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The Capital Controversy in Historical Perspective Gary Mongiovi St Johns University Email: mongiovg@stjohns.


It is indeed a peculiarity of our science that its investigations generally start from a point which is, so to speak, behind the zero of ignorance. It is necessary to escape from error before reaching positive truth. (F.Y. Edgeworth, 1925, p.273)

More than half a century has passed since the so-called Cambridge capital theory debates were triggered by Joan Robinsons paper on The Production Function and the Theory of Capital (1953). Several thoughtful efforts have been made to take stock of the debate, and all of them begin by pointing out what is (for me, anyway) disappointingly evident that despite the attention paid to the debate in the 1960s and 70s, the ultimate impact of the critique on economic thinking was negligible (see Birner, 2002; Elmslie & Sedgley, 2003; Cohen & Harcourt, 2003). Contemporary mainstream economics treats the issues as settled in its own favour, and deem the entire episode to have been much ado about nothing. In this paper I wish to assess the outcome of the controversy from a perspective that remains to be fully explored. The capital theory debate is generally interpreted as a technical controversy concerning the specification of capital in the neoclassical theory of growth and distribution. Although Piero Sraffas Production of Commodities by Means of Commodities (1960) is accorded a central role in the controversy, the connection of the debate to Sraffas larger projectthe reconstruction of the theoretical approach of the classical political economistsis not as well understood. It is perhaps only a slight oversimplification to say that while one side in the debate was acutely aware of this historical dimension, the other was concerned mainly with technical issues. But the technical dimensions of the problem themselves have a history that dates back to Ricardo, who encountered the problem of measuring capital in his attempt to explain the profit rate. The problem was not fatal to Ricardos theory, which does not require that the magnitude of capital be specified prior to the determination of prices and the profit rate; but its resolution in neoclassical theory requires a change in the object of analysisthat is, the abandonment of the long-period method of analysis in favor of models of intertemporal general equilibrium. Sraffas well-deserved reputation as a razor-sharp critic has overshadowed the constructive project to which he devoted his career from at least 1927the revival of classical political economy. William Stanley Jevons famously wrote that Ricardo had shunted the car of economic science on to a wrong line (1879, p. lvii). Sraffas work suggests, though, that it was Jevons himself, along with Marshall, Walras and Menger, who had knocked economic science off course, and that progress in economics would

require the recovery and resuscitation of the classical political economy tradition of Smith and Ricardo. This conclusion runs counter to the usual view of science as a forward-moving process in which knowledge and understanding accrue over time as new theories displace or assimilate old ones. Though modern discourse in the philosophy of science is wary of the claim that science brings us ever-closer to some objective truth, the argument that later theories areaccording to sensible criteria such as predictive accuracy, success at puzzle-solving, and so forthsuperior to their predecessors is less controversial (see Kuhn, 1970, pp. 205207). The reappearance of a discarded paradigm has no precedent in the history of science, and philosophers of science have, accordingly, not given the prospect much thought. The central premise of the classical theory is that the distribution of the social product is regulated not by the forces of supply and demand, but by historical and institutional processes that reflect the interplay of class interests. The ratios at which commodities exchange were understood to depend upon the technical conditions of production and the distribution of the social product between labor and the owners of capital. A difficulty arises in connection with the determination of the profit rate, which the classicals regarded as the main influence on the rate of accumulation. They conceived the normal rate of profit as the ratio of the social surplus (gross output less the outputincluding wage goodsconsumed in production) to the capital utilized in production. Both the surplus and the capital stock, however, are vectors comprised of heterogeneous wage goods and produced means of production. Calculation of the ratio between them requires that they be made commensurable. An obvious way to proceed would be to weight the elements of the two vectors by their long-period prices of production. The difficulty is that prices of production themselves depend upon the profit rate. Ricardo (1821) thought he could get around the problem by supposing that commodities exchange approximately in proportion to the quantities of labor required to produce them; the profit rate could then be calculated as a ratio of quantities of labor-time (Sraffa, 1951, pp. xxxxxxiii). This solution is unsatisfactory, however, since, as Ricardo well understood, commodities do not generally exchange in proportion to quantities of embodied labor-time: labor values deviate from long-period normal prices in a systematic fashion, according to the degree in which different production processes utilize more or less labor relative to produced inputs.1 The puzzle vexed Ricardo until the end of his life (he was working on it when he died; see Ricardo, 1823). We now know that the solution requires the simultaneous determination of relative prices and the profit rate (Sraffa, 1960, p. 6). The failure of the classical economists to resolve the difficulties posed by the interdependence of prices and distribution partially explains why classical political economy faded from the scene over the half-century that followed Ricardos death. No doubt the decline was hastened by the misappropriation of Ricardos labor value analysis by nineteenth century social reformers, who made it the basis of a claim that workers are

