Category: History of Economic Thought

V K R V Rao: The Entrepreneur Economist

The contents of the following post was written over a year ago for an in-house publication. Hence, the tone of the post is different from that of the rest. And since we are more enamoured by American economists these days, this is a timely post, which talks of one of the many great economists India has seen.

V K R V Rao founded Delhi School of Economics (DSE), Institute of Economic Growth (IEG) and Institute for Social and Economic Change (ISEC). These institutions were established so as to impart economics education in India, which would compete with world-famous institutes like LSE, Cambridge, etc. He was also instrumental in establishing the Indian Council of Social Science Research (ICSSR). Apart from establishing these institutes, Rao also served in various administrative positions – Planning Commission Member, Union Cabinet Minister first for Shipping and Transport and then Education and Youth Services. For the services rendered, he was awarded Padma Vibhushan in 1974.

Rao completed his Master’s in economics from Bombay University, where he worked on the taxation of income in India for his Master’s thesis. He then moved on to Cambridge to pursue his PhD, where he became a student of Keynes. For Rao, economics was a social science that would aid in improving the human condition. In Cambridge, he discovered that the tools of government intervention could aid in fulfilling the objective of economic as well as social betterment. And it was Colin Clark who stimulated his interest in statistical demography and national income accounting. However, as Shigeto Tsuru points out in his review of Reflections on Economic Development and Social Change: Essays in Honour of Professor V K R V Rao by C H Hanumantha Rao and P C Joshi published in 1979, Rao had insisted that ‘the blind application of Keynesian formulae to the problems of economic development has inflicted considerable injury on the economies of underdeveloped countries.’ For Rao, economic theory was only a servant of economic policy.

There are three published works by V K R V Rao on national income – An Essay on India’s National Income 1925-29 (1936); The National Income of British India (1940) and India’s National Income 1950-80 (1983). Though V K R V Rao has published on various aspects of economics, his work on India’s National Income is of special interest. This is because of a variety of reasons. Austin Robinson provides one such reason: ‘I myself remember Rao as the brilliant Cambridge undergraduate and research student of almost fifty years ago, who single-handed tackled the almost impossible task of estimating the Indian national income at a time when hardly a single ingredient was known and even guesses involved heroic despatch of countless questionnaires to every corner of India to establish, for example, the milk-yields of she-buffaloes or the average earnings of village barbers.’ An analysis of economic growth and change is possible by studying the National Accounts Statistics (NAS), as Rao has demonstrated in his 1983 book.

Despite the limitations of NAS in India, Rao is able to meaningfully explain the changing structure of the economy through the relative shares of agriculture, industry and services in the gross domestic product (GDP). In addition, he calculates the implicit price deflator so as to understand how much of GDP increase is on account of price rise. Also, implicit price deflators are constructed for the three major sectors to find out how each sector has performed vis-a-vis the others. Savings, capital formation and consumption are also dealt with in detail. V M Dandekar has hailed his 1983 book as ‘a model of scholarship and objectivity particularly coming from one who, during the period, was in the thick of making and implementing policies and programmes for economic development of the country.’

Thus, V K R V Rao was a model economist ‘ a practical man who was well aware of various theories and their limitations in applicability to India. And because he wanted to use economics for policy purposes, he was committed to extensive data collection and data analysis. Also, he was clear that, in practice, economics must interact with other social sciences, especially sociology and anthropology. This is evident from the name of the institute he founded in Bengalooru ‘ Institute for Social and Economic Change.

Sraffa: The Origins of ‘Marginal’ Analysis

Since the advent of the ‘marginal’ method, the doctrines of the old classical economists have been submerged and forgotten. It is this standpoint that Sraffa revives in his 1960 book Production of Commodities by Means of Commodities. Being third in the series of posts [Post 1; Post 2] on Sraffa, this post examines the origin of the ‘marginal’ method and its subsequent (mis)use by the neoclassical economists. The posts concludes with a brief mention of how history of economic thought is important so as to place theories in a proper context.

