The Cambridge Controversy
These writings marked the beginning of the famous 'Cambridge Controversy', a heated debate between Cambridge, England, where Robinson and Sraffa
12 The qualitative differences between production techniques generate inflections that make reswitching possible.
These writings marked the beginning of the famous 'Cambridge Controversy', a heated debate between Cambridge, England, where Robinson and Sraffa
12 The qualitative differences between production techniques generate inflections that make reswitching possible.
Nitzan Bichler - 2012 - Capital as Power
A typical example is provided by the recent debate over the resurgence of leverage buyouts.
Supporters of the trend argue that private firms are more productive than those listed on the stock market, while its critics maintain that delisting is driven by manipulators and asset strippers.
'So who is right?
' asks Martin Wolff, chief economist of the Financial Times.
'An obvious answer is that private equity is a growing activity in which willing sellers meet willing buyers.
If it prospers, it must be profitable.
If it is profitable, it should also be adding value' (Wolf 2007).
This rule can be frustrated by 'market imperfections', but its underlying logic is taken as self-evident.
? 72 The enigma of capital
society for them is an external and largely irrational sphere which constantly threatens to prevent their 'economy' from reaching its collective orgasm of Pareto Optimality. 3
With so much going for it, the marginal productivity theory was quickly endorsed by professional economists - and, of course, by their captains of finance. The latter used and abused the theory partly for what it said, but especially for what it didn't.
Marginal productivity theory in historical context
It turns out that Clark's theory of distribution could say very little about the reality in which it developed - and this for a simple reason: the theory rose to prominence precisely when the conditions necessary for it to work disap- peared.
Recall that, in liberal theology, everyone is equal before mother competi- tion and father market. No single person can affect the market outcome. This conclusion (or assumption) is formalized in neoclassical manuals through the properties of demand and supply. Individual consumers are said to face a supply curve which they cannot alter (a flat schedule equal to the market price); similarly, individual producers confront a flat demand curve over which they have no control (also equal to the market price). This convenient setting makes the market demand and supply independent of each another. And this independence in turn leads to a unique equilibrium - a spontaneous yet stable 'one dollar, one vote' democracy.
The end of equilibrium
By the beginning of the twentieth century, however, when this vision became the canon, the assumption of independent supply and demand - as well as of the autonomy of consumers, the anonymity of sellers and the absence of government - was no longer tenable. It turned out that perfectly competitive equilibrium was no longer possible, even on paper.
There were three basic reasons for this impossibility. First, oligopoly substituted for 'free' competition, and that changed pretty much everything. In oligopolistic markets sellers become inter-dependent, and this inter- dependence - even if we pretend that consumers remain fully rational, know- ledgeable and autonomous - makes the individual firm's demand curve
3 Pareto Optimum, a neoclassical mantra named after the Italian thinker Vilfredo Pareto, refers to a situation in which no individual can be made better off without another individual becoming worse off. This situation is said to exist when the overall pie cannot be made any bigger - that is, when the economy works at full employment and in maximum efficiency. Of course, since no one has thus far been able to identify such an Optimum, the mantra is of little practical significance. But its ideological importance is considerable: if maximum output is already optimal, why worry about its distribution?
? Neoclassical parables 73
indeterminate. In the absence of a clear demand curve, firms don't know how to maximize income. And without this unambiguous yardstick for action the oligopolistic market as a whole becomes clueless, lacking a clear equilibrium point on which to converge. 4
Second, by the end of the nineteenth century there emerged an obvious asymmetry between the buy and sell sides. While individual consumers remained powerless to alter market conditions and therefore had to obey them, the giant corporation enjoyed far greater flexibility. For large firms, the 'demand curve' was no longer an external condition given by sovereign consumers, but rather a malleable social context to be influenced and shaped relentlessly as part of the firm's broader investment and pricing strategy. 5 Of course, in public big business continued to talk about the 'market discipline' to which it was presumably subjugated. But that was doublespeak, the use of mythical forces to conceal real power. In private, large firms saw themselves not only as 'price makers', but also as 'market makers'. 6
These two developments marked the end of spontaneous equilibrium. Originally, economics had two unknown variables and two independent func- tions with which to explain them: jointly solving the demand and supply equations yielded unique values for price and quantity. But with the introduc- tion of power into the picture, demand became dependent on, if not subsumed by, supply, leaving economics with only one (combined) equation to explain the two unknowns. In one swoop, economics lost its 'degree of freedom'.
4 To illustrate this conclusion with a hypothetical example, consider a price change by Nokia. This price change will elicit responses from Nokia's oligopolistic rivals, such as Motorola, Samsung and Panasonic, and these responses will in turn change the demand curve for Nokia's own product. Since the direction and magnitude of these responses are open-ended, the eventual position of Nokia's demand curve becomes unclear. And given that Nokia cannot foretell this eventual position, it cannot know the profit maximizing price and there- fore cannot know how to act. Game theorists have managed to solve this problem a million times over - but only by imposing predetermined theoretical rules that real oligopolists such as Nokia and its rivals are perfectly free to ignore.
5 The concept of 'consumer sovereignty' also depreciated due to the immense increase in the complexity of production and consumption. We can perhaps fathom an independent farmer in the United States of the mid-nineteenth century assessing the marginal benefit of growing corn and cabbage instead of beets and tobacco, or of a slave hunter contemplating the marginal rate of substitution between the income from seizing an additional escapee and a week of idle leisure. But these types of computations are rather difficult to make in a world loaded with millions of different commodities and endless 'choices'. It is no wonder that instead of the individualist ethos of the nineteenth century we now refer to consumers as 'masses' and to investors - even the most sophisticated - as 'herds'.
6 These concepts were already part of common business parlance at the turn of the twentieth century. For early analyses of firms as 'price makers', see the works of Brown (1924) on General Motors, of Means (1935a) on administrative prices and of Hall and Hitch (1939) on business behaviour. On the broader politics of 'market making', see Kaplan et al. (1958). The nineteenth-century precursors of anti-market corporatism (including the young J. B. Clark) are examined in Perelman (2006). The power aspects of pricing will be examined in Chapter 12.
? 74 The enigma of capital
From now on, there could be any number of price/quantity outcomes, all perfectly consistent and none necessarily stable. And if the real world did appear stable, the reason was not the invisible hand of the market but the visible hand of power. 7
The third development, which we already alluded to in previous chapters, was the rise of big government and, later, of active economic policy. This development presented another serious difficulty for mainstream economics. On the one hand, large governments have become integral if not necessary to the process of capital accumulation. On the other hand, their existence has 'contaminated' economics with power, annulling the invisible hand and leaving the notion of spontaneous equilibrium hanging on the thread of denial.
Public management
As noted in Chapter 4, economists have partly managed to ignore this dilemma by keeping the study of macroeconomics as separate as possible from microeconomics, nested uneasily in what Paul Samuelson called the 'neoclassical synthesis' and John Ruggie later labelled 'embedded liberalism'. But that wasn't enough. It was also necessary to ascertain that the public sector, no matter how large and active, remained subservient to the logic of laissez faire individualism and the interests of its large capitalists.
This requirement was greatly assisted by the founding of 'public manage- ment' - a new social science that would imitate, at least nominally, the princi- ples of Frederick Taylor's 'scientific management' (1911). We say nominally, since unlike the so-called scientific management of private enterprise, public management lacked from the beginning any clear yardstick for success.
7 For those who care to read further, we should add that demand and supply are unlikely to be independent of each other even in the absence of power. The basic reason is that any change in the supply price of a given commodity redistributes income between buyers and sellers of that commodity. This redistribution in turn shifts the respective demand curves of those buyers and sellers. And since different buyers have different preferences, the redistribution of income works to alter the overall market demand curve. This simple logic implies that move- ments along the supply curve are accompanied by shifts of the demand curve - leading not to one, but to multiple equilibria.
Neoclassical economists solve this problem by making two assumptions. First, they ask us to forget about the liberal ideal of individual freedom and think of all consumers as drones, each one identical to the 'representative consumer' and therefore possessing the same set of preferences. Second, they ask us to further believe that these drones have a mental fix, such that the proportion of their income spent on various items is independent of their income level (a consumer spending 30 per cent on food when her annual income is $10,000 will also spend 30 per cent on food when her income is $10 million). These two assumptions - known as the Sonnenshein-Mantel-Debreu conditions - indeed imply that redistribution of consumer income leaves the market demand curve unchanged. But since these assumptions are patently impossible, they also imply that neoclassical consumer theory has practically nothing to say about any real world situation.
? Neoclassical parables 75
The dilemma is simple. The administration of business, neoclassicists argue, is guided by a single goal: the maximization of profit. According to Clark's marginal productivity theory, the more profit the corporation earns, the greater the well-being it must have generated, by definition. Public admin- istration, though, has no comparable rule. Since public services commonly do not have a market price, and since public officials do not normally profit from the services they administer, there is no 'natural' way to tell how much utility is being generated. Unlike in the private sphere, here you have to decide what the utility is. But then utility is subjective, so how can public administrators ever hope to mimic the objective market?
