By Thomas Ferguson, the Institute for New Economic Thinking’s Director of Research Projects, a Professor of Political Science at the University of Massachusetts, Boston and a Senior Fellow at the Roosevelt Institute. Originally published at the Institute for New Economic Thinking website
The famous scene in Gabriel García Márquez’s One Hundred Years of Solitude epitomizes Magical Realism: army troops machine gun striking banana workers and their families in the town square and toss the bodies into railway cars for disposal. But José Arcadio Segundo is only lightly wounded and jumps from the train when he comes to. When he finally picks his way back to his hometown of Macondo, a surprise awaits: everyone flatly denies any massacre took place. At night the authorities hunt for rebels from house to house; by day, they deny everything. Eventually, an extraordinary proclamation is made to the nation, repeated until finally accepted: “there were no dead [and] the satisfied workers had gone back to their families.”
Contemporary Economics has more than one Magical Realist moment like this – just look at how the basic building block of the Keynesian Revolution – the decisive role of the principle of effective demand – all but vanished from sight after the late nineteen seventies. But there is another, almost equally fateful: the Cambridge Capital Controversy, which came to consummate expression in a memorable issue of the Quarterly Journal of Economics in 1966.
Probably no summary of the issues at stake in this giant dust up has much hope of gaining assent from all the stakeholders. The issues are so complex and the background so ideological that one can easily understand how one commentator on an early contribution by Robert Solow exclaimed that “perhaps the whole problem is too complicated for adequate reflection in a formal model.” [1]
But with the caution that on this treacherous terrain readers are well advised to protect themselves from bias by sampling the classic contributions for themselves, one might venture to describe the Capital Controversy as the Waterloo of the idea that you could explain the distribution of income in terms of the balance of supply and demand for comparable factors of production reflecting purely physical (or “technical”) production relations. [2]
The most durably influential of these schemes appealed to an “aggregate production function” to partial out the separate effects of capital and labor on overall output. [3] The approach led easily to a theory of distribution according to which capital and labor are each rewarded in proportion to their relative scarcity. In equilibrium, capital should receive its marginal product, while workers should receive a real wage equal to the marginal product of labor.
If this sounds familiar, it is because it is. Just like the non-stop propaganda in Macondo, the refrain is incessantly repeated in contemporary economics – it is almost the Rosary of modern microeconomics. Virtually all textbooks still reflect this approach: divergent cases, such as monopoly, or obvious political distortions (“rent seeking”), are sometimes recognized but taught as deviations from this norm. When you listen to some private equity trader carrying on in the major media about how he (they are mostly he’s) really deserves all the money he is swilling down, because that reflects his contribution to the economy, it is this theory that you are hearing and journalists are witlessly repeating.
But the Cambridge Capital Controversy demonstrated that this approach to production and distribution led to impossible inconsistencies. Some economists, notably Knut Wicksell, who might be accounted the father of the whole “production function” line of thinking, were at least sometimes wary of its logic. Even some protagonists on the MIT side of the controversy occasionally voiced reservations, but they stuck with it. As late as 1964, the sixth edition of Paul Samuelson’s famous textbook proclaimed that the turn of the twentieth century version of the theory advanced by John Bates Clark, “although simplified, is logically complete and a true picture of idealized competition.” [4]
In the nineteen fifties, Joan Robinson, who had been reading Wicksell, started asking loudly how heterogeneous capital goods could be valued in monetary terms without first knowing the rate of interest to discount them by. Piero Sraffa, who himself resembled a character in a Márquez novel, eventually zeroed in on what such approaches assumed about changes in techniques of production at varying levels of wages and profits and showed that prices won’t predictably change when distribution changes. Gradually, battle lines formed between Cambridge, England on one side, which considered the production function approach hopelessly misleading, and Cambridge, USA, led by Paul Samuelson and Robert Solow, which, with increasingly dense qualifications, defended it.
