Download The theory of output in the Modern Classical Approach

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Attilio Trezzini1 and Antonella Palumbo1
The theory of output in the Modern Classical Approach
1. Introduction
Although Piero Sraffa did not directly deal, in his published or unpublished work,
with the theory of output, much literature has developed, in the approach which
originates from Sraffa’s rediscovery and revival of the theory of classical economists, in
the field of output determination and growth theory. The conception of the working of
the economy which is proper to Sraffa’s approach and to classical economics has in fact
relevant implications for the theory of output. This paper attempts at exposing the main
lines of this approach, which may be labeled as ‘Classical-Keynesian’ since it combines
the classical approach to value and distribution with Keynes’s principle of effective
demand, regarded as the foundation of a long-period theory of growth. Once applied to
the long period tendencies of the system, the principle of effective demand is interpreted
as entailing that the evolution in time of resources and productivity is the product of the
evolution of aggregate demand.
The reasons for regarding Sraffa’s contribution as very relevant also in the field of
the theory of output, and notwithstanding the lack of any direct analysis of the matter on
his part, depend on the implications of the two fundamental aspects of his theoretical
work: the rediscovery and revival of the classical approach to value and distribution and
the critique to the neoclassical notion of capital as factor of production. The latter does
in fact entail the possibility of showing – in a crucial way – the inconsistency of the
mechanisms on which neoclassical theory states the spontaneous tendency of the system
towards full employment. The classical theory of value and distribution, on the other
hand, may be shown to constitute for the theory of output and growth an analytical
foundation which is deeply consistent with the theoretical description of the growth
process as driven by demand and not generally constrained by the availability of
resources. This may appear to be contradicted by the widespread acceptance, among
Classical authors and most notably in Ricardo, of Say's law stating the non existence of
demand limits to the general level of production.
However, in analyzing the structure of the classical theory of value and distribution,
Garegnani (1978-9) has shown its ‘open’ character with respect to the theory of output,
thus showing that Ricardo’s endorsement of Say’s Law was the effect of peculiar
hypotheses and of lack of clear distinction between investment decisions and saving
decisions2, while being by no means a necessary implication of his theory of value and
1
2
Dipartimento di Economia, Università Roma Tre.
See particularly Garegnani (1978, section 2).
2
distribution.
On the contrary, the very conception of prices and of the determinants of
distribution proper to classical economists is such as to provide a firm and consistent
analytical basis for a theory of output which does not regard full employment of
resources as the normal condition of the system. As noted by Kurz (2012, p. 308), “[i]t
is ironic to see that the classical approach, coherently developed, actually undermines
Say’s law – the law for which Keynes had thought he could put classical analysis to one
side”.
In this paper, we will try to deal with this question, and to describe the main
characteristics of the Classical-Keynesian approach by highlighting the analytical and
methodological insights which in our opinion derive to this approach from the
theoretical basis of classical theory. By dwelling on the practical and policy
implications of the approach, we will also try to show its potential fruitfulness for
understanding the real world.
The paper is structured as follows. The first sections will be devoted to summarizing
the relations between the Keynesian theory of output determination and the implications
of Sraffa’s contribution starting from the irreconcilable contradiction of the marginalist
theories of value and distribution with any possible role of aggregate demand in the
determination of output (section 2) and the relevance of the critique to the neoclassical
notion of capital for the long-period extension of the principle of effective demand
(section 3). Section 4 deals with the analytical structure of Classical theory of value and
distribution and its implications for the theory of output.
In section 5 we describe the main features of the Classical-Keynesian approach.
Section 6 is devoted to an open issue within the approach, which is currently matter of
debate, namely the question of capacity adjustment. In addressing this question, we will
maintain that it is in the logic of the Classical-Keynesian approach that the process of
growth is described as an open, path-dependent process. This, as we will try to show,
we regard as a direct implication of the theory and method proper to the classical
analysis of value and distribution.
Section 7 is devoted to the implications of the Classical-Keynesian approach for
economic policies. Section 8 concludes.
2. Keynes’s principle of effective demand: incompatibility with the
neoclassical theory of distribution
That the revival of the Classical approach to value and distribution prompted by
Sraffa’s work, together with his connected critique of the neoclassical theory, had
relevant implications for the theory of output, has been stated by Garegnani (1978-9) on
the basis of his analysis of Keynes’s theory of effective demand. As is known, Keynes
conceived his own theory of the effective demand as profoundly innovative and
alternative to dominant theory. He aimed to show that the economic system may tend to
3
realize equilibria with underutilization of labor and installed equipment and that no
automatic mechanisms ensure the tendency to full employment. This necessarily
implied a critique of the traditional adjustment mechanism between investment and
saving, entailing the spontaneous tendency of decisions to invest to absorb fullemployment savings due to the flexibility of the rate of interest.
As is known, Keynes’s critique to this traditional mechanism consists both in the
identification of another, more powerful, adjusting mechanism between investment and
saving (represented by output variations), and in identifying reasons for possible
inflexibility of the rate of interest due to its monetary determination. The liquidity
preference was the theoretical tool used to criticize the role of the rate of interest as
adjusting investment and saving and to put forward an alternative theory of the rate of
interest as a monetary phenomenon. In relying on this theory of the rate of interest,
Keynes could regard the adjusting mechanisms of neoclassical theory as inoperative and
did not regard a deeper critique to the neoclassical theory of distribution as necessary.
He did not in fact deny the validity of the demand curves for factors of production on
which the neoclassical equilibrating mechanisms rest: such functions, on the contrary,
play a relevant role in Keynes's theory in the form of the curves of the marginal
efficiency of capital and the marginal product of labour.
What did not appear clearly to Keynes was that the spontaneous tendency of the
economic system to full employment of resources is a necessary implication of the
neoclassical theory of distribution.
Such tendency is in fact inbuilt in the very definition of the prices of factors as those
allowing equality between the demand for factors and their available supply. The
adjusting mechanisms are the outcome of the whole equilibrium system which, on the
basis of given technical conditions, consumer tastes and the amounts of productive
factors, determines simultaneously prices of goods, distributive variables, produced and
exchanged quantities of goods and the quantities demanded of productive factors which
correspond to their available (or supplied) quantities.