There are two solutions to the problem. The first, used mostly to justify higher budgets, is to keep a straight face, pretend that the public sector behaves just like a free market, and subject it to the neoclassical mechanics of indifference curves, budget lines, production functions and possibilities fron- tiers. The absurd, albeit politically effective, outcome of this venue is best illustrated by marginalist analyses of 'national defence' - the arena most removed from the neoclassical fantasy land (Hitch and McKean 1960). The second solution, ideal for periods of 'belt tightening', is to simply reiterate the basic maxim of liberalism: if in doubt, minimize. Since the public sector is a necessary evil, an authoritarian wasteful institution whose sole purpose is to ameliorate temporary 'market failure' and counteract communist ideology, the best yardstick for its success is the extent to which we can limit its inter- vention. 8
Many of the key institutions of the welfare state were originally established and run by people schooled in and conditioned by neoclassical maxims. Although they all spoke of 'public policy' and 'government intervention', they tended to think of such activities as necessary 'distortions'. With a few exceptions, mostly in the Nordic countries, there was never a systematic attempt to develop the public sector into a humane form of democratic planning.
And it is not as if the possibility wasn't there. As a new discipline - and one that emerged after the chaos and misery of the Great Depression and two world wars - public management could have opened the door to new ways of thinking about and organizing society. It could have introduced truly demo- cratic budgeting, new ways of assessing public projects, new frameworks for
8 The inferior status of the public sector is evident in the theory and practice of the national accounts. In these accounts, government expenditures on goods and services are (reluctantly) treated on par with private spending: both are considered additions to GDP. But the treat- ment of interest payments - paid usually to capitalist owners of the public debt - is different. Interest on private debt (to finance the production of cosmetics, cigarettes and fast food, say) is counted as payment for a productive service and is therefore made part of the national income. By contrast, interest on the public debt (for instance, to finance education, war and health services) is considered a mere 'transfer', a one-sided transaction like welfare or unem- ployment insurance payments. Presumably, no service is being rendered, and therefore there is no reason to treat such interest payments as part of the national income.
? 76 The enigma of capital
ecological planning, new pension schemes, a new architecture for public credit, mass housing for the benefit of inhabitants rather than contractors, effective public transportation, non-neoclassical conceptions of intergenera- tional transfers, and perhaps even a new, democratic theory of value.
But that never happened. Instead of transcending neoclassical dogma and the business creed, much of the post-war effort went into making sure people didn't even think in such directions. As a rule, public-sector salaries were kept low, public processes were presented as inefficient and corrupt, the status of public activity was demeaned and public officials were commonly criticized and mocked. And indeed, once communism collapsed in the late 1980s, government officials and politicians around the world seemed all too eager to dismantle their own welfare states. The neoclassical Trojan horse has achieved its purpose. The commanding heights again are controlled by the free marketeers. It is as if the Great Depression had never happened.
The best investment I ever made
And so, although Clark's distribution theory was out of sync with the new reality of power, paradoxically, it has proven immensely useful in both concealing and manipulating that very reality. The theory helps protect the belief in perfect competition despite the massive gravitational force created by large governments and big business. It helps hide the fact that oligopolistic interdependence nullifies the notion of spontaneous equilibrium while simul- taneously enabling oligopolies to mould their consumers and impose their own outcomes. And it helps use the public sector for capitalist ends while preventing that sector from ever generating a democratic alternative to capi- talism.
Given these tall achievements, it is only fitting that the most generous sponsors of this ideology were no other than the Rockefellers - a family whose members invented every possible trick in limiting competition and output, in using religious indoctrination for profitable ends, in rigging stock prices and bashing unions, in enforcing 'free trade' while helping friendly dictators, in confiscating oil-rich territories and in uprooting and destroying indigenous Indian populations (Colby and Dennett 1995). The clan's founder, John D. Rockefeller, donated $45 million to establish the Baptist University of Chicago, where Clark's production function would later become gospel. Eventually, Chicago became the bastion of neoclassical econ- omics - and the neoclassical economists in turn helped make Rockefeller and his like invisible. According to Rockefeller's own assessment, 'it was the best investment I ever made' (Collier and Horowitz 1976: 50). 9
9 Chicago, like most other universities, was only too happy to serve the new capitalist bene- factors:
In the world of learning, the janissaries of oil or lard potentates, with a proper sense of taste and fitness, sought consistently to sustain the social structure, to resist change, to
? Some very unsettling questions
The difficulty with Clark's logic, though, goes much deeper than indicated in the previous section. In fact, even if we ignore the external reality of power and assume away governments, oligopolies and all other contaminating factors, the theory still doesn't stand.
The quantity of capital
The central problem, identified already by Wicksell at the turn of the century, is the very 'quantity' of capital (Wicksell 1935, Vol. 1: 149, originally published in 1901-6). According to received convention, a given capital usually is associated with different types of capital goods. This heterogeneity means that capital goods cannot be aggregated in terms of their own 'natural' units. 10 The only way to 'add' a machine producing aircraft parts to one making shoes to another making biscuits is by summing their values measured in money. The money value of any capital good - that is, the amount investors are willing to pay for it - is the present value of its expected future profit (computed by discounting this profit by the prevailing rate of interest, so value = expected profit / rate of interest). 11
Now, as long as our purpose is merely to measure the money value of capital, this method is hardly problematic and is indeed used regularly by
combat all current notions which might thereafter "reduce society to chaos" or "confound the order of nature". As a class, they shared with their patrons the belief that there was more to lose than to gain by drastic alterations of the existing institutions, and that it was wisest to "let well enough alone". While ministers of the Baptist Church defended the Trusts as "sound Christian institutions" against "all these communistic attacks", the managers of Rockefeller's Chicago University also championed the combi- nations year by year. . . . [One] teacher of literature ostensibly. . . declared Mr Rockefeller and Mr Pullman "superior in creative genius to Shakespeare, Homer and Dante". . . . [while] Professor Bemis, who happened to criticize the action of the rail- roads during the Pullman strike in 1894 was after several warnings expelled from the university for "incompetence".
(Josephson 1934: 324)
Syracuse University, endowed by Mr John Archbold of the Standard Oil combine, similarly dismissed John Commons, a young economics instructor who revealed too strong an interest in the rising labour movement (p. 325).
10 Although labour and land are not homogenous either, their heterogeneity is fundamen- tally different from that of capital goods. The so-called quality of labour can be moulded through education, whereas land can be improved through cultivation. Capital goods, in contrast, are rarely that supple, and once made they can seldom be converted for new tasks. This difference, though, doesn't get labour off the hook. As we shall see later in our discussion of Marx, the transformation of labour also faces insurmountable aggregation problems.
11 As we have already mentioned in Chapter 1 and will elaborate further in Chapters 9 and 11, the discounting formula is more complicated, having to take into account factors such as varying profit flow, end-value and risk perceptions. These additional factors can be ignored for our purpose here.
Neoclassical parables 77
? 78 The enigma of capital
investors around the world. The difficulty begins when we interpret such
value as equivalent to the 'physical' quantity of capital.
Circularity
To see the problem, suppose that the rate of interest is 5 per cent and that a given machine is expected to yield $1 million in profit year after year in perpe- tuity. Based on the principle of present value, the machine should have a physical quantity equivalent to $20 million (= $1 million / 0. 05). But then what if expected profit were to go up to $1. 2 million? The present value should rise to $24 million (= $1. 2 million / 0. 05) - yet that would imply that the very same machine can have more than one quantity! And since a given machine can generate many levels of profit, there is no escape from the conclusion that capital in fact is a 'multiple' entity with an infinite number of quantities. . . .
As it turns out, Clark's productivity theory of distribution is based on a circular notion of capital: the theory seeks to explain the magnitude of profit by the marginal productivity of a given quantity of capital, but that quantity itself is a function of profit - which is what the theory is supposed to explain in the first place! Clark assumed what he wanted to prove. No wonder he couldn't go wrong.
These are logical critiques. Another perhaps more substantive social challenge to the notion of physical capital came around the same time from Thorstein Veblen, to whom we turn in Chapter 12. Yet, for almost half a century Clark's theory remained resilient, and it was only during the 1950s that the early criticism against it began to echo.
Reswitching
The first shots were fired by Joan Robinson (1953-54) and David Champer- nowne (1953-54), followed by the publication of Pierro Sraffa's seminal work, Production of Commodities by Means of Commodities (1960). Sraffa's book, which was forty years in the making, had only 99 pages - but these were pages that shook the world, or at least they should have. In contrast to earlier sceptics who rejected the 'quantity of capital' as a circular concept, Sraffa began by assuming that such a quantity actually existed and then proceeded to show that this assumption was self-contradictory. The conclusion from this contradiction was that the 'physical' quantity of capital - and, indeed, its very objective existence - was a fiction, and therefore that productive contributions could not be measured without prior knowledge of prices and distribution - the two things that the theory was supposed to explain in the first place.
Sraffa's attack centred on the alleged connection between the quantity of capital and the rate of interest. As noted, because capital goods are heteroge- neous, neoclassicists have never been able to directly aggregate them into
Neoclassical parables 79
capital. But this aggregate, they've argued, nonetheless can be quantified, if only indirectly, by looking at the rate of interest.
The logic runs as follows: the higher the rate of interest - everything else being the same - the more expensive capital becomes relative to labour, and hence the less of it that will be employed relative to labour. According to this view, the 'capital intensity' of any productive process, defined as the ratio between the (indirectly observable) quantity of capital and the (directly observable) quantity of labour, should be negatively related to the rate of interest: the higher the rate of interest, the lower the intensity of capital, and vice versa. Of course, the relationship must be unique, with each 'capital inten- sity' associated with one and only one rate of interest. Otherwise, we end up with the same capital having more than one 'intensity'.