In 1965, Luigi Pasinetti, whom INET is delighted to interview here, produced a decisive counterexample demonstrating that such production functions could not work in a world of more than one good (or technique of production). Concluding that “there is no connection that can be expected in general between the direction of change of the rate of profit and direction of change of the ‘quantity of capital’ per man,” Pasinetti argued that the Neoclassical approach to analyzing production needed to be abandoned in favor of something much closer in spirit to Classical Economics. [5] A number of notable economists confirmed his analytical critique, though they often interpreted its implications differently.
Paul Samuelson, at least, took the point. He repudiated a “non-switching theorem” associated with work by him and his students and handsomely acknowledged that Cambridge, UK, was correct. “Pathology illuminates healthy physiology. Pasinetti, Morishima, Bruno-Burmeister-Sheshinski, Garegnani merit our gratitude for demonstrating that reswitching is logical possibility in any technology…If this causes headaches for those nostalgic for the old parables of neoclassical writing, we must remind ourselves that scholars are not born to live an easy existence. We must respect, and appraise, the facts of life.” [6]
But Samuelson’s generous response was not typical of the economics profession as a whole, which to this day collectively continues to brush aside and deny the relevance of this controversy and, in fact, suppresses virtually all reference to it. Even before Pasinetti’s result became known, however, some Neoclassical economists had explored whether their general approach to “factor rewards” and “marginal productivity” could be pursued by jettisoning production functions and appealing to notions of general equilibrium. [7]
There are good reasons for doubting this program can really go much beyond sketches for analyzing any real economy. Subsequent research on general equilibrium has emphasized how precarious any such momentary equilibria are. [8] In addition, as emphasized by Joseph Halevi in some recent lectures, the Cambridge dispute has destructive implications for the stability of Neoclassical versions of growth theory.[9] Not surprisingly, some economists who attend carefully to the Cambridge results think they require a wholesale rethinking of economic theory and especially of the theory of distribution, since the technical conditions of production cannot determine a unique solution for the distributive variables..
But for mainstream economics, we remain in the Magical Realist world of Macondo. Contemporary students of economics rarely hear of the controversy or Samuelson’s straightforward concession to the Cambridge, U.K. critics. Pasinetti’s subsequent work on growth, income distribution, finance, and structural dynamics, as well as the other work of Sraffa, Kaldor, and Joan Robinson are only rarely discussed. Instead, growth models that feature cheerfully guilt free old style production functions proliferate, with most of their consumers and producers seemingly unaware of their fragility. Central bankers and many affluently supported monetary theorists also talk airily about “natural rates” of interest, without realizing that the Cambridge results shake that notion, too. [10]
Now, however, developments in the world economy, especially soaring inequality within countries and anxieties about the mainsprings of economic growth, are once again bringing to the fore the issues of growth and “factor rewards” that fueled the Cambridge Capital Controversy. Not one, but several reviews of Thomas Piketty’s invaluable Capital in the Twenty-First Century, for example, have emphasized the importance of the Cambridge discussions.[11]
Believable “general equilibrium” approaches to this brave new world are few and far between. At best one finds highly contrived Dynamic Stochastic General Equilibrium Models that have nothing to say about soaring corporate compensation, the real political economy of tax cuts and starvation public budgets, or rising mark ups in major big business sectors.
Sometimes the fastest route to new economic thinking begins with a careful study of existing strands of economic theory, especially when its protagonists have so clearly been right about so many subsequent policy questions and won the basic theoretical debate. [12] In the summer of 2014 the Institute for New Economic Thinking interviewed Professor Luigi Pasinetti for several hours over the course of a week. Dr. Nadia Garbellini was the interviewer. I also interviewed Professor Pasinetti and Dr. Marcello de Cecco together for one special session.
Professor Pasinetti relates some of the high points of his distinguished career in the videos: Born near Bergamo in the north of Italy, he compiled a brilliant academic record that eventually won him fellowships to Cambridge University, Oxford, and Harvard. He describes how his thinking evolved at Cambridge, where he was first supervised by Richard Goodwin, then by Richard Kahn, and actively engaged with Nicholas Kaldor, Joan Robinson, and Piero Sraffa.
