[Monti]

The Neoclassical school has dominated microeconomics for 150 years and is called “mainstream”. Its theorems are well known by all students of economics. They are considered as the economic truth by the economic profession.

Topics in microeconomics are for instance: consumption, market equilibrium, production, earning of the factors of production (mainly capital and labour). In this article, I am focusing on this last topic: earnings. A theorem, among the most important ones, states the rule which explains how remunerations are determined. Provided certain conditions, as perfect competition, the earning of a factor (for instance, interest, wage, rent) is equal to the value of the marginal product of this factor. Factor prices are settled on the ad hoc markets, but supply and demand play in such a way that equilibrium price obeys this law sometimes named “law of marginal productivity “.

The said law is dependent on an assumption relative to marginal product. More there are units of a factor, less is its marginal product, i.e. the supplement of product brought by the fact that there is not one unit less, when the quantity of other factors is fixed.

So, this law settles a systematic relation between earnings and productivity.
Naturally, everything that is related to earnings is sensitive and can be politically controversial. This gives our law the important role to pronounce the economic truth in social debates. Political deductions of this law could be: do not complain about your pay; we cannot go against such a law without provoking wrath of the economic system. Allusion to productivity, badly understood, could also make you feel guilty.

But at bottom, is the law of marginal productivity so robust; does it occupy so high a place that criticism cannot reach it?

To answer this question, I have written the article “Does Marginal Productivity Mean Anything in Real Economic Life?”, published on the “MPRA” site. Access is given by the link:

Does Marginal Productivity Mean Anything in Real Economic Life?

Abstract
The equality between factor pay and marginal product is a major component of the neoclassical paradigm. The paper begins with a brief historical review of this principle. Follows a questioning about the relevance of this law as an argument in the social debates: does marginal product represent the very contribution of the agent and if so, is it a legitimate reference for the setting of remuneration? Our answer to the first part of the question is irresolute; to the second, it is negative.
But most of the article is devoted to analysing the economic realism of the said law, both empirically and theoretically. We review some statistical studies present in the literature, with particular attention for the debate regarding the regressions of Cobb and Douglas. Evidence does not strengthen the neoclassical law of retribution.
The paper analyses the factors that hinder either the determinateness of marginal product or the equalisation between it and factor's remuneration. Are analysed: - the restrictions inherent in the law of marginal productivity: constant returns to scale and perfect competition - an alternative explanation of interest: the Austrian theory - incentive wage theories: efficiency wage and tournament theory.
The article then considers the particular case of the CEO's remuneration.


John Bates Clark, initiator of the theory

[Steve_American]

I would expect that you-all know where I stand on this.

I believe that MS econ. as taught for ovr 100 years now is intended to justify the rich running things, so that they get richer. From 1940 until 1980 there was a period when the economy was much more fair for everyone. That was an aberation. It was the time of my youth and early adulthood, so to me it is normal and proper.

So, I think this theory of Margial Productivity is just a mass of gibberish that is intended to be so confusing that most people can't follow it. The rich hope that by indroctrinationg all econ. students into it that it will be enough to get most of the people to accept it as trure.

It is not true. The corp. owners pay the lowest wage the supply and demand labor market allows them to pay. It has zero to do with the value of what the workers produce. For the last 40 years workers right have been reduced year after year. Now, they have also no rights. They have no power to demand a change either. We see that in the Senate right now. Workers are being screwed every day there.

This is my reply.

[Unthinking Majority]

The corp. owners pay the lowest wage the supply and demand labor market allows them to pay. It has zero to do with the value of what the workers produce. For the last 40 years workers right have been reduced year after year. Now, they have also no rights. They have no power to demand a change either. We see that in the Senate right now. Workers are being screwed every day there.

That's all true. We have to assume that both owners and workers are rational actors trying to maximize their self-interests, most notably how much money they make.

Workers and owners operate according the voluntary contracts they agree to sign. Contracts are negotiated based on leverage, which mainly acts on the supply and demand of the labor the worker can provide. If you have very little leverage you'll sign the best contract someone puts in front of you on a piece of paper with no room to negotiate. If you have a lot of leverage due to your skills being rare, like a talented lawyer or a professional athlete, you'll have many different employers making offers to you for high sums of money. Unions create lots of leverage in contract negotiations by threatening to strike etc.

Corporations use politics/politicians to maximize their self-interests. Most workers are pretty clueless, less educated, and far less organized. Most politicians are also rational actors trying to maximize their self-interests, which means lying, using doublespeak to try to appeal to as many people as possible, and taking donations from people, sometimes for favors, in order to maximize their chances of getting elected/re-elected.

[Monti]

I would expect that you-all know where I stand on this.

I believe that MS econ. as taught for ovr 100 years now is intended to justify the rich running things, so that they get richer. From 1940 until 1980 there was a period when the economy was much more fair for everyone. That was an aberation. It was the time of my youth and early adulthood, so to me it is normal and proper.

So, I think this theory of Margial Productivity is just a mass of gibberish that is intended to be so confusing that most people can't follow it. The rich hope that by indroctrinationg all econ. students into it that it will be enough to get most of the people to accept it as trure.

