Posts Tagged ‘neoclassical’


Those of us in economics are confronted on a regular basis with the fantasy of perfect markets. It’s the idea, produced and presumed by neoclassical economists, that markets capture all the relevant costs and benefits of producing and exchanging commodities. Therefore, the conclusion is, if a market for something exists, it should be allowed to operate freely, and, if it doesn’t exist, it should be created. Then, when markets are allowed to flourish, the economy as a whole will reach a global optimum, what is often referred to as Pareto efficiency.

OK. Clearly, in the real world, that’s a silly proposition. And the idea of “market imperfections” is certainly catching on.

I’m thinking, for example, of Robert Shiller (who, along with George Akerlof, recently published Phishing for Phools: The Economics of Manipulation and Deception):

Don’t get us wrong: George and I are certainly free-market advocates. In fact, I have argued for years that we need more such markets, like futures markets for single-family home prices or occupational incomes, or markets that would enable us to trade claims on gross domestic product. I’ve written about these things in this column.

But, at the same time, we both believe that standard economic theory is typically overenthusiastic about unregulated free markets. It usually ignores the fact that, given normal human weaknesses, an unregulated competitive economy will inevitably spawn an immense amount of manipulation and deception.

And then there’s Robert Reich, who focuses on the upward redistributions going on every day, from the rest of us to the rich, that are hidden inside markets.

For example, Americans pay more for pharmaceuticals than do the citizens of any other developed nation.

That’s partly because it’s perfectly legal in the U.S. (but not in most other nations) for the makers of branded drugs to pay the makers of generic drugs to delay introducing cheaper unbranded equivalents, after patents on the brands have expired.

This costs you and me an estimated $3.5 billion a year – a hidden upward redistribution of our incomes to Pfizer, Merck, and other big proprietary drug companies, their executives, and major shareholders.

We also pay more for Internet service than do the inhabitants of any other developed nation.

The average cable bill in the United States rose 5 percent in 2012 (the latest year available), nearly triple the rate of inflation.

Why? Because 80 percent of us have no choice of Internet service provider, which allows them to charge us more.

Internet service here costs 3 and-a-half times more than it does in France, for example, where the typical customer can choose between 7 providers.

And U.S. cable companies are intent on keeping their monopoly.

And the list of such market imperfections could, of course, go on.

The problem, as I see it, is that these critics tend to focus on the sphere of markets and to forget about what is happening outside of markets, in the realm of production, where labor is performed and value is produced. The critics’ idea is that, if only we recognize the existence of widespread market imperfections, we can make the market system work better (and nudge people to achieve better outcomes). My concern is that, even if all markets work perfectly, a tiny group at the top who perform no labor still get to appropriate the surplus labor of those who do.

Accepting that our task is to make imperfect markets work better makes us all look like fools. In the end, it does nothing to eliminate that fundamental redistribution going on every day, “from the rest of us to the rich,” which is hidden outside the market.


Richard Maxwell and Toby Miller recently made the case for solidarity-based consumerism in response to Apple’s business model:

Faced with a global political economy that condones such a business model, proponents of solidarity between electronics workers and digital consumers(link is external) have big ambitions. They aim to eliminate the estrangement between worker and consumer, awaken consciousness of the political and economic ties that bind them, and install resolute ethical commitments to building a new kind of bond based in mutuality, justice, and equality that stretches across the global supply chain of electronic goods.

As consumers, we should support a solidarity-based consumerism. The alternative is the status quo where profits are beat out of the lives of electronics workers while consumers pay a premium to keep the mark-ups feeding those profits. To the egoistic consumer, we say it’s time to stop blaming higher wages for higher prices. Instead, ask Apple, the most valuable company in the world, to lower its prices and pay good wages directly to factory workers who make their i-Things. Trust us, they won’t go broke.

They base their argument on an analysis of the financial relationships between Electronic Manufacturing Services (providers such as Flextronics, Foxconn, and Jabil) and the Brand Names (like Apple) of consumer electronics by industry veteran Anthony Harris (pdf).

Harris’s example clearly shows how the wages of workers who actually produce smart phones and other electronic gadgets are a small (he estimates them to be 2 percent) of the final price of those commodities.