And yet that is exactly what Sraffa found.
His famous 'reswitching' examples demonstrated that, contrary to neoclas- sical theory, 'capital intensity' need not have a unique, one-to-one relation- ship with the rate of interest. To illustrate, consider an economy with two technologies: process X, which is capital intensive, and process Y, which is labour intensive (i. e. less capital intensive). A rise in the rate of interest makes capital expensive relative to labour and, according to neoclassical theory, should cause capitalists to shift production from X to Y. However, Sraffa showed that if the rate of interest goes on rising, it is entirely possible that process Y once again will become the more costly, causing capitalists to 'reswitch' back to X. Indeed, since usually there are two or more ways of producing the same thing, and since these methods are almost always qualita- tively different in terms of the inputs they use and the way they combine them over time, reswitching is not the exception, but the rule. 12
The result is a logical contradiction, since, if we accept the rate of interest as an inverse proxy for capital intensity, X appears to be both capital intensive (at a low rate of interest) and labour intensive (at a high rate of interest). In other words, the same assortment of capital goods represents different 'quantities' of capital. . . .
The consequence of Sraffa's work was not only to leave profit in search of an explanation, but also to rob capital goods - the basis of so much theorizing - of any fixed magnitude.
The Cambridge Controversy
These writings marked the beginning of the famous 'Cambridge Controversy', a heated debate between Cambridge, England, where Robinson and Sraffa
12 The qualitative differences between production techniques generate inflections that make reswitching possible. For a clear exposition of how reswitching works and why it would tend to infect neoclassical production models (save for those protected by special assump- tions), see Hunt (1992: 536-48).
? 80 The enigma of capital
taught, and Cambridge, Massachusetts, the home of many neoclassical econ- omists (the controversy is summarized in Harcourt 1969; 1972). Eventually, the neoclassicists, led by towering figures such as Nobel Laureate Paul Samuelson, conceded that there was a problem, offering to treat Clark's neoclassical definition of capital not literally, but as a 'parable' (Samuelson 1962). A few years later, Charles Ferguson, another leading neoclassicist, admitted that because neoclassical theory depended on 'the "thing" called capital' (1969: 251), accepting that theory in light of the Cambridge Controversy was a 'matter of faith' (pp. xvii-xviii). 13
Yet faith was hardly enough. The realization that capital does not have a fixed 'physical' quantity set off a logical chain reaction with devastating consequences for neoclassical theory. It began by destroying the notion of a production function which, as we noted, requires all inputs, including capital, to have measurable quantities. This destruction then nullified the neoclassical supply curve, a derivative of the production function. And with the supply curve gone, the notion of equilibrium - the intersection between supply and demand - became similarly irrelevant. The implication was nothing short of dramatic: without equilibrium, neoclassical economics fails its two basic tasks of explaining and justifying prices and quantities.
Clearly, this was no laughing matter. For neoclassical theory to continue and hold, the belief that capital is an objective-material thing, a well-defined physical quantity with its own intrinsic productivity and corresponding prof- itability, had to be retained at all costs. And so the rescue attempts began.
Resuscitating capital
The first and most common solution has been to gloss the problem over - or, better still, to ignore it altogether. And as Robinson (1971) predicted and Hodgson (1997) confirmed, so far this solution seems to be working. Most economics textbooks, including the endless editions of Samuelson, Inc. , continue to 'measure' capital as if the Cambridge Controversy had never
13 These machinations are typical of a faith in trouble. In The Birth of Europe, Robert Lopez describes similar challenges to the Christian dogma during the twilight of feudalism - along with the Church's response:
In general, faith is still sufficiently adaptable in the thirteenth century for the great majority of Catholic thinkers to feel no more bound by its dogmas than the confirmed liberal or marxist today feels fettered by the basic principles of liberalism or marxism. . . . Conflict between faith and reason cannot always be avoided but in most cases it is successfully solved by an allegorical interpretation of the sacred writings. . . . St. Augustine. . . suggested that 'if we happen across a passage in Holy Scripture which lends itself to various interpretations, we must not. . . bind ourselves so firmly to any of them that if one day the truth is more thoroughly investigated, our interpretation may collapse, and we with it'. The early mediaeval writers, as we have seen, seized upon alle- gory with the typical enthusiasm of ages poorly equipped with exact information and clear ideas. . . .
? (Lopez 1967: 361-62, emphases added)
Neoclassical parables 81
happened, helping keep the majority of economists - teachers and students - blissfully unaware of the whole debacle.
A second, more subtle method has been to argue that the problem of quan- tifying capital, although serious in principle, has limited practical importance (Ferguson 1969). However, given the excessively unrealistic if not impossible assumptions of neoclassical theory, resting its defence on real-world relevance seems somewhat audacious.
The third and probably most sophisticated response has been to embrace disaggregate general equilibrium models. The latter models try to describe - conceptually, that is - every aspect of the economic system, down to the smallest detail. The production function in such models separately specifies each individual input, however tiny, so the need to aggregate capital goods into capital does not arise in the first place.
General equilibrium models have serious theoretical and empirical weak- nesses whose details have attracted much attention. 14 Their most important problem, though, comes not from what they try to explain, but from what they ignore, namely capital. Their emphasis on disaggregation, regardless of its epistemological feasibility, is an ontological fallacy. The social process takes place not at the level of atoms or strings, but of social institutions and organizations. And so, although the 'shell' called capital may or may not consist of individual physical inputs, its existence and significance as the cen- tral social aggregate of capitalism is hardly in doubt. By ignoring this pivotal concept, general equilibrium theory turns itself into a hollow formality. 15
14 First, the production theatre becomes infinitely complex, making identification and quanti- fication impossible. Second, without aggregation some input complementarity is inevitable, so the corresponding marginal products cannot be derived, even on paper. Third, because rationality and utility maximization alone do not guarantee downward-sloping excess demand functions, general equilibrium models need not be 'stable' (see for example Risvi 1994). And fourth, the theory is inherently static and hence can say little on the dynamic gist of accumulation.
15 Aware of the inherent circularity of 'tangible' marginalism, the Austrian economists sought to circumvent the problem altogether by substituting time for capital goods. Following Jevons (1871), who formulated his production function with time as an input, writers such as Bo? hm-Bawerk (1891), Wicksell (1935) and later Hicks (1973) reinterpreted capital goods as stages of a temporal production process. Capital here is counted in units of the 'average period of production', itself a combination of original inputs and the time pattern of their employment. In general, it is believed that 'roundabout' processes (which are longer, more mechanized and indirect) are more productive, and that lengthening the average period of production therefore is tantamount to raising its 'capital intensity'.
The Austrian theory has two main drawbacks. First, it's politically risky. The early Austrians sought to undermine the labour theory of value - but like Balaam in the Book of Numbers ended up bolstering it. Their emphasis on original inputs - to the exclusion of tangible capital goods - is dangerously close to Marx's, something the neoclassicists have been more than eager to avoid. Second, the theory's focus, including its link to the time preferences of consumers, remains exclusively materialistic. It tries to establish a positive rela- tionship between an aggregate quantity of capital on the one hand and productivity/utility on the other. Its route therefore is not that different from Clark's, and indeed this theory too falls into the 'reswitching' trap (on this last point, see Howard 1980; Hunt 1992, Ch. 16).
? 82 The enigma of capital
The measure of our ignorance
Of course, ignoring problems does not solve them. The inconvenience is evident most vividly in empirical neoclassical studies, in which production functions are used to explain changes in output. The results of such studies are usually highly disappointing. Commonly, only part of the output varia- tions - and often only a small part - is explained by the 'observed' variations of the inputs, leaving a sizeable 'residual' hanging in the air (a term commonly attributed to Solow 1957).
As we elaborate later in the book, one possible reason for this failure is that production is a holistic process and hence cannot be expressed as a func- tion of individual inputs in the first place. Neoclassicists do not even consider this possibility. Instead, they prefer to circumvent the problem by separating inputs into two categories - those that can be observed, namely labour, land and capital, and those that cannot, lumped together as technology, or 'total factor productivity'. This by-pass, suggested by Marshall (1920) and popular- ized by Galbraith (1958; 1967) and Drucker (1969), enables neoclassicists to avoid the embarrassment of a large output residual. To paraphrase Henri Poincare? , this residual is simply a 'measure of our ignorance' (Abramovitz 1956: 10). The problem, they argue, is not theoretical but practical. It lies not in the production function but in the fact that we do not know how to measure technology. Did we know how, and could we incorporate the 'quan- tity' of technology into the production function, the residual most surely would disappear. 16
Unfortunately, this phlogiston-like argument is only too convenient, in that it can never be falsified, let alone verified. Theories that claim to explain reality should be tested on how well they do so - the smaller the 'error', the more convincing the theory. 17 Here, however, the problem is not the theory but the facts, so the error does not matter. . . . 18
16 The hopes and frustrations of those involved in this quest are echoed in the brief history of the 'residual' written by true believer Zvi Griliches (1996).
17 For a discipline that takes its cue from physics, the following words of Nobel Laureate Robert Laughlin should ring loud: 'Deep inside every physical scientist is the belief that measurement accuracy is the only fail-safe means of distinguishing what is true from what one imagines, and even of defining what true means. . . . in physics, correct perceptions differ from mistaken ones in that they get clearer when experimental accuracy is improved' (Laughlin 2005: 15).