This is based on a conception of the productive process according to which the
elements necessary to production are conceived as factors which are used in proportions
which vary inversely with the corresponding rates of remuneration. Such mechanisms
of substitution among factors of production are very basic to the theory, and are what
allows the system to find an equilibrium configuration.3 Substitution, expressed by the
decreasing demand curves for factors of production, may be either direct technical
substitutability among factors, as expressed by marginal products, or indirect
substitutability due to the substitution among goods in consumption. It is through
substitution that the available quantities of productive factors are allocated to the
3
In such a theoretical framework, the possibility of substitution among factors of production is
essential to the attainment of equilibrium. In fact, if consumers’ tastes were such as to imply fixed
proportions of the various goods in consumption regardless of price changes, and if at the same time the
production of the various goods required fixed proportions of factors of production regardless of changes
in distribution, no equilibrium would ever be possible except by chance, because no mechanism would
ensure the existence of a set of prices bringing demand and supply to equality.
4
production of the various consumption goods in a way that ensures the general
compatibility of the system4. Equilibrium prices of goods will thus reflect, ultimately,
the relative scarcity of the factors used in their production.
The decreasing demand curves for factors of production allow for the automatic
tendency to the full utilization of the factors if a second property is postulated, namely
flexibility in the factor rates of remuneration in response to any divergence between
demand and supply. It has to be noted that the assumption of unlimited flexibility finds
its rationale in the very existence of the decreasing demand functions.5
These two theoretical elements are also crucial when the role of monetary variables
is taken into account and the tendency to full employment is considered from the point
of view of aggregate demand tending to adjust to aggregate supply.
Unemployment would induce a fall in money wage, causing in its turn an increase in
labour employment, output, income and saving. Lack of adjustment of real aggregate
demand to this higher level would imply that this potential expansion would be lost. The
adjustment of aggregate demand takes place thanks to the role of the rate of interest in
bringing about equality between investment and full-employment saving.
The saving-investment market is thus crucial for the alleged tendency to full
employment and constitutes the center of Keynes’s critical attention. In the neoclassical
representation of the saving-investment market, a crucial role is played by the
decreasing demand for investment, which derives its form and its elasticity to the rate of
interest from the demand of capital as a factor of production proper to the general
equilibrium system.6 The decreasing shape of the function is what allows the
effectiveness of the adjusting mechanism based on the flexibility of the rate of interest.
Keynes's partial acceptance of the traditional theory of distribution shows in his
analysis of investment, where we find the traditional shape and elasticity to the rate of
interest together with an altogether different analysis, based on the role of institutional
and conventional factors which determine volatility of the marginal efficiency of
capital. While such partial acceptance, according to Garegnani's (1979, p. 77-8)
reconstruction, may have contributed positively to Keynes’s statement of the innovative
part of his theory, by rendering a more complete critique of neoclassical theory
unnecessary, this also implies that in Keynes’s analysis two very different theories were
simultaneously present: the theory of effective demand on the one hand, with its
implication of the potential plurality of equilibrium levels of output, and the
neoclassical theory of distribution on the other, especially represented by the inverse
relationship between the demand for investment and its rate of return, with its
4
This second kind of substitutability is based on the assumption that the different goods require
different proportions of factors in their production.
5
Unlimited flexibility is in fact possible only if it acts as an adjusting mechanism; in the absence of
decreasing demand functions, unlimited flexibility would imply that the wage rate would indefinitely tend
either towards zero or to a level such as to absorb the whole product.
6
For a detailed analysis of the relationship between the flow demand for investment and the demand
for the stock of capital in marginalist analysis see especially Garegnani (1978, section 5). See also Petri
(2013).
5
implication of the definition of full employment as the only long-period equilibrium of
the system. The compresence of these two theories gave rise to an 'inherently unstable
compromise' (Garegnani, 1979, p.77) and left the way open to the reduction of the
principle of effective demand merely to the explanation of short-period phenomena of
depression, as in the neoclassical synthesis.
3. The debate on the marginalist notion of capital as a productive factor: a
fatal critique to the adjustment mechanisms of neoclassical theory
As was recalled above, one of the basic elements of Sraffa’s analysis, together with
the rediscovery and revival of the classical surplus approach, is the analysis of the
dependence of changes in prices on changes in distribution and the connected critique of
the neoclassical conception of capital.
The structure of the marginalist theories does in fact require a special analytical
treatment of the capital. The rate of profit, conceived as the rate of remuneration of
capital, has to be determined, symmetrically and simultaneously with the other
distributive variables, by the equilibrium between its demand and supply. This implies
that the set of heterogeneous capital goods used in production has to be regarded as a
single homogeneous factor of production measured in value.
Thus capital, as the other factors of production, should be present in the economy in
a limited and well defined quantity (which also implies the necessity of an unambiguous
measure of such quantity). At the same time, in order to construct the decreasing
function of demand for capital with respect to its rate of return, it is necessary to
postulate substitutability between capital and the other factors.
Sraffa (1960, § 48) notes that the dependence of relative prices on income
distribution makes it impossible to conceive capital (an aggregate of heterogeneous
commodities) as a homogeneous single factor and that its available quantity cannot be
known before and independently of the determination of the distributive variables and
prices.
This critique to the neoclassical conception of capital has been developed during the
1960s and early 1970s in the so-called “capital controversy”7. The discussion showed
the logical impossibility of deriving the univocal functions relating the amount of
capital demanded to the rate of interest which are an essential element of neoclassical
theories (Garegnani, 1966, 1970; Pasinetti, 1966). The criticism was also extended to
different versions of the marginal theory in which capital goods were conceived as a set
of distinct factors of production (Walrasian general equilibria) showing the radical
incompatibility between this treatment and the condition of uniformity of the rate of
return on different capital goods (cf. Garegnani 1990a).8
7
See Harcourt (1972) for a reconstruction.
The relevance of critical these results, which at the time was also recognized by the ‘advocates’ of
neoclassical theory (see for example Samuelson, 1966) has contributed, according to the reconstruction
8
6
This debate has also relevant implications for the theory of output. By questioning
the very analytical bases of the neoclassical theories of value and distribution (i.e. the
existence of demand functions for factors of production inversely elastic to rates of
remuneration), it has shown their inadequacy to represent the actual functioning of
market economies and it has deprived the alleged tendency to full employment of
resources of its ultimate theoretical justification.
Keynes’s critique to the adjusting mechanisms of neoclassical theory is thus
reinforced: no systematic tendency of investment to adjust to full employment saving
may be postulated, and this does not depend on the possible inflexibility of the rate of
interest in presence of saving-investment disequilibria, but on the very absence of the
systematic decreasing relationship between the rate of interest and the demand for
investment.
