The Theory of Value and Distribution

and the Problem of Capital*

Heinz D. Kurz

1. Introduction

The problem of capital was high on the agenda ever since the inception of systematic
economic analysis at the time of the Classical political economists. A major focus of their
attention was how to deal with a multiplicity of produced means of production in a coherent
way in an explanation of the generation of the social product, its sharing out amongst different
claimants or social classes and the exchange values of commodities in interdependent markets
that support this process of production and distribution. The recognition that in conditions of
free competition, that is, the absence of significant barriers to entry into or exit from markets,
there is a tendency towards a uniform rate of profits, made the discussion centre around this
variable and relative prices supporting it. This had a significance not only for a given system
of production at a particular moment of time, but also for a system of production moving
through time, reflecting inter alia a growing population, a rising scarcity of natural resources
of production, especially land, and technological and organisational progress. The problem of
capital was therefore at the centre of an understanding of the static and dynamic properties of
the economic system.

In this paper some of the issues under consideration will be dealt with. We start, in Section 2,
with a brief account of how two major schools of thought, the classical and the marginalist
school, responded to the challenge the problem of capital posed. Section 3 provides a brief
summary account of the so-called Cambridge controversies in the theory of capital, which
turned around the properties of an economic system with a positive rate of profits and the
effects of hypothetical variations of this rate on other variables of the system. Section 4 goes

*
Paper given in the session “The Cambridge-Cambridge controversy on the theory of capital:
50 years after” at the 22nd Conference of the Forum for Macroeconomics and Macroeconomic
Policies (FMM) in Berlin, 26th October 2018. I should like to thank the chairman of the
session, Harald Hagemann, for having organised the session and him, Bertram Schefold, Carl
Christian von Weizsäcker and people in the audience for useful discussions. I am most
grateful to Hans-Walter Lorenz for valuable comments on an earlier version of the paper.
1
back to David Ricardo’s statement of what the problem of capital is and how he tried to tackle
it. We then turn to Piero Sraffa’s contribution (Sraffa 1960) and show how he managed to
solve the problem Ricardo had struggled with. Section 5, following Sraffa, distinguishes
between “spurious ‘margins’” and “the genuine article” and argues that in conditions of
economic equilibrium an equality between the rate of profits and the marginal productivity of
capital, appropriately defined, must not be read as meaning that the marginal productivity of
capital determines the rate of profits. Section 6 turns to the properties of a zero-profits (or
interest) economy and summarizes some of the results elaborated by Opocher and Steedman
(2015). It is shown that even in this case, in which compound interest effects play no role, the
conventional marginalist theory cannot be sustained in general. Section 7 deals briefly with
the implication of the capital critique for Keynes’s concept of the marginal efficiency of
capital schedule. Section 8 provides some concluding observations. In a short appendix
George Stigler’s concept of Ricardo’s alleged “93% labor theory of value” will be critically
scrutinised.

2. The problem of capital

When we talk about “capital” in this paper, following the British classical economists from
Adam Smith to David Ricardo, we mean produced means of production, or capital goods or
intermediate products, such as tools, machines, raw materials and the like. The reference is
thus to a set of heterogeneous things, which in a capitalist economy are commodities traded in
interdependent markets in which prices are formed. The attention focuses on “natural prices”
or “prices of production”, which are seen to reflect the systematic, non-accidental and
permanent forces at work as opposed to “market prices”, which reflect all kinds of factors,
many of a short-lived or even evanescent nature. In competitive conditions prices are seen to
tend towards their centres of gravitation, which are given by cost of production plus a uniform
rate of return on capital invested. The questions the classical authors asked included: Which
role does capital play in explaining income distribution and especially the determination of
the general rate of profits, given real wages, and the rents of land.1 How does it affect the
formation of competitive prices? Which role does it play in the development and growth of
the economic system?

1
In the following we set aside for simplicity the problem of the scarcity of natural resources
and rents; see therefore Kurz and Salvadori (1995: chaps 10 and 12).
2
For the purpose of this paper we may broadly distinguish between two kinds of approaches to
the problem of value and distribution. First, there is the classical surplus approach, which
treats profits and wages asymmetrically: in determining the general rate of profits and relative
prices for a given system of production, characterised by given gross output levels and given
methods of production to produce them, it takes real wages as given, ascertained in another
part of the theory, that is, the theory of capital accumulation and technological progress.
Property incomes such as profits (and rents) are thus determined residually. Sraffa showed
that for a given system of production the general rate of profits and relative prices can be
consistently determined. Second, there is the marginalist or neoclassical scarcity approach,
which treats profits and wages symmetrically: it determines the general rate of profits and real
wages in terms of the marginal productivities of the factor services of capital and labour and
takes as given the technical alternatives from which cost-minimising producers can choose,
the endowment of the economy with capital and labour and the preferences of agents. In order
for the social product to be just exhausted by the claims of the owners of factors, technology
must exhibit constant returns to scale because of Euler’s Theorem. Such a condition is not
implied by the classical approach.

The main questions asked are: (i) Are the two theories logically consistent or flawed? (ii) Do
they convincingly explain the facts they purport to explain? In the Cambridge controversy, the
attention focused on the logical consistency of the theories. The second aspect initially played
no significant role. It was only when the logical deficiency of the marginalist theory became
apparent that its defenders invoked its alleged empirical validity. However, this invocation is
dubious and therefore in this paper we will not enter into a discussion of it, but limit the
argument to the analytical aspect.