18 Consider two hypothetical production functions, with physical inputs augmented by tech- nology: (1) Q = 2N + 3L + 5K + T and (2) Q = 4N + 2L + 10K + T, where Q denotes output, N labour, L land, K capital, and T technology. Now, suppose Q is 100, N is 10, L is 5 and K is 4. The implication is that T must be 45 in function (1) and 10 in function (2). Yet, since technology cannot be measured, we will never know which function is correct, so both can safely claim scientific validity.
? The victory of faith
Neoclassical theory remains an edifice built on foundations of sand. The most questionable of these foundations is the notion that capital is a material entity, measurable in physical units and possessing its own intrinsic produc- tivity. In fact, capital fulfils none of these requirements. The result is that the theory is unable to convincingly explain not only the structure of prices and production, but also the distribution of income which supposedly results from such structure.
In The Structure of Scientific Revolutions, Thomas Kuhn (1970) claimed that the accumulation of anomalies in science tends to engender a paradig- matic breakdown, opening the door to new theories and, eventually, to a new paradigm. Nothing of the sort has ever happened to neoclassical political economy. Although suffering from deep logical contradictions and serious empirical anomalies, neoclassical theory hasn't broken down. On the con- trary, it has only grown stronger. Its overall structure has remained more or less intact for more than a century - a feat unparallel by any other science - and it has managed, with the help of massive business and government subsi- dies, to strangle pretty much all of its theoretical competitors.
But then, this victory shouldn't surprise us, simply because neoclassical political economy is not a science, but a church. And like every church with forged scriptures, the neoclassical priests go on with their daily business, spreading the faith by building 'elegant-seeming arguments in terms which they cannot define' and searching for 'answers to unaskable questions' (Robinson 1970: 317).
Neoclassical parables 83
6 The Marxist entanglement I
Values and prices
. . . the whole substance of the bread is changed into the whole substance of Christ's body, and the whole substance of the wine into the whole substance of Christ's blood. Hence. . . it can be called 'transubstantiation. '
--Thomas Aquinas, Summa Theologica
As radical thinkers, we find it far more difficult to criticize Marx than the neoclassicists. So much of our thinking about capitalism originates from his writings. The very concept of the 'capitalist system'; the view of capital as a political institution and of political critique as part of the class struggle; the emphasis on the ruling class and the socio-historical context in which it emerges; the dialectical development of history in general and of capital accu- mulation in particular; the imperative of empirical research; the universal- izing tendencies of capital - these ideas and emphases are all due to Marx. It is hard to approach contemporary social phenomena - from globalization, to economic crisis, to militarization, imperialism, ecology, price movements, the modern corporation, cultural development, elite dynamics and technical change, to name a few - without feeling indebted to Marx and the controver- sies he opened up. His insights, along with the debates among his followers and critics, are deeply embedded in our current thinking.
But then it is precisely this crucial importance of Marx - along with his emphasis on dialectical thinking - that forces us to re-examine his underlying framework. Capitalism, he argued, is a system of commodities, driven by the accumulation of capital and denominated in prices. To decipher the secrets of this process is to look behind the front window of prices, and to do so we need a theory of value. This is the starting point, the 'algorithm' that Marx uses to develop much of his subsequent concepts and analysis. Marx chose to develop a value theory based on labour, and it is here that his analysis went wrong. Our purpose in this and the next chapter is to examine why. What are the inconsistencies in Marx's logic, how has the development of capitalism under- mined that logic, and most importantly, what can we learn from these theoretical and historical considerations as we seek to develop a radical alternative?
Content and form
Throughout Das Kapital there is no 'analytical' definition of capital, perhaps for a good reason. In contrast to his classical predecessors, Marx saw capital not as a 'thing', but as a comprehensive social relation whose description was intertwined with its explanation. The context of capital included the produc- tion process, the division of labour and technological progress, as well as the institutional and power arrangements shaping the collective consciousness. According to Erik Olin Wright (1977: 198), the notion that capital accumula- tion involves merely the tangible augmentation of machinery, buildings, raw materials and alike is alien to Marxist thinking. Instead, he maintains, 'capital accumulation must be understood as the reproduction of capitalist social relations on an ever-expanding scale through the conversion of surplus value into new constant and variable capital'. Emphasizing this aspect of Marx's writing, Anwar Shaikh (1990: 73) similarly reiterates that 'capital is not a thing, but rather a definite set of social relations', and that in order to under- stand it we must 'decipher its character as a social relation'.
Marx started with three fundamental principles. The first was that human history is driven largely by a struggle over surplus. The second was that production and redistribution are inseparable: surplus presupposes a class society, and classes mean a struggle over how this surplus is created, who is going to get it and how it is to be used and abused. The third principle was that, regardless of its particular form, surplus is always generated through the labour process. The analysis of every class society therefore has to begin with the underlying process of production: 'A distinct mode of production thus determines a specific mode of consumption, distribution, exchange and the specific relations of these different phases to one another' (Marx 1859: 205). This latter conviction created the infamous 'materialistic' bias underlying Marx's theory of accumulation.
The consequence of this bias was an over-preoccupation with content and less attention to form. The content of capitalism is the concrete technological fusion of workers and instruments through an ever-expanding social process of production and consumption. The form of capitalism is capitalist control; that is, the manipulation of human beings via the quantitative accumulation of universal ownership titles. As a historian of capitalism, Marx repeatedly emphasized the inherent interdependence of these two aspects. As a theoreti- cian, though, he failed to integrate this interdependence into his analytical framework of accumulation. When it came to describing accumulation in abstract terms, his attention was focused almost solely on a relatively narrow understanding of production, leaving much of the power dynamics ignored. And so although Marx saw accumulation as an antagonistic social process, in the end his theorizing got entangled in the same 'materialistic' trap that would later confound the neoclassicists.
The Marxist entanglement I 85
86 The enigma of capital
The labour theory of value
For the capitalist, accumulation is a simple process in which 'money makes money'. The capitalist invests M dollars, ends up with M+? M dollars, and the key challenge is how to make ? M as big as possible. For Marx the ques- tion is different. He asks not so much how, but why: where does ? M come from? And the answer, he argues, can be given only by looking over the capi- talist's shoulder, peering beyond the phenomenon and into the kernel.
What appears on the surface as the self-expansion of money, in fact, is a reflection of a social process. Money can 'make' money, Marx says, only through the exploitation of productive labour.
Conceptually, the process of capital accumulation can be represented by the following expression:
1. M? c+v? Production? c+v+s? M+? M
The capitalist uses money (M) to buy constant capital (c) and variable capital (v). The first of these capitals consists of used-up raw materials and semi- finished goods, as well as machinery and structures that depreciate during production; the second form of capital comprises labour power. All commod- ities, including c and v, are assumed to be exchanged at prices proportionate to their value; that is, proportionate to the socially necessary abstract labour- time required for their reproduction (a concept which we define in the next section and examine more closely in Chapter 8).
Constant and variable capital nevertheless differ in that, when they go through production, c simply transfers its own value to the new products and in that sense remains 'constant', whereas v transfers its own value as well as generates new value, which is why it is called 'variable'. Once the product is sold on the market, this new value, denoted by s for 'surplus' value, is realized by the capitalist in the form of money profit (? M).
How is surplus value created? The answer is based on the distinction between labour power and labour. Labour power is the ability to work, which is what the worker sells. By contrast, labour is the actual time he or she ends up working for the capitalist. Since labour power is treated as a commodity, its price, like that of every commodity, is proportionate to the socially neces- sary cost of its own reproduction. In this case, it is proportionate to the average cost, counted in labour time, of having the worker replenish herself or himself for yet another day of labour. 1
1 Some, like Karl Polanyi (1944: Ch. 6), argue that labour (or labour power from a Marxist perspective) is really a fictitious commodity, since, unlike true commodities, human beings generally are not produced for the purpose of sale on the market. This reasoning is vulner- able on three counts, all related to the notion of 'purpose'. First, it is not at all clear that labour power isn't produced for the market (aren't capitalist institutions geared very specifically for the production and reproduction of human workers, and isn't it true that most people in capitalist societies indeed raise their children with an eye to their future
? The Marxist entanglement I 87
But this price of labour power, when measured in labour time, is, as a rule, smaller than the actual labour time the worker works for the capitalist. And here lies the crux of the matter: the secret of accumulation rests on the unique ability of labour power to create surplus value - a surplus which the institu- tion of private property then allows the capitalists to appropriate.
Three challenges
This elegant exposition of both the social character of production and the conflictual-exploitative basis of accumulation enabled Marx to excite genera- tions of followers and alter the course of history. And yet Marx's conception of capital - particularly his Smithian emphasis on production as the engine of accumulation and his Ricardian belief that labour values reflect the inner quantitative code of the process - was far too restrictive and, in the final analysis, misleading.
Socially necessary abstract labour
The problem is threefold. The first difficulty concerns the underlying unit of measurement: socially necessary abstract labour time. 2 Marx was appalled yet fascinated by the 'mechanized' order of capitalism, a social system that objectifies its human subjects and fetishizes their social interactions. His method reflected this double-sided sentiment. On the one hand, he subjected the transformations of capitalism to dialectical analysis. On the other hand, he viewed capitalist processes as obeying historical 'laws of motion' and therefore as amenable to scientific inquiry. This latter view was deeply influ- enced by the contemporary revolutions in physics and chemistry, and it drove Marx, just as it drove natural scientists, to search for basic units. He looked for the underlying building blocks, for the simplest elements with which the complex processes of capitalism are socially constructed and ideologically articulated.