This criticism also undermines, it follows, the interpretation of Keynes’s
contribution that has prevailed in macroeconomic literature due to the neoclassical
synthesis, which by using the basic principles of neoclassical theories partly shared by
Keynes has reaffirmed the spontaneous tendency to full utilization of resources for the
long term and for the study of growth.
It is thus on the firmer basis of a radical critique to the adjusting mechanisms of
neoclassical theory that the Keynesian principle of effective demand may be reaffirmed
and made into the basis of a theory of the long-run determination of output and growth.
4. The Classical ‘core’ and the theory of output
If the critique of the marginalist notion of capital as a productive factor frees the
analysis of output determination from the constraints set by the marginalist theory of
value and distribution, the other fundamental strand of Sraffa’s analysis, i.e. the
rediscovery of the Classical approach to value and distribution, may represent (as
originally maintained by Garegnani, 1978-9) the opportunity for a more solid
foundation to the Keynesian theory of effective demand. The classical approach does
not entail in fact any mechanisms, as instead we find in the neoclassical theory of
distribution, automatically driving the system towards full employment. In the words of
Garegnani (1978, p. 340), “it neither provides premises capable of justifying the
tendency of investment to adjust to saving, nor depends on the existence of such a
tendency”.
later provided by Garegnani (2005), to a profound reformulation of the marginalist theories which implied
a radical change in methodology of the theory itself. These developments are currently object of a
complex debate which has shown, as a first result, that the re-definition of the notion of "equilibrium" is
characterized by impermanence of some key variables (Garegnani, 1976, 1990a, 2005). This feature has
condemned the general equilibrium theory of value to a substantial irrelevance for the analysis of reality.
Moreover, this change in the notion of equilibrium is not sufficient, according to Garegnani (2000), to
avoid the same difficulties related to the notion of capital which reappear, albeit in a different form, in
these modern reformulation of the neoclassical theory.
7
One very relevant feature of classical analysis is the separation of the determination
of prices and the determination of quantities in two different stages of the analysis.
As is known, the analyses of value and distribution proper to classical economists are
based on the concept of social surplus; i.e., that part of social production which exceeds
what is necessary to reintegrate the means of production and the means of subsistence.
The distribution of such social surplus depends on arbitrary and socially-determined
rules deriving from power relations (i.e. the relative strength of workers and capital
owners), which give rise to the determination of the real wage9.
Outputs are given when determining relative prices and the residual distributive
variable, which implies that the classical theory of distribution may be regarded as
‘open’ (i.e. neutral) with respect to the theory of output determination. It is thus
compatible, in principle, both with a theory of output implying a tendency to full
employment (or full utilization of productive capacity) and with a theory conceiving
unemployment and/or underutilization of capacity as normal phenomena. Different
'closures' as regards output determination, in other words, are possible. We might
maintain that classical theory is endowed in this regard with a 'degree of freedom' with
respect to marginalist theory, which is instead characterized by a strict necessary
connection between output and distribution, since the determination of wage and
interest by means of the demands and supplies of factors of production necessarily
entails the tendency to full employment.
The characteristics of classical analysis have been further clarified by Garegnani
(1984) by means of the notion of the 'core'. As is known, Garegnani (1984; see also
1990b, 2002) identifies the core as that part of the theory in which the general and
necessary quantitative relations between relative prices and distribution are defined once
the technical conditions of production, the levels of outputs, and a distributive variable
are given. The core contains the necessary and general quantitative relations between
the data and relative prices, but by no means does it represent the entire field of
economic analysis.
On the contrary, it is a very limited analytical field in which strictly deductive
relations may be defined on the basis of the given variables and the competitive rule of
uniformity of the rate of profits.
This does not exclude from the sphere of interest of economic theory either the
determinants of output levels and distribution or, for that matter, the study of the forces
determining accumulation and technical progress. But, according to Garegnani, the
classical economists recognized that the determination of such magnitudes is likely to
be influenced by plural and complex forces, of different intensity and effect in different
circumstances. The study of the determinants of output belongs, in the classical
structure of analysis, to the relations that lie outside the core, which are different in
nature, and must be studied differently, from the relations within the core.
The magnitudes which are taken as given when studying the relations between
9
Or the rate of profit, as in Sraffa’s system.
8
relative price and distribution, as Garegnani (2002) notes, should be considered by no
means as ultimate data of the theory, but rather as 'intermediate' data, i.e. as variables
which are exogenous only with respect to a specific problem, studied in a specific part
of the theory, and whose determinants are studied in another part of the theory. Such a
procedure is possible only in a theoretical framework which envisages the abovedescribed separation in different stages of analysis, and would be utterly inconceivable
in neoclassical theory, which is instead logically based on the simultaneous
determination of prices, distributive variables and quantities produced and exchanged,
on the basis of ultimate data.
This also entails, it is worth noting, that the relations which lie ‘outside the core’ are
generally much more complex than the relations within the core and thus require a
different method of analysis: political and social factors play a fundamental role, but
they are likely to act with different intensity according to differences in formal and
informal institutions and to the specific historical and political context.
It follows that such relations cannot be expressed by means of simple and general
quantitative relations of the same nature as those which govern the relations between
relative prices and the rate of profit, being less general and more historically-determined
than those involved in the determination of prices. Rather than definite, general and
univocal relations, what is at stake are ‘systems of influences’ with multiple
interrelations and a strong role for specific historical circumstances.10
As will be seen in the next section, the separation between determination of output
and determination of prices and the methodological characteristics of classical political
economy are at the basis of the theory of growth which has been developed in the
modern classical approach.
5. The Classical-Keynesian approach to the analysis of growth
5.1. Elasticity of long-period output
If we should use a single phrase in order to define in brief the Classical-Keynesian
approach to growth, we could say that it is essentially based on the recognition of the
wide margins of elasticity with which output responds, in the long no less than in the
short period, to changes in aggregate demand. The elasticity of output with respect to
aggregate demand, which is the very core of Keynes’ contribution as regards the shortperiod theoretical context, is due, in the short period, to the possibility of varying the
utilization of installed fixed capital and of the available stock of labour and other
resources. In the long period such elasticity is further increased by the possibility of
creating new resources, or destroying the existing ones, at different possible speeds.