One of the high points of the whole series is his discussion of the conference panel at which he first presented his famous paper on the Capital Controversy. But many viewers and readers may find Pasinetti’s discussions of growth and income distribution, multi-sectoral economic models, and international trade a very helpful way into his later work. There are some other good sources also, including Pasinetti’s website at the Catholic University of Milan.[13]
In Márquez’s novel, when the government declared that up was down, it poured rain in Macondo for almost five years, leading to floods that washed away most of the town. But economists ought to be capable of coming in out of the rain. Our hope is that these interviews with one of the great figures of contemporary economics will lead to some serious rethinking of fundamental tenets of mainstream thinking.
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The link does not take the reader to the paper.
Apologies. The link works but the title of the paper is different and the subtitle claims the article is an interview of Luigi Pasinetti. Interview follows article. The footnotes appear after a long list of Pasinetti’s publications.
Samuelson also knew that the Bretton Woods period wasn’t truly Keynesian and called it neoclassical synthesis Keynesianism, thereby being upfront about the difference. Others were less careful. I hesitate to call them deliberately deceitful.
For an MMT perspective Bill Mitchell discusses the Cambridge Capital Controversy somewhat here (“Myths about pay and value”):
It wasn’t ‘magic realism’ . It happened, more than once. The most famous was in 1978 in Guatemala,
https://nacla.org/article/guatemala-peasant-massacre
but similar things happened in the ’50’s and 60’s. Massacres that really were disappeared, except from the memories of those who saw them.
the real problem is this: When you’re contending with a mental disorder by assuming, even as a disguise, the conceptual accoutrements of the disorder in order to clarify to minds consumed by the disorder that they are suffering from intellectual psychosis, you invariably only perpetuate the disorder by accepting its conceptual vocabulary as a valid structure. This is a Gödel’s Theorem moment. If you really want something new — and not just the same shlt wrapped up in “sort of a little bit almost new but not really new” rhetoric. You really just have to start over from scratch with new concepts, new ideas of relationships, new phenomenon and new words. You have to throw the whole thing, as it is, on the garbage pile. It’s hard to admit it, but that’s pretty much what it is.
Craazyman, your comment reminds me of many discussions of political analysts about xxxx or BBBB election, and why certain demographics or strategies produced certain election results–and they persist in doing so, despite the mounting piles of evidence that many–yes, many–of the prior or current “election results” on which they base their analysis, were fraudulent. This is indeed an inconvenient truth.
Our election systems have been so poor in so many places that the exceptions (e.g., Sanders’ popularity in Vermont over decades) prove the rule. We skew our polling based on past elections, with no critical evaluation of how likely those prior election results were to have been an accurate reflection of votes cast. We’ve created a distorted reality that is self-referencing and looped back on itself.
It’s not impossible to get out of this mindset–and other self-perpetuated delusion–but it’s not easy or pleasant.
Shared psychotic disorder, or folie à deux, is a rare delusional disorder shared by two or, occasionally, more people with close emotional ties. An extensive review of the literature reveals cases of folie à trois, folie à quatre, folie à famille (all family members), and even a case involving a dog. – H/T PP
The old NC post[s on the community psychotropic events, especially in France seems applicable here…
Disheveled Marsupial…. Humans is one thing…. but dogs is just wrong… hence why its good to have a cat around just to keep any eye on things….
I don’t understand the purpose of this article. If Yves Smith knows what all this means, then why not explain it? I have read so many of these abstract, vague stories about the Cambridge controversey, Robinson etc… and MMT and no one can explain what in the world they are talking about. I can believe if the theory was new, perhaps no one can articulate it. But really, after 80 years no one can explain this? I find it hard to believe. It all seems to me a result of complicated mathematics that no one can explain in terms of actual human behavior.
The Cambridge capital controversy IS very technical and no, my explaining it would be an assignment. We don’t do assignments. I have far more to do than I can possibly do and my writing a post about it is not going to change how economists behave around this issue, so it is not a productive use of my time.
none of these people have ever worked a day in their lives. what can they possibly know? not much. they sit around in a library or a classroom and read books. they live in a house of mirrors reflecting mirrors. minds reflecting minds. there’s no reality anywhere.
at least the anthropologists would go and live in a culture and study it. at least the pyschoanalyts would actually talk to crazy people. at least the historians would look at events and personalities. the painters would look at light and form and color. the poets would look at the human form as it presented itself in all its passions and abnegations.
but economists? what do they look at? they look at their anorexic abstractions, through the malapropical filter of Newtonian physics.
