Home > Uncategorized > Rising tides and marginal productivity theory

Rising tides and marginal productivity theory

from David Ruccio

A constant refrain among mainstream economists and pundits since the crash of 2007-08 has been that, while the state of mainstream macroeconomics is poor, all is well within microeconomics.

The problems within macroeconomics are, of course, well known: Mainstream macroeconomists didn’t predict the crash. They didn’t even include the possibility of such a crash within their theory or models. And they certainly didn’t know what to do once the crash occurred.

What about microeconomics, the area of mainstream economics that was supposedly untouched by all the failures in the other half of the official discipline? Well, as it turns out, there are major problems there, too—especially given the obscene levels of inequality that both preceded and have resumed since the crash erupted, not to mention the slow economic growth that rising inequality was supposed to solve.

In particular, as I have written many times over the years, the idea that a rising tide lifts all boats—along with its theoretical justification, marginal productivity theory—needs to be questioned and ultimately abandoned.

But you don’t have to take my word for it. Just read the latest essay by Nobel Prize-winning economist Joseph Stiglitz.

Stiglitz first explains that neoclassical economists developed marginal productivity theory as a direct response to Marxist claims that the returns to capital are based on the exploitation of workers. 

While exploitation suggests that those at the top get what they get by taking away from those at the bottom, marginal productivity theory suggests that those at the top only get what they add. The advocates of this view have gone further: they have suggested that in a competitive market, exploitation (e.g. as a result of monopoly power or discrimination) simply couldn’t persist, and that additions to capital would cause wages to increase, so workers would be better off thanks to the savings and innovation of those at the top.

More specifically, marginal productivity theory maintains that, due to competition, everyone participating in the production process earns remuneration equal to her or his marginal productivity. This theory associates higher incomes with a greater contribution to society. This can justify, for instance, preferential tax treatment for the rich: by taxing high incomes we would deprive them of the ‘just deserts’ for their contribution to society, and, even more importantly, we would discourage them from expressing their talent. Moreover, the more they contribute— the harder they work and the more they save— the better it is for workers, whose wages will rise as a result.

Then he argues that three striking aspects of the evolution of the United States and most other rich countries in the past thirty-five years—the increase in the wealth-to-income ratio, the stagnation of median wages, and the failure of the return to capital to decline—call into question the neoclassical story about the distribution of income.

Standard neoclassical theories, in which ‘wealth’ is equated with ‘capital’, would suggest that the increase in capital should be associated with a decline in the return to capital and an increase in wages. The failure of unskilled workers’ wages to increase has been attributed by some (especially in the 1990s) to skill-biased technological change, which increased the premium put by the market on skills. Hence, those with skills would see their wages rise, and those without skills would see them fall. But recent years have seen a decline in the wages paid even to skilled workers. Moreover, as my recent research shows, average wages should have increased, even if some wages fell. Something else must be going on.

As Stiglitz sees it, that “something else” is a combination of rent-seeking (especially land rents, intellectual property rents, and monopoly power) and increased exploitation (especially the weakening of workers’ bargaining power, based on weak unions and asymmetric globalization).*

The result is that the rising tide has only lifted a few boats at the top and left everyone else behind.

But Stiglitz is not done. He also explains that not only is growing inequality not necessary for growth; it actually has negative effects: it leads to weak aggregate demand (and, in an attempt to solve that problem, asset bubbles), less equality of opportunity (thus lowering growth in the future), and lower levels of public investment (since the rich believe they don’t need things like public transportation, infrastructure, technology, and education).

It should be noted that the existence of these adverse effects of inequality on growth is itself evidence against an explanation of today’s high level of inequality based on marginal productivity theory. For the basic premise of marginal productivity is that those at the top are simply receiving just deserts for their efforts, and that the rest of society benefits from their activities. If that were so, we should expect to see higher growth associated with higher incomes at the top. In fact, we see just the opposite.

Neoclassical marginal productivity theory was never a plausible explanation of the distribution of income in capitalist societies. And, as Stiglitz explains, it is even more questionable in light of the spectacular growth of inequality in recent decades.