The potentiality of such process of endogenous creation/destruction of resources in
10
As noted by Garegnani (1990b, 2002), the method of analysis for outside-the-core relations is a
mixture of induction and deduction, with a role both for theoretical abstraction and observation of reality,
very different, as such, from the entirely deductive method of marginal theories.
9
widening the margins of output elasticity has been originally highlighted by the authors
in the Classical-Keynesian approach (see especially Garegnani, 1992; Vianello, 1985;
Ciccone, 1996) as a critique of the idea, implicit in some Keynesian approaches to
growth, that in the long period the amount of output is quite rigidly linked to the amount
of capacity thus leaving less space for the level of output to adjust to changes in
demand.11
A crucial notion is the elasticity with which plants (and fixed capital in general) may
be used according to the requirements of production (Ciccone, 2011, p. 77-8). The very
definition of normal utilization of capacity implies that overutilization, as well as
underutilization, is technically possible even for protracted periods of time. Normal
utilization does not in fact coincide with full utilization, the latter being the maximum
amount of output which could technically be obtained by fully using all available
equipment and plants.12 On the contrary, ‘normal’ utilization is an economic and not a
technical concept and is defined as the average ratio between output and full capacity
output which entrepreneurs expect to realize on newly installed capacity (White, 1996).
Following Ciccone (1986), who in his turn founds on Steindl’s classical analysis of the
issue, it is plausible to assume that firms tend to install more fixed capital than they
could utilize fully, especially due to the fluctuations in demand they expect to face.
Capacity will be dimensioned at least on the peak levels of demand, thus giving rise to
the expectation of using it, on average, less than fully.13
Once this potential flexibility in the use of capacity is properly acknowledged, it
follows that to state the rigidity of output with respect to demand, besides being
unwarranted from a realistic point of view, is completely alien to the basic Keynesian
proposition that no mechanism whatsoever ensures the tendency of the economy to fully
(or normally) use the available resources.
This variability in the use of capacity is also at the basis of the mechanism whereby
the amount and pace of growth of capacity and resources tend in the long period to be
influenced by the state of demand. Once a tendency of aggregate demand to be
particularly high for a certain protracted period should appear in the economy, this
would produce a prolonged overutilization of existing plants and other means of
production. This will sooner or later induce firms to create new resources or to
11
We especially refer to the so-called ‘Cambridge theory of distribution’ (Kaldor, 1955-6, Robinson,
1962), which interprets the extension of the principle of effective demand to the long period as the need to
identify a different adjusting mechanism of saving to investment, due to the assumption that long-run
output is not elastic and cannot react to changes in demand. The hypothesis that workers and profitearners have different propensities to save entails that changes in distribution may act as the adjusting
mechanism: the theory thus postulates a strict and necessary direct relation between the rate of
accumulation and the rate of profit.
12
It is assumed that neither labour nor natural resources represent a constraint.
13
Founding on Steindl’s analysis Ciccone (1987) maintains that the hypothesis of the existence of
systematic spare capacity does not contrast with the principle of profit maximization, if the latter is
interpreted as including a long-run ‘strategic’ element which implies that firms do not want to lose market
shares in favour of competitors. The strategic element even induces firms, according to Steindl (1952) to
install capacity in excess of the expected peak demand, in order to face unexpected increases in demand.
For the determination of utilization from the point of view of the choice of technique see Kurz (1986).
10
accelerate the pace at which they are created. Symmetrically, the underutilization of
existing capacity, if sufficiently protracted in time, will induce firms not to reintegrate
in full the worn-out capacity, and to let part of it destroy. After a certain period, the
unused capacity will simply disappear.
It has to be noted that this process of creation or destruction of resources has
enormous potentialities: a single-period underutilization does not only imply the
immediate loss of output with respect to installed capacity but also the loss of the output
that could have been produced in case new capacity had been installed in response to
higher utilization and then normally used. As shown by Garegnani (1992), such losses
may even be quantified, on arbitrary but not implausible hypotheses on the value of the
different parameters, and prove to be such that even a limited underutilization may
imply in few decades a cumulated loss of potential output which is at least equal to the
level of the whole initial capacity.14
Such endogenous process of creation or destruction of resources is by no means
limited to fixed capital or produced means of production, but refers also to labour. The
high elasticity that labour supply shows in reality, given sufficient time, to changes in
demand for labour has been noted by some authors, as for example Kaldor (1985), and
is based on a whole series of different adjustment mechanisms, such as changes in the
labor force participation rate, migration flows, transfers between low-productivity and
high-productivity sectors within the economy15.
Over long periods and in the generality of cases, it is unlikely if not impossible to
observe phenomena of underutilization of labour or of fixed capital which imply that as
much as (say) 80 or 90 percent of existing resources are left idle, due to the fact that
unused resources tend to shrink and progressively disappear. This may contribute to
what Garegnani and Palumbo (1998, p. 11) have defined as the ‘optical illusion’ which
has induced many authors – and some prominent Keynesians between them – to believe
that the margins for output expansion in response to changes in demand are narrower in
the long period, while the very endogenous creation of resources makes them actually
wider.16
The dependence of the evolution of productive capacity on the expansion of actual
output and demand which is proper to this approach is the very result of the extension to
the analysis of growth and accumulation of the Keynesian principle of effective demand
14
On the assumption of a propensity to save equal to 0,2, and a 0,5 output/capital ratio, Garegnani
(1992) shows that a 10 percent underutilization of capacity in a single year determines in about 40 years a
loss of capacity of the same amount of initial capacity.
15
It is interesting to note that the recognition of such phenomena did contribute to induce Kaldor, in
a later phase of his analysis of growth, to abandon the full-employment hypothesis and to elaborate an
explanation of growth in which demand (particularly for exports) played a fundamental role. See Palumbo
(2009).
16
When long-run output elasticity is taken into due account, the necessary link between
accumulation and distribution envisaged by the Cambridge theory of distribution disappears. No
necessary trade-off between investment and consumption exists, while the equilibrating mechanism
between savings and investment envisaged by Keynes, based on the variations of the level of income, also
holds in the long period. See Garegnani (1992) and the other literature quoted in the text.
11
freed from the constraints of the adhesion to the marginalist principles of distribution.
The attribute of ‘Classical’ to this Keynesian approach may be regarded as due in the
first place to the role played by the modern reappraisal of the Classical Political
economy to free Keynesian ideas from marginalist principles.
