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An Outline of the History of Economic Thought - Screpanti and Zamagni(Oxford 2005 2nd Ed)

An Outline of the History of Economic Thought - Screpanti and Zamagni(Oxford 2005 2nd Ed)

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Although the possibility of substitution among primary factors is excluded

under the hypotheses of the non-substitution theorem, it would seem possible

to argue for another type of substitution: that between capital and labour.

Even excluding the effects of final demand on prices, is it not possible that a

significant relationship exists between demand for the ‘productive factors’,

labour and capital, and their remunerations? If the prices of the factor

services are indexes of scarcity, then the following should occur: with an

increase in the wage–interest ratio, there should be an increase in the demand

for the services of capital in relation to that of the services of labour. Under

perfect competition the real compensations to factors should equal their

marginal productivity; therefore, a decreasing function should link the

capital intensity of the techniques to the relative cost of capital; a decrease in

the marginal productivity of capital in relation to that of labour should be

caused by the substitution of labour by capital.

This is the neoclassical theory of distribution. Already Wicksell, as we men-

tioned in Chapter 6, had noticed the strangeness of certain phenomena (later


the relationship between the capital intensity of the techniques and the

remuneration of capital. However, it was only in the debate of the 1950s and

1960s that the problem was solved. The debate was opened by J. V. Robinson


in which she put forward an argument inspired by Sraffa’s ‘Introduction’

(1951) to Ricardo’s Principles: that the ‘degree of mechanization’ of a pro-

ductive technique can increase, rather than decrease, following an increase in

the interest–wage ratio. Robinson also noted that the origin of this strange

effectistobefoundintheimpossibilityofmeasuringcapitalinphysical terms,

given itsheterogeneous composition,and theconsequent necessity to measure

it in value. Then D. Champernowne, in a comment on Robinson’s article,


solved by measuring capital by means of an index of his own construction,


at the margins of orthodoxy

although he admitted that his index might not work in some ‘strange’ cases.

Robinson counter-attacked, especially in a section of The Accumulation of

Capital (1956), where she pointed out that the strange relationship existing

between the prices of factor services and the capital intensity of techniques

is not due to purely ‘financial’ phenomena, as Champernowne seemed to

suggest, but can be generated by real technical change.

In that year, by a strange historical quirk, the first neoclassical aggregate

growth models came to light: those of Solow and Swan, already discussed in

Chapter 9. These models used exactly the same aggregate production func-

tion and the same theory of capital which had been criticized by Robinson.

This certainly helped to liven up the party. In 1960 Sraffa’s Production of

Commodities by Means of Commodities was published, a book which con-

tained, albeit in very concise form, all the elements needed to clarify the

question. At the same time, Garegnani’s Il capitale nelle teorie della distri-

buzione was published, a book in which criticism of the neoclassical theory of

capital was explicitly formulated.

Robinson’s criticism was accepted without resistance by many neoclassical

economists—for example by Morishima and Hicks. As late as 1962 and

1965, however, Samuelson and Levhari made attempts to resolve the prob-

lem in a different way from that suggested by Robinson. The debate reached

its climax in 1966, when the Quarterly Journal of Economics published a

special issue dedicated to capital theory. Decisive were Pasinetti’s and

Garegnani’s contributions. But the most important one was Samuelson’s

‘Summing Up’, in which he acknowledged the validity of the criticisms and,

while trying to minimize their importance, he admitted the error inherent in

the neoclassical theory of aggregate capital. This closed the debate, even if

the aftermath continued until the early 1970s. The final word on this problem

was given by Garegnani in ‘Heterogeneous Capital, the Production Function

and the Theory of Distribution’ (1970).

In order to explain this subject in the simplest way, we will use a model of

an economy in which only two goods are produced, a consumer and a capital

good, by means of capital and labour:



The priceoftheconsumergoodistakenasnumeraire, wistherealwage,pthe

price of the capital good, r the rate of profit, which is equal to the rate of

interest, lk and lc the labour coefficient in the two industries, and kc and kk the

capital coefficients. With a few simple algebraic passages it is possible to




lcÀlclk kk=lkÀkc=lc




at the margins of orthodoxy

Two different wage–profit curves have been drawn in Fig. 19. They represent

two different productive techniques (two different systems of equations); let

us call them a and b. The techniques differ in the ways in which capital and

labour are combined, but it is also possible that one (or some) capital good(s)

is (are) physically different in the two cases.