All along the product supply chain – from the component supplier to the assembly factory to the retail outlet – prices are factored up by percentage of goods value. The factory price is marked-up on basis of invoice value without differentiating between cost of labour, manufacturing complexity, materials, IP, or other value. The EMS selling price gets a margin added every time it is moving down the chain. For example, a smartphone with a factory price of 100 Euro of which 2 Euro = labour costs. Next in line exports to USA/Europe and adds 30% (logistics, management, margin) = 130 Euro. Distributor in USA adds another 30% for logistics, risk and labour = 169 Euro. The store adds its percentage and then there is the internet provider contract and Vat, all pushing upwards to 500 Euro. With this standard business model mark-up on the EMS selling price the actual labour cost becomes almost insignificant as an element of the retail store price.

He also explains the high cost to workers of “flexibility” at the bottom of the chain:

To illustrate what happens: When Apple launched the initial manufacturing of the iPhone, a screen change was suddenly required. 8,000 workers were woken from their dormitories in the middle of the night in China. Within 30 minutes, after being given tea and biscuits, they began an unscheduled 12-hour shift to kick-start the change for the new screens. Foxconn relentlessly ramped up production to 10,000 pieces (a day) after only four days. One Apple executive, as quoted in The New York Times, said “That speed and flexibility is breath taking. There’s no American plant that can match that.”

Breath taking speed and flexibility, however, come at a human price, which clearly American workers at that time were not prepared to endure. Yet with a cup of tea and a biscuit, impoverished Chinese workers were all too ready to earn some extra money to help cover basic costs and feed their families.

I am interested in Harris’s analysis because, in class the other day, the students wanted to know if the iPhone represented an example of a utility theory of value or a labor theory of value. (We were discussing the different assumptions and consequences of those two theories of value.) And, when I answered that both theories could be used to make sense of the price of an iPhone but the two theories were incompatible, they wanted to know if it was possible to combine them (rather than choose between them).

Let me pose a bit of a different question: which of the two theories is more compatible with the kind of solidarity-based consumerism Maxwell and Miller are advocating?

According to the utility (or neoclassical) theory of value, the final price of an iPhone represents a balance between supply and demand and, as such, reflects the preferences, technology, and resource endowments of the societies at each stage of the supply chain. In particular, the workers in the Electronic Manufacturing Services, who receive low wages and agree to flexible rules, are being paid according to their productivity and desire to work. No more, no less. Therefore, consumers can remain content to purchase their iPhones at the going price and, if by chance they become aware of what’s going at the bottom, let “the market” work things out. No need to worry.

According to a labor theory of value (in particular, a Marxian labor theory of value), the final price of an iPhone represents something else: it’s a combination of the materials and equipment purchased to produce and transport iPhones, the wages paid to workers at various stages of the supply chain, and a surplus created by those workers. That surplus is in turn used for various purposes: taxes to governments, salaries of executives, dividends to shareholders, and, perhaps most important, an extensive advertising campaign to make sure millions of people continue to want to purchase more iPhones. And the less workers are paid on the bottom and at each stage of the supply chain, and the more “flexible” are their work rules, the more surplus Apple is able to appropriate and the higher price at which they can sell their smart phones.

Clearly, a labor theory of value is more compatible with Maxwell and Miller’s solidarity-based consumerism. It makes people aware of the work and value-creation that are taking place at each stage of the supply chain—from the initial research and development through the production of the phones to their transportation to wherever they are sold—and the amount of surplus Apple is able to capture for its own purposes.

In the end, those are the high costs that serve as the basis of the high price of our iPhones.



In the end, it all comes down to the theory of value.

That’s what’s at stake in the ongoing debate about the growing gap between productivity and wages in the U.S. economy. Robert Lawrence tries to define it away (by redefining both output and compensation so that the growth rates coincide). Robert Solow, on the other hand, takes the gap seriously and then looks to rent as the key explanatory factor.

The custom is to think of value added in a corporation (or in the economy as a whole) as just the sum of the return to labor and the return to capital. But that is not quite right. There is a third component which I will call “monopoly rent” or, better still, just “rent.” It is not a return earned by capital or labor, but rather a return to the special position of the firm. It may come from traditional monopoly power, being the only producer of something, but there are other ways in which firms are at least partly protected from competition. Anything that hampers competition, sometimes even regulation itself, is a source of rent. We carelessly think of it as “belonging” to the capital side of the ledger, but that is arbitrary. The division of rent among the stakeholders of a firm is something to be bargained over, formally or informally.