The same attribute however is also well justified on other considerations. The
specificity of the Classical-Keynesian approach to the analysis of growth, with respect
to other theories of growth that share the idea of the fundamental role of aggregate
demand in shaping the system’s path of growth, is the reference to the classical theory
of value and distribution. This has at least two straightforward implications: the
proposition that ‘normal’ positions of the system are characterized by an inverse
relationship between real wage and the rate of profit (in other words, a conflict view of
distribution), and the independence between accumulation and distribution and their
separate determination. The latter is a direct implication of the above-described
analytical structure of classical economics, and of its characteristic separation in
different stages of analysis.
This separation of course does not amount to denying the possibility of mutual
interrelations, of multiple (and even contrasting) influences between the forces
determining distribution and those determining output and growth. Just to make an
example, while in the generality of cases a phase of rapid accumulation may be said to
positively affect the bargaining power of workers, and thus to be likely associated with
high or growing real wages, rapid accumulation may also be associated with stagnating
real wages if, for example, it is based on the opening and fast expansion of commercial
interchange with lower-wage areas.
What instead seems to be incompatible with the basic structure of classical analysis
is the idea of a uni-directional, general and necessary relationship between the rate of
accumulation and normal distribution of income, as for example the one postulated by
the Cambridge theory of distribution.
Equally fundamental, as maintained above, is the recognition of the existence of a
trade-off between the real wage and the rate of profit, both an essential characteristic of
the actual working of real economies, and a basic implication of the classical theory of
distribution. The distributive conflict surely plays a fundamental role in the process of
growth. The absence of a univocal relationship between accumulation and distribution
does not imply, as maintained above, the absence of mutual interrelations between the
two, and different distribution structures may prove more or less favourable to growth.
Conflict, and the way it is ruled, may consequently bring about accelerations or
decelerations in the process of growth and influence the sectors or the parts of the
economy towards which it is directed.
This conflict view of distribution sets the Classical-Keynesian approach apart from
other approaches, like the ‘Kaleckian’ one (Rowthorn 1981; Amadeo, 1986, 1987),
characterized by the recognition of the fundamental role of demand but postulating the
possibility of a direct (and not inverse) relationship between the real wage and the rate
12
of profit.17 The critical literature (Committeri, 1986; Ciccone, 1987; Vianello, 1989;
Park, 1995; Trezzini, 2011; Cesaratto, 2012), has shown that such proposition derives
from an unwarranted identification between the realized rate of profit and the normal
one, and from lack of appraisal of the role that normal capacity utilization plays in
determining relative prices and normal distribution. Given the possibility of installing
capacity which is adjusted to expected demand, it is in fact logical to assume that
normal utilization is what firms expect to realize on the flow of newly installed
capacity. Thus, normal utilization is the only one relevant for investors’ decisions,
which implies both that the inverse relationship between real wage and the rate of profit
necessarily emerges (see also Committeri, 1986; Ciccone, 1986), and, again, that no
systematic and uni-directional influence may be detected of the level of activity on
distribution of income.
We may thus conclude that the Classical-Keynesian approach describes the growth
process as a process characterized by long-run output elasticity, endogenity of resource
formation with respect to demand, conflict view of distribution and independence (but
reciprocal influences) between accumulation and distribution. The basic proposition is
that no automatic mechanisms guarantee that a market economy, left to itself, tends
necessarily to fully utilize available labour and available resources. Moreover,
endogenity of capacity implies that actual underutilization tends normally to be
underestimated, at least if measured against long-period production potentialities.
6. Some open questions in the Classical-Keynesian approach: capacity
adjustment and path dependence
As maintained above, the separation of analytical stages proper to classical analysis
and the distinction between relations within the core and relations outside the core have
relevant implications as regards the method of analysis to be used in addressing the
different theoretical questions. The study of the determinants of output and of
accumulation processes belongs to the category of relations which lie outside the core. It
cannot therefore be addressed with the same kind of abstract deductive method which is
used in order to study the relationship between distribution and relative prices which
form the core of the theory, but rather with the above-seen approach made of a mixture
of deduction and observation, where historical, political and social phenomena are given
a fundamental role.
It is worth noting that institutional and political factors are by no means, in the
classical approach, mere disturbances or imperfections as is implicit in the neoclassical
framework, where the economic result that the system achieves is the effect of ‘natural’
ultimate determinants. On the contrary, they are to be seen as factors that affect and
17
This derives in Kaleckian models from assuming a positive influence of higher real wages on
aggregate demand, which gives rise to increased production and increased utilization of capacity,
generating higher profits out of the same stock of capital.
13
dramatically modify the relations themselves, and as the very ultimate determinants of
the economic variables.
In our opinion, the implications of this methodological attitude as regards the
analysis of growth are fundamental and far-reaching. We will try to address this
question through the analysis of the controversial issue of capacity adjustment.
6.1. Variability of long-period utilization of capacity and the role of normal prices
As maintained above, the authors in the Classical-Keynesian approach start from the
common ground of the classical theory of value and distribution as the basis for the
long-run principle of effective demand, the independence between accumulation and
distribution, the relevance of socio-institutional factors in shaping the process of
growth. They recognize the high flexibility in the use of capacity, and on this basis
identify a mechanism of endogenous creation/destruction of resources in response to
changes in demand which is the basic characterization of the growth process.
Although this mechanism of adjustment of capacity to demand is a crucial
characteristic of the growth process for all the authors in the approach, a difference has
emerged among them about the analytical role to be attributed to the so-called ‘fully
adjusted situations’ (the definition is originally due to Vianello , 1985), i.e. positions of
the economy characterized by complete adjustment between demand, output and
capacity, which should supposedly represent the final point of the adjustment
mechanism.
Some authors in the classical-Keynesian approach express the long-period
relationship between the level of output and autonomous demand through the notion of
‘supermultiplier’ (Serrano, 1995; Bortis, 1997; Dejuan, 2005; Freitas and Dweck, 2013;
Cesaratto, 2012) which represents, for each level of autonomous demand, the output
that would be produced if the tendency of capacity to adjust to demand should realize
fully and entirely.18 Capacity-creating investment is regarded in this case as entirely
induced and such as to continuously adjust the size of capacity to aggregate demand.