3. The Cambridge controversy in a nutshell

The results of the Cambridge controversy can be summarised in the following way.2

The result, which at the time drew the greatest attention was the possibility of the reswitching
of entire techniques (or systems of production). By this we mean that techniques cannot
generally be ordered monotonically with the rate of profits (or rather the w/r ratio, where w is

2
For a summary account, see Kurz and Salvadori (1995: chap. 14) and Harcourt (1972);
see also Garegnani (1970), Schefold (1989) and Petri (2016).
3
the real wage rate and r the rate of profits). This means that the direction of change of “input
proportions” cannot be related unambiguously to changes in the distributive variables. This
contradicts the marginalist principle of substitution as it is typically invoked in micro- and
macroeconomics. According to it an increase (decrease) of the wage rate relative to the rate of
interest (or profits) prompts cost-minimising producers to employ relatively less (more) of the
factor of production, in this case labour, that has become relatively more expensive. The
conventional principle of substitution underlies the usual demand functions of factor services
that are inversely elastic with regard to the factor price. With reswitching, the demand
function need not be downward sloping in its entire domain, but may exhibit rising segments.
Therefore, a fall in the real wage rate need not always lead to an increase in labour
employment, as marginalist theory maintains. The results of the capital controversy have
occasionally been dubbed barren and irrelevant with respect to the “real world” and economic
policy issues. However, the result under consideration shows that this is not so. If
employment could be increased by an increase rather than a decrease of real wages, this
would put conventional wisdom upside down.

This result was received with disbelief in marginalist circles and made Paul Samuelson ask
one of his students, David Levhari, to prove that this is not possible (see Levhari 1965). The
proof was shown to be flawed by Luigi Pasinetti, Pierangelo Garegnani and others and
strengthened the critics of neoclassical theory.

Reverse capital deepening, or capital reversing, means that the relationship between the
capital-labour (K/L) or capital-output (K/Y) ratio and the rate of profits or the r/w ratio is
increasing rather than decreasing, as conventional marginalist theory maintains. Again, input
proportions are not necessarily everywhere inversely related to “factor price” proportions.

Consumption per capita (i.e. per unit of labour employed) c and the rate of interest r may be
positively related to one another, which runs counter to conventional neoclassical wisdom and
therefore was dubbed “perverse” like other findings that contradicted the marginalist gospel
by its advocates.

What did the criticism of marginalist theory amount to? At the deepest level it expressed a
refutation of the marginalist “vision” of how the economy works, the kind of “forces” it
contemplates (in particular the preferences of isolated agents) to the detriment of other forces
(such as economic power), the individualistic methodology adopted and the analytical method
used. More specifically, it implied an attack on the narrow and mistaken use of the “ceteris

4
paribus clause”, based on the assumption that one can change the price of just one commodity
or factor service at a time. However, this is impossible, because at least some other price(s)
have to change as well. Therefore the results obtained using the ceteris paribus clause in the
sense explained are bound to be misleading, not only quantitatively, but also qualitatively:
they may postulate forms of relationships between economic variables that are opposite to
those derived in a (more) general framework. Partial equilibrium analysis thus turns out to be
a highly problematic guide to economic policy recommendations.3

In the light of the capital theoretic findings the conventional microeconomic “laws” of input
demand and output supply turn out to be highly problematic. The conventional apparatus of
demand-and-supply analysis proves to be much less solid than many of us are inclined to
think.

The implications of these “negative” findings – negative only with regard to marginalist
theory – reach far beyond the field of value and distribution, which is hardly surprising given
the fact that the latter constitutes the centrepiece of economic analysis. The criticism has been
carried over to other fields of economics, including international trade, growth and
development, taxation and so on.

There have been numerous responses by authors, who count themselves, or are typically
counted, as belonging to mainstream or neoclassical economics. Paul Samuelson admitted the
correctness of the critique in his “Summing up” paper (Samuelson 1966). He and Edwin
Burmeister were particularly intrigued by the possibility of a positive relationship between
consumption per capita and the rate of interest. This was seen to be the most striking of all
“perversities” established in the Cambridge controversy.

In his Marshall Lectures Robert Lucas, not surprisingly, felt the need to ask who was right in
the Cambridge controversies in the theory of capital. If, he surmised, the controversy had
been about whether capital consists of heterogeneous means of production, he graciously
conceded that the Cambridge U.K. side had won the debate. As if the heterogeneity of capital
goods had ever been, or could ever be, a matter of dispute! But then he surprisingly added that
physical capital is to be treated as if it was homogeneous. He justified this radical turn by
insisting that like human capital physical capital “is best viewed as a force, not directly

3
It hardly needs to be stressed that any economic analysis is per se always partial in the
sense that it cannot take into account all the elements that may play a role in the context
under consideration. Here the question is whether important aspects are ignored that
cannot possibly be so.
5
observable, that we postulate in order to account in a unified way for certain things we can
observe.” (Lucas 1988: 36; the first three emphases are mine) One can only wonder whether
there are any limits to this kind of postulating things. Lucas at any rate addressed the capital
theoretic problem besetting marginalist theory by then gratuitously ignoring it.

Andreu Mas Colell (1989) on the other hand stressed that the relationship between the capital-
labour ratio and the rate of return on capital can have almost any shape whatsoever.4 This
implies that the “demand function” for capital in terms of the rate of interest need not be
downward sloping in the perhaps only point in which it cuts a given “supply function” of
capital. The resulting equilibrium, while unique, would be unstable. We may ask with
Marshall, what is the explanatory power of an unstable equilibrium?

