On the Incoherence of ‘Marginalist’ Labour Economics

The labour market, along with finance/banking and development, is one of the areas where neoclassical theory has proven to be most off the mark. Although more advanced models of the labour market try to address some of the flaws in MVP theory, they generally do this by adding ‘frictions’ such as heterogeneity and job search problems. The general premise – as with much of neoclassical economics- is that without these ‘frictions’, the labour market would operate as described in the textbooks. But this is not true.

Production, by definition, requires that all the factors of production be brought together. As a result, labour is employed at the same time as capital (and land, but we can lump the two together for the purposes of this post) in every circumstance. A taxi driver without his taxi is worthless, and vice-versa. Adding an extra worker to an office necessitates an extra computer, desk and stationary. Adding another builder to a site necessitates tools. Hence any ‘marginal productivity’ can only be applied to the labour and capital as a whole (what Ricardo called a ‘bushel’).

Not only this, but the Division of Labour (DoL) means that it is often impossible to separate the produce of one worker from that of his colleagues. A construction site requires carpenters, plumbers, bricklayers, supervisors, semi-skilled labourers, labourers and many more. But what if you remove only the carpenter? You wouldn’t be able to construct the house. But it would be incoherent to claim his MVP were an entire house – you can only evaluate the product of the entire team together, including their capital. So the marginalist approach makes absolutely no sense, particularly in a society where the DoL spans global borders.

This is also a prime example of an area where historical context in teaching would be appropriate, for the fact is that John Bates Clark created his ‘Marginal Value Product’ theory – the reasoning for which is entirely circular – at the turn of the century, a time of unrest among the working classes, in order to try and settle them. Basically, it was a justification for the status quo: you are paid what you are worth, sorry that isn’t as much as you thought. This context is strangely absent in economics classes, though surely its presence would lead students to ask some questions.

Given that the only coherent way to think of produce is as a result of all of the factors of production combined, what determines each factor of production’s share of the produce? Each wants as much as possible, but each requires the others in order to gain any produce at all. So the share for one factor of production is determined by its relative ability to replace the other factors of production. Or, to put it another way, the produce is distributed by bargaining power. In absence of government, capital, being scarcer, generally holds this, and hence receives higher returns. History also suggests that when capital finds itself in a position where this isn’t true, it will use government apparatus to correct this injustice (increasing interest rates, busting unions).

The empirical failure of the standard theory with respect to the minimum wage is well documented*. Furthermore, employment was generally higher during the post-WW2 age of rising real wages and strong unions, and has been lower post 1980, the age of stagnant real wages and weak unions. This doesn’t suggest a causal link, but it does show that high employment is not incompatible with higher wages, and, along with Card-Krueger and the outright logical inconsistency of the MVP theory, makes me inclined to align with the bargaining power story.

*I’m aware that Card and Krueger do not adopt a classical bargaining power perspective, but their evidence still corroborates with it.

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  1. #1 by Paul Rosenberg (@PaulHRosenberg) on March 27, 2012 - 9:58 pm

    I was thinking about this more primitively just last weekend. But I was more fixated on the market compensation side, how the durability of capital & the need of workers to eat meant that labor market transactions have inherent capital-favoring inequalities built in from the beginning–which is why capitalist economics would never chose production as its protypical starting point.

    I was trying to imagine what a possibly-valid model might look like instead, trying to think about what elements ought to be added in. This post does a good job of ticking off some of those that would be needed.

    • #2 by Unlearningecon on March 27, 2012 - 10:07 pm

      That’s a very interesting point. I also had another point that I didn’t want to put in – partly because it is underdeveloped, partly for fear of overextending the post.

      Over time and unrestrained, capitalism will act to reduce labour’s share of the proceeds of production, because the companies that don’t will, by definition, go bankrupt. In other words, wages are a cost of production, and so lowering them increases profits. Capitalism rewards profit.

      I’m worried I’ve made a basic logical error here (there is the countervailing force of competition between companies for labour, but that itself doesn’t refute the above hypothesis). If not, we may be on the way to a quite a rich and coherent heterodox theory of the labour market!

  2. #3 by JMRJ on March 28, 2012 - 1:35 pm

    Is “capital” really scarcer than labor (labour? When in Rome…)? That’s a very dense thought that you more or less toss off.

    Let me hazard a guess: if you unpack that claim a little, you might put the same idea in morally laden terms rather than morally neutral ones, and say that virtue is scarcer than vice. And while it may appear I’m equating virtue and capital, that’s only an appearance.

    It’s all well and good to observe that there are disparities of bargaining power, just as there are disparities of physical power and military power and the power of thought and the power of language and the power of this and that. Marx had his insights, no doubt. But I thought it was an interesting comment in that blog you linked to (on the term “scarcer”) that asked what the Marxist bias might be, the Marxist having identified so many of the facilitating capitalist biases.

    And I think the Marxist bias is in reducing every social question to class and power. Social relations, including economic ones, are not only much more complicated than that; it is also especially deleterious to explicitly reduce them in that manner, to elevate such an impoverished understanding of human relations to the level of “science”.

    I hope this isn’t too far off topic. It’s just the thought that occurred to me after reading the very interesting post.

    • #4 by Unlearningecon on March 28, 2012 - 8:22 pm

      Perhaps that is true, but I think in the case of capitalist labour remuneration, it really is a class struggle between capital and labour.

      It seems to me that capitalism requires capital to be scarcer than labour to function. I mean, if there are too many capitalists, competition forces some of them to go bankrupt and become labourers, no?

  3. #5 by Will on April 14, 2012 - 12:11 am

    Unlearning Economics, I have recently come across Herbert Davenport’s essay On the Extent and Significance of the Unearned Increment, and have found it to be a great resource, and a great read. It seems like something you might enjoy, if you’re not familiar with it: http://www.jstor.org/stable/1814938

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