Home > neoclassical economics, Piketty's Capital > Piketty and the non-applicability of neoclassical economics

Piketty and the non-applicability of neoclassical economics

from Lars Syll

economic-mythIn yours truly’s On the use and misuse of theories and models in economics the author of Capital in the Twenty-First Century is criticized for not being prepared to fully take the consequences of marginal productivity theory — and the alleged close connection between productivity and remuneration postulated in mainstream income distribution theory — over and over again being disconfirmed both by history and, as shown already by Sraffa in the 1920s and in the Cambridge capital controversy in the 1960s, also from a theoretical point of view:

Having read Piketty (2014, p. 332) no one ought to doubt that the idea that capitalism is an expression of impartial market forces of supply and demand, bears but little resemblance to actual reality:

“It is only reasonable to assume that people in a position to set their own salaries have a natural incentive to treat themselves generously, or at the very least to be rather optimistic in gauging their marginal productivity.”

But although I agree with Piketty on the obvious – at least to anyone not equipped with ideological blinders – insufficiency and limitation of neoclassical marginal productivity theory to explain the growth of top 1 % incomes, I strongly disagree with his rather unwarranted belief that when it comes to more ordinary wealth and income, the marginal productivity theory somehow should still be considered applicable. It is not.

Wealth and income distribution, both individual and functional, in a market society is to an overwhelmingly high degree influenced by institutionalized political and economic norms and power relations, things that have relatively little to do with marginal productivity in complete and profit-maximizing competitive market models – not to mention how extremely difficult, if not outright impossible it is to empirically disentangle and measure different individuals’ contributions in the typical team work production that characterize modern societies; or, especially when it comes to “capital,” what it is supposed to mean and how to measure it. Remunerations, a fortiori, do not necessarily correspond to any marginal product of different factors of production – or to “compensating differentials” due to non-monetary characteristics of different jobs, natural ability, effort or chance.

It’s pleasing to see that Piketty has taken this critique to heart. In an interview in Potemkin Review he admits that marginal productivity explanations of income is wanting, not only for those at the very top, but, generally:

Piketty: I do not believe in the basic neoclassical model. But I think it is a language that is important to use in order to respond to those who believe that if the world worked that way everything would be fine. And one of the messages of my book is, first, it does not work that way, and second, even if it did, things would still be almost as bad …

All I am saying to neoclassical economists is this: if you really want to stick to your standard model, very small departures from it like an elasticity of substitution slightly above 1 will be enough to generate what we observe in recent decades. But there are many other, and in my view more plausible, ways to explain it. You should be aware of the fact that even with your perfect competition and simplified one good assumption, things can still go wrong, in the sense that the capital share can rise, etc.

PR: Are you saying that notwithstanding your rhetorical strategy to communicate with neoclassical economists on a ground where they feel comfortable, in your views it is not just that you reject marginal productivity explanations of income for those at the very top but more generally as well?

Piketty: Yes, I think bargaining power is very important for the determination of the relative shares of capital and labor in national income. It is perfectly clear to me that the decline of labor unions, globalization, and the possibility of international investors to put different countries in competition with one another–not only different groups of workers, but even different countries–have contributed to the rise in the capital share.

  1. graccibros
    May 17, 2015 at 5:58 pm

    Good post Lars, thank you very much. Micro theory, “the margin this and the margin that,” always reminded of the trouble I had following the higher reaches of geometry, where I was being asked to imagine lines, intersections, angles and spheres that were presented as common sense everyday renderings, as if that were the way I visualized the world, real and imagined. Of course some of it was based on the physical realities of every day life; but it soon ascended into something quite remote and abstract…I always had the feeling of being led over a cliff, step by step, further and further from my comfort with a world that I could know and grasp. Power, who holds it and how it shapes economic theory? How silly!

    I wonder if any readers here are familiar with Mark C. Taylor’s 2004 book, “Confidence Games: Money and Markets in a World without Redemption.” A fascinating author from Williams College and then Columbia, an atheist head of the Religion Department and visiting professor of Architecture, who handles economics with the best of the profession, having apparently drunk lots of coffee and other beverages across the table from some savvy inside players in the go-go “creative” world of investing and speculating that we all grew to love so much in the 1990-2007 era. Taylor is impossible to pigeon hole, and he is brilliant in helping us understand the grand hopes, Utopian hopes for the world of hedge funds as they developed: infinite leverage based on zero capital/collateral. An economic “perpetual motion machine.” LTCM….chaos theory, “self-organizing, complex networked systems,” avalanches, and the Santa Fe Institute…it’s all there.

    I’ve met one other person in my life who has read it. I still recommend it.

  2. graccibros
    May 17, 2015 at 6:20 pm

    And a additional thought to connect your post, Lars with Taylor’s “Confidence Games, and the strange fact that here is a Religion Department chairman writing as fluidly about the most difficult parts of advanced economics as well as… John Meriweather.

    But here’s the thing: is not religion a vast extension, a vast series of walking out over the cliff based on a few fragments and hopes, a vast system built upon longings…economics has nicely filled the void for those who can no longer accept the old faiths…has assumed, among the powerful, the same role as consulting the auguries…whether it is built upon any more solid foundations, Lars is pointing out to us what has been left out…the sociology of power, with just a hint that Marx was a better sociologist than economist…

    And this delicious thought, that the Republican Right in the US is built upon a near religious intensity about the market and micro economics, and its alliance with the Religious Right, fundamentalists and the slightly more diverse evangelicals and their fierce intensities about matters religious and cultural…a strange alliance which buries class…for now…

    No wonder James Galbraith notes in the Acknowledgements at the end of his latest book, “The End of Normal,” no, he actually apologizes for this “fairly gloomy work…”, for his having come to “these dire straits” of his conclusions,” his recognition of Taylor’s world “without redemption.”

    Cheers.

  3. May 17, 2015 at 6:40 pm

    “insufficiency and limitation of neoclassical marginal productivity theory”. NO Lars. This “theory” is INCONSISTENT. Because you cannot have at the SAME TIME perfect competition and constant returns to scale (“competitive” demands are NOT DEFINED. It’s and old question (see http://bernardguerrien.com/Competition-and-zero-profit.pdf). It’s why you cannot find somebody who explains clearly this “theory” (NOTHING in Wikipedia). Try “neoclassical distribution theory” in the NewPalgrave Dictionary of Economics : NOTHING. Try with Google …

  4. Garrett Connelly
    May 17, 2015 at 7:27 pm

    Yes, thank you, I enjoyed Piketty and am glad people are still slamming at him, especially now that he is the economist for Podemos.

    Marginal productivity is a tough concept in economies that do not avoid pollution, my newest asymptotic margin is concentration of wealth to fewer and fewer. Here at the limit we find that capitalism leads to nobody owning everything.

    Forgive me if I am repeating from my latest economics books. I just finished a series of four that begins with a planet eating corporation that won the race on its home planet.

  5. bongmendoza
    May 18, 2015 at 2:56 am

    Reblogged this on bong mendoza's blog.

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