the mathematics you need to see this is basic arithmetic, the only mathematics that the classical authors used. Differential calculus may look more sophisticated, but is a less appropriate tool with fundamental problems identified by Sraffa.

    However, those developing the implications of the Cambridge controversies have been concerned with theory, while Piketty has been concerned with empirical data instead. But what you really need is to combine both. Once we understand that the central problem of economics is the distribution of the surplus rather than the allocation of scarce resources, we then have a proper framework to study inequality, and the data provided by Piketty.

    The Cambridge controversies also showed that from a technical point of view, distribution is an exogenous variable, not an endogenous variable determined by marginal productivities. This means that distribution is a political and institutional issue. So the emphasis on a (marginalist) scarcity approach, rather than on a (classical-Keynesian) surplus approach, also has political implications. If everyone is convinced that the central problem is scarcity rather than the surplus, then everyone tends to think that austerity is unavoidable (due to scarcity), since no one sees that the real issue is how to distribute the surplus “r” in a different way.

    • April 25, 2014 at 3:37 pm

      Thank you for this very insightful comment!

    • originalsandwichman
      April 25, 2014 at 10:28 pm

      Yes, exactly! And the so-called “scarcity” can always be simulated by those with the capability to withhold productive factors, as Veblen pointed out.

  2. April 25, 2014 at 1:24 pm

    The socio-economic system as an open system? That is your personal axiom ?

  3. April 26, 2014 at 2:11 am

    One only needs to read the Preface to The New Palgrave 1990, Capital Theory by Eatwell, Milgate and Newman to appreciate the difficulties of neoclassical capital theory. The problem, in my view, is one of an economics fundamentally grounded in price theory and not in an ontology located in material, sociocultural phenomena. As Mirowski has pointed out, neoclassical theory has no theory of production. Instead, neoclassical theory, and much of economics, is grounded in an smothering field formalism. Capital then becomes embedded in field theory that employ market prestidigitation. Thus, a muddled mess ensues. I am much more kind to an economics that attempts to describe a real economy made up of material and institutional economic activities. Then see if there are laws of regularity to offer.

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