I mean really. It should be obvious. But it isn’t. And so it’s fair to call it all a mental disorder. they’re in the grip of a mental disorder and they have lost the ability to help themselves.
They really should just forget about it and start over. But of course they won’t. At any rate, it’s long past the point when they’re not amusing anymore. It’s like “oh man, there they are again with their yada yada.” It’s like that. Thank God there’s YouTube and the eternal hope for a 10-bagger. The only reason I pay attention to these people is just in case I read something that can make me money, easily and without working or exerting any effort at all. Is that so bad? Not to me. Money for absolutely nothing is infinite efficiency. Efficiency is good. Therefore money for nothing is the highest form of economic achievement. It should be obvious if you see how people who are really really rich make money. They don’t do anything at all. I’m not greedy and just want a few million dollars. Just for laying around money until all the time I have has been wasted and there’s no more left. Then you don’t need it anymore. At least you hope not. But until you find out, you don’t want to run out of money, because the longer you lay around doing nothing the harder it is to actually do something. Its something you have to avoid at all costs. Doing something, that is.
To me, this is another demonstration that the emperor (modern economics) is naked. And more, the emperor was proven to be naked many years ago, his tailor conceded in writing at the time that he was naked, but we continue to be told of his marvelous robes.
As fun as it is to speculate about mass hysteria, cognitive dissonance, or other psychological explanations for the inability of the profession to come to grips with reality, I think that we must not avoid seeing the truth ourselves: The profession of economics exists to justify the immoral concentration of wealth both to the wealthy, and to the serfs. It serves the same role as the medieval church in the sense of distracting and dividing the 99%, and giving them false hope to keep them from taking matters into their own hands. When the priesthood relentlessly suppresses their own evidence, it is hard to consider them merely ignorant and misguided. They are whores (my apologies to sex workers, whose labor provides value to society).
Let me see if I can simplify for the lazy.
The key issue is the way the product of society is distributed. In this respect the article reviews a debate about the nature of the returns to capital – a debate that was carefully hidden from Econ students like me in the 80’s.
Essentially, European economists demonstrated conclusively that there is no relationship between the productivity of various factors of production — capital, labour, materials — and the distribution of income in society. It isn’t well known, but orthodox American economists basically gave up the debate and admitted defeat — but went right on teaching that every factor of production earns its “just reward,” and that if capitalists were richer than everyone else, it’s because capital is more productive than labour.
This is a very big deal. If it’s true that you can’t derive the shares of national income that go to capital and labour from their role in the production process, then everything about modern economics and politics is a sham. Keynesianism is just massaging the system to keep it stable.
Marx (and Piero Sraffa, amongst others) essentially argued that whatever the productivity of the different factors of production, the actual distribution of income (and thus consumption) in society is a political question based on the power of those who own capital to steal the “surplus product” of labour.
If that’s true there is no reforming, moderating or fixing capitalism. It also suggests that a lot of what we consider to be the “core issues” of modern politics are in some ways by-products of this bigger injustice.
and my writing a post about it is not going to change how economists behave around this issue, so it is not a productive use of my time.
Really? Is that to say that this blog is for economists only or is it meant for a larger audience?
As a member of the “larger” audience, I’d like these issues explained in layman’s terms. In short, in deconstructed, easy to understand language. Similar
to taking all the legalese out of a contract.
That is an assignment. Please see our written comments policies. We don’t do assignments. You are as capable as anyone of Googling “Cambridge capital controversy” and reading more about it on your own if you want to learn more. Our typical reader is curious and able to do additional research on his own.
I work a punishing schedule and have no personal life. I was sick this weekened and up until 10 AM this morning getting posts out. Given that I doubt you make similar demands of much better resourced organizations like the New York Times, your petulance is unreasonable and insensitive.