As time went by, ever larger parts of the profession followed Lucas in simply ignoring the
results of the Cambridge controversies in the theory of capital. Today the knowledge about it
is poor. Many colleagues do not even know what the controversies were all about, let alone
what its results were and how they might affect their own work. This is not exactly a sign of
the widespread view that the science of economics is a teleological process, an irresistible and
triumphant march away from false ideas and perceptions towards the truth.

4. Back to the roots: Ricardo and Sraffa on the problem of capital in a positive
profits framework

The starting point of the following consideration is Ricardo’s discussion with McCulloch in
their correspondence in the second half of 1823. In his letter of 21 August, Ricardo asked
McCulloch “what means [do] you have of ascertaining the equal value of capitals?” and
answered himself:
[Any two] capitals are not the same in kind – what will employ one set of workmen, is
not precisely the same as will employ another set, and if they themselves are produced
in unequal times they are subject to the same fluctuations as other commodities. Till you
have fixed the criterion by which we are to ascertain value, you can say nothing of equal
capitals, for what is equal to day may be unequal in a year. (Works IX: 360)

4
It deserves to be mentioned that with the works of Mantel, Debreu and Sonnenschein in
the 1970s general equilibrium theory has established the possibility of cases that
contradict conventional marginalist doctrine and the usual assumption of stability of
equilibrium.
6
Capitals consist of vectors of capital goods that can only be compared by using prices. Prices
however depend not only on the technical conditions of production actually employed, which
translate into dated quantities of labour expended in the production of the different
commodities, but also on income distribution, that is, on the real wage rate or the rate of
profits. If the rate of profits changes, the wage rate will change and so will (relative) prices
and the values of capitals invested in the various lines of production. Ricardo’s formulation
may be said to foreshadow Sraffa’s later criticism of the marginalist concept of capital as a
magnitude that can be given prior to, and independently of, the determination of prices and
the other distributive variable.

Before we take a brief look at Sraffa’s critical and constructive work in the 1940s, we may
recall first his 1960 solution to Ricardo’s search for a consistent theory of value and
distribution in the case in which wages are paid post factum and there is free competition
corresponding to a uniform rate of profits (see Kurz and Salvadori 1995: chap. 4).5 We deal
only with the simplest possible case, that is, that of single production with only basic
commodities and no scarce natural resources. (For more general cases, including non-basics,
fixed capital, scarce natural resources and joint production proper, see Kurz and Salvadori
1995). In this case, using matrix notation and setting gross output levels of the different
commodities equal to unity, the system of price equations associated with a given system of
production is given by

p = (1 + r)Ap + wl. (1)

Here p is the price vector, A the matrix of material inputs, l the vector of direct labour inputs,
r the rate of profits and w the wage rate. Fixing a standard of value (and wages) in terms of
the semi-positive vector d implies

dTp = 1. (2)

System (1)-(2) determines p for – 1 ≤ r < R, where R is the maximum rate of profits of the
system of production under consideration corresponding to zero wages.6

We may now study how prices depend on income distribution, given the technique (A, l)

5
Ricardo assumed ante factum payment of wages, but the assumption concerning the
timing of wage payments does not affect the substance of the argument.
6
With w = 0, the price (or production) equations become p = (1 + R)Ap and one sees at a
glance that R corresponds to the left hand eigenvalue λ = 1/(1 + R) of A.
7
actually used (see Kurz and Salvadori 1995: chap. 4). Let ṗ denote the vector of derivatives
of prices and ẇ the derivative of the wage rate with respect to r, respectively. Differentiating
the above price equations gives

ṗ = Ap + (1 + r)Aṗ + ẇ l (3)

and

dTṗ = 0. (4)

In the case in which –1 ≤ r < R, equation (3) implies

ṗ = [I – (1 + r)A]–1 (ẇ l + Ap), (5)

and, as a consequence of equation (5),

dT [I – (1 + r)A]–1 (ẇ l + Ap) = 0, (6)

that is,

dT[I - (1+r)A]-1Ap
ẇ = – (< 0) .7 (7)
dT[I - (1+r)A]-1l

From equations (6) and (7) it follows that

⎧⎪ 1 T -1
⎫⎪
ṗ = [I – (1 + r)A]–1 ⎨Ap - T -1 ld [I - (1+r)A] Ap⎬ , (8)
⎩⎪ d [I - (1+r)A] l ⎭⎪

and finally that

ṗ = (I – pdT)[I – (1 + r)A]–1Ap. (9)

Prices and the wage rate are differentiable functions of the rate of profits, given the system of
production in use. Ricardo sought to establish this fact, and while we owe him important
insights into the matter, he lacked the tools to fully accomplish the task.

We may now go one step further and discuss a choice of technique problem by assuming that
with regard to commodity k there are two methods available to cost-minimising producers,
method α and method β, whereas with regard to all other commodities only a single method is
known. The technique, or system of production, using method α is given by (Aα, lα), whereas
the technique using method β is given by (Aβ, lβ). The two techniques will typically be
7
It deserves to be emphasized that in the case of single production ẇ < 0 irrespective of
the standard of value chosen; see Kurz and Salvadori (1995: chap. 4).
8
associated with different maximum rates of profit, Rα and Rβ (and different maximum wage
rates corresponding to a zero rate of profits). With regard to each of the two techniques we
may then differentiate the corresponding price vector with respect to the rate of profits as in
equation (9). Figure 1 plots the dependence of the price of commodity k in terms of the
numeraire (2) on the rate of profits for all non-negative rates up until the maximum rate for
technique α (blue line) and technique β (red line). In the case depicted, Rα < Rβ, and the blue
line cuts the red line twice, at r = r1 and r = r2. For 0 ≤ r < r1 cost-minimizing behaviour will
prompt producers to adopt method (and technique) β, at r = r1 both methods (and techniques)
are equi-profitable and exhibit the same prices for all commodities, for r1 < r < r2 method
(and technique) α will be adopted, at r = r2 both methods (and techniques) are again equi-
profitable, and for r2 < r ≤ Rβ method (and technique) β will be adopted. (Technique α would
yield rates of profit larger than Rα only at negative levels of the real wage rate.) The case
under consideration illustrates the reswitching of a technique and exemplifies the fact that
techniques α and β cannot be ordered monotonically with the rate of profits.

