I am fascinated by the capacity of the GEM Project to rescue powerful theories from the New Keynesian (NK) dustbin. Generalizing rational exchange from the marketplace to workplaces restricted by costly, asymmetric information is apparently a very good idea. A related source of amazement is how many models have been pushed into undeserved obscurity by the mainstream NK insistence that market-centric general equilibrium analysis is finished theory.
The Helping Great Economists series vividly illustrates the damage that the modern commitment to market-centric modeling has caused. One of the most egregious examples of burying good work is the subject of this week’s post. Piero Sraffa (1898-1983) was born in Turin Italy into a prominent family. After initially enrolling in the University of Turin law faculty, he switched to economics, writing his doctoral thesis on inflation in WWI Italy. After publishing a paper on bank regulation that Mussolini attacked as “an act of true and real sabotage of Italian finance”, Sraffa disembarked to England. There he became an admired participant of the so-called Cambridge Circus, an informal group that met to discuss Keynes’s depression research.
Sraffa’s masterwork, Production of Commodities by Means of Commodities: Prelude to a Critique of Economic Theory, was published in 1960. The book, over three decades in the making and fewer than 100 pages in length, powerfully argues that an adequate theory of value in highly specialized economies requires the restoration of the Ricardo’s emphasis on surpluses that are generated in the process of production. He was especially interested in the capacity of surplus-oriented models to accommodate economies of scale and better explain the distribution of factor incomes. But Sraffa, like so many others, never reconciled the existence of his surplus with optimization and equilibrium, the two fundamental tenets of economic theory. In mainstream textbooks, Sraffa’s ideas lost out to the market-centric elegance of Wicksell/Wicksteed income distribution.
Despite its broad acceptance, the venerable W-W distribution theory has always been problematic. Perhaps most notably, it cannot accommodate scale economies and inherently eliminates pure profit (Πj). It is unfortunate that the W-W Euler-based model has somehow morphed into an implicit tenet of mainstream thinking. Surely nobody really believes that profit is a dispensable variable in stabilization-relevant macro analysis. Pure profit plays, for example, the central role in the formation of expectations required for firms to invest in new capital goods.
GEM Helping Hand
In the GEM Project, Πj is understood as surplus remaining after all necessary production-related outlays – each input meeting the test of profit- and utility-maximization – are deducted from firm revenues. Pure profit does not motivate the participation of any input required in the production process and effectively represents Sraffa’s surplus. In W-W market-centric modeling with constant returns to scale, rational factor payments equilibrate marginal productivities and opportunity costs, exhausting the total product and eliminating residual claims. In GEM modeling, enriched by microfounded meaningful wage rigidity in combination with an intuitive treatment of the capital stock and its utilization, an income-distribution residual claimed by owners of sunk capital rationally exists and is assigned a crucial macrodynamic role. Residual rent neither disappears in the long-run nor reflects the market opportunity cost of some hidden input.
In the generalized-exchange model class, pure profits motivate the rational management of stationary and nonstationary productive capability. Those two classes of decision-making are critical to understanding how the timepath of employment is influenced by involuntary layoffs and job downsizing as well as capital accumulation (with its associated worker hiring) and inter-venue labor transfer. Pure profit plays the most significant role in the formation of surplus expectations required to induce firms to invest in new capital goods.
Is the Game Worth the Candle?
Piero Sraffa labored to restore the centrality of the Ricardian surplus in modern economic theory. The GEM Project does that and, in so doing, establishes Sraffa’s place in the pantheon of rational general-decision-rule equilibrium theorists. Goodbye dustbin. Cumulative score of the Helping-Hand game: Worth it: 10 (Lewis, Solow, Harris-Todaro, Bernanke, Lucas, Samuelson, Kerr et al, Okun, Hicks, Sraffa). Not worth it: 0.
As the game is played and the score builds, keep in mind the major objection of mainstream theorists to generalized-exchange macroeconomics: Adding a second (workplace) venue of rational exchange is too much work. Its benefits are not worth the effort. At some point, that argument surely becomes untenable.
Blog Type: New Keynesians Saint Joseph, Michigan