Ricardo appears to have been the first economist clearly to grasp that the impact of a change in distribution on relative prices depends upon the capital structures of different sectors of the economy. Marx (186794, Vol. III, Part II) developed this insight further in his analysis of the connection between sectoral differences in the organic composition of capital and the pattern of price deviations from labor values. Sraffas work (esp. 1960, pp. 1415) showed that the effects of distribution changes on prices are far more complex than either Ricardo or Marx supposed.

entitled to the whole of the social product. Marx had no use for these so-called (but in fact mislabeled) Ricardian socialists. In Capital (186794) and Theories of Surplus Value (186263) Marx critiqued and elaborated Ricardos ideas, and demonstrated the rich analytical potential of the surplus approach. But he was no more successful than Ricardo at reconciling his labor value analysis with prices conceived as long-period centers of gravitation;2 moreover, his rhetorical style and ideological stance were ill-designed to promote a sympathetic re-evaluation of the Ricardian approach among his less radical contemporaries. Nassau Senior (1836) and John Stuart Mill (1871; first edition 1848) had already begun to nudge the discipline towards marginalismSenior with his argument that interest is a reward for abstention from consumption, and Mill with the wages fund doctrine (which he later repudiated, but by then the damage was done) and with his assignment of a prominent role to utility in the explanation of economic behavior. By the start of the twentieth century the classical theory had been, as Sraffa (1960, p. v) put it, submerged and forgotten, its distinctive elements obscured in the wake of marginalisms ascendance. Marshall (1920, pp. 420421; Appendix I) had mischaracterized Ricardos theory as an embryonic version of the supply and demand framework. Jevons, of course, recognized the classical approach to be different from the marginalist theory, but precisely on that account he thought it hopeless. These views have informed modern interpretations that regard the classical theory essentially as a special case of neoclassical analysis, with the demand side of the story missing or inadequately developed (see Arrow, 1993; Bliss, 1975; Hahn, 1982). The lack of attention to the historical background has also led the capital critique to be confused with the problem of capital aggregation in empirical models aimed at testing neoclassical growth theory. They are in fact two distinct issues that intersect at one juncture: the problem of the measurement of capital. In the case of the Cambridge debates the measurement of capital is problematic because the prices of capital goods change when distribution changes; in the standard production function literature on aggregation, the problem is whether production function can be constructed that exhibits the properties needed to establish downward-sloping factor demand functions. Similarly the assertion, by Christopher Bliss and others, that the aggregation problems associated with labor and land are comparable to those associated with capital, is misplaced: the claim exemplifies the muddling of the two kinds of measurement problems mentioned above. Capital is problematic because its endowment must be specified independently of distribution in order to determine the profit rate. This problem doesnt arise in connection with labor or land, though there may be other problems of aggregation involving them that must be resolved when constructing models designed for empirical testing. The degree of the misunderstanding arises with particular clarity in one of the standard presentations of the logic of the reswitching phenomenon. This common formulation is ill-designed to expose the nature of capital reversing; I not believe the defect has hitherto been noticed: it came to my attention when I was had been asked to read a draft of a paper on why the capital controversy fizzled, and was in fact the catalyst for the present note. The model is generally attributed to Ferguson (1969), but variations

In Marx this manifested itself as the problem of transforming labor values into prices of production.