The latter contains an autonomous element which is identified with ‘unproductive’ (i.e.,
non-capacity-creating) expenditure. Output and capacity would be determined by
demand through adjustment of the relative shares of autonomous demand and
investment, without the need of postulating changes in normal distribution; while
normal utilization would be ensured by capacity growing in step with demand.
Other authors (Trezzini, 1995, 1998, 2013; White, 2006; Smith, 2013; Palumbo and
Trezzini, 2003; Palumbo, 2013) have exposed the limits of these models. The model
would only show convergence to fully adjusted situations if autonomous expenditure
were to grow for an unlimited long period at a constant rate and if entrepreneurs formed
their expectations about capacity requirements not on the basis of demand facing the
individual firm but on the evolution of the autonomous components of aggregate
18
The supermultiplier, originally proposed by Hicks (1950), is the coefficient linking output to
autonomous demand in the hypothesis that investment may be expressed as a function of output. Serrano
(1995) has been the first to propose its use in the modern classical approach to growth.
14
demand (see Trezzini, 2013 for a synthetic account of the criticism). Such constraints
seem both unrealistic and in contradiction with the idea of the autonomy of demand.
Following this second route, we will propose here an analysis of the growth process
which regards lack of full adjustment between capacity and demand as the normal
situation of the system and does not assign any role to fully adjusted situations, neither
in representing the state of the system nor in guiding the analysis (see also Palumbo and
Trezzini, 2003).
Although capacity is installed on the basis of expected demand, once capacity comes
into existence, actual demand is independent of it. On the basis of the non-existence of
equilibrating mechanisms (as results both from Keynes’s analysis and from the critique
to the equilibrating mechanisms of neoclassical theory), it cannot be assumed that actual
demand must necessarily be equal to that required for normal utilization of installed
capacity. This does not depend solely on the possibility of wrong expectations. Rather,
there are a number of reasons why we may assume that capacity will not react instantly
and adjust fully if demand happens to change during the life of fixed capital.
In the first place, due to the elasticity in the utilization of fixed capital, i.e. the
possibility of obtaining various different levels of output from a given stock, firms are
likely to try to correct over- or under-utilization of fixed capital only when it is
perceived as systematic and not transitory (see also Hein, Lavoie and van Treeck, 2008,
p. 30-1), i.e. after a period in which average actual utilization has proven to be different
from normal. In the second place, when demand and production requirements change,
due to the durability of fixed capital, existing plants and equipment may continue to be
used until they can contribute to production, even if their use is not required in the new
dominant techniques and does not give rise to normal profits.19 In the third place, the
very process of adjustment of capacity implies new flows of demand which may operate
against adjustment (Trezzini, 2013; White, 2006). It may even be maintained that the
high elasticity with which fixed capital may be used makes the precise definition of
normal utilization uncertain, and that a whole range of ‘acceptable’ degrees of
utilization instead of a single ‘normal’ degree should be identified (Dutt, 1990; Hein,
Lavoie and van Treeck, 2008; Parrinello, 2014).
It may thus be concluded that the tendency of capacity to adjust to demand, though
always at work, never realizes in full, and that consequently there is no reason to regard
fully adjusted situations as relevant for studying growth processes. As noted by Ciccone
(1986), this does not imply that normal prices and the uniform rate of profit, which are
defined with reference to the dominant techniques and thus implicitly also to the normal
19
The techniques chosen by the entrepreneurs on newly installed capacity may be defined as
‘dominant’, i.e. as the most efficient among the sufficiently widespread ones (Vianello, 1989, p. 173).
They may well coexist with some newer, still more convenient techniques, which are ‘susceptible of
becoming dominant at some point in the future’, and with less convenient techniques, employing fixed
capital items which would not be chosen currently, but which it is convenient to keep and employ ‘for
what they can get’ (Sraffa, 1960, p. 78). Parrinello (2014) suggests to treat existing fixed capital as a
means of production of different quality relative to the machines installed through the flow of new (gross)
investment.
15
degree of utilization of capacity, lose their role in the analysis. On the contrary, the
normal rate of profit is the only relevant for investors’ decisions, since it is what they
expect to realize on their newly installed capacity. Gravitation towards long-period
prices does not require the simultaneous gravitation of the effective utilization of
capacity around its ‘normal’ level (Ciccone, 1986). The degree of utilization which is
relevant for prices is in fact the one which entrepreneurs expect to realize on the flow of
newly installed capacity, which they are planning as adjusted (both in size and
composition) to expected demand.
The process of growth may thus be studied by making use of the normal long-period
positions as the analytical points of reference. Such positions may be regarded as
characterized by normal prices and normal distribution, and by adjustment of output
levels to sectoral demands―which also implies adjustment of total output to the level of
aggregate demand―with this latter adjustment not necessarily implying full adjustment
of the whole stock of capacity.
It is worth noting that, if there are reasons to consider the tendency of fixed capital to
adjust to the changing requirements of production as slow and imperfect, something
similar may be maintained as regards labor. The different mechanisms through which
labour supply reacts and adjusts to labor demand may imply very different adjustment
speeds, and in some cases involve processes that may fully manifest themselves in
generations. In addition to that, and perhaps more importantly, there are reasons to
believe that the existence of a non-negligible amount of unemployment is always
required, as an essential condition for ensuring stability of market economies (Kalecki,
1943).
In our opinion, there are reasons to regard this account of the growth process as a
direct application, from the methodological point of view, of the above-described basic
characteristics of classical analysis. No unique cause or unidirectional force is in fact
recognized in driving the evolution of capacity in the long-run. Although the tendency
of adjustment to demand is a recognized as a fundamental force, it is admitted that
investment decisions may be subject to a plurality of influences, with potentially open
results.
6.2 Path dependence of growth processes as a fundamental feature of the ClassicalKeynesian approach
If the analytical and methodological implications of the classical approach are fully
developed, it follows that growth processes cannot be conceived as following regular
pre-ordained trajectories. The fundamental characteristic of the system is the absence of
any automatic mechanism ensuring full utilization of resources, which implies the
impossibility of knowing in advance the level and composition of output that the
economy will realize. Such level and composition will affect the very way in which
resources will grow from that moment on. At each point in time, not a single path of
growth but a plurality of possible growth paths opens up, with actual demand conditions
determining the relevant one. The way the system develops in any period determines the
16
whole set of possibilities for the following period, so that growth may be described as
an open, path-dependent process. Cyclical fluctuations, in this account, are not to be
regarded as determined by separate causes, but rather as an essential part of the growth
process itself (Trezzini, 2013), because it is precisely with the intensity and frequency
of booms and slumps that the trend of actual growth materializes and influences the
potential path.
