6.7 A captive market: Marginalism-in-action

Marginalism reduces to a calculus of pure exchanges. But capitalism is a lot more than a set of pure exchanges of one thing for another, as we argued in Chapters 4 and 5. Thus, the one realm where Marginalism seems perfectly at home is the world of collectors. Exchanges are part of the collector’s mindset and a means by which collections are enriched, not to mention an activity that carries its own utility. Additionally, and by definition, collectibles are out of production and this renders them a perfect case study for a price theory that pays no attention to the actual production process (recall Section 6.5), save for the dis-utility involved in supplying some factor of production. Collectibles, therefore, offer Marginalism an opportunity to exhibit its wares at their best.

The best way of illuminating Marginalism’s limits is to look carefully at the one case we know in which Marginalist theory works seamlessly,²⁹ and which comes as close to a real economy without invalidating Marginalism’s insights. It was recorded by R.A. Radford, a British army officer unfortunate enough to have been captured by the Germans early in the Second World War, thus spending a long period of incarceration in a prisoner of war (POW) camp somewhere in southern Germany. A formally trained economist, Radford was delighted to see Marginalism-in-action everywhere he turned his eyes within his