The visible building block of capitalism, he argued, is the commodity. On the face of it, commodities are qualitatively different from each other and in that sense incommensurate: a meal in a restaurant is different from a barrel of oil, and both are unlike an automobile. And yet all commodities share a common denominator: their price. A meal may cost $50, a barrel of oil $100 and an automobile $20,000. Although incommensurate qualitatively, they
saleability? ).
? 72 The enigma of capital
society for them is an external and largely irrational sphere which constantly threatens to prevent their 'economy' from reaching its collective orgasm of Pareto Optimality. 3
With so much going for it, the marginal productivity theory was quickly endorsed by professional economists - and, of course, by their captains of finance. The latter used and abused the theory partly for what it said, but especially for what it didn't.
Marginal productivity theory in historical context
It turns out that Clark's theory of distribution could say very little about the reality in which it developed - and this for a simple reason: the theory rose to prominence precisely when the conditions necessary for it to work disap- peared.
Recall that, in liberal theology, everyone is equal before mother competi- tion and father market. No single person can affect the market outcome. This conclusion (or assumption) is formalized in neoclassical manuals through the properties of demand and supply. Individual consumers are said to face a supply curve which they cannot alter (a flat schedule equal to the market price); similarly, individual producers confront a flat demand curve over which they have no control (also equal to the market price). This convenient setting makes the market demand and supply independent of each another. And this independence in turn leads to a unique equilibrium - a spontaneous yet stable 'one dollar, one vote' democracy.
The end of equilibrium
By the beginning of the twentieth century, however, when this vision became the canon, the assumption of independent supply and demand - as well as of the autonomy of consumers, the anonymity of sellers and the absence of government - was no longer tenable. It turned out that perfectly competitive equilibrium was no longer possible, even on paper.
There were three basic reasons for this impossibility. First, oligopoly substituted for 'free' competition, and that changed pretty much everything. In oligopolistic markets sellers become inter-dependent, and this inter- dependence - even if we pretend that consumers remain fully rational, know- ledgeable and autonomous - makes the individual firm's demand curve
3 Pareto Optimum, a neoclassical mantra named after the Italian thinker Vilfredo Pareto, refers to a situation in which no individual can be made better off without another individual becoming worse off. This situation is said to exist when the overall pie cannot be made any bigger - that is, when the economy works at full employment and in maximum efficiency. Of course, since no one has thus far been able to identify such an Optimum, the mantra is of little practical significance. But its ideological importance is considerable: if maximum output is already optimal, why worry about its distribution?
? Neoclassical parables 73
indeterminate. In the absence of a clear demand curve, firms don't know how to maximize income. And without this unambiguous yardstick for action the oligopolistic market as a whole becomes clueless, lacking a clear equilibrium point on which to converge. 4
Second, by the end of the nineteenth century there emerged an obvious asymmetry between the buy and sell sides. While individual consumers remained powerless to alter market conditions and therefore had to obey them, the giant corporation enjoyed far greater flexibility. For large firms, the 'demand curve' was no longer an external condition given by sovereign consumers, but rather a malleable social context to be influenced and shaped relentlessly as part of the firm's broader investment and pricing strategy. 5 Of course, in public big business continued to talk about the 'market discipline' to which it was presumably subjugated. But that was doublespeak, the use of mythical forces to conceal real power. In private, large firms saw themselves not only as 'price makers', but also as 'market makers'. 6
These two developments marked the end of spontaneous equilibrium. Originally, economics had two unknown variables and two independent func- tions with which to explain them: jointly solving the demand and supply equations yielded unique values for price and quantity. But with the introduc- tion of power into the picture, demand became dependent on, if not subsumed by, supply, leaving economics with only one (combined) equation to explain the two unknowns. In one swoop, economics lost its 'degree of freedom'.
4 To illustrate this conclusion with a hypothetical example, consider a price change by Nokia. This price change will elicit responses from Nokia's oligopolistic rivals, such as Motorola, Samsung and Panasonic, and these responses will in turn change the demand curve for Nokia's own product. Since the direction and magnitude of these responses are open-ended, the eventual position of Nokia's demand curve becomes unclear. And given that Nokia cannot foretell this eventual position, it cannot know the profit maximizing price and there- fore cannot know how to act. Game theorists have managed to solve this problem a million times over - but only by imposing predetermined theoretical rules that real oligopolists such as Nokia and its rivals are perfectly free to ignore.
5 The concept of 'consumer sovereignty' also depreciated due to the immense increase in the complexity of production and consumption. We can perhaps fathom an independent farmer in the United States of the mid-nineteenth century assessing the marginal benefit of growing corn and cabbage instead of beets and tobacco, or of a slave hunter contemplating the marginal rate of substitution between the income from seizing an additional escapee and a week of idle leisure. But these types of computations are rather difficult to make in a world loaded with millions of different commodities and endless 'choices'. It is no wonder that instead of the individualist ethos of the nineteenth century we now refer to consumers as 'masses' and to investors - even the most sophisticated - as 'herds'.
6 These concepts were already part of common business parlance at the turn of the twentieth century. For early analyses of firms as 'price makers', see the works of Brown (1924) on General Motors, of Means (1935a) on administrative prices and of Hall and Hitch (1939) on business behaviour. On the broader politics of 'market making', see Kaplan et al. (1958). The nineteenth-century precursors of anti-market corporatism (including the young J. B. Clark) are examined in Perelman (2006). The power aspects of pricing will be examined in Chapter 12.
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From now on, there could be any number of price/quantity outcomes, all perfectly consistent and none necessarily stable. And if the real world did appear stable, the reason was not the invisible hand of the market but the visible hand of power. 7
The third development, which we already alluded to in previous chapters, was the rise of big government and, later, of active economic policy. This development presented another serious difficulty for mainstream economics. On the one hand, large governments have become integral if not necessary to the process of capital accumulation. On the other hand, their existence has 'contaminated' economics with power, annulling the invisible hand and leaving the notion of spontaneous equilibrium hanging on the thread of denial.
Public management
As noted in Chapter 4, economists have partly managed to ignore this dilemma by keeping the study of macroeconomics as separate as possible from microeconomics, nested uneasily in what Paul Samuelson called the 'neoclassical synthesis' and John Ruggie later labelled 'embedded liberalism'. But that wasn't enough. It was also necessary to ascertain that the public sector, no matter how large and active, remained subservient to the logic of laissez faire individualism and the interests of its large capitalists.
This requirement was greatly assisted by the founding of 'public manage- ment' - a new social science that would imitate, at least nominally, the princi- ples of Frederick Taylor's 'scientific management' (1911). We say nominally, since unlike the so-called scientific management of private enterprise, public management lacked from the beginning any clear yardstick for success.
7 For those who care to read further, we should add that demand and supply are unlikely to be independent of each other even in the absence of power. The basic reason is that any change in the supply price of a given commodity redistributes income between buyers and sellers of that commodity. This redistribution in turn shifts the respective demand curves of those buyers and sellers. And since different buyers have different preferences, the redistribution of income works to alter the overall market demand curve. This simple logic implies that move- ments along the supply curve are accompanied by shifts of the demand curve - leading not to one, but to multiple equilibria.
Neoclassical economists solve this problem by making two assumptions. First, they ask us to forget about the liberal ideal of individual freedom and think of all consumers as drones, each one identical to the 'representative consumer' and therefore possessing the same set of preferences. Second, they ask us to further believe that these drones have a mental fix, such that the proportion of their income spent on various items is independent of their income level (a consumer spending 30 per cent on food when her annual income is $10,000 will also spend 30 per cent on food when her income is $10 million). These two assumptions - known as the Sonnenshein-Mantel-Debreu conditions - indeed imply that redistribution of consumer income leaves the market demand curve unchanged. But since these assumptions are patently impossible, they also imply that neoclassical consumer theory has practically nothing to say about any real world situation.
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The dilemma is simple. The administration of business, neoclassicists argue, is guided by a single goal: the maximization of profit. According to Clark's marginal productivity theory, the more profit the corporation earns, the greater the well-being it must have generated, by definition. Public admin- istration, though, has no comparable rule. Since public services commonly do not have a market price, and since public officials do not normally profit from the services they administer, there is no 'natural' way to tell how much utility is being generated. Unlike in the private sphere, here you have to decide what the utility is. But then utility is subjective, so how can public administrators ever hope to mimic the objective market?
There are two solutions to the problem. The first, used mostly to justify higher budgets, is to keep a straight face, pretend that the public sector behaves just like a free market, and subject it to the neoclassical mechanics of indifference curves, budget lines, production functions and possibilities fron- tiers. The absurd, albeit politically effective, outcome of this venue is best illustrated by marginalist analyses of 'national defence' - the arena most removed from the neoclassical fantasy land (Hitch and McKean 1960). The second solution, ideal for periods of 'belt tightening', is to simply reiterate the basic maxim of liberalism: if in doubt, minimize. Since the public sector is a necessary evil, an authoritarian wasteful institution whose sole purpose is to ameliorate temporary 'market failure' and counteract communist ideology, the best yardstick for its success is the extent to which we can limit its inter- vention. 8
Many of the key institutions of the welfare state were originally established and run by people schooled in and conditioned by neoclassical maxims. Although they all spoke of 'public policy' and 'government intervention', they tended to think of such activities as necessary 'distortions'. With a few exceptions, mostly in the Nordic countries, there was never a systematic attempt to develop the public sector into a humane form of democratic planning.