Technical discussions of economics are low on our list of priorities here because as I said, what we write about that will not influence debate or public perceptions. We only on an exceptional basis go into that area. For instance, we have published a great deal on Modern Monetary Theory because it is a relatively new theory that is getting traction. It is directly opposed to the neoliberal fixation with balanced budgets which is used to justify austerity, so it relates to active political debates. And NC has played a role in advancing MMT, but even there, the overwhelming majority of our “contribution” was cross posts, not original work. By contrast, on matters that are firmly within the economics discipline and the economists are not open to lay input (and we have no status whatsoever in that field), we rely on the work of economists when we do find suitable material.
You have self identified wanting us to be something that we are not. We are not changing how we operate on our very thin resources to cater to you, Please read another site.
Let me see if I can simplify for the lazy.
The key issue is the way the product of society is distributed. In this respect the article reviews a debate about the nature of the returns to capital – a debate that was carefully hidden from Econ students like me in the 80’s.
Essentially, European economists demonstrated conclusively that there is no relationship between the productivity of various factors of production — capital, labour, materials — and the distribution of income in society. It isn’t well known, but orthodox American economists basically gave up the debate and admitted defeat — but went right on teaching that every factor of production earns its “just reward,” and that if capitalists were richer than everyone else, it’s because capital is more productive than labour.
This is a very big deal. If it’s true that you can’t derive the shares of national income that go to capital and labour from their role in the production process, then everything about modern economics and politics is a sham. Keynesianism is just massaging the system to keep it stable.
Marx (and Piero Sraffa, amongst others) essentially argued that whatever the productivity of the different factors of production, the actual distribution of income (and thus consumption) in society is a political question based on the power of those who own capital to steal the “surplus product” of labour.
If that’s true there is no reforming, moderating or fixing capitalism. It also suggests that a lot of what we consider to be the “core issues” of modern politics are in some ways by-products of this bigger injustice.
And here I was, thinking what the F! Why are we reading about this arcane mainstream economics dribble, written in their intensely dense and obstuse manner which screams for an English translation, when I read craazyman and skippy in the posting. Hat tip and drinks around! craazyman for his economic analysis – money for nothing is infinite efficiency and his Godel’s insight – you can’t change a person’s belief about reality by only using their words and assumptions; and to skippy to his keen insight into dogs and cats – I love them both, but cats, in the city I’m in, is the way to go.
‘Concluding that “there is no connection that can be expected in general between the direction of change of the rate of profit and direction of change of the ‘quantity of capital’ per man,” Pasinetti argued that the Neoclassical approach to analyzing production needed to be abandoned in favor of something much closer in spirit to Classical Economics.’
I see.
One wonders how many theoretical errors are now built into our models of reality across the spectrum of knowledge and inquiry. For how long can an important mistake propagate before the output can no longer be explained by the holders of the theory? What might this error mean for a fundamental tenet of capitalism, i.e., that some by their aptitudes and skills are simply worth more others, and that ability in accumulating capital belongs in the category of incredibly lucrative ‘talent’ rather than meaner alternatives?
“One wonders how many theoretical errors are now built into our models of reality across the spectrum of knowledge and inquiry.”
Lots. Most?
Our consensus reality is quite limited and omits most of the picture.
Wilbert Smith (former director of Canada’s department of communication) gave 2 interesting short talks on this topic in 1957 and 1958. He followed it up with more specifics about The New Science he was being shown. This is just one example, which I provide because he was so grounded as an engineer and a careful researcher, and this comes across clearly when listening to his talks.
Bringing in more, Machaelle Small Wright’s books have profound–and useful–insights about form and reality from nature’s perspective.
As the world moves from the 1970s, where we had the lowest levels of inequality in history, to a polarised world of rich and poor with almost no middle class we might ask, “How did this happen?”
We can look back to see that capitalism in its raw state in the 19th Century was very similar, the rich lived in the lap of luxury and wanted for nothing and the poor lived in abject squalor.
The earliest economists never imagined the poor would move out of a bare subsistence existence, this is the way it was and always would be.
The Classical Economists looked in greater detail to see why this was happening and how they could make the capitalist system work for everyone.
