{"id":81,"date":"2007-06-07T09:05:12","date_gmt":"2007-06-07T16:05:12","guid":{"rendered":"http:\/\/www.thomaspalley.com\/?p=81"},"modified":"2019-01-06T08:51:17","modified_gmt":"2019-01-06T15:51:17","slug":"marginal-productivity-theory-and-the-mainstream","status":"publish","type":"post","link":"https:\/\/thomaspalley.com\/?p=81","title":{"rendered":"Marginal Productivity Theory and the Mainstream"},"content":{"rendered":"

In an earlier discussion on the state of orthodox economics hosted by TPM Caf\u00c3\u00a9, I posted an article<\/a> excavating the microeconomic foundations of neo-classical economics. In that article I wrote:<\/p>\n

“There is one place that even orthodox lefties dare not go. That untouchable place is marginal product theory of income distribution, which basically says that competitive markets ensure that people are paid their contribution to production. This theory provides both a justification and an explanation of income distribution.” <\/p>\n

Dani Rodrik has challenged this claim in a blog titled \u00e2\u20ac\u0153Do heterodox lefties have a better grasp on reality than neo-classical lefties<\/a>?\u00e2\u20ac\u009d As one would expect anything Dani writes is thoughtful and constructive. Let me try and develop some further insights.<\/p>\n

Dani\u00e2\u20ac\u2122s counter is that the mainstream empirical literature on pay determination is full of references to the impact of institutions, particularly unions. He also points to his own paper titled \u00e2\u20ac\u0153Democracies Pay Higher Wa<\/a>ges\u00e2\u20ac\u009d that was published in the Quarterly Journal of Economics (QJE). That paper shows that bargaining environment, and especially the degree to which the political system is democratic, exerts a significant impact on labor\u00e2\u20ac\u2122s share of the surplus. Democracy can raise wages by as much as fifty percent, controlling for productivity. I agree with this, although in a separate paper titled \u00e2\u20ac\u0153Democracy, Labor Standards and Wages<\/a>\u00e2\u20ac\u009d I have argued democracies work their wage effects through better labor standards that they promote.<\/p>\n

On the basis of this Dani concludes that (1) neo-classical economics is not averse to going beyond marginal productivity theory, and (2) the fact his paper was published in the mainstream establishment QJE suggests orthodox economics is not closed.<\/p>\n

Dani is absolutely right about the empirical literature on pay, which is broad and multi-faceted. The question is what is the relation of that literature to marginal product theory and does it move mainstream economics beyond marginal product theory? I suggest not.<\/p>\n

When it comes to unions, it is well documented that unions raise wages. Union supporters argue that (especially in highly unionized economies) unions do so with no adverse employment effects. Neo-classicals interpret unions through a marginal product labor demand lens, and generally argue they raise wages at the cost of lower employment. However, it is also the case that if employers have monopsony (buyer monopoly) power unions can also raise both wages and employment in a marginal product framework.<\/p>\n

What about democracy? I suggest democracy raises wages by altering the division of the cake, but there is no adverse employment effect. Furthermore, by raising wages and improving income distribution, democracy strengthens consumer demand and may increase employment through a Keynesian channel. This is an argument based on a non-marginal product approach to income distribution.<\/p>\n

What does neo-classical marginal productivity theory imply about democracy? Holding productivity constant, democracy would tend to lower employment because it raises wages. However, as with unions one could argue democracy lowers the monopsony power of employers, thereby raising both wages and employment. Under this neo-classical interpretation, democracy serves to move the economy closer to the idealized state of perfect competition in which the idealized version of marginal productivity theory of income distribution holds.<\/p>\n

The bottom line is there are two stories about the wage effects of democracy (and unions) – one rooted in marginal product theory, the other not. My view is the institutionalist \u00e2\u20ac\u201c Keynesian story is more plausible. I am not sure what Dani\u00e2\u20ac\u2122s view is, as he seems to support both. However, that seems theoretically problematic.<\/p>\n

When it comes to the neo-classical theory of income distribution you are either in or out with regard to the concept of marginal product. Under conditions of perfect competition, the marginal product of labor is the labor demand schedule, which tightly determines the relationship between wages and employment as a technological relationship. Under conditions other than perfect competition, the marginal product of labor remains ever-present and provides the reference point for determination of wages. However, if marginal product is an incoherent or unusable concept most of neo-classical economics (including its approach to income distribution) disintegrates: hence, the unwillingness to question marginal product analysis.<\/p>\n

The bigger story is that the empirical data settle nothing and can be interpreted to be consistent with either theory. That suggests both should be taught with equal prominence in all economics departments, including top departments. Yet they are not. Instead, only the neo-classical marginal productivity theory is taught as part of the core curriculum, the concept of marginal product is never questioned, and heterodox theory is essentially suppressed.<\/p>\n

Recently MIT economists Peter Temin and Frank Levy have published a paper about the role of institutions in explaining inequality in 20th century America. Their paper is welcome \u00e2\u20ac\u201c and (to be self-promoting) expands analytical themes developed in my 1998 book, Plenty of Nothing: The Downsizing of the American Dream<\/a> and the Case for Structural Keynesianism. The engagement of these economists may be a sign that the economics profession\u00e2\u20ac\u2122s thinking about income distribution is headed for change. If that is so, neo-classical economics will be in serious trouble because marginal productivity theory figures critically in its macroeconomics (both new classical and new Keynesian), its microeconomics, and it approach to trade and globalization.<\/p>\n

Lastly, Dani argues the publication of his paper in the QJE is evidence of mainstream openness. I am delighted the QJE published his paper because it is a leading journal, which means the paper got wide circulation. However, the paper was issued earlier by the National Bureau of Economic Research and Dani is a Harvard professor. Both of those facts matter. The scuttlebutt is that the QJE is the Harvard\/MIT working papers series, as evidenced by the extraordinarily large proportion of articles accepted from those faculties. This is just another example of the sociology of economics that my TPM Caf\u00c3\u00a9 discussion<\/a> also emphasized.<\/p>\n

[Note: I am re-posting this article because I think the original did not hit its target cleanly]<\/p>\n

Copyright Thomas I. Palley<\/p>\n","protected":false},"excerpt":{"rendered":"

In an earlier discussion on the state of orthodox economics hosted by TPM Caf\u00c3\u00a9, I posted an article excavating the microeconomic foundations of neo-classical economics. In that article I wrote: “There is one place that even orthodox lefties dare not go. That untouchable place is marginal product theory of income distribution, which basically says that […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[5],"tags":[],"class_list":["post-81","post","type-post","status-publish","format-standard","hentry","category-economics"],"_links":{"self":[{"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/posts\/81","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=81"}],"version-history":[{"count":2,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/posts\/81\/revisions"}],"predecessor-version":[{"id":1637,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/posts\/81\/revisions\/1637"}],"wp:attachment":[{"href":"https:\/\/thomaspalley.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=81"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=81"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=81"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}