And it is not as if the possibility wasn't there. As a new discipline - and one that emerged after the chaos and misery of the Great Depression and two world wars - public management could have opened the door to new ways of thinking about and organizing society. It could have introduced truly demo- cratic budgeting, new ways of assessing public projects, new frameworks for
8 The inferior status of the public sector is evident in the theory and practice of the national accounts. In these accounts, government expenditures on goods and services are (reluctantly) treated on par with private spending: both are considered additions to GDP. But the treat- ment of interest payments - paid usually to capitalist owners of the public debt - is different. Interest on private debt (to finance the production of cosmetics, cigarettes and fast food, say) is counted as payment for a productive service and is therefore made part of the national income. By contrast, interest on the public debt (for instance, to finance education, war and health services) is considered a mere 'transfer', a one-sided transaction like welfare or unem- ployment insurance payments. Presumably, no service is being rendered, and therefore there is no reason to treat such interest payments as part of the national income.
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ecological planning, new pension schemes, a new architecture for public credit, mass housing for the benefit of inhabitants rather than contractors, effective public transportation, non-neoclassical conceptions of intergenera- tional transfers, and perhaps even a new, democratic theory of value.
But that never happened. Instead of transcending neoclassical dogma and the business creed, much of the post-war effort went into making sure people didn't even think in such directions. As a rule, public-sector salaries were kept low, public processes were presented as inefficient and corrupt, the status of public activity was demeaned and public officials were commonly criticized and mocked. And indeed, once communism collapsed in the late 1980s, government officials and politicians around the world seemed all too eager to dismantle their own welfare states. The neoclassical Trojan horse has achieved its purpose. The commanding heights again are controlled by the free marketeers. It is as if the Great Depression had never happened.
The best investment I ever made
And so, although Clark's distribution theory was out of sync with the new reality of power, paradoxically, it has proven immensely useful in both concealing and manipulating that very reality. The theory helps protect the belief in perfect competition despite the massive gravitational force created by large governments and big business. It helps hide the fact that oligopolistic interdependence nullifies the notion of spontaneous equilibrium while simul- taneously enabling oligopolies to mould their consumers and impose their own outcomes. And it helps use the public sector for capitalist ends while preventing that sector from ever generating a democratic alternative to capi- talism.
Given these tall achievements, it is only fitting that the most generous sponsors of this ideology were no other than the Rockefellers - a family whose members invented every possible trick in limiting competition and output, in using religious indoctrination for profitable ends, in rigging stock prices and bashing unions, in enforcing 'free trade' while helping friendly dictators, in confiscating oil-rich territories and in uprooting and destroying indigenous Indian populations (Colby and Dennett 1995). The clan's founder, John D. Rockefeller, donated $45 million to establish the Baptist University of Chicago, where Clark's production function would later become gospel. Eventually, Chicago became the bastion of neoclassical econ- omics - and the neoclassical economists in turn helped make Rockefeller and his like invisible. According to Rockefeller's own assessment, 'it was the best investment I ever made' (Collier and Horowitz 1976: 50). 9
9 Chicago, like most other universities, was only too happy to serve the new capitalist bene- factors:
In the world of learning, the janissaries of oil or lard potentates, with a proper sense of taste and fitness, sought consistently to sustain the social structure, to resist change, to
? Some very unsettling questions
The difficulty with Clark's logic, though, goes much deeper than indicated in the previous section. In fact, even if we ignore the external reality of power and assume away governments, oligopolies and all other contaminating factors, the theory still doesn't stand.
The quantity of capital
The central problem, identified already by Wicksell at the turn of the century, is the very 'quantity' of capital (Wicksell 1935, Vol. 1: 149, originally published in 1901-6). According to received convention, a given capital usually is associated with different types of capital goods. This heterogeneity means that capital goods cannot be aggregated in terms of their own 'natural' units. 10 The only way to 'add' a machine producing aircraft parts to one making shoes to another making biscuits is by summing their values measured in money. The money value of any capital good - that is, the amount investors are willing to pay for it - is the present value of its expected future profit (computed by discounting this profit by the prevailing rate of interest, so value = expected profit / rate of interest). 11
Now, as long as our purpose is merely to measure the money value of capital, this method is hardly problematic and is indeed used regularly by
combat all current notions which might thereafter "reduce society to chaos" or "confound the order of nature". As a class, they shared with their patrons the belief that there was more to lose than to gain by drastic alterations of the existing institutions, and that it was wisest to "let well enough alone". While ministers of the Baptist Church defended the Trusts as "sound Christian institutions" against "all these communistic attacks", the managers of Rockefeller's Chicago University also championed the combi- nations year by year. . . . [One] teacher of literature ostensibly. . . declared Mr Rockefeller and Mr Pullman "superior in creative genius to Shakespeare, Homer and Dante". . . . [while] Professor Bemis, who happened to criticize the action of the rail- roads during the Pullman strike in 1894 was after several warnings expelled from the university for "incompetence".
(Josephson 1934: 324)
Syracuse University, endowed by Mr John Archbold of the Standard Oil combine, similarly dismissed John Commons, a young economics instructor who revealed too strong an interest in the rising labour movement (p. 325).
10 Although labour and land are not homogenous either, their heterogeneity is fundamen- tally different from that of capital goods. The so-called quality of labour can be moulded through education, whereas land can be improved through cultivation. Capital goods, in contrast, are rarely that supple, and once made they can seldom be converted for new tasks. This difference, though, doesn't get labour off the hook. As we shall see later in our discussion of Marx, the transformation of labour also faces insurmountable aggregation problems.
11 As we have already mentioned in Chapter 1 and will elaborate further in Chapters 9 and 11, the discounting formula is more complicated, having to take into account factors such as varying profit flow, end-value and risk perceptions. These additional factors can be ignored for our purpose here.
Neoclassical parables 77
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investors around the world. The difficulty begins when we interpret such
value as equivalent to the 'physical' quantity of capital.
Circularity
To see the problem, suppose that the rate of interest is 5 per cent and that a given machine is expected to yield $1 million in profit year after year in perpe- tuity. Based on the principle of present value, the machine should have a physical quantity equivalent to $20 million (= $1 million / 0. 05). But then what if expected profit were to go up to $1. 2 million? The present value should rise to $24 million (= $1. 2 million / 0. 05) - yet that would imply that the very same machine can have more than one quantity! And since a given machine can generate many levels of profit, there is no escape from the conclusion that capital in fact is a 'multiple' entity with an infinite number of quantities. . . .
As it turns out, Clark's productivity theory of distribution is based on a circular notion of capital: the theory seeks to explain the magnitude of profit by the marginal productivity of a given quantity of capital, but that quantity itself is a function of profit - which is what the theory is supposed to explain in the first place! Clark assumed what he wanted to prove. No wonder he couldn't go wrong.
These are logical critiques. Another perhaps more substantive social challenge to the notion of physical capital came around the same time from Thorstein Veblen, to whom we turn in Chapter 12. Yet, for almost half a century Clark's theory remained resilient, and it was only during the 1950s that the early criticism against it began to echo.
Reswitching
The first shots were fired by Joan Robinson (1953-54) and David Champer- nowne (1953-54), followed by the publication of Pierro Sraffa's seminal work, Production of Commodities by Means of Commodities (1960). Sraffa's book, which was forty years in the making, had only 99 pages - but these were pages that shook the world, or at least they should have. In contrast to earlier sceptics who rejected the 'quantity of capital' as a circular concept, Sraffa began by assuming that such a quantity actually existed and then proceeded to show that this assumption was self-contradictory. The conclusion from this contradiction was that the 'physical' quantity of capital - and, indeed, its very objective existence - was a fiction, and therefore that productive contributions could not be measured without prior knowledge of prices and distribution - the two things that the theory was supposed to explain in the first place.
Sraffa's attack centred on the alleged connection between the quantity of capital and the rate of interest. As noted, because capital goods are heteroge- neous, neoclassicists have never been able to directly aggregate them into
Neoclassical parables 79
capital. But this aggregate, they've argued, nonetheless can be quantified, if only indirectly, by looking at the rate of interest.
The logic runs as follows: the higher the rate of interest - everything else being the same - the more expensive capital becomes relative to labour, and hence the less of it that will be employed relative to labour. According to this view, the 'capital intensity' of any productive process, defined as the ratio between the (indirectly observable) quantity of capital and the (directly observable) quantity of labour, should be negatively related to the rate of interest: the higher the rate of interest, the lower the intensity of capital, and vice versa. Of course, the relationship must be unique, with each 'capital inten- sity' associated with one and only one rate of interest. Otherwise, we end up with the same capital having more than one 'intensity'.
And yet that is exactly what Sraffa found.