In the preface of his book, Sraffa points out that in a system of production where the scale of an industry or proportions of factors of production remained unchanged, one would not be able to locate marginal product and marginal cost. To put it differently, marginal analysis is done by considering ‘potential change’. That is, we try to find out variations in equilibrium quantities and prices with respect to infinitesimal changes in the neighbourhood. [Bharadwaj 1986, p 39]

What we do not pay adequate attention to, is that the most familiar case of ‘marginal analysis’ is that of the product of marginal land (also known as no rent land) in agriculture, when lands of different qualities are cultivated side by side. This refers to the well known differential rent theory of David Ricardo. In fact, it is the case of diminishing marginal returns on land which is at the junction of the ‘fundamental methodological shift from classical to equilibrium theory’. [Bharadwaj 1986, p 40] This can be understood only through a discussion of ‘extensive’ and ‘intensive’ margins.

Cultivation on lands of different qualities is visualised as the outcome of a process of ‘extensive’ diminishing returns. On the other hand, successive use of more output producing techniques refers to the process of ‘intensive’ diminishing returns. [Sraffa 1960, p 76] In the case of ‘extensive’ margins in cultivation, ‘the rents can directly worked out on the basis of the single observed situation.’ [Bharadwaj 1986, p 41] Whereas, in the case of ‘intensive’ margins, the calculation of rent requires a quantitative change in the situation. That is, successive doses of labour and ‘capital’ need to be added to the land. And, a further assumption is made on the nature of these ‘doses’. These ‘doses’ are considered to be homogeneous. As Krishna Bharwadwaj explains: ‘At any moment of observation, no dose is distinguishable from each other. No ‘marginal product’ can, therefore, exist in this case without introducing potential change.’ [Bharadwaj 1986, p 42]

Thus, it is the Ricardian theory of rent which provided the basis for the neoclassical theory of distribution by providing an inverse relationship between successive doses of labour and ‘capital’ and their remuneration. This theory of Ricardo was intended to explain the origin of rents. In the hands of later authors, this was generalised to labour and ‘capital’. Hence, we see the inverse relation between ‘capital intensity’ and rate of profit in microeconomics textbooks of today.

From this excursion into the Ricardian theory of rent, two aspects are very clear. First, the concept of ‘marginal’ or ‘margins’ was used exclusively in the domain of cultivation. In ‘intensive’ cultivation, it is obvious that the output would increase only until a certain point, owing to the quality of that piece of land. Whereas, in the case of ‘extensive’ cultivation, the output would increase till all the acres of land are cultivated- notice the scarcity element here. What is not clear is the rationale of extending such an analysis into the area of manufacturing! Also, it is well accepted that land is scarce; but, is ‘capital’ or produced commodities scarce in a similar way’

No book of microeconomics mentions the origins of the famous ‘marginal’ analysis. And this method is so entrenched in the profession, that it is almost impossible to throw it away. It is in this context that other conceptual frameworks, that pay more attention to the changing historical conditions, assume importance. Probably, we need to revisit earlier theories and theorists not just for their own sake but for our sake as well in throwing light on contemporary issues. Sraffa’s work has inspired a lot of work on the history of economic thought, which will be summarised in a later post.

References

Bharadwaj, Krishna (1986), ‘Classical Political Economy and Rise to Dominance of Supply and Demand Theories‘, Universities Press: Calcutta.

Sraffa, Piero (1960), ‘Production of Commodities by Means of Commodities: Prelude to a Critique of Economic Theory‘, Cambridge University Press: Cambridge.