Thus an ‘historical’ method has to be employed in the analysis of accumulation
processes, which implies that the simple and clear-cut relationships which could be
stated with reference to the hypothetically fully adjusted situations cannot be
representative of the actual relations between them.
The use of quantitative functional relationships should be limited to the construction
of ‘examples’ or ‘models’ which allow and facilitate abstract reasoning, without being
the representation of the general form of relations between variables. In fact, the aboveseen variability of the relations according to the specific historical circumstances
implies that no general quantification is possible.20
The historical method also implies that growth processes cannot be studied, as
instead happens frequently also in neo-Keynesian or neo-Kaleckian models, by referring
to steady state growth paths, characterized by constant relations between variables and
constant and uniform growth in time. Such paths imply a constant ratio between output
and capacity, thus excluding the very elasticity of output which we have defined as the
main characteristic of the approach (Garegnani, 1992).21
7. The implications for economic policy
In drawing the policy implication of the Classical-Keynesian approach, it is worth
stressing that some of the policy analyses and prescriptions which derive from this
approach and which we are going to describe are by no means exclusive of this
approach. Other approaches, especially those founding on the role of aggregate demand
in the growth process, do in fact share at least some of the considerations and
conclusions here discussed.
The central proposition of the Classical-Keynesian approach is that no mechanisms
whatsoever ensure full (or normal) utilization of resources. This calls into question the
very roots of the corpus of analysis and policy prescriptions arising from dominant
theories: i.e. the principle that the forces of supply and demand lead to full and efficient
20
See on this respect Palumbo’s (2011) critical analysis of balance-of-payments-constrained growth
models: though the notion of external constraint may be very useful in identifying a possible obstacle to
growth in many circumstances, not only does it defy any general quantitative representation, but it cannot
be considered as a general theory of long-period output.
21
At the same time, it has been noted (Committeri, 1986; Trezzini, 2011) that the use of steady
growth paths with different-from-normal utilization in the Kaleckian models of growth is contradictory,
because they would imply that firms did not undertake any action in order to install an amount of capacity
which is likely to be required on the basis of expected demand and to correct possible misalignments.
17
use of available resources, namely the principle of optimality of market economies (see
Garegnani, 2007).
The denial of the spontaneous tendency to full employment and the recognition of
the potential elasticity of production with respect to changes in aggregate demand imply
that the spontaneous outcome of market forces could well be represented by normal
stable positions of the economy22 in which from a strictly technical point of view it is
possible to increase the well-being — at least the one connected with the availability of
produced goods — of a part of the population without necessarily diminishing that of
other parts.
The notion of Pareto optimality is strictly related to the principles ensuring the
tendency to the full and efficient use of available resources. The bulk of policy analysis
and policy prescriptions which are to be found in the literature are based on such notion
and such principles.
They imply the notion of scarcity (understood as scarcity of the means available to
reach the social ends) and imply as a necessary consequence the existence of a whole
series of trade-offs which dominate policy analysis and influence policy prescriptions.
The alleged tendency to the full and efficient use of resources proper to neoclassical
theory leads to postulate a necessary trade-off between (public or private) consumption
and growth and accumulation.23
The tendency of actual income to potential income, in fact, implies that in
neoclassical theory any increase in private or public consumption corresponds to a
necessary reduction of actual savings, which also implies a reduction in actual
investments, with negative consequences on the pace of growth of capacity, potential
and actual output.
In other words, to assume that output constantly tends to its potential level and is
solely determined by supply factors, being thus necessarily inelastic to any autonomous
change in demand, necessarily implies a trade-off between investment (and thus
accumulation) and any other component of aggregate demand.
Thus private consumption, government spending, social expenditure are seen as
draining on resources and weakening the possibilities of accumulation and growth. This
trade-off dominates, of course, the debate over the presence of the state in the economy,
welfare systems, deficits and public debt. The spontaneous tendency of the economy to
optimal use of resources also dominates the debate on foreign trade: any policies which
increase openness to trade is prejudicially regarded as desirable, while industrial
policies which aim to foster or subsidy specific sectors or to protect others are seen as
distortionary.
The completely different theoretical and conceptual framework of the Classical22
We refer to positions which are not merely transitory i.e. positions of the economy which in
marginalist terms would be defined ‘equilibrium’ positions.
23
As regards to the alleged trade-off between growth and private consumption also see Garegnani
and Trezzini (2010), which conceive the asymmetric behavior of private consumption in the business
cycle as a source of endogenous growth driven by demand.
18
Keynesian approach implies that the narrow limits that Pareto optimality of market
economies imposes to economic policy entirely dissolve. It leaves the possibility open
of regarding policy measures as potentially increasing the general welfare. No market
mechanism ensures that the configuration spontaneously reached by the economic
system24 is desirable from a social point of view. Policy measures contribute to create
new conditions that may (or may not) imply increased utilization of resources, better
allocation of them, different growth potentialities and different distribution
arrangements.
The scope for public policies becomes wide.
It should also be noted that to recognize the fundamental role of demand does by no
means imply that public policies should only aim at fostering demand in quantitative
terms, and that any expansionary policy is to be regarded as equally desirable. On the
contrary, the very recognition of the arbitrariness of the result spontaneously reached by
market forces implies that collective action may well aim to determine the content of
production and the particular shape that growth processes may take. Thus all industrial
policies fostering specific sectors or production, stimulating innovation, encouraging the
production of particular goods (or banning others) should be regarded in the scope of
policy-makers25.
The policy question may be addressed also from the point of view of the different
meanings of prices of commodities in classical political economy and in marginalist
theories. Relative prices, in classical political economy, express the conditions of
technical and social reproducibility of commodities (thus embodying the condition that
competition distributes profits uniformly across sectors)26. Prices of commodities,
therefore, have no relationship with the relative scarcity of resources necessary for their
production, as instead happens with neoclassical theories (see section 1 above).
This difference in the meaning of prices has wide implications. Obviously, most
kinds of public intervention, from trade policies to industrial policies, from
redistributive measures to the design of welfare institutions, and so on, necessarily
affect (directly or indirectly) relative prices of commodities. While in neoclassical
analyses equilibrium prices are indexes of scarcity of productive resources and only the
category of ‘market failures’ (be they due to market imperfections or market
incompleteness or to particular characteristics of individual goods) justifies, in specific
cases, state intervention, in classical political economy prices may be altered without
compromising any optimal allocation of resources and without interfering with any
‘natural’ forces supposedly determining the optimal equilibrium.