This is a tricky matter because there is no direct measurement of rent in this sense. You will not find a line called “monopoly rent” in any firm’s income statement or in the national accounts. It has to be estimated indirectly, if at all. There have been attempts to do this, by one ingenious method or another. The results are not quite “all over the place” but they differ. It is enough if the rent component lies between, say, 10 and 30 percent of GDP, where most of the estimates fall. This is what has to be divided between the claimants—labor and capital and perhaps others. It is essential to understand that what we measure as wages and profits both contain an element of rent.

Until recently, when discussing the distribution of income, mainstream economists’ focus was on profit and wages. Now, however, I’m noticing more and more references to rent.

What’s going on? My sense is, mainstream economists, both liberal and conservative, were content with the idea of “just deserts”—the idea that different “factors of production” were paid what they were “worth” according to marginal productivity theory. And, for the most part, that meant labor and capital, and thus wages and profits. The presumption was that labor was able to capture its “just” share of productivity growth, and labor and capital shares were assumed to be pretty stable (as long as both shares grew at the same rate). Moreover, the idea of rent, which had figured prominently in the theories of the classical economists (like Smith and Ricardo), had mostly dropped out of the equation, given the declining significance of agriculture in the United States and their lack of interest in other forms of land rent (such as the private ownership of land, including the resources under the surface, and buildings).

Well, all that broke down in the wake of the crash of 2007-08. Of course, marginal productivity theory was always on shaky ground. And the gap between wages and productivity had been growing since the mid-1970s. But it was only with the popular reaction to the problem of the “1 percent” and, then, during the unequal recovery, when the tendency for the gap between a tiny minority at the top and everyone else to increase was quickly restored (after a brief hiatus in 2009), that some mainstream economists took notice of the cracks in their theoretical edifice. It became increasingly difficult for them (or at least some of them) to continue to invoke the “just deserts” of marginal productivity theory.

The problem, of course, is mainstream economists still needed a theory of income distribution grounded in a theory of value, and rejecting marginal productivity theory would mean adopting another approach. And the main contender is Marx’s theory, the theory of class exploitation. According to the Marxian theory of value, workers create a surplus that is appropriated not by them but by a small group of capitalists even when productivity and wages were growing at the same rate (such as during the 1948-1973 period). And workers were even more exploited when productivity continued to grow but wages were stagnant (from 1973 onward).

That’s one theory of the growing gap between productivity and wages. But if mainstream economists were not going to follow that path, they needed an alternative. That’s where rent enters the story. It’s something “extra,” something can’t be attributed to either capital or labor, a flow of value that is associated more with an “owning” than a “doing” (because the mainstream assumption is that both capital and labor “do” something, for which they receive their appropriate or just compensation).

According to Solow, capital and labor battle over receiving portions of that rent.

The suggestion I want to make is that one important reason for the failure of real wages to keep up with productivity is that the division of rent in industry has been shifting against the labor side for several decades. This is a hard hypothesis to test in the absence of direct measurement. But the decay of unions and collective bargaining, the explicit hardening of business attitudes, the popularity of right-to-work laws, and the fact that the wage lag seems to have begun at about the same time as the Reagan presidency all point in the same direction: the share of wages in national value added may have fallen because the social bargaining power of labor has diminished.

The problem, as I see it, is that Solow, like all other mainstream economists, is assuming that profits, wages, and rents are independent sources of income. The only difference between his view and that of the classicals is that Solow sees rents going not to an independent class of landlords, but as being “shared” by capital and labor—with labor sometimes getting a larger share and other times a smaller share, depending on the amount of power it is able to wield.

We’re back, then, to something akin to the Trinity Formula. And, as the Old Moor once wrote,

the alleged sources of the annually available wealth belong to widely dissimilar spheres and are not at all analogous with one another. They have about the same relation to each other as lawyer’s fees, red beets and music.

Is Dan Price [ht:sm], the founder and CEO of Gravity Payments who raised the salaries of his employees and slashed his own pay, a socialist hero?

Well, no. Not really. Price certainly doesn’t think so. And, in the end, he—not Gravity’s employees as a group—is the one who decided what the new pay scheme would look like. He is the one who took the decision to distribute some of the surplus produced by his workers back to them in the form of higher wages and to take a smaller amount of that surplus in his compensation.