Fig. 1: Choice of technique and non-monotonic ordering of technical alternatives

The important point to be made from a history of economic analysis point of view is this:

9
Ricardo’s discovery that relative prices depend not only on technical conditions of production
but also on the distribution of the product amongst different claimants, workers and capitalists,
contains the seeds to the findings Sraffa elaborated, which fuelled the Cambridge
controversies in the theory of capital. This is also the reason, why Sraffa (1960: v) insisted
modestly that what he had done was simply to go back to the “standpoint … of the old
classical economists from Adam Smith to Ricardo, [which] has been submerged and forgotten
since the advent of the ‘marginal’ method.”

Let us now turn briefly to Sraffa’s constructive and critical work that culminated in the
publication of his 1960 book. Sraffa in the early 1940s, when resuming his work after ten
years dedicated to the task of bringing out the Ricardo edition, composed a few notes that
substantiated Ricardo’s above claim. In a note composed on 6 August 1942, entitled
“Measure of Capital”, Sraffa insisted that the quantity of capital employed cannot be
measured in “price”, because its price varies with “the variations in the proportional
distribution of the product between wages and profits” (D3/12/16: 10).8 The term
“proportional distribution” echoes Ricardo’s concept of “proportional” wages, by which he
referred to the share of wages in the social product.9 The difficulty besetting marginalist
capital theory Sraffa then specified in the following terms:

If the quantity of capital, when measured in a variable standard, is proportional to the

income of the capitalist, then the quantity of capital, measured in an invariable standard,
is not proportional to the income of the capitalist; that is to say, the income divided by
the rate of interest does not give the quantity of capital. (D3/12/16: 11; Sraffa’s
emphasis)

Hence Ricardo’s search, far from representing an outmoded concern that is irrelevant with
regard to modern theory, implicitly pointed towards a crucial stumbling block to the
marginalist concept of capital: the “quantity of capital”, whose relative scarcity is supposed to
reflect its marginal productivity, cannot be given independently of relative prices and the rate

8
The reference is to Sraffa’s Papers at Trinity College, Cambridge, catalogued by
Jonathan Smith, archivist.
9
In his book Sraffa adopted Ricardo’s concept, but as we have already noted instead of
assuming wages paid ante factum he assumed post factum payment. He then developed
his argument with the help of the Standard system and Standard commodity and
established a linear relationship between the rate of profits r and proportional wages w,
r = R(1 – ω),
where R is the Standard ratio or Maximum rate of profits and ω is the share of wages.

10
of profits. How then could the rate of profits be determined by marginalist theory? Ricardo’s
findings, if developed coherently, we might say using Sraffa’s own words “cannot be
reconciled with any notion of capital as a measurable quantity independent of distribution and
prices” (Sraffa 1960: 38; emphasis in the original).

In a note drafted in August 1942 Sraffa elaborated on his previous argument. He enunciated
the following requirement: “What is demanded of a Model is that it should show a constant
(constant with respect to variations of r) ratio between quantity of capital and quantity of
product.” He concluded that marginalist authors, including Eugen von Böhm-Bawerk and
Knut Wicksell, failed to accomplish the task:

The reason why B-B., Wicksell and Co fail to find an invariable measure of capital is
their obsession with the marginal product theory of interest. For them a measure is
satisfactory only if it suits the marg. prod. theory: naturally they fail to find any
satisfactory. In the end W. confesses that the difficulties of a measure are “insuperable”,
but always clings to, and in fact never has any doubts, about the marg. prod. It never
occurs to him that it is the latter problem that is impossible and has to be given up.
(D3/12/16: 14)

And on 17 February 1946 Sraffa emphasized that the conventional concept of capital bases its
“prestige ... on an extension of the uniform means of production” case and adds that this is
“the only case in which the price measure applies accurately” and so does “also the ton
measure (and any other)”, for in this case capital is “uniform in quality, e.g. wheat.”
(D3/12/16: 27) The corn model is required for the marginalist theory to hold true!

In his book, Sraffa (1960: 6) expresses his findings in a passage that leaves nothing to be
desired and does away with the received concept of a “given quantity of capital”. He writes:

This is because the surplus (or profit) must be distributed in proportion to the means of
production (or capital) advanced in each industry; and such a proportion between two
aggregates of heterogeneous goods (in other words, the rate of profits) cannot be
determined before we know the prices of the goods. On the other hand, we cannot defer
the allotment of the surplus till after the prices are known, for ... the prices cannot be
determined before knowing the rate of profits. The result is that the distribution of the
surplus must be determined through the same mechanism and at the same time as are
the prices of commodities.

I now turn briefly to what I consider to be a confusion in the literature about the meaning of a
fact that concerns a capital theoretic finding by Sraffa and others.
11
5. Avoid mistaking “spurious ‘margins‘ for the genuine article”!