His famous 'reswitching' examples demonstrated that, contrary to neoclas- sical theory, 'capital intensity' need not have a unique, one-to-one relation- ship with the rate of interest. To illustrate, consider an economy with two technologies: process X, which is capital intensive, and process Y, which is labour intensive (i. e. less capital intensive). A rise in the rate of interest makes capital expensive relative to labour and, according to neoclassical theory, should cause capitalists to shift production from X to Y. However, Sraffa showed that if the rate of interest goes on rising, it is entirely possible that process Y once again will become the more costly, causing capitalists to 'reswitch' back to X. Indeed, since usually there are two or more ways of producing the same thing, and since these methods are almost always qualita- tively different in terms of the inputs they use and the way they combine them over time, reswitching is not the exception, but the rule. 12
The result is a logical contradiction, since, if we accept the rate of interest as an inverse proxy for capital intensity, X appears to be both capital intensive (at a low rate of interest) and labour intensive (at a high rate of interest). In other words, the same assortment of capital goods represents different 'quantities' of capital. . . .
The consequence of Sraffa's work was not only to leave profit in search of an explanation, but also to rob capital goods - the basis of so much theorizing - of any fixed magnitude.
The Cambridge Controversy
These writings marked the beginning of the famous 'Cambridge Controversy', a heated debate between Cambridge, England, where Robinson and Sraffa
12 The qualitative differences between production techniques generate inflections that make reswitching possible. For a clear exposition of how reswitching works and why it would tend to infect neoclassical production models (save for those protected by special assump- tions), see Hunt (1992: 536-48).
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taught, and Cambridge, Massachusetts, the home of many neoclassical econ- omists (the controversy is summarized in Harcourt 1969; 1972). Eventually, the neoclassicists, led by towering figures such as Nobel Laureate Paul Samuelson, conceded that there was a problem, offering to treat Clark's neoclassical definition of capital not literally, but as a 'parable' (Samuelson 1962). A few years later, Charles Ferguson, another leading neoclassicist, admitted that because neoclassical theory depended on 'the "thing" called capital' (1969: 251), accepting that theory in light of the Cambridge Controversy was a 'matter of faith' (pp. xvii-xviii). 13
Yet faith was hardly enough. The realization that capital does not have a fixed 'physical' quantity set off a logical chain reaction with devastating consequences for neoclassical theory. It began by destroying the notion of a production function which, as we noted, requires all inputs, including capital, to have measurable quantities. This destruction then nullified the neoclassical supply curve, a derivative of the production function. And with the supply curve gone, the notion of equilibrium - the intersection between supply and demand - became similarly irrelevant. The implication was nothing short of dramatic: without equilibrium, neoclassical economics fails its two basic tasks of explaining and justifying prices and quantities.
Clearly, this was no laughing matter. For neoclassical theory to continue and hold, the belief that capital is an objective-material thing, a well-defined physical quantity with its own intrinsic productivity and corresponding prof- itability, had to be retained at all costs. And so the rescue attempts began.
Resuscitating capital
The first and most common solution has been to gloss the problem over - or, better still, to ignore it altogether. And as Robinson (1971) predicted and Hodgson (1997) confirmed, so far this solution seems to be working. Most economics textbooks, including the endless editions of Samuelson, Inc. , continue to 'measure' capital as if the Cambridge Controversy had never
13 These machinations are typical of a faith in trouble. In The Birth of Europe, Robert Lopez describes similar challenges to the Christian dogma during the twilight of feudalism - along with the Church's response:
In general, faith is still sufficiently adaptable in the thirteenth century for the great majority of Catholic thinkers to feel no more bound by its dogmas than the confirmed liberal or marxist today feels fettered by the basic principles of liberalism or marxism. . . . Conflict between faith and reason cannot always be avoided but in most cases it is successfully solved by an allegorical interpretation of the sacred writings. . . . St. Augustine. . . suggested that 'if we happen across a passage in Holy Scripture which lends itself to various interpretations, we must not. . . bind ourselves so firmly to any of them that if one day the truth is more thoroughly investigated, our interpretation may collapse, and we with it'. The early mediaeval writers, as we have seen, seized upon alle- gory with the typical enthusiasm of ages poorly equipped with exact information and clear ideas. . . .
? (Lopez 1967: 361-62, emphases added)
Neoclassical parables 81
happened, helping keep the majority of economists - teachers and students - blissfully unaware of the whole debacle.
A second, more subtle method has been to argue that the problem of quan- tifying capital, although serious in principle, has limited practical importance (Ferguson 1969). However, given the excessively unrealistic if not impossible assumptions of neoclassical theory, resting its defence on real-world relevance seems somewhat audacious.
The third and probably most sophisticated response has been to embrace disaggregate general equilibrium models. The latter models try to describe - conceptually, that is - every aspect of the economic system, down to the smallest detail. The production function in such models separately specifies each individual input, however tiny, so the need to aggregate capital goods into capital does not arise in the first place.
General equilibrium models have serious theoretical and empirical weak- nesses whose details have attracted much attention. 14 Their most important problem, though, comes not from what they try to explain, but from what they ignore, namely capital. Their emphasis on disaggregation, regardless of its epistemological feasibility, is an ontological fallacy. The social process takes place not at the level of atoms or strings, but of social institutions and organizations. And so, although the 'shell' called capital may or may not consist of individual physical inputs, its existence and significance as the cen- tral social aggregate of capitalism is hardly in doubt. By ignoring this pivotal concept, general equilibrium theory turns itself into a hollow formality. 15
14 First, the production theatre becomes infinitely complex, making identification and quanti- fication impossible. Second, without aggregation some input complementarity is inevitable, so the corresponding marginal products cannot be derived, even on paper. Third, because rationality and utility maximization alone do not guarantee downward-sloping excess demand functions, general equilibrium models need not be 'stable' (see for example Risvi 1994). And fourth, the theory is inherently static and hence can say little on the dynamic gist of accumulation.
15 Aware of the inherent circularity of 'tangible' marginalism, the Austrian economists sought to circumvent the problem altogether by substituting time for capital goods. Following Jevons (1871), who formulated his production function with time as an input, writers such as Bo? hm-Bawerk (1891), Wicksell (1935) and later Hicks (1973) reinterpreted capital goods as stages of a temporal production process. Capital here is counted in units of the 'average period of production', itself a combination of original inputs and the time pattern of their employment. In general, it is believed that 'roundabout' processes (which are longer, more mechanized and indirect) are more productive, and that lengthening the average period of production therefore is tantamount to raising its 'capital intensity'.
The Austrian theory has two main drawbacks. First, it's politically risky. The early Austrians sought to undermine the labour theory of value - but like Balaam in the Book of Numbers ended up bolstering it. Their emphasis on original inputs - to the exclusion of tangible capital goods - is dangerously close to Marx's, something the neoclassicists have been more than eager to avoid. Second, the theory's focus, including its link to the time preferences of consumers, remains exclusively materialistic. It tries to establish a positive rela- tionship between an aggregate quantity of capital on the one hand and productivity/utility on the other. Its route therefore is not that different from Clark's, and indeed this theory too falls into the 'reswitching' trap (on this last point, see Howard 1980; Hunt 1992, Ch. 16).
? 82 The enigma of capital
The measure of our ignorance
Of course, ignoring problems does not solve them. The inconvenience is evident most vividly in empirical neoclassical studies, in which production functions are used to explain changes in output. The results of such studies are usually highly disappointing. Commonly, only part of the output varia- tions - and often only a small part - is explained by the 'observed' variations of the inputs, leaving a sizeable 'residual' hanging in the air (a term commonly attributed to Solow 1957).
As we elaborate later in the book, one possible reason for this failure is that production is a holistic process and hence cannot be expressed as a func- tion of individual inputs in the first place. Neoclassicists do not even consider this possibility. Instead, they prefer to circumvent the problem by separating inputs into two categories - those that can be observed, namely labour, land and capital, and those that cannot, lumped together as technology, or 'total factor productivity'. This by-pass, suggested by Marshall (1920) and popular- ized by Galbraith (1958; 1967) and Drucker (1969), enables neoclassicists to avoid the embarrassment of a large output residual. To paraphrase Henri Poincare? , this residual is simply a 'measure of our ignorance' (Abramovitz 1956: 10). The problem, they argue, is not theoretical but practical. It lies not in the production function but in the fact that we do not know how to measure technology. Did we know how, and could we incorporate the 'quan- tity' of technology into the production function, the residual most surely would disappear. 16
Unfortunately, this phlogiston-like argument is only too convenient, in that it can never be falsified, let alone verified. Theories that claim to explain reality should be tested on how well they do so - the smaller the 'error', the more convincing the theory. 17 Here, however, the problem is not the theory but the facts, so the error does not matter. . . . 18
16 The hopes and frustrations of those involved in this quest are echoed in the brief history of the 'residual' written by true believer Zvi Griliches (1996).
17 For a discipline that takes its cue from physics, the following words of Nobel Laureate Robert Laughlin should ring loud: 'Deep inside every physical scientist is the belief that measurement accuracy is the only fail-safe means of distinguishing what is true from what one imagines, and even of defining what true means. . . . in physics, correct perceptions differ from mistaken ones in that they get clearer when experimental accuracy is improved' (Laughlin 2005: 15).
18 Consider two hypothetical production functions, with physical inputs augmented by tech- nology: (1) Q = 2N + 3L + 5K + T and (2) Q = 4N + 2L + 10K + T, where Q denotes output, N labour, L land, K capital, and T technology. Now, suppose Q is 100, N is 10, L is 5 and K is 4. The implication is that T must be 45 in function (1) and 10 in function (2). Yet, since technology cannot be measured, we will never know which function is correct, so both can safely claim scientific validity.