It is not true. The corp. owners pay the lowest wage the supply and demand labor market allows them to pay. It has zero to do with the value of what the workers produce. For the last 40 years workers right have been reduced year after year. Now, they have also no rights. They have no power to demand a change either. We see that in the Senate right now. Workers are being screwed every day there.

This is my reply.

I agree with you. But I think that it is not enough to claim that "Marginal Productivity is just a mass of gibberish". We have to prove it. And, modestly, I think that my article in link "Does Marginal Product Mean Anything..." brings matter in this debate.

[Rugoz]

Well it's always good to start with a straw man I suppose.

E.g.

They are considered as the economic truth by the economic profession.

There's no such thing.

The equality between factor pay and marginal product is a major component of the neoclassical paradigm.

Every neoclassical economist will admit this only holds under very specific and unrealistic circumstances, namely perfect competition.

[Monti]

Well it's always good to start with a straw man I suppose.

E.g.



There's no such thing.



Every neoclassical economist will admit this only holds under very specific and unrealistic circumstances, namely perfect competition.

Neoclassical economists admit the assumptions of their theorems. In the present case, mainly perfect competition, constant returns to scale (bound to the preceding one) and perfect divisibility of factors. They write these in mathematical expressions, which has the "advantage" that the unrealistic aspect is less conspicuous. It often happens that the assumptions are so unrealistic that the theorem loses its interest. But the theory does not lose its unrealistic theorems.
There is also an assumption that is often hidden: capital value cannot be measured independently of the interest rate (as Wicksell showed). In consequence, the neoclassical tale is only correct when capital intensity is uniform in the whole economy.
And it is not yet the whole of the problem. When all assumptions are satisfied, how does equalisation between earnings and marginal product value happen? By the variation of quantities of factors in operation. But when we think of the very long time needed for capital investments in new plants, it is obvious that firms have large periods where they are free to pay factors over or below marginal product value.

[Rugoz]

Neoclassical economists admit the assumptions of their theorems. In the present case, mainly perfect competition, constant returns to scale (bound to the preceding one) and perfect divisibility of factors. They write these in mathematical expressions, which has the "advantage" that the unrealistic aspect is less conspicuous. It often happens that the assumptions are so unrealistic that the theorem loses its interest. But the theory does not lose its unrealistic theorems.

This is nonsense. Neoclassical theory concerns itself with all kinds of market forms, perfect competition being just one of them.

There is also an assumption that is often hidden: capital value cannot be measured independently of the interest rate (as Wicksell showed). In consequence, the neoclassical tale is only correct when capital intensity is uniform in the whole economy.

If you are referring to a macro production function using the value of capital as an input, I agree there are obvious serious theoretical issues with this. That said, it can be argued it's still approximately correct, just enough to tell a tale. E.g. http://theme.univ-paris1.fr/M1/hpe/HPEM1-TD7.pdf

And it is not yet the whole of the problem. When all assumptions are satisfied, how does equalisation between earnings and marginal product value happen? By the variation of quantities of factors in operation. But when we think of the very long time needed for capital investments in new plants, it is obvious that firms have large periods where they are free to pay factors over or below marginal product value.

I can think of a variety of reasons factors aren't paid their marginal product. That doesn't mean you cannot model said reasons in a neoclassical framework. A good example are search-and-matching labor market models.

[Monti]

This is nonsense. Neoclassical theory concerns itself with all kinds of market forms, perfect competition being just one of them.



If you are referring to a macro production function using the value of capital as an input, I agree there are obvious serious theoretical issues with this. That said, it can be argued it's still approximately correct, just enough to tell a tale. E.g. http://theme.univ-paris1.fr/M1/hpe/HPEM1-TD7.pdf



I can think of a variety of reasons factors aren't paid their marginal product. That doesn't mean you cannot model said reasons in a neoclassical framework. A good example are search-and-matching labor market models.

My nonsensical reference to perfect competition was justified only in recalling the assumptions of marginal product theory, the theory which was "the present case" in my statement. Actually, it is one of these assumptions, as constant returns to scale...
Concerning market structures, I shall show in a later article that the neoclassical concept of competition is dubious. In consequence, its typology of market structures is problematic.

[Steve_American]

That's all true. We have to assume that both owners and workers are rational actors trying to maximize their self-interests, most notably how much money they make.

Workers and owners operate according the voluntary contracts they agree to sign. Contracts are negotiated based on leverage, which mainly acts on the supply and demand of the labor the worker can provide. If you have very little leverage you'll sign the best contract someone puts in front of you on a piece of paper with no room to negotiate. If you have a lot of leverage due to your skills being rare, like a talented lawyer or a professional athlete, you'll have many different employers making offers to you for high sums of money. Unions create lots of leverage in contract negotiations by threatening to strike etc.

Corporations use politics/politicians to maximize their self-interests. Most workers are pretty clueless, less educated, and far less organized. Most politicians are also rational actors trying to maximize their self-interests, which means lying, using doublespeak to try to appeal to as many people as possible, and taking donations from people, sometimes for favors, in order to maximize their chances of getting elected/re-elected.

