Piketty and the non-applicability of neoclassical economics

16 May, 2015 at 10:55 | Posted in Economics | 8 Comments

economic-mythIn yours truly’s On the use and misuse of theories and models in economics the author of Capital in the Twenty-First Century is criticized for not being prepared to fully take the consequences of marginal productivity theory — and the alleged close connection between productivity and remuneration postulated in mainstream income distribution theory — over and over again being disconfirmed both by history and, as shown already by Sraffa in the 1920s and in the Cambridge capital controversy in the 1960s, also from a theoretical point of view:

Having read Piketty (2014, p. 332) no one ought to doubt that the idea that capitalism is an expression of impartial market forces of supply and demand, bears but little resemblance to actual reality:

“It is only reasonable to assume that people in a position to set their own salaries have a natural incentive to treat themselves generously, or at the very least to be rather optimistic in gauging their marginal productivity.”

But although I agree with Piketty on the obvious – at least to anyone not equipped with ideological blinders – insufficiency and limitation of neoclassical marginal productivity theory to explain the growth of top 1 % incomes, I strongly disagree with his rather unwarranted belief that when it comes to more ordinary wealth and income, the marginal productivity theory somehow should still be considered applicable. It is not.

Wealth and income distribution, both individual and functional, in a market society is to an overwhelmingly high degree influenced by institutionalized political and economic norms and power relations, things that have relatively little to do with marginal productivity in complete and profit-maximizing competitive market models – not to mention how extremely difficult, if not outright impossible it is to empirically disentangle and measure different individuals’ contributions in the typical team work production that characterize modern societies; or, especially when it comes to “capital,” what it is supposed to mean and how to measure it. Remunerations, a fortiori, do not necessarily correspond to any marginal product of different factors of production – or to “compensating differentials” due to non-monetary characteristics of different jobs, natural ability, effort or chance.

It’s pleasing to see that Piketty has taken this critique to heart. In an interview in Potemkin Review he admits that marginal productivity explanations of income is wanting, not only for those at the very top, but, generally:

Piketty: I do not believe in the basic neoclassical model. But I think it is a language that is important to use in order to respond to those who believe that if the world worked that way everything would be fine. And one of the messages of my book is, first, it does not work that way, and second, even if it did, things would still be almost as bad …

All I am saying to neoclassical economists is this: if you really want to stick to your standard model, very small departures from it like an elasticity of substitution slightly above 1 will be enough to generate what we observe in recent decades. But there are many other, and in my view more plausible, ways to explain it. You should be aware of the fact that even with your perfect competition and simplified one good assumption, things can still go wrong, in the sense that the capital share can rise, etc.

PR: Are you saying that notwithstanding your rhetorical strategy to communicate with neoclassical economists on a ground where they feel comfortable, in your views it is not just that you reject marginal productivity explanations of income for those at the very top but more generally as well?

Piketty: Yes, I think bargaining power is very important for the determination of the relative shares of capital and labor in national income. It is perfectly clear to me that the decline of labor unions, globalization, and the possibility of international investors to put different countries in competition with one another–not only different groups of workers, but even different countries–have contributed to the rise in the capital share.

8 Comments »

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  1. Economics is where truth lies
    and it lies in its axiomatic proofs
    like Clark Kent going into a telephone booth
    and coming out in a Superman suit
    i.e., Lyotards (leotards) exposing untruths (he, he)

  2. I know you have a soft spot for Romer. Have you seen his new paper: “Mathiness in the Theory of Economic Growth”

    • Yes indeed, as you will see in a couple of minutes! Talk about serendipity🙂

      • he could do with a better title. As his former teacher McCloskey would say, that ain’t english (he,he)

  3. As Joseph Schumpeter observed and contemporary entrepreneur Peter Thiel affirms in his book Zero to One, entrepreneurs especially and business people in general seek market power and regard perfect competition as their enemy.

    For example, critics of contemporary “trade agreements” have countered arguments of neoclassical apologists by showing that these agreements are not about so-called free trade as claimed and are binding treaties rather than agreements.They are about permanently securing market power of firms at the expense of national sovereignty through international law and institutional arrangements.

    Proponents are attempting to sneak them through under the cloak of neoclassical myths about free trade. Ha-Joon Chang in particular has been attacking neoclassical economists as political ideologues rather than scientists. His book Bad Samaritans is specifically about trade.

  4. Reblogged this on DAMIJAN blog.

  5. I am, like most who visit here, generally in favor of many things you espouse. However, the critique that fueled this post is, while (perhaps excessively) learned, that critique is in the end rather stupid. If someone reads Piketty and comes away thinking that he is a neo-classical, there is something wrong.

    Lars, you want Piketty to declare neo-classical economics dead and buried. You want Piketty to speak in the jargon of other economic ideas. But you want Piketty to do this precisely because Piketty has gotten a global audience, as if Piketty has a genie in his pocket the whole time, and all he must do is rub his magic lantern and everyone will listen.

    Piketty got his audience because he attacked neo-classical sophistries on their own turf, using their own language – the language that our globe speaks today. That is how it is done. If you, Lars, expect to have an effect on the world, you must climb down from your castle tower and find ways to engage the rest of the world. If you cannot speak in terms that your audience understands, your life will be lived in your monk’s cell. And since you aren’t Rapunzel, there will be no prince to rescue you from it.

    Please understand that I have your best interests at heart, and I would like to see you succeed.


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