In recent times there has been some confusion about whether the fact that in a long-period
equilibrium the rate of profits equals the marginal productivity of capital, appropriately
defined, confirms the correctness of the marginal productivity principle and re-establishes a
theory that (for a short while) had fallen in disrepute. The answer is, of course, no. The
following shows why. It is interesting to note that Sraffa anticipated the kind of
misunderstanding under consideration when he wrote:

Caution is necessary ... to avoid mistaking spurious “margins” for the genuine article.
Instances will be met in these pages which at first sight may seem indistinguishable
from examples of marginal production; but the sure sign of their spuriousness is the
absence of the requisite kind of change. (Sraffa 1960: v; emphasis added)

He added that “P.H. Wicksteed, the purist of marginal theory”, condemned “such a use of the
term ‘marginal’ as a source of ‘dire confusions’.” (Ibid.: vi) We shall see that in the view
under scrutiny, the “requisite kind of change” is indeed absent.10

Christian Bidard (2004), for example, stressed on the basis of a “differentiability hypothesis”
and Shephard’s lemma that the rate of profits and the marginal productivity of capital are
equal to one another.11 Clearly, for each commodity i any input vector (li , ai1 , ai2 , . . . , ain)
satisfying a smooth and convex isoquant

Fi(1; li , ai1 , ai2 , . . . , ain) = 0

is technically feasible and the smoothness and convexity properties imply that there is an
infinite number of such vectors. In terms of this assumption the following can immediately be
established: For a given rate of profits r*, there is a unique technique (A*, l*) that pays the
largest wage rate, whatever is the standard of value. This technique then satisfies conditions
that can be interpreted as the equilibrium condition reflecting the equality between the
marginal productivity of an input and the price of that input in terms of the output.

This fact cannot be disputed, and to the best of my knowledge has never been disputed by
critics of marginalist theory starting from Sraffa’s contribution. The question is, what does

10
The following considerations contain a summary account of Kurz and Salvadori (2010).
11
Burmeister and Dobell (1970: chap. 9) had already used the differentiability hypothesis
and had explored its implications.
12
this fact mean? The answer is obvious: The marginal conditions are simply a logical
implication of cost minimisation in cases in which there are no “jumps” in input use. These
conditions do not undermine or spell trouble for many important “negative” results deriving
from Sraffa’s analysis, as some commentators seem to think. In fact these results can be
obtained even when marginal conditions hold.

In short, the fact that the rate of profits equals the marginal productivity of capital,
appropriately defined, must not come as a surprise. It should especially not be mistaken to
imply that the rate of profits is determined by the marginal productivity of capital. Since the
rate of profits has been treated as a known magnitude, a given or data, income distribution is
already fixed. The marginal equality under consideration therefore cannot be interpreted as
reflecting a causal relation leading from the marginal productivity to the rate of profits. The
absence of the “requisite kind of change” is all too obvious: The question is not by how much
total output Y will change due to an infinitesimal change in the “quantity of capital” employed
K, and whether the marginal productivity of capital determines the general rate of profits as
marginalist theory potulates, that is,

∂Y
= r.
∂K

The question rather is which technique will cost-minimising producers adopt, given the rate of
profits (or the real wage rate). Therefore these equilibrium properties or equalities render no
support whatsoever to the marginalist attempt to explain the rate of profits in terms of the
“marginal productivity” or “relative scarcity” of a factor called “capital”. The “quantity” of
this factor cannot generally be conceived of as a magnitude that is independent of the rate of
profits. As Pasinetti (1969: 529) stressed: “It is this idea which has been shown to be an
illusion; for, in general, such a thing does not exist.”

6. Problems of marginalist economics in a zero-profit framework

It would be wrong to assume that the difficulties of marginalist (or neoclassical) capital and
value theory, some of which have been discussed during the Cambridge controversies, are due
to the assumption of a positive rate of interest (or profits) and the compound interest effects
that come with it. This is definitely not the case, as Ian Steedman and Arrigo Opocher have
made clear in a number of contributions and most recently in their book Full Industry
Equilibrium (2015); see also Symposium (2017). They show in terms of numerous cases
regarding the given set of technical alternatives from which producers can choose that even if

13
extra profits and extra losses are eliminated and the rate of interest is nil, the microeconomic
“laws of input demand” (Hicks 1939, Samuelson 1947), derived within a partial equilibrium
framework, do not hold true. A change in the (service) price of a primary input may induce,
for example, a qualitative change in input use, including produced inputs (capital goods) of
various types.

They establish the following results:

− In the case of just two inputs (primary or produced) or of an arbitrary number of only
primary inputs no problem arises: the conventional laws of input demand correctly
predict the substitution effects.
− With more than two inputs, both primary and produced, a parametric change in one
input price entails a variety of compensating effects in other prices through cost and
price adjustments across the economy.
− There is a fundamental difference between primary inputs and produced inputs: While
the price of a primary input either increases or decreases relative to all other input
prices, the price of a produced input increases relative to some input prices and
decreases relative to others.
− This is the reason, as Opocher and Steedman show, why no “law of input demand”
can predict the qualitative change in produced input use, even if all pairs of inputs are
Hicksian substitutes.
− It follows that a simple relationship between produced input use and produced input
price (in terms of some numéraire), as it is typically assumed in microeconomic
textbook and empirical analyses, lacks any theoretical meaning.

It can happen, for example, that an increase in the wage rate is associated with an increase in
the employment of labour per unit of output – a possibility contemplated, for example, by
Schumpeter without, however, having the means to establish this possibility analytically.

We thus get at the industry level phenomena that are somewhat reminiscent of the phenomena
of reswitching and capital reversing at the level of the economy as a whole. The simple and
seemingly unobtrusive “laws” of input demand and output supply are violated.