of it have been put forth by others, and it forms the basis of Birners summary of the logic of the Cambridge critique. Fergusons model contains but one capital good, so the circumstance that gives rise to capital reversing and reswitchinga multiplicity of capital goodsis not present. Capital heterogeneity is alleged to be captured by the supposition that the different techniques adopted at alternative profit rates utilize different types of capital goods (see Birner, 2002, p. 15). But this sort of heterogeneity is not manifest in any of the formal features of the model, and is not what gives rise to the perverse results. The latter stem from the differences in input proportions between the consumption goods sector and the sector which produces the sole capital good, couples with the adoption of the consumption good as numeraire. But this is a sleight of hand that misrepresents the root cause of capital reversingagain, the multiplicity of capital goods. The model writes the price equations as follows, on the assumption that constant returns to scale prevail and all capital doesnt depreciate: lMw + aMrpM = pM lCw + aCrpM = pC (1) (2)

where lM and lC are the unit labor input coefficients for the machine sector and the consumption goods sector respectively, aM and aC represent the amount of the machine required to produce a unit of the machine and a unit of the consumption good respectively; w is the real wage, r is the profit rate pM is the price of the machine and pC is the price of the consumption good. We have two equations with four unknowns. If we designate the consumption good as the numeraire, we can reduce this to two equations in three unknowns: lMw + aMrpM = pM lCw + aCrpM = 1 This system has one degree of freedom, and its solution for the real wage is: . Thus we have the standard trade-off between the real wage and the profit rate. The tradeoff is in general nonlinear, and its precise shape will depend on the technical coefficients of both sectors. The nonlinearity of the trade-off according to Ferguson is what creates the possibility of reswitching when two alternative techniques are counterposed against one another. But the model is seriously misleading as an explanation of reswitching. We do observe that when the wage-profit trade-offs for two alternative technique (let us call them and are graphed against one another in w-r space the possibility arises that one technique can dominate at low rates of profit, be supersede by the other technique at higher profit rates, and then dominate again at still higher rates of return. But this pattern has nothing at all to do with the heterogeneity of capital: it emerges because the two

sectors utilize labor and the machine in different proportions, so that the wage curve is nonlinear: it would be just as apt to occur if the two techniques utilized exactly the same sort of machine. Moreover, what ultimately accounts for the nonlinearity of the trade-off is the adoption of the non-basic consumption good as numeriare. A consequence of this decision the technical conditions of production in the consumption good sector influence the trade-off between w and r, even though the consumption good is not basic in the sense of Sraffa. But the model is fully determined without the consumption good equation. In effect, the model introduces a redundant equationthe price equation for the consumption goodto determine a redundant unknownthe price ratiowhen in fact the price equation for the machine is adequate to determine the wage curve if we designate the machine, that is, the sole basic commodity, as the numeriare. If we set pM = 1, we obtain from equation (1) . The wage curve is fully determined, is linear and its slope and intercept depend entirely on the technical coefficients of the machine sector. Provided that 0 < r < 1/aM, the real wage will be nonnegative. Once we know r and w, they can be inserted into the price equation for the non-basic consumption good to determine the pC. The solution value for pC enables a worker to purchase precisely the same amount of the consumption good per unit of waged employment as the solution value, given r, for w when the wage curve was derived using the consumption good as the numeraire. By making the (non-basic) wage good the numeraire, the model gives the sector that produces it an artificial role in the solutiona role that it could not have if the capital good were the numeraire.3 Reswitching and capital reversing are not simply by-products of the choice of numeraire. Models such as this one obscure the important point that the capital theoretic problems of orthodox theory stem from the possibility of reconciling the conventional theory of distribution with a satisfactory specification of the endowment of capital. The model isnt really capturing reswitching or capital reversing, for the simple reason that neither of these phenomena can occur when there is only one capital good. They arise because, except for special cases, capital cannot be measured independently of distribution. In their overview of the capital controversy, Cohen & Harcourt (2003, p. 200) remark that the debate involved three deep issues: (i) (ii) (iii) the meaning and, as a corollary, the measurement of capital. the usefulness of equilibrium as an analytical device; and the role of ideology and vision in fuelling controversy when the results of simple models are not robust.