But I do like the fact that the two KTVB interviewers, Dee Sarton and Carolyn Holly, are clearly taken with Dan Price and his decision—which presumably stand in sharp contrast to all the other CEOs they’ve been forced to interview over the years.

Even more, Price’s decision proves once again (as I argued back in 2013) that “capitalists do lots of different things.”

They do make profits (at least sometimes, but over what timeframe are they supposedly maximizing those profits?). But they don’t follow any single rule. They also seek to grow their enterprises and destroy the competition and maintain good public relations and buy government officials and reward their CEOs and squeeze workers and lower costs and build factories that collapse and. . .well, you get the idea. In other words, they appropriate and distribute surplus-value in all kinds of ways depending on the particular conditions and struggles that take place over the shape and direction of their enterprises.

So, I’m not prepared to celebrate Price as a “good capitalist,” as against all the “bad capitalists” who are choosing to increase the gap between average workers’ pay and the enormous payments to CEOs.

My point is a actually somewhat different: first, that capitalists—whether in Columbus or Seattle—do lots of different things, and presuming they follow a simple rule (whether profit-maximization as in the usual neoclassical story, or the accumulation of capital in many heterodox stories) means missing out on the complex, contradictory dynamics of capitalist enterprises; and second, that other kinds of enterprises (in which workers themselves make the decisions about how the surplus is appropriated and distributed) would do even more, on a wider scale, to transform the dynamics of the distribution of income and wealth in the U.S. economy.


Neoclassical economists don’t have a lot to say about the value of art. Basically, they start from the proposition that a work of art, such as Picasso’s “Les femmes d’Alger (Version ‘O’),” is often considered to have two different values: an aesthetic or cultural value (its cultural worth or significance) and a price or exchange-value (the amount of money a work of art fetches on the market). They then demonstrate that, within free markets, individual choices ensure that the price of art generally captures or represents all of the various dimensions of value attributable to the work of art, rendering the need for a separate concept of aesthetic or cultural value redundant. Therefore, on their view, Picasso’s painting is “worth” the record auction price of $179.37 million.*

But the Wall Street Journal (gated) observes that yesterday’s sale of other paintings—including Mark Rothko’s “Untitled (Yellow and Blue)”—reveals something else:

Some paintings act like object lessons in tracking the global migration of wealth, bouncing from one owner to the next in timely turns. Such was the case Tuesday when Sotheby’s sold a $46.5 million Mark Rothko abstract that previously belonged to U.S. banker Paul Mellon and later to French luxury executive François Pinault.

All night long, Sotheby’s sale demonstrated the power that the younger, international set is wielding over the art market, pushing up brand-name artists and newcomers alike. Bidders from more than 40 countries raised their paddles at some point during Sotheby’s $379.7 million sale of contemporary art, and the house said bidding proved particularly strong from collectors in Asia and across Latin America.

Clearly, the ever-expanding bubble in high-end art is predicated on the extraordinary amount of surplus that is being captured by a tiny number of individuals at the very top of the world’s distribution of income and their willingness to spend a portion of it on “vanity capital.”

As Neil Irwin explains,

Let’s assume, for a minute, that no one would spend more than 1 percent of his total net worth on a single painting. By that reckoning, the buyer of Picasso’s 1955 “Les Femmes d’Alger (Version O)” would need to have at least $17.9 billion in total wealth. That would imply, based on the Forbes Billionaires list, that there are exactly 50 plausible buyers of the painting worldwide.

This is meant to be illustrative, not literal. Some people are willing to spend more than 1 percent of their wealth on a painting; the casino magnate Steve Wynn told Bloomberg he bid $125 million on the Picasso this week, which amounts to 3.7 percent of his estimated net worth. The Forbes list may also have inaccuracies or be missing ultra-wealthy families that have succeeded in keeping their holdings secret.

But this crude metric does show how much the pool of potential mega-wealthy art buyers has increased since, for example, the last time this particular Picasso was auctioned, in 1997.

After adjusting for inflation and using our 1 percent of net worth premise, a person would have needed $12.3 billion of wealth in 1997 dollars to afford the painting. Look to the Forbes list for that year, and only a dozen families worldwide cleared that bar.

In other words, the number of people who, by this metric, could easily afford to pay $179 million for a Picasso has increased more than fourfold since the painting was last on the market. That helps explain the actual price the painting sold for in 1997: a mere $31.9 million, which in inflation-adjusted terms is $46.7 million. There were, quite simply, fewer people in the stratosphere of wealth who could bid against one another to get the price up to its 2015 level.