The only conclusion is that we live in strange times—when the illusion of a rising tide that lifts all boats (and, with it, trickledown economics, “just deserts,” and the like) has been shattered, and yet mainstream economists continue to teach (and use as the basis of economic policy) its theoretical underpinnings, marginal productivity theory.

There’s nothing left but to declare that both mainstream macroeconomics and microeconomics—as basic theory and a guide for economic policy—have failed. There’s simply nothing there to be fixed. Both mainstream macroeconomics and microeconomics need to be set aside in favor of very different analyses and explanations of capitalist instability and inequality.


*Elsewhere (e.g., herehere, and here), I have raised questions about the rent-seeking argument and showed how it is different from the alternative, surplus-seeking explanation of inequality.

  1. louisperetzperetz
    September 19, 2016 at 3:22 pm

    “Mainstream macroeconomists didn’t predict the crash. They didn’t even include the possibility of such a crash within their theory or models «As I knew, J.Stieglitz predicted it, but not exactly when happened, but surely one day. He said that a crash will come because of too much moneys flowing in the world. Mainly dollar will cause some crash. He said, in a book, just before 2008, that he didn’t how to avoid it, but, perhaps that we have to confine the big flow somewhere. My idea in this way is to create two moneys in the country, one for current people market, the other one only for financial market. With, of course, a possible osmose between them, through special banks which could control the flows coming or going to financial market. This proposal solution seems to be foolish for any economic theory. But it is not for the brain of an informatician man who knows that macroeconomics is a dynamic one, with moneys always running through the two markets. Don’t you think that if this system was created in 2007, it could have avoided the crash by breaking the flow going in the people market? It would be easy if having transformed the financial money not pair to pair but in a lower value. So whatever wrong comes into the financial market, should be indifferent to the people market: some banks suffer only, because the change of value between the two national moneys growing trough special banks to people market, could replace the decreasing flow in the people market. Sorry if I cannot explain easily this new theory. It will be easier in my book, I hope.

  2. September 19, 2016 at 3:56 pm

    “In particular, as I have written many times over the years, the idea that a rising tide lifts all boats—along with its theoretical justification, marginal productivity theory—needs to be questioned and ultimately abandoned.”

    An acquaintance of mine learned the hard way that a rising tide DOESN’T lift ALL boats. He left his tied down beside a river, so when the river flooded so did his boat.

    Louis, an excellent comment. Let me just suggest to you that there are not two markets but three: the consumer, investment and money markets serving current and future needs, with third creaming off the seed corn and surplus being put by for a metaphorical “rainy day”.

  3. Larry Motuz
    September 19, 2016 at 5:58 pm

    Marginal productivity ‘theory’ is the Siamese twin of marginal utility ‘theory’, with the same overall defects hinging on the lack of any objective definition of ‘capital” and ‘utility’. Both ‘theories’ need to be abandoned if economics is to progress beyond its axiomatic-deductive framework. Both err in that each confuses value-in-use with value-in-exchange.

  4. louisperetzperetz
    September 19, 2016 at 6:11 pm

    Davetaylor 1. If I understand what you say, there is a flow of dirty money coming from crash. Yes, you are right, but what I said that this money is the one which disappear from the financial market. I say that I don’t care. Only the bank owners of it have to worry. The quantity of flow should be the same for the need of consumer market if the remaining financial money going inside of it will be the same by a new value of change of the financial money. That means one dollar of financial money will be changed in more of a dollar, to maintain the same quantity of dollar moneys flowing in the consumer market as it was before the crash. Of course, this new value of change suppose that the aims of the financial current moneys has to be known at once. To spend for goods, to buy firms or to lend (too much) to people? About the subprime crisis, I think that, at the contrary, the money which was too much blended to people should be blended in a minus dollar value. So the flow of money running will not become from any surplus. It was the surplus which was not returned to the bank which made the crash. It is not easy, as I said to explain this “theory”, with few words. Thanks to your interest of it.

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