The concavity of curve a implies that in the technique a it holds

kk/lk>kc/lc, whereas curve b is linear because kk/lk¼kc/lc. In technique a the

capital–labour ratio varies with variations in the price of capital and,

therefore, with variations in the distribution of income, even without a

change in the productive technique. In technique b, on the other hand, the

aggregate capital–labour ratio does not vary with variations in the distri-

bution of income, as prices do not change. Graphically, the capital–labour

ratio is measured, for technique b, by the slope of line b. In fact, in the case in

which kk/lk¼kc/lc the preceding formula can be reduced to:




in which kk/lc measures the slope of line b. For technique a, instead, the

capital–labour ratio is measured, for example at point P2, by the width of

angle a, and is different for every different point on curve a.

Let us now compare the two techniques in correspondence to different

distributive patterns. At the points to the left of r1, the capitalists will choose

technique b as, with respect to a, it gives higher profits in relation to each

wage. Technique a will be preferred at the points between r1 and r2, while

at those to the right of r2 technique b will be preferred again. This is the

phenomenon of the ‘reswitching of techniques’: technique b, which had been

abandoned following an increase in the rate of profit around r1, is preferred

again when the rate of profit becomes still higher, i.e. higher than r2. At each



















Fig. 19


at the margins of orthodoxy

of points P1 and P2 the two techniques are equally profitable and have the

same price systems. Passing from technique b to a around pointP1 there is a

decrease in the capital–labour ratio. Such a change in the capital intensity of

the techniques has purely real causes, as at pointP1 the two techniques have

the same price system. This phenomenon is known as the positive ‘real

Wicksell effect’. In the movement from technique a to b around point P2,

there is, therefore, a negative real Wicksell effect. In this case, with an

increase in the rate of profit, the capital–labour ratio increases rather than

decreases; and this occurs because of a real technical change. Also at the

points between P1 and P2, the capital–labour ratio increases when the

interest rate increases, but this occurs, in this case, only because the price of

capital changes. This is the ‘price Wicksell effect’. The phenomenon of the

increase in the capital–labour ratio following an increase in the interest rate

is called ‘capital reversal’.

Broadly speaking, the root of the problem is that, if the economy produces

heterogeneous goods, capital must be measured in value terms. When the

real wage varies, the cost of labour changes in every industry and, since the

incidence of labour input varies from one industry to another, the prices of

goods change. As a consequence, the value of capital varies, not because

techniques change, but as a simple consequence of the change in relative

prices. This is the Wicksell price effect. In general, the capital–labour ratio

may change in any direction and it may increase when the interest–wage

ratio increases. This means that the capital intensity of techniques may

increase when the capital ‘factor’ becomes dearer than the labour factor: the

reverse of what marginalist theory predicts. In this case the phenomenon is

caused by a perverse price Wicksell effect.

But things may be worse. When the real wage changes, capitalists are

forced to change techniques, not only because the cost of labour varies, but

also because, following the change in the price of goods, all production costs

change. As a consequence, the quantities of capital goods used and the value

of capital will change. This is the real Wicksell effect, and may be either

positive or negative. If it is negative, the aggregate capital–labour ratio rises

as the interest–wage ratio increases. Again: the reverse of what is envisaged

by the marginalist theory. In this case the phenomenon occurs as a con-

sequence of a genuine change in techniques and the physical quantities of

capital goods used.

An old marginalist prejudice was propagandized by telling the following

parable. When the employment of labour increases, given the employment of

other production factors, its marginal productivity is reduced. Firms will be

prepared to increase employment only if wages are reduced. In competitive

equilibrium, the wage corresponds to the marginal productivity of labour,

so it can be said that labour is remunerated according to its production

contribution. In the same way, when employment of the ‘capital’ factor

increases, its marginal productivity is reduced. Therefore, firms will be


at the margins of orthodoxy

prepared to adopt more intensively capitalist techniques only if the interest

rate is reduced. In competitive equilibrium the rate of interest remunerates

the productive contribution of capital, corresponding to its marginal pro-

ductivity, and is reduced when its use is increased. Well, this parable can no

longer be told, because the use of capital may increase when its cost increases

instead of when it decreases.

The conclusion can be generalized: it does not apply to capital alone, but

also to all primary factors, land, for instance. The relation between the use of

land and the use of labour may increase when the rent–wage ratio increases.

This is also a result which came out of Sraffa’s work. However, it was

explicitly brought to light by his followers, and most clearly in the essay by

J. S. Metcalfe and I. Steedman, ‘Reswitching and Primary Input Use’ (1972).

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