They realised capitalism had two sides, a productive side and a parasitic, rentier side. The productive side yields “earned” income and the parasitic side “unearned” income. To make the system work for all you tax “unearned” income, generated by the parasitic side, to help the productive side and as a source of income for the public sector.
This gave conclusions that many were not happy with, people who were happy with things just the way they were.
They got behind a new economics, Neoclassical Economics, that hides the distinctions between “earned” and “unearned” income. They used their influence to ensure this economics was adopted.
This economics did what it naturally does and led to the inequality of the 1920s, the Wall Street Crash of 1929 and the Great Depression. The New Deal and Keynesian economics were required to sort out the mess.
Neoclassical Economics was resurrected for the globalisation project; it has led to 1920s levels of inequality, another Wall Street Crash in 2008 and another global recession.
You can bias economics to suit certain vested interests but you can’t make it work.
The Euro was designed with Neoclassical Economics and as a result is polarising the Euro-zone as the rich countries get richer and the poor countries get poorer.
Bretton Woods deliberately put in place recycling mechanisms so that surplus nations recycled money to deficit nations to maintain supply and demand. The deficit nation cannot keep consuming as it gets into more and more debt and there is no point in supply when there is no demand. It just keeps the whole thing running.
The knowledge used in Bretton Woods is sadly missing from the Euro-zone.
In Keynesian days, high progressive taxation stopped things polarising with the lowest levels of inequality in history.
Even Keynes’s economics was just Neoclassical Economics with some fixes to make it work; you have to go back to Classical Economics to find a true economics that works for all.
Classical Economics is not taught otherwise people would see the contradictions; it gives rise to conclusions that are the opposite of today’s philosophy.
You want:
1) Low cost housing
2) Free or low cost services
3) Free or low cost healthcare
4) Free or low cost education
This keeps the basic cost of living down, keeping the minimum wage down and making you internationally competitive.
This is funded through taxes on “unearned” income.
The basic cost of living drives the minimum wage and for the West to be competitive in a global economy the basic cost of living needs to be similar in East and West.
Classical Economics can achieve it.
Today’s philosophy doesn’t like those lower down the scale getting free or subsidised stuff.
It misses out the fact that if it isn’t free or subsidised those costs have to be covered by wages making labour more expensive and uncompetitive in the global market place.
This lack of knowledge of Classical Economics has let us support ridiculous housing booms in the West, raising the cost of living through high mortgage payments and rents, pricing Western labour out of the global economy.
People did look into the Wall Street Crash of 1929 to see exactly why it happened.
In the 1930s, Irving Fisher developed a theory of economic crises called debt-deflation, which attributed the crises to the bursting of a credit bubble.
Hyman Minsky came up with “financial instability hypothesis” in 1974 and Steve Keen carries on with this work today with mathematical models that include realistic assumptions about money and debt.
Steve Keen warned a debt crisis was coming in 2005.
Neoclassical Economics ignores this work as it would destroy their core belief that markets reach stable equilibriums.
Debt inflated asset bubbles now rage around the world in the form of housing booms.
We can only guess which nation will be next to experience its “Minsky Moment”.
Cananda, Australia, Hong Kong, Sweden and Holland all look like prime candidates.
Putting capitalism into the grand scheme of things.
Nearly every social system since the dawn of civilization has been set up to support a Leisure Class at the top who are maintained in luxury and leisure through the economically productive, hard work of the middle and lower classes.
The lower class does the manual work; the middle class does the administrative and managerial work and the upper class lives a life of luxury and leisure.
Feudalism used land to look after the upper class and Capitalism uses capital (wealth).
This was very obvious in its early days of the 18th and 19th Century and the Classical Economists identified the sources of “unearned” income that looked after the upper, leisure class.
Its use of Capital is efficient and even Marx was impressed.
Capitalism has two sides, its productive, efficient side and its parasitic, rentier side designed to look after the idle rich, upper class.
I have many numerical examples building on the CCC: http://robertvienneau.blogspot.com/search/label/Sraffa%20Effects. I am not sure these will help. I suggest just looking at the graphs. You might also want to skip to the end and work forward in chronological time. My more recent examples tend to be more complicated, as I seek to illustrate how far the criticism extends.
This is great. Thanks a lot!