At the same time, the distribution of income spontaneously reached by market forces
24
In such spontaneous configuration a fundamental role is played, as noted above, by the interests,
choices and actions of the various groups of the society, by institutional arrangements, historical and
contingent factors.
25
Ginzburg (2014) defines such mix of demand and industrial policies as ‘structural Keynesianism’.
26
The conditions of reproduction of commodities are determined, in classical analysis, by historical,
social, institutional and political circumstances, also technology being historically and socially
determined.
19
is not endowed, according to the insights of the Classical-Keynesian approach, with
characteristics of ‘naturalness’ and optimality, nor is associated with output and social
welfare maximization. The idea that any actual distributive structure different from that
automatically reached by the market would necessarily generate general economic
problems (involuntary unemployment or inflation, for example) also disappears together
with the idea that determination of income distribution should be subtracted to political
influences.
On the contrary, all the possible distribution structures from that implying biological
subsistence wages and maximum profits to that with zero profits and wages absorbing
the entire surplus would, in principle, be economically sustainable.
Market forces — not the supply and demand for factors but the institutional and
political forces governing the labour market — may actually determine any of these
distribution structures. Economic policy could then either accommodate any distribution
structure achieved, or contrast it, by fostering changes and pursuing a different
distributive arrangement.27
Also the methodological characteristics of the Classical-Keynesian approach have
implications for economic policy. The approach states the impossibility of analyzing
complex economic phenomena by means of general and definite quantitative
relationships. This implies that there is less room for forecasts and projections about the
effects of different policies, both when such forecasts are based on theoretical models or
on econometric estimates of the models themselves.
This apparent weakness of the Classical-Keynesian approach may turn out to be an
element of relative strength. In the first place in fact, this implicitly shows that the
forecasts which generally accompany and support policy prescriptions are based on
inappropriate quantifications of their effects.28 What is more, this recognition leaves no
space to the illusion that simple formulas and recipes may affect the economy in a well
defined way, independently of social, political and cultural circumstances of the specific
economy and the historical phase in which the policy measure is implemented.
As a final point, we may note that it is typical of classical analysis to be aware of the
arbitrary and not necessitated nature of the particular structure of income distribution
which is generated in the economy in a certain historical period. There is thus also the
awareness that policy decisions generally favor some groups and damage others. This
implies that it is almost impossible to define what has to be understood as ‘collective’
interest independently of the point of view of specific social groups. Consequently, it
becomes impossible to present any measure of economic policy as a measure
technically necessary to better operate a mechanism (the economy) in accordance with
27
One example of such socially desirable changes is to be found in the recognition, proper by now to
a wide literature, that the distributive structure prevailing in the last few decades, by widening social
differences and income polarization, has produced disequilibria in the structure and financing of demand
of large classes of consumers, thus contributing significantly to the explosion of the 2007 crisis (see for
example Barba and Pivetti, 2009).
28
See Palumbo’s (2013) critical discussion of the standard measures of potential output as an
instance.
20
its natural rules of functioning.
The abandonment of the neoclassical vision of the economy, which had claimed to
find in the individual utility maximization and the equilibrium between supplies and
demands the alleged rational and universal basis to build a pseudo-exact ‘science’, may
lead to the return to classical political economy, a social science that studies the
relationships between human beings and real societies and the conflicts of interests.
Although less developed than the dominant approach with respect to empirical
analyses, contributions to the debates on political issues and general prescriptions of
policy, the Classical-Keynesian approach may certainly help to develop the collective
critical intelligence needed to understand and govern the complex changes in
contemporary societies.
8. Conclusion: classical features in the Keynesian theory of growth
The analysis of the previous sections aimed to give substance to our initial
contention, i.e. that the approach to value and distribution proper to the classical
economists and rediscovered and revived by Sraffa is a fruitful starting point for the
construction of a theory of output and growth.
Actually, classical analysis proves to be a solid foundation for the theory of long-run
output based on recognition of the fundamental role of effective demand in the growth
process. This is essentially based, as originally noted by Garegnani and described
above, on the absence in classical analysis of any equilibrating mechanisms (of the sort
we find in neoclassical theory) automatically driving the system towards full
employment and on the substantial ‘openness’ of the classical approach with regard to
output determination, as implied in the characteristic separation in classical analysis
between determination of prices and determination of outputs.
This implies that we do not find in Ricardo’s analysis any mechanisms automatically
ensuring full employment of labour, notwithstanding the fact that the lack of a clear
distinction between income and expenditure decisions led him to share the belief in
Say’s Law, i.e. the belief that production is not limited in general by demand. Not only
does he explicitly recognize that in some circumstances unemployment of labour may
emerge as a persistent phenomenon29; but the very mechanism that in his analysis
ensures convergence between labour demand and labour supply over secular periods
entails endogenity of labour supply to demand changes, a principle that we described as
basic to the Classical-Keynesian approach (and which is instead completely alien to
neoclassical analysis). In other classical economists (and most notably in Marx) we find
analyses of output determination, growth and accumulation where such elements as we
defined as characteristic of the Classical-Keynesian approach – both the lack of a
necessary tendency towards ‘normal’ utilization of resources and the endogenity in
29
See Principles, ch. XXXI, dealing with the introduction in the productive process of fixed capital
replacing labour.
21
resource formation – are recognized as essential.
We have also attempted to show that the methodological characteristics of classical
analysis – not only the separation of the analysis in different stages, but the use of
different methods to address the determination of the different variables – may prove
extremely fruitful for the analysis of growth processes. The ‘historical’ method with
which classical economists used to address these kinds of questions is the only method
which may take into account the complexity of the object of analysis: the plurality of
forces affecting growth determinants, the essential role of social and political factors,
the multiple and sometimes contrasting interrelations among variables.
If such type of analysis deprives economic policy of clear-cut prescriptions and
simple recipes, at the same time it offers the possibility of regarding the economic
outcome as the effect of deliberate social choices. The main analytical conclusion of the
Classical-Keynesian approach is in fact that no strictly economic rule determines the
level of output and its growth in time, but that the result that a system actually achieves
is in principle open and indeterminate.
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