All of these issues are indeed tangled up in the late 20th century discourse connected to capital theory. But the second seems to me to be something of a red herring and the last

To put it another way, Fergusson has in effect set up a corn model and then adopted some other commodity besides corn as the numeraire!

cannot be separated from the first, not so much because of ideology but because of the difficulty of abandoning entrenched modes of thinking. The early reactions to the capital critique combine an awareness that a serious blow had been struck with a quite natural inclination to discount the magnitude of the damage. Paul Samuelson, who has engaged the issues as directly as anyone on the marginalist side, forthrightly declared in his Summing Up of the debate that reswitching can be called perverse only in the sense that the conventional parables did not prepare us for it (1966, p. 578). But a few pages later he characterizes reswitching as a pathology [that] illuminates healthy physiology, in effect retracting his concession. And he reinforces this defensive maneuver by suggesting that capital reversing is empirically rare. Stiglitz (1974) suggested that capital reversing and reswitching are phenomena akin to Giffen goods in the theory of consumer demand: theoretical possibilities, but so unlikely as to be of no practical significance. This line of argument misses the point. The 19th century originators of the principle of factor substitution did not derive it from observation of empirical regularities; they constructed it by deduction from postulates ... now generally admitted to be invalid (Garegnani, 1970, pp. 424425). The marginalist theory of value and distribution was not developed by inductive reasoning based on observations of behavior that reflects the existence of underlying supply and demand functions. No economist has ever observed a factor demand function (or indeed any sort of demand function). What we observe are market phenomena, such as pricequantity couplets, that require explanation. Providing an explanation is complicated by the fact that observed magnitudes are conditioned by both accidental and systematic causes. It is the job of theory to identify and isolate the systematic causesthat it, to find the order in a highly complex reality. Here is where the role of vision comes into play. The intuition of economists has been deeply penetrated by the idea that a decrease in the price of a productive factor will cause the economy to use that factor more intensively, so that alternative theoretical frameworks can only be interpreted as concerned with anomalies. But that conventional view of the relationship between distribution and the factor intensity of production was not derived from empirical observation or common sense. Rather it emerged from a particular idea about how markets regulate the distribution of income, i.e. from the idea that factor prices are the outcome of an allocative process that is essentially designed to accommodate scarcity.4 From this premise follow all of the neoclassical notions of downward-sloping factor and commodity demand functions, factor remuneration corresponding to the marginal productivity of labor and capital. Without the premise, we would never have been tempted to think about distribution in neoclassical terms: theory shapes our conceptions of what is intuitive, what is common sense. The basis for any theoretical proposition is the set of premises from which it is deduced; if the premises are unsound, so must be the theory built upon them, and we ought to look elsewhere for the regulating mechanism. Empirical evidence often runs counter to neoclassical propositions: declining real wages are not routinely associated with increases in the labor intensity of production; lower interest rates (as the makers of Japanese and US monetary policy have recently discovered) need not induce higher levels of capital spending. These observations are accommodated within neoclassical theory by the introduction of

The roots of the idea, I suspect, lie in the vulgar economy of the mercantilists, as channeled through Malthus and Say.