In 1848 John Stuart Mill contended: “Happily, there is nothing in the laws of Value which
remains for the present or any future writer to clear up; the theory of the subject is complete.”
([1848] 1965, Vol. III: 456). Opocher and Steedman show impressively that even one century
and a half later this is still not true.

14
7. Keynes and capital theory – more than 80 years after

Since the main audience at this conference consists of “Keynesians” of various orientations,
Harald Hagemann has asked me to say a few words on the implications of the Cambridge
controversies in the theory of capital for Keynes’s work. This section is devoted to this task.

In his criticism of Keynes’s Treatise on Money (1930), to which Lionel Robbins, editor of
Economica, had invited Friedrich August von Hayek (1931), the latter attacked Keynes’s
work, among other things, for lacking a capital theoretic foundation. Such a foundation was
badly needed, and Hayek recommended Keynes to adopt Böhm-Bawerk’s theory of capital
and interest as he, Hayek, had done.

Keynes did not follow Hayek’s recommendation, but in chapter 17 of the General Theory
took up the concept of “commodity rates of interest” (a concept originally introduced by
Irving Fisher) Sraffa (1932) had used in his criticism of Hayek. Keynes, who was not familiar
with the main building blocks of Hayek’s argument – Böhm-Bawerk’s capital theory, Ludwig
von Mises’ monetary theory and Vilfredo Pareto’s general equilibrium theory, had asked
Sraffa to help him out of the difficulty, what Sraffa did. Keynes appears to have convinced
himself, apparently without discussing the matter with Sraffa, that the concept of commodity
rates provided the missing foundation and based his own analysis upon it or upon what he
thought the concept meant. When upon the publication of the General Theory, Sraffa saw
what Keynes had done, he expressed his strong disagreement with it in annotations in chapter
17 in his own copy of the book and in two manuscript fragments left in the copy, which
became known only after Sraffa’s passing away and his papers and library were archived.

Sraffa criticised Keynes essentially for the following reasons:12 (i) Keynes had used two
contradictory definitions of the concept – (Irving Fisher and) Sraffa’s and an entirely new one
according to which the own rate of an asset equals the sum of the asset’s yield, its carrying
cost and its liquidity premium. However, Sraffa insisted, the concept is only defined in terms
of an expected change of the price of an asset, that is, the difference between its spot and
future price. (ii) Keynes’ choice of money as the standard of value had distorted his
perspective. In one of his annotations in the General Theory Sraffa explained: “The point is,
that in the case of the rate of the article chosen as standard, the effect upon it of the expected
depreciation is concealed” (emphasis added; compare Keynes 1936: 227). Thus, an expected
fall in the value of money, for example, implies a high “money-rate of wheat interest”
12
For a detailed discussion of Sraffa’s criticism, see Kurz (2000, 2015).
15
(Keynes’ concept), which, alas, Keynes did not take into account. (iii) Keynes variously did
not reason correctly and occasionally arrived at results that are the opposite of what a cogent
argument implies. His contention that a fall of the money rate of interest is bounded from
below because of liquidity preference cannot be sustained. (iv) The liquidity preference
schedule is at any rate only a particular exemplar of the conventional marginal utility curve,
which Sraffa found inacceptable. (v) Investment demand need not be inversely related to the
money rate of interest. In short, in Sraffa’s view the chapter was a mess.

As regards item (v), Keynes’ marginal efficiency of capital schedule, which expresses his
view that investment demand is inversely related to the rate of interest, Sraffa objected: It is
simply a variant of the marginalist scarcity-cum-marginal productivity theory of capital that
cannot be sustained in general. Keynes derived it by starting from the same fallacy we have
spotted at the beginning of this paper: that of believing to be able to change a single price or
distributive variable only at a time – here the rate of interest – and keeping all other prices
constant. Accordingly, his concept suffers from adopting the “stupid” ceteris paribus clause
in a situation in which it must not be adopted. Once one takes into account the changes of
other prices that necessarily accompany a change in the rate of interest, a cost element, these
changes can be expected to have an impact on relative prices and thus on costs. This impact
may reverse the results reached by employing the ceteris paribus assumption.

This can be illustrated in terms of the following figures.13 Figure (2a) gives the ranking of five
investment projects in terms the expected rates of return r j (j = 1, 2, ..., 5) and the volumes of
investment associated with them (0A, AB, BC etc.) when the money rate of interest equals i.
In the situation depicted four projects will be realised and the volume of total investment (and
credit) demand will be given by 0D. Figure (2b) gives the case in which the rate of interest is
higher, i∗ > i. This involves, first, lower expected rates of return with regard to each project
and, secondly, different prices and thus costs associated with the commodities needed in order
to realise the projects. In the case depicted, some projects are more expensive in the new

13
For the following, see also Kurz (2012: subsection 5.4). It is perhaps interesting to point
out that Joseph A. Schumpeter (1912) saw the possibility of a non-conventional shape
of the investment demand schedule. He was however unable to establish this possibility
in strictly analytical terms. One may wonder why he showed so much alertness in this
regard, whereas Keynes did not. One reason might be that someone brought up with
Walras’s general equilibrium theory had perhaps a deeper grasp of the complexities
involved than someone brought up with Marshall’s partial equilibrium theory, which
shied away from such complexities.

16
situation than they were in the old, for example 0’A’ > 0A and A’B’ > AB. (Some projects
might be less expensive: C’D’ < CD.) At the higher rate of interest now not only the fifth
project (DE and D’E’ respectively) is eliminated, as it was already at the lower rate, but also
the fourth project (CD and C’D’, respectively). But since the increase in the value of the first
three projects as a consequence of the movement from i to i∗ is larger than the value of the
eliminated fourth project, the volume of total investment demand will be larger: 0’C’ > 0D. A
relationship between investment demand and the rate of interest, as in Figure (2c), that is not
downward sloping throughout cannot therefore be ruled out.