No!
This is another example of a false assumption, that when used in a proof can lead to false conclusions.
Most decisions by most people are made from a position of emotion. And with incomplete info.

For example, for the owners, explain why it is rational for an owner with a net worth of $2B want to keep his workers poor by kkeping their wages as low as possible. The Billionaire can't find a use for additional money that will change his life style one tiny bit. The only benefit he gets from a higher income is more status.
. . . OTOH, better paid workers will be better workers. Better workers can cause the corp. to do better and this can lead to higher status for the owner and managers. Status like awards from high status groups. Awards like the Nobel Prizes.

. . . Wanting status is not rational. It is driven by a deep-seated primate instinct to want status because this helps it end up with more grandchildren. So, getting status just feels good.
. . . It is exactly like wanting sex. Sex feels good becuase primates that had more sex ended up with more grandchildren. [Sex feels good in humans because of nerves that grow automatically in certain places on the body, these nerves are connected automatically to certain areas of the brain that feel pleasure. All this is because of DNA. Nurture has very little, if any, to do with it.]
.

[Unthinking Majority]

For example, for the owners, explain why it is rational for an owner with a net worth of $2B want to keep his workers poor by kkeping their wages as low as possible.
.

The owner wants to further their self-interests, which means maximizing profit. Most companies run by billionaires are publicly owned and so by their nature need to seek to maximize profit for shareholders. Shareholders don't care about workers, nor do many individual owners.

I've known small business owners who hire younger workers and work them as hard as legally possible until they break from the stress and quit, and then the owners just hire more young workers and repeat. They lose more experienced workers all the time this way, but they'd rather get more work done and pay smaller wages than keep older more expensive experienced workers who work slower.

You're trying to say greed isn't rational but how is charity and treating people well rational? Charity is more about good feelings and personal morals than cold calculation towards self-interest. It's not that hard to believe that people who negotiate a contract will want to negotiate it in the most favourable way for their own interests.

[Steve_American]

The owner wants to further their self-interests, which means maximizing profit. Most companies run by billionaires are publicly owned and so by their nature need to seek to maximize profit for shareholders. Shareholders don't care about workers, nor do many individual owners.

I've known small business owners who hire younger workers and work them as hard as legally possible until they break from the stress and quit, and then the owners just hire more young workers and repeat. They lose more experienced workers all the time this way, but they'd rather get more work done and pay smaller wages than keep older more expensive experienced workers who work slower.

You're trying to say greed isn't rational but how is charity and treating people well rational? Charity is more about good feelings and personal morals than cold calculation towards self-interest. It's not that hard to believe that people who negotiate a contract will want to negotiate it in the most favourable way for their own interests.

Sir, you are the one who asserted that "we must assume" that people are always rational when they make economic decisions. This sentences does nothing to refute my claim or support your claim. In fact if making a donation to a chaity "is an economic act", then you just proved my clim that not all economic decisions are rational.

Your point about stock prices is a better point But, a billionaire rationally should not care about the stock price and he owns a controlling interest and can do what he wants, right?
. . . But, then, maybe there are legal reasons that owners can't do what they want.

You tell me which is right.
.

[Rugoz]

Concerning market structures, I shall show in a later article that the neoclassical concept of competition is dubious. In consequence, its typology of market structures is problematic.

I suggest you focus on the actual weaknesses of neoclassical theory, such as rational expectations. Of course a shit ton of work has already been done in that direction. Furthermore, it's not enough to criticize, you have to offer something better.

[Steve_American]

I suggest you focus on the actual weaknesses of neoclassical theory, such as rational expectations. Of course a shit ton of work has already been done in that direction. Furthermore, it's not enough to criticize, you have to offer something better.

It would not be hard to propose a 'better' system of economic predicitons, becaue the current system has gotten 90+% of its predictions wrong. I would say 99% wrong, but I'll be conservative here.

The problem is that the current system props up the rich and the rich benefitted from the GFC/2008. So, why would the rich want to replace an economic theory that helps them get richer and doesn't hurt them when it totally fails?
.

[Monti]

I suggest you focus on the actual weaknesses of neoclassical theory, such as rational expectations. Of course a shit ton of work has already been done in that direction. Furthermore, it's not enough to criticize, you have to offer something better.

I have a conception of economy which would revolt, repel, repulse most economists. My conception is that the complexity of the economy makes it hardly "model-able". An economic theory cannot be precise. Most theories are wrong because they go beyond the threshold of "theorisability". My apologies to all readers who risk a cardiovasculate event.

Concerning an alternative theory, I have one which explains competition, equilibrium of production a s o. It is the matter of a next article.

[Unthinking Majority]

Sir, you are the one who asserted that "we must assume" that people are always rational when they make economic decisions.
.

I never said that.

I said when it comes to contracts owners and workers are rational actors: they both want to maximize their self-interest. It doesn't always happen, sometimes an owner will throw somebody a bone, but there's a reason a cashier makes less than a lawyer and it's because an owner isn't going to pay a cashier a lawyer's salary if they don't have to because they aren't stupid, they're rational. All other things being equal a worker also isn't going to sign a contract for $15 an hour if they can get $20 an hour somewhere else because they're rational and not stupid.