Posted by Alex M Thomas on 31st October 2013
In the past, several posts on this blog have raised dissatisfactions and have expressed discontent with the prevalent orthodoxy in economics – neoclassical economics (more accurately, marginalist economics). This post is similar in intent as the previous posts, but it chooses to focus on, what I deem to be, the two most theoretically and empirically inadequate tenets of marginalist economics: (1) the marginal productivity theory of (income) distribution and (2) the supply-side growth theory.
Equilibrium prices and quantities of commodities and factors of production (such as labour and ‘capital’) are determined simultaneously in marginalist economics. Distribution is endogenously determined according to the relative scarcity of factors, i.e., based on the demand and supply of factors. Under conditions of perfect competition, in equilibrium, the wage rate equals the marginal product of labour and the profit rate equals the marginal product of ‘capital’. That is, there is no surplus in the marginalist theory of value and distribution. The origin of the marginal principle is to be found in Ricardo’s discussion of intensive rents. This principle has been illegitimately extended to labour and to ‘capital’. In marginalist production theory, labour is freely substitutable with ‘capital’. The famous Cobb-Douglas production function is based on the substitutability of the two factors of production. The use of the aggregate production function has been shown to be logically unsound (due to problems of not just measurement but also aggregation of ‘capital’) and therefore its applicability in empirical analysis is severely undermined. But, this logical critique, famously known as the Cambridge Capital Controversies, remains ignored.
Underlying the supply-side theory of growth is the marginal productivity theory of distribution. Relative scarcities of the factors induce changes in their prices such that the demand for factors equals their supply. This implies that, in equilibrium, all factors are employed. The real wages are assumed to be sufficiently sensitive to disequilibrium in the labour market such that they adjust in order to render the labour demand equal to its supply. And, the aggregate production function states that a growth in the factors will lead to a growth in output. In other words, if the labour and ‘capital’ endowments are increased, there will be higher growth. Aggregate demand adapts to aggregate supply and the possibility of an aggregate demand deficiency is ruled out. Slight modifications have been made to this theory in order to explain the presence of unemployment. These modifications take the form of rigidities of the real wage, which cause labour unemployment. In marginalist theory, one of the explanations for the presence of unemployment is labour market rigidities. If these rigidities are absent, labour will tend to be fully employed. Such theories have come under severe criticism and rightly so.
To conclude, marginalist economics is unsatisfactory on logical grounds. Moreover, it does not perceive the possibility of an aggregate demand deficiency. Lastly, unemployment is seen to be a consequence of imperfections or rigidities and not as permanent feature of competitive economies.
Tags: Marginal productivity theory, Marginalist economics, Supply-side theory of growth
Posted in Economic Growth, Economics, Marginalist economics, Neoclassical Economics | 1 Comment »
Posted by Alex M Thomas on 2nd January 2013
Wages is the payment made to a labourer for the number of hours worked – sowing seeds, rolling tobacco, developing computer software or providing medical care in a hospital. How are these wages determined? Are they determined in a similar manner as that of commodities? That is, are they determined based on some sort of demand and supply mechanism? Or, are they predominantly set by non-economic forces which are not easily quantifiable? This blog post looks at the dominant neoclassical or marginalist viewpoint and contrasts it with the theoretical approach of classical economics. In this light, the post examines certain characteristics of the Indian economy relating to labour and employment.
The basic principles of neoclassical economics tell us that the price and quantity demanded and supplied of a commodity are determined by the intersection of its demand and supply curves. This is the demand and supply approach to economics. When extended to labour, the intersection of the demand and supply curves of labour is supposed to determine the wages per hour (the price of labour) and the number of hours worked (the quantity of labour). Therefore, an increase in the demand for labour relative to its supply is expected to raise the wage rate and a relative increase in supply of labour (say, from an increase in the working population commonly termed the demographic dividend) leads to a fall in the wage rate.
Classical economics, a distinct theoretical framework in economics, has a very different view of wages. It largely considers wages as an exogenous variable; that is, wages are not determined by market forces – demand and supply of commodities or of labour. Of course, temporary changes can be brought about by market forces. In the theoretical world of classical economics, wages are determined primarily by socio-cultural factors such as trade union strength, the collective notion of minimum wages for different occupations and the society’s views on trust, risk, etc. In this theoretical world, which to me, seems closer to the reality, an improvement in social institutions lead to an increase in subsistence wages. Wages, in this framework, has a subsistence (relatively fixed) component and a surplus (relatively flexible) component. Hence, classical economics allows for an increase in wages, in its surplus component, when GDP is rising on account of higher labour productivity.
A conflict is present in the distribution of GDP between workers and capitalists. Neoclassical economics eliminates this conflict by recourse to marginal productivity theory. By employing logically fallacious concepts (especially of capital), a theory of distribution has been erected where both labour and ‘capital’ are ‘justly’ remunerated. In this framework, trade unions distort the market and causes injustice! According to classical economics, the presence of strong trade unions and fair labour laws ensure that workers get a fair share of productivity gains, which will otherwise entirely go as profits of the capitalists. The Global Wage Report 2012/13 published by the International Labour Organisation (ILO) notes that in several countries wage rises have not matched the increase in employment and productivity (see especially p. 28).
There are enormous disparities in wage rates across the states in India, with Kerala paying relatively high wages. One reason for the high wages is the presence of strong trade unions. As per the Labour Bureau (as part of the Rural Labour Enquiry) report on ‘Wage Rates in Rural India’ for September 2012, the average daily wage rates for men for engaging in sowing in Gujarat is 132 rupees; in Kerala, it is 500 rupees; and in Tamil Nadu, it is 222.02 rupees. A carpenter in Gujarat is paid 233.33 rupees daily; in Kerala, he is paid 514.05 rupees and in Tamil Nadu, he is paid 388.6 rupees. The differences are starker with respect to unskilled labour: a male unskilled worker in Gujarat gets paid 109 rupees; in Kerala, he earns 411.32 rupees; and in Tamil Nadu, he earns 223.54 rupees. The corresponding wages for a female worker are: 101.71 rupees in Gujarat, 266 rupees in Kerala and 159. 76 rupees in Tamil Nadu. Note the gender-wage inequality in Kerala. Also, the economic condition in rural Kerala is significantly better than rural Tamil Nadu; therefore, the statistics will have to be interpreted with some restraint.
Subsistence wage, as a concept, has enormous theoretical and practical significance. In fact, the legislations pertaining to minimum wages in India ought to look at socio-cultural factors too, such as gender, caste, geographic location, kind of labour (formal vs. informal, rural vs. urban) and so on. The enforcement of minimum wages has been beset with difficulties as evident from a recent study (published in 2011) by Patrick Belser and Uma Rani; the proportion of salaried workers and the proportion of casual workers below the minimum wage at the national level is 25.3 and 50.6 per cent respectively. Discussions on and about subsistence wages, and by extension, on minimum wage legislations are much needed. Moreover, discussions surrounding subsistence wages can also result in more dignified definitions of poverty and minimum wages.
Tags: Average Daily Wage Rates, Gujarat, Kerala, Marginalist economics, Subsistence wages, Tamil Nadu, Wages
Posted in Agricultural sector, Classical Economics, Classical Political Economy, Development Economics, Economics, Employment, India, Kerala Economy, Labour Economics, Wages | 2 Comments »