896 H.D. Kurz

Fig. 1 Rate of interest and volume of investment

Fig. 2: Investment demand and the rate of interest

We may add that whilst in the illustration given the ranking of the five
Sraffa’s objectionsprojects
against Keynes’
does not changeliquidity preference
with a change and
in the interest histhisinvestment
rate, need not be demand theory, it
the case. It is well possible that the projects cannot be ordered monotonically
seems, were on thewith the rate of interest across the entire interval of feasible interest rates.
whole well taken: As recent developments show impressively, the money
The above possibility, which contradicts conventional ‘wisdom’, ought to be
related to the other one we have already encountered: the possibility that the
rate of interest has wage
not rate
beenandprevented
employment from falling
of labour tobeeven
need not negative
inversely ratesthein real terms. And
related over
whole range of feasible levels of the real wage rate. In fact, both possibilities
this fall did not spur
areinvestment activity
but different sides of the and
same cause a tendency
coin. Since Schumpetertowards full employment again.
did not possess
a comprehensive theory of value and distribution that would have allowed
In important respects
him Keynes
to analyse was still ofa avictim
the effects ofthe
change in “habitual
money ratemodes of on
of interest thought
the and
other distributive variables and relative prices, he could not make his case in a
expression”. He wasstraightforward
right, though,and compelling manner. Therefore
in opposing it also comes
the received viewasthat
no surprise
the rate of interest
that his respective remarks, in which he dissented from mainstream opinion,
hardly received the attention they deserve. Most readers
14 appear to have simply
equilibrates investment
ignoredand
them,full
sinceemployment savings.
their mindset was not prepared for the unconventional
possibilities that were only much later firmly established on the basis of Piero

14
In recent discussions about the problem of secular stagnation even some scholars, who
consider themselves as Keynesians of sorts, interestingly focus attention on this alleged
role of the rate of interest. But why should the rate of interest be able to perform this
role vis-à-vis a lack of effective demand that is reflected in substantial margins of
underutilised productive capacity and unemployment?
17
8. Concluding observations

The profession of economists will not succeed in escaping the results established during and
in the aftermath of the Cambridge controversies in the theory of capital. These findings
cannot be brushed aside since they show that the usual input demand and output supply
functions postulated in microeconomics theory and carried over in aggregate terms to
macroeconomics cannot generally be sustained. However, if the conventional workhorses of
marginalist theory do not perform well, what can be expected of them as means of intellectual
transport in economics and providers of sound policy recommendations?

There are cases in which marginalist capital theory holds true (see also Kurz and Salvadori
2010: 111). These include: (i) the capital and the product consist of the self-same commodity
(the “corn model”); (ii) the input proportions in the production of all commodities are
identical, that is, commodities cannot be distinguished by looking at the input side (Marx’s
“equal organic compositions of capital” case and Samuelson’s “surrogate production
function”); (iii) the rate of profits (or interest) is equal to the (steady-state) rate of economic
growth, that is, the so-called “golden rule” applies (see von Weizsäcker 1971). Each of these
cases simplifies matters considerably for the economist, but as Paul Samuelson has reminded
us, economists have not been born to live easy lives. To the best of my knowledge no
compelling theoretical or empirical reasons have ever been put forward in support of any of
these cases. Why then should one base one’s own argument upon any such problematic
foundation other than in preliminary thought experiments whose relevance must not be
overrated?

Whether “labout values” approximate actually observed prices sufficiently well, as for
example David Ricardo thought, is obviously a questio facti. Needless to say that what can be
meant by “sufficiently well” is a touchy issue. The locus classicus in which this issue has
been raised in more recent times is George Stigler’s paper “Ricardo and the 93% labor theory
of value” (Stigler 1958). I relegate a brief critical discussion of his view to an appendix and
focus attention here on the simplest multi-sector case typically assumed in the literature.
Accordingly, labour values are given by the Leontief inverse (I – A)–1 multiplied by the
vector of direct labour inputs l, that is, v = (I – A)–1l. Obviously, they can be ascertained only
by solving a system of simultaneous equations, as is the case with the system of price
equations employed in Section 4 above. In fact, they presuppose the special case in which r =
0 and therefore p = Ap + Wl, with W as the maximum wage rate associated with a zero profit

18
rate. Dividing the equations by W gives p/W = p°, where p° represent prices in terms of
“labour commanded”. We have p° = Ap° + l, and solved for p°: p° = (I – A)–1l = v. In a
profitless situation, as Adam Smith knew well, labour commanded prices equal labour values,
whereas with 0 < r ≤ R they typically deviate from them.