More people with more money bidding on a more or less fixed supply of something can only drive the price upward. On Monday, the auction was for fine art. But the same dynamic applies for prime real estate in central London or overlooking Central Park, or for bottles of 1982 Bordeaux.

The pool of “potential mega-wealthy art buyers” has indeed expanded but it’s still a infinitesimal fraction of the world’s population. Still, it’s enough to set record prices in recent art auctions, which (along with real-estate and fine-wine markets) thereby serves as a window on the grotesque levels of economic inequality we are witnessing in the world today.

But there’s another aspect of the Wall Street Journal story (and of many other articles I’ve read about recent art auctions) that deserves attention: the worry that the highly unequal distribution of income and wealth is migrating out of the West—to the East (especially China) and the Global South (particularly Latin America). It’s a worry that the cultural patrimony of the West is being exported (or, if you prefer, re-exported, after centuries of plunder of the empire’s hinterland) as the surplus being generated within the world economy is increasingly being captured by individuals outside the West.

I wonder, then, if this worry (about the migration of wealth and art) will ultimately be reflected in Western neoclassical economists’ long-held celebration of free markets—and if will there be a new round of preoccupation about the differences between market and aesthetic values, as the demands of new buyers from outside the West succeed in determining ever-higher prices for the art (and utilizing the surplus) the West has long claimed as its own.

*For other mainstream economists, if art’s cultural value is not adequately represented by its exchange-value (because, for example, art has “positive externalities,” that is, benefits to society beyond what is captured in the market price), then there is room for public subvention of art and of artists. And that ends up determining the limits of debate within mainstream economics: the neoclassical view of free private art markets (when the two values are the same) versus the alternative view in favor of public support for the arts (if and when they are not).


Both sides of mainstream economics will likely claim support in the International Monetary Fund’s latest report, the April 2015 World Economic Outlook—especially chapter 4, on business investment.*

The Keynesians will certainly like the relationship between investment and output—in other words, the idea that private business investment has declined since the start of the economic crisis because aggregate demand has fallen. Even more: they’ll find support in claim that fiscal policy aimed at reducing budget deficits has actually undermined private investment (which is the flip side of the Keynesian crowding-in argument, i.e., the notion that deficit spending doesn’t crowd out private investment, as neoclassical economists claim, but actually spurs or crowds in corporate investment).

The neoclassicals, for their part, will be encouraged by the focus on “business confidence,” that is, the argument that uncertainty (e.g., with respect to government policies) has played a role in discouraging business investment.

In other words, for Keynesians, the problem with insufficient business investment is mostly on the demand side; while for neoclassical economists, it’s mostly on the supply side.

And, true to form, the authors of that section of the report suggest policy changes on both the demand and supply sides:

We conclude that a comprehensive policy effort to expand output is needed to sustainably raise private investment. Fiscal and monetary policies can encourage firms to invest, although such policies are unlikely to fully return restore investment fully to precrisis trends. More public infrastructure investment could also spur demand in the short term, raise supply in the medium term, and thus ‘crowd in’ private investment where conditions are right. And structural reforms, – such as those to strengthen labor force participation, – could improve the outlook for potential output and thus encourage private investment. Finally, to the extent that financial constraints hold back private investment, there is also a role for policies aimed at relieving crisis-related financial constraints, including through tackling debt overhang and cleaning up bank balance sheets.

What no one seems to want to admit—the authors of the report as well as mainstream (both Keynesian and neoclassical) economists—is that private corporations, which got us into this mess in the first place, have failed to get us out of it. They’re the only ones that have benefited from the recovery, as corporate profits have reached record levels, but they haven’t responded by increasing investment. Instead, they’ve been using the profits they’re accumulated to buyback their stock, engage in new mergers and acquisitions, and distribute them to high-level executives and shareholders.

They want us to believe they’re superman. But we know they’ve simply failed—on both the demand and supply sides.

*To be clear, the chart does not indicate actual declines in business investment and output. Rather, it represents percent deviations from forecasts in the year of recessions.


My article, “Contending Economic Theories: Which Side Are You On?” has just been published on Taylor & Francis Online for the journal Rethinking Marxism.

The first 50 interested readers (actually 49, since I downloaded a copy for myself) can download the text of the article here.