influences that interfere with the operation of the fundamental substitution mechanismsprice rigidities, information asymmetries and the like. Joan Robinson was not immune to this influence. Her 1953 article made little of the curiosum that Ruth Cohen had noticed concerning the possibility of the capital intensity of production moving in the same direction as the interest rate. Indeed, she too raised doubts about its empirical significance (1953, p. 106). Robinson, via Sraffa, was well aware of the logic which supported that possibility, and of the connection of the phenomenon to the struggles of Ricardo and Marx to formulate a coherent theory of value. But she appears not to have fully grasped the destructive potential of reswitching. She wrote in 1953 (p. 83) that the problem which the production function professes to analyse, although it has been too puffed up by the attention paid to it, is a genuine problem. We observe that developed countries tend to utilize techniques that are more mechanized than techniques in use in underdeveloped economies. [I]t seems pretty clear that the main reason for this state of affairs is that capital in some sense is more plentiful in [developed countries] than in [underdeveloped] countries. The problem is a real one. We cannot abandon the production function without an effort to rescue the element of common-sense that has been entangled in it. Elsewhere in the paper (p. 96) she makes a surprising statement: The neo-classical system is based on the postulate that, in the longrun, the rate of real wages tends to be such that all available labour is employed. In spite of the atrocities that have been committed in its name there is obviously a solid core of sense in this proposition. I do not for a moment imagine that the resistance of orthodoxy to the capital critique would collapse if only the critical argument were anchored more explicitly to the constructive alternative of classical political economy as formulated by Sraffa, and supplemented with a further development of Keynesian & Post Keynesian principles. Yet I do think that the issues surrounding the debate would have been better understood if that connection had been kept more constantly in focus. Robinsons insistence that the main issue concerned the inadequacy of comparative statics for dynamic analysis, astute and accurate as it is, nevertheless weakened the impact of the critique. Contra Cohen & Harcourt (2003, p. 204) Capital theory is [no more] fundamentally intertwined with issues of time than any other aspect of economic theory concerned with understanding real world processes. The aspect of Sraffas work that drew the most attention was the challenge it posed to foundational elements of neoclassical theory that had come to be regarded as intuitively (if not empirically) evident. But once the neoclassicals walked away from the capital theory debate the prospects for Sraffas constructive agenda receded. Sraffas terseness did not help matters. In the Preface to Production of Commodities he is explicit about his critical purpose: It is a peculiar feature of the set of propositions now published that, although they do not enter into any discussion of the marginal theory of value and distribution, they have nevertheless been designed to serve as a basis for a critique of that theory. He alludes to a more constructive purpose when he identifies the framework of his Parts I and II, in which no changes in outputs or proportions are considered, as the standpoint of the old classical economists from Adam Smith to Ricardo (1960, p. vi), and in his Appendix D on References to the Literature. But these hints are, to say the least, faint, and most readers would have had to work hard to grasp their significance.

Sraffas reticence is all the more striking in light of what his manuscripts reveal about his intellectual activity during the 1920s, 30s and 40s. Paul Samuelson is fond of an anecdote in which Keynes, upon being told that Nicholas Kaldor had contracted athletes foot, responds: I dont believe it. Next youll be telling me Piero has writers cramp (Samuelson, 1990, p. 26). Samuelsons diagnosis of writers block is a case of spurious induction. Though Sraffa published relatively little over the decades since 1930, he in fact wrote hundreds of manuscript pages in preparation for Production of Commodities. In addition to voluminous notes relating to the working-out of the mathematical and technical properties of the equation systems of Production of Commodities, the manuscripts contain an enormous number of documents (including lecture notes) on the character and evolution of classical political economy and its displacement by marginalist theory. Sraffa was a perceptive and highly original intellectual historian, and taken together these documents amount to a peerless exposition of the development of economics from the seventeenth century through to the first three decades of the twentieth (see Kurz, 1998, for thorough overview of Sraffas manuscript writings on the history of economic thought). Evidence from the manuscripts suggests that Sraffas original plan was to publish a larger work that would present a fully-developed account of his interpretation of the classicals, and connect that interpretation to the analytics of his price equations and to his implicit critique of orthodox capital theory. Indeed, at an early stage he appears to have considered the historical dimension of the project to be more important than the formal analytics. In notes (written in Italian) dated November 1927 he described the project as he then envisioned it:
Approach of the book The only way is to present history in reverse, and that is: the present state of ec[onomics]; how it was arrived at, showing the differences and the superiority of the old theories. Then to expound the theory. If chronol[ogical] order is followed, Petty, Physiocr[ats], Ric[ardo], Marx, Jevons, Marsh[all], it is necessary that it be preceded by a statement of my theory in order to explain what we are driving at. That means first expounding all of the theory. And then there is the danger of ending up like Marx, who publ[ished] Cap[ital] first, and then did not manage to complete the Histoire des Doct[rines]. And even worse, he was unable to make himself understood, without the historical explan[ation]. My plan is: I to lay out the history, which is really the essential element II to make myself understood: for which it is required that I proceed from the known to the unknown, from Marshall to Marx, from disutility to material cost (D3/12/11; my translation).

Sraffa remarks in the Preface to Production of Commodities that while the book was being put together out of a mass of old notes, little was added. In retrospect the remark is pregnant with irony. Yes, little was added; but much was set aside. And what Sraffa set aside was the historical material that would have made the constructive purpose of the project apparent. References

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