? The victory of faith
Neoclassical theory remains an edifice built on foundations of sand. The most questionable of these foundations is the notion that capital is a material entity, measurable in physical units and possessing its own intrinsic produc- tivity. In fact, capital fulfils none of these requirements. The result is that the theory is unable to convincingly explain not only the structure of prices and production, but also the distribution of income which supposedly results from such structure.
In The Structure of Scientific Revolutions, Thomas Kuhn (1970) claimed that the accumulation of anomalies in science tends to engender a paradig- matic breakdown, opening the door to new theories and, eventually, to a new paradigm. Nothing of the sort has ever happened to neoclassical political economy. Although suffering from deep logical contradictions and serious empirical anomalies, neoclassical theory hasn't broken down. On the con- trary, it has only grown stronger. Its overall structure has remained more or less intact for more than a century - a feat unparallel by any other science - and it has managed, with the help of massive business and government subsi- dies, to strangle pretty much all of its theoretical competitors.
But then, this victory shouldn't surprise us, simply because neoclassical political economy is not a science, but a church. And like every church with forged scriptures, the neoclassical priests go on with their daily business, spreading the faith by building 'elegant-seeming arguments in terms which they cannot define' and searching for 'answers to unaskable questions' (Robinson 1970: 317).
Neoclassical parables 83
6 The Marxist entanglement I
Values and prices
. . . the whole substance of the bread is changed into the whole substance of Christ's body, and the whole substance of the wine into the whole substance of Christ's blood. Hence. . . it can be called 'transubstantiation. '
--Thomas Aquinas, Summa Theologica
As radical thinkers, we find it far more difficult to criticize Marx than the neoclassicists. So much of our thinking about capitalism originates from his writings. The very concept of the 'capitalist system'; the view of capital as a political institution and of political critique as part of the class struggle; the emphasis on the ruling class and the socio-historical context in which it emerges; the dialectical development of history in general and of capital accu- mulation in particular; the imperative of empirical research; the universal- izing tendencies of capital - these ideas and emphases are all due to Marx. It is hard to approach contemporary social phenomena - from globalization, to economic crisis, to militarization, imperialism, ecology, price movements, the modern corporation, cultural development, elite dynamics and technical change, to name a few - without feeling indebted to Marx and the controver- sies he opened up. His insights, along with the debates among his followers and critics, are deeply embedded in our current thinking.
But then it is precisely this crucial importance of Marx - along with his emphasis on dialectical thinking - that forces us to re-examine his underlying framework. Capitalism, he argued, is a system of commodities, driven by the accumulation of capital and denominated in prices. To decipher the secrets of this process is to look behind the front window of prices, and to do so we need a theory of value. This is the starting point, the 'algorithm' that Marx uses to develop much of his subsequent concepts and analysis. Marx chose to develop a value theory based on labour, and it is here that his analysis went wrong. Our purpose in this and the next chapter is to examine why. What are the inconsistencies in Marx's logic, how has the development of capitalism under- mined that logic, and most importantly, what can we learn from these theoretical and historical considerations as we seek to develop a radical alternative?
Content and form
Throughout Das Kapital there is no 'analytical' definition of capital, perhaps for a good reason. In contrast to his classical predecessors, Marx saw capital not as a 'thing', but as a comprehensive social relation whose description was intertwined with its explanation. The context of capital included the produc- tion process, the division of labour and technological progress, as well as the institutional and power arrangements shaping the collective consciousness. According to Erik Olin Wright (1977: 198), the notion that capital accumula- tion involves merely the tangible augmentation of machinery, buildings, raw materials and alike is alien to Marxist thinking. Instead, he maintains, 'capital accumulation must be understood as the reproduction of capitalist social relations on an ever-expanding scale through the conversion of surplus value into new constant and variable capital'. Emphasizing this aspect of Marx's writing, Anwar Shaikh (1990: 73) similarly reiterates that 'capital is not a thing, but rather a definite set of social relations', and that in order to under- stand it we must 'decipher its character as a social relation'.
Marx started with three fundamental principles. The first was that human history is driven largely by a struggle over surplus. The second was that production and redistribution are inseparable: surplus presupposes a class society, and classes mean a struggle over how this surplus is created, who is going to get it and how it is to be used and abused. The third principle was that, regardless of its particular form, surplus is always generated through the labour process. The analysis of every class society therefore has to begin with the underlying process of production: 'A distinct mode of production thus determines a specific mode of consumption, distribution, exchange and the specific relations of these different phases to one another' (Marx 1859: 205). This latter conviction created the infamous 'materialistic' bias underlying Marx's theory of accumulation.
The consequence of this bias was an over-preoccupation with content and less attention to form. The content of capitalism is the concrete technological fusion of workers and instruments through an ever-expanding social process of production and consumption. The form of capitalism is capitalist control; that is, the manipulation of human beings via the quantitative accumulation of universal ownership titles. As a historian of capitalism, Marx repeatedly emphasized the inherent interdependence of these two aspects. As a theoreti- cian, though, he failed to integrate this interdependence into his analytical framework of accumulation. When it came to describing accumulation in abstract terms, his attention was focused almost solely on a relatively narrow understanding of production, leaving much of the power dynamics ignored. And so although Marx saw accumulation as an antagonistic social process, in the end his theorizing got entangled in the same 'materialistic' trap that would later confound the neoclassicists.
The Marxist entanglement I 85
86 The enigma of capital
The labour theory of value
For the capitalist, accumulation is a simple process in which 'money makes money'. The capitalist invests M dollars, ends up with M+? M dollars, and the key challenge is how to make ? M as big as possible. For Marx the ques- tion is different. He asks not so much how, but why: where does ? M come from? And the answer, he argues, can be given only by looking over the capi- talist's shoulder, peering beyond the phenomenon and into the kernel.
What appears on the surface as the self-expansion of money, in fact, is a reflection of a social process. Money can 'make' money, Marx says, only through the exploitation of productive labour.
Conceptually, the process of capital accumulation can be represented by the following expression:
1. M? c+v? Production? c+v+s? M+? M
The capitalist uses money (M) to buy constant capital (c) and variable capital (v). The first of these capitals consists of used-up raw materials and semi- finished goods, as well as machinery and structures that depreciate during production; the second form of capital comprises labour power. All commod- ities, including c and v, are assumed to be exchanged at prices proportionate to their value; that is, proportionate to the socially necessary abstract labour- time required for their reproduction (a concept which we define in the next section and examine more closely in Chapter 8).
Constant and variable capital nevertheless differ in that, when they go through production, c simply transfers its own value to the new products and in that sense remains 'constant', whereas v transfers its own value as well as generates new value, which is why it is called 'variable'. Once the product is sold on the market, this new value, denoted by s for 'surplus' value, is realized by the capitalist in the form of money profit (? M).
How is surplus value created? The answer is based on the distinction between labour power and labour. Labour power is the ability to work, which is what the worker sells. By contrast, labour is the actual time he or she ends up working for the capitalist. Since labour power is treated as a commodity, its price, like that of every commodity, is proportionate to the socially neces- sary cost of its own reproduction. In this case, it is proportionate to the average cost, counted in labour time, of having the worker replenish herself or himself for yet another day of labour. 1
1 Some, like Karl Polanyi (1944: Ch. 6), argue that labour (or labour power from a Marxist perspective) is really a fictitious commodity, since, unlike true commodities, human beings generally are not produced for the purpose of sale on the market. This reasoning is vulner- able on three counts, all related to the notion of 'purpose'. First, it is not at all clear that labour power isn't produced for the market (aren't capitalist institutions geared very specifically for the production and reproduction of human workers, and isn't it true that most people in capitalist societies indeed raise their children with an eye to their future
? The Marxist entanglement I 87
But this price of labour power, when measured in labour time, is, as a rule, smaller than the actual labour time the worker works for the capitalist. And here lies the crux of the matter: the secret of accumulation rests on the unique ability of labour power to create surplus value - a surplus which the institu- tion of private property then allows the capitalists to appropriate.
Three challenges
This elegant exposition of both the social character of production and the conflictual-exploitative basis of accumulation enabled Marx to excite genera- tions of followers and alter the course of history. And yet Marx's conception of capital - particularly his Smithian emphasis on production as the engine of accumulation and his Ricardian belief that labour values reflect the inner quantitative code of the process - was far too restrictive and, in the final analysis, misleading.
Socially necessary abstract labour
The problem is threefold. The first difficulty concerns the underlying unit of measurement: socially necessary abstract labour time. 2 Marx was appalled yet fascinated by the 'mechanized' order of capitalism, a social system that objectifies its human subjects and fetishizes their social interactions. His method reflected this double-sided sentiment. On the one hand, he subjected the transformations of capitalism to dialectical analysis. On the other hand, he viewed capitalist processes as obeying historical 'laws of motion' and therefore as amenable to scientific inquiry. This latter view was deeply influ- enced by the contemporary revolutions in physics and chemistry, and it drove Marx, just as it drove natural scientists, to search for basic units. He looked for the underlying building blocks, for the simplest elements with which the complex processes of capitalism are socially constructed and ideologically articulated.
The visible building block of capitalism, he argued, is the commodity. On the face of it, commodities are qualitatively different from each other and in that sense incommensurate: a meal in a restaurant is different from a barrel of oil, and both are unlike an automobile. And yet all commodities share a common denominator: their price. A meal may cost $50, a barrel of oil $100 and an automobile $20,000. Although incommensurate qualitatively, they
saleability? ).