Since we are possessed of a consistent and rather general theory of prices of production that
encompasses as a highly special case the labour theory of value, which interestingly
corresponds to a non-capitalistic situation (r = 0), one may wonder what motivates a special
interest in the latter. And can labour values v and their empirical representation in studies that
are concerned with the validity of the labour theory of value be taken to reflect the quantities
of labour “embodied” in the different commodities? Many objections can be put forward
against this presupposition. Here it suffices to point out that v and l assume that labour is
homogeneous or has already been rendered homogeneous prior to its use in the above
mathematical formulation. The classical economists and also Marx were very clear about this
necessity; see the discussion in Kurz and Salvadori (1995: chap. 11). So was Sraffa, who
stressed: “We suppose labour to be uniform in quality or, what amounts to the same thing, we
assume any differences in quality to have been previously reduced to equivalent differences in
quantity so that each unit of labour receives the same wage.” (1960: 10) Sraffa thus
aggregated different qualities of labour by means of the given structure of wage rates – just as
the classical economists and Marx had done. To the best of my knowledge recent
investigations of how the labour theory of value performs in approximating relative
competitive prices do not follow this example, but simply count all kinds of labour alike, that
is, they just add up hours or days irrespective of the quality of labour performed. In my view
this is highly unsatisfactory.15

There is a further problem that ought to be mentioned, which concerns the assumed stability
of the aggregating device over time – in the case of the classical economists and Marx: the
wage structure. Only if this structure remains relatively stable, can it be used across time to
assess the changing amounts of labour embodied in the different commodities. These amounts
are bound to change due to the impact of technological change. They would also change due
to changing wage differentials (not to speak of entirely new qualities of work entering the
system and some old ones exiting). Now it seems to be safe to assume that the two kinds of
change are not independent of each other, that is, the type of technological change actually

15
The same unsatisfactory procedure is adopted in conventional labour productivity
studies, in which different kinds of labour are treated as if they were of the same
quality. They are not.
19
realised will affect the wage structure, and vice versa. While in the past the wage structure
happened to be relatively stable, and thus provided a reasonable scale to reduce different
qualities of labour to a single quality, it has recently been shaken up, with wages for some
skilled labours rising markedly relative to wages of some unskilled labours. This raises tricky
index problems and at any rate spells trouble for the labour theory of value. I wonder whether
and how scholars attracted by some labour-value based reasoning meet this challenge.

Appendix: Stigler on Ricardo’s theory of value

Stigler (1958) derives his concept of Ricardo’s alleged 93% labour theory of value from a
numerical example in the Principles in terms of which Ricardo illustrates how a change in
income distribution, that is, a rise in wages and corresponding fall in the rate of profits, affects
relative prices of commodities produced with different proportions of fixed and circulating
capital.16 Ricardo concludes: “The greatest effects which could be produced on the relative
prices of these goods from a rise of wages, could not exceed 6 or 7 per cent.” The reason he
gives in support of what he calls a “comparatively slight” effect, is that “profits could not,
probably, under any circumstances, admit of a greater general and permanent depression than
to that amount.” (Works I: 36) Of which amount does he speak? He assumes that “owing to a
rise of wages, profits fall from 10 to 9 per cent.” (Works I: 35) Here Ricardo has recourse to
his “fundamental law of distribution”, the inverse relationship between the general rate of
profits and wages. Alas, since he is not possessed of an analytically precise specification of
this relationship, he can only put forward a guesstimate by how much the rate of profits will
“probably” have to fall as a consequence of the postulated rise in wages. He stipulates a fall
by one per cent. Clearly, if it fell by more (or less) than that, the change in relative prices
would be different.

It is to be stressed that Ricardo started from a positive rate of profits (10 per cent.), which
means that relative prices will already at the beginning of his thought experiment have been
different from relative labour values. Hence, what Ricardo in fact discusses, and what escapes
Stigler’s attention, is not a deviation of prices from labour values, but a change in the
deviation due to a change in income distribution. And this change in the deviation Ricardo
considers to be relatively small, in the range of 6 to 7 per cent. The whole deviation is an
entirely different matter and may, for a given distribution of income (that is, a given wage
rate), be a great deal larger with respect to some prices and a great deal smaller with regard to
16
In the following I draw on Kurz (2019).
20
some other prices. If the chosen standard of value exhibits a medium proportion of fixed to
circulating capital, Ricardo was convinced, its price will ex hypothesi not change and remain
equal to its labour value, independently of income distribution. Yet commodities that are
produced with a larger proportion than the medium one, will fall in price relative to the
standard consequent upon a rise in wages (and the corresponding fall in the rate of profits),
whereas commodities produced with a smaller proportion will rise in price. In view of these
facts, which Ricardo stresses, it makes little sense to talk of a 93% labour theory of value.

Closely related, for a given system of production and a given rate of profits, not 93% of all
prices will be “explained” by labour, some prices will deviate more strongly and others less
strongly from labour values. Depending on the measurement device employed with regard to
labour values and prices, some prices will exceed and others fall short of their labour values!17
Would one then have to say in the latter case that labour values explain more than the price
under consideration? One may construct at will numerical examples in which the average
(weighted or not) percentage will be higher or lower, as the case may be. And with a change
in the general rate of profits (and an inverse change in the real wage rate), given the system of
production in use, the percentage with regard to each commodity will typically change more
or less. Hence, attributing to Ricardo a definite percentage labour theory of value, while
suggestive, is neither faithful to his argument nor does it make analytically much sense.

Ricardo, it deserves to be stressed again, managed to elaborate only the beginnings of a

correct theory of value and distribution. Yet without such a theory the deviation of relative
competitive prices from relative labour values for a given system of production and a given
distribution of income cannot be ascertained. Therefore, Stigler’s attribution to Ricardo of a
93% labour theory of value is somehow hanging in the air, not least because with a change in
the system of production and in the real wage rate (or the share of wages) the percentage will,
in general, change too. Since Sraffa (1960) elaborated a correct theory by adopting, correcting
and extending Ricardo’s approach to cover all important phenomena from fixed capital via
joint production to scarce natural resources, we may today look at the issues at hand from this
higher standpoint.

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This is typically the case with respect to Marx’s “transformation” of labour values in
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deviations cancel out in the aggregate. See Bertram Schefold’s contribution to the
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