Knut Wicksell: Some Aspects of his Work

This post is different from the others because it deals with the contributions of a single economist. Knut Wicksell was a Swedish economist who made significant contributions to capital theory, monetary economics and fiscal policy. Despite being grouped under the neoclassical or the Austrian school because of his affinities to ‘marginal’ analyst, Wicksell was a socialist and a radical. He advocated policies which involved the government in a big way. And owing to his varied interests in poetry, mathematics, feminism, mathematics, politics, etc he became a Professor of Economics and Fiscal Law at Lund University only when he was fifty. A few of his well known students are Erik Lindahl, Gunnar Myrdal and Bertil Ohlin. They are considered to be part of Stockholm or Swedish school of economic thought.

In the passages below, only a few of his contributions will be elaborated. He has also made lasting contributions to the theory of interest, revitalised quantity theory of money, introduced mechanisms linking the real and monetary sector, etc.

Wicksell demonstrated that problems could arise if capital is treated just like other ‘factors of production’ ‘ land and labour. Cambridge capital controversies dealt with many of these problems. ‘Knut Wicksell (1851’1926) himself casts doubt on the specification of the value of capital, along with the physical quantities of labour and land, as part of the data of the system. ‘Capital’ is but a set of heterogeneous capital goods. Therefore, unlike labour and land, which ‘are measured each in terms of its own technical unit . . . capital . . . is reckoned . . . as a sum of exchange value’ (Wicksell, 1901, 1934, p. 49). But capital goods are themselves produced commodities and, as such, their ‘costs of production include capital and interest’; thus, ‘to derive the value of capital goods from their own cost of production or reproduction’ would imply ‘arguing in a circle’ (ibid., p. 149).’ [Segura and Braun 2004]

Like other contemporaries of his, Wicksell did not write about unemployment. This was because the existence of unemployment was considered to be a paradox, an anomaly for neoclassical economists. As they could not comprehend why resources (here, labour) would be left idle! The central problem in (neoclassical) economics was not to provide or create uses for factors, but only to allocate the factors among various uses. As Bo Sandelin, editor of Wicksell’s papers and the author of A History of Swedish Economic Thought writes in the introduction that ‘the fundamental question in economics was how to manage an economy with scarce resources.’ Strange indeed!

Wicksell was a strong proponent of the marginal productivity theory of distribution. A corollary of this theory is the the sum of all the marginal products of the factors should be equal to the total product, known as the product exhaustion theorem. However Wicksell demonstrated that the operation of this theory depends on the returns to the scale. That is, only under constant returns to scale will the marginal products exactly add up to the total product. And that for both decreasing returns and increasing returns, the product will not be completely exhausted.

The Swedish school made another important contribution to economic theory. They introduced the categories of ex ante and ex post. These categories, we know are used widely today and were the result of the School’s dissatisfaction with the equilibrium analysis. Apart from these ways of thinking, Myrdal has provided us with the concept of circular and cumulative causation as well. These categories provide us with alternative modes of conceptualising or thinking about economic problems.

Relying solely on textbooks reduces our extent of reach. We often fail to come across interesting and heterodox economists. But, history of economic thought provides us with ample personalities to look into. Wicksell is one among them. Also, some of their categories provide us with alternatives, which remain unfinished. For instance, after going through some of the secondary and primary works on/by Wicksell, he appears exceedingly interesting and aware of the implications of certain simplifying assumptions. He pointed out the ‘necessity’ of the constant returns to scale assumption, which economics faithfully aligned with for a considerable period. This was challenged within the mainstream only with the entry of the endogenous growth theories, which emphasised increasing returns.

References

Pressman, Steven (2004), Fifty Great Economists, Routledge: India.

Groenewegen, P and Vaggi, G (2006), A Concise History of Economic Thought: From Mercantilism to Monetarism, Palgrave Macmillan.

De Marchi, N and Blaug, M (1991), Appraising Economic Theories: Studies in the Methodology of Scientific Research Programmes, Edward Elgar.

Segura, J and Braun, C (2004), An Eponymous Dictionary of Economics: A Guide to Laws and Theorems Named After Economists, Edward Elgar.