Vernengo on Keynes vs Neoclassical Synthesis

In previous posts, I have made frequent reference to the Cambridge Capital Controversy and its significance for macroeconomic debates. Robert Vienneau, who often writes on issues relating to this controversy, draws attention (here) to a recent post by Matias Vernengo which very clearly distinguishes Keynes’ contribution from the marginalism of the neoclassical synthesis and New Keynesian economics. Vernengo is addressing a recent post by Krugman on the history of macroeconomics.

Vernengo emphasizes that in neoclassical approaches, including the neoclassical Keynesianism of Krugman, the cause of unemployment is either excessive real wages or real interest rate rigidity. Krugman, for example, does not blame excessive real wages, but does put the onus on a liquidity trap, which involves a supposed failure of the real rate of interest to adjust to its “natural” level.

Vernengo points out that this is in sharp contrast to Keynes’ own contention (especially in chapter 19 of the General Theory) that real wage flexibility could not be relied upon to eradicate unemployment. It also contradicts Keynes’ view on interest. He did not consider a liquidity trap to be the cause of unemployment and rejected Wicksell’s notion of a “natural” rate of interest.

Having made this important distinction, Vernengo argues:

The fundamental problem of the neoclassical/marginalist approach, and the importance of Keynes’ analysis, can ONLY be properly understood in light of the 1960s capital debates.

These debates showed, among other things, that the marginalist claim of an automatic tendency to the full utilization of the “factors” of production, labor and capital, was without sound foundation. This automatic tendency was supposed to occur on the basis of “factor substitution”. If there was unemployment, a fall in the real wage was meant to cause a substitution of labor for capital goods.

The capital debates, as Vernengo explains, demonstrated that this rise in employment in response to a falling wage is not certain. First, since labor is employed in the production of capital goods, both labor and capital goods are likely to cheapen as a result of the real wage reduction, giving no guarantee that the substitution effects will operate in the right direction. Second, even if in a given case the substitution effects do operate in the right direction, they may be more than offset by the income effects associated with workers receiving lower real wages, with the negative impact on demand possibly causing less of both labor and capital goods to be employed.

The point is not that employment will necessarily fall in response to a reduction in the real wage (although that scenario seems more likely than the reverse under present circumstances), but rather that there is no general, systematic effect. It could go either way.

The ramifications of the capital debates for marginalist theory are substantial. The notion of a well-behaved “demand for capital” function and, with it, the supposed real determination of the rate of interest, is invalidated. This was acknowledged by Samuelson in his “Summing Up” of the debate (see Nobel-nomics). The supposed determination of real wages through the interaction of supply and demand in an aggregate “labor market” is similarly deprived of legitimacy. As Vernengo concludes, it means:

… there is no natural tendency to full utilization of labor or capital, and both the natural rate of unemployment and its evil twin the natural rate of interest do NOT exist.

Whereas the marginalist approach is severely undermined by the capital debates, Keynes’ position – that unemployment is due to a deficiency of aggregate demand, not wage or price rigidities, and the rate of interest has a monetary, not real, determination – is left unscathed.

It is partly this understanding that informs Post Keynesian (including MMT) approaches to the determination of employment and interest.


4 thoughts on “Vernengo on Keynes vs Neoclassical Synthesis

  1. Hi Peter

    This discussion is quite evocative of two central issues in Marxian economics: the underconsumptionist interpretation of Marx’s theory of crisis and the labour theory of value.

    Although in your piece this is not immediately evident, in Vernengo’s it is (I also commented there, with more details, if you are interested).

    I am misinterpreting this subject? Thanks.

  2. Hi Magpie. Economists influenced by Sraffa have usually regarded the capital debates as being destructive both of the neoclassical theory of value and Marx’s theory of value.

    For many economists, Marx’s theory is interpreted as referring to two separately determined systems (one for value, one for prices) in which the values and prices of inputs and outputs are assumed to be determined simultaneously. This is sometimes called a dual-system simultaneist interpretation. In this kind of interpretation, Marx’s three aggregate equalities do not all hold and his law of the tendential fall in the rate of profit (LTFRP) also will not hold, in accordance with the Okishio theorem.

    Marx’s three aggregate equalities and LTFRP do all hold when his theory is interpreted as referring to a single system (mutually determining both values and prices) in which values and prices are determined temporally (one period’s input prices enter as data in the determination of the next period’s output values and prices). This is called a temporal single-system interpretation (TSSI). The development of this interpretation is mainly associated with Andrew Kliman, Alan Freeman and a few others.

    There are also single-system simultaneist interpretations. In these interpretations, Marx’s three aggregate equalities all hold but his LTFRP does not.

    There is still debate between the different interpreters. A good summary of the debate from the TSSI perspective is provided by Kliman in this book. Robert Vienneau provides a helpful list of some of the literature against the TSSI. The debate is still going back and forth. Personally, I think I agree with the TSSI, as that most closely resembles my own understanding of Capital, but I think most (perhaps all) Sraffians and some Marxian and Marxist economists disagree with it.

  3. Thanks Peter for that overview.

    I am vaguely aware of those developments (RE: Sraffa, dual system and single system), although I haven’t made up my mind.

    At the moment, I am more interested in achieving a clear understanding of the “literary” theory and its relations to other economic theories (What little maths I once knew is long forgotten and I’ll eventually have to pick my old books for the linear algebra involved).

    In particular, the question arises because I have found that Keynesian ideas often relate quite obviously (even though this is largely unacknowledged) to Marxian economics.

    Joan Robinson, is my understanding, considered that Keynes would have gained a lot from Marx.

  4. As I understand it, aggregate demand and supply were simply the aggregate labor supply and demand – with the proviso that demand was deficient because the interest rate did not clear the market for savings and investment – that is, changes in savings did not result in significant changes in the interest rate which did not lead to sufficient changes in investment.

    Thus, if people saved a lot, the interest rate might fall, but investment would not increase dollar for dollar. Thus aggregate demand falls.

    Wage rigidity is not required.

    I think this story makes sense – especially during recessions when investors are concerned more about current demand than the interest rate.

    And one might be able to argue that falling prices and interest rates will eventually lead to an increase in investment, or perhaps some technological change – but on the whole these effects do not seem to be that strong. And the fact that investors invest based on current demand seems to suggest the low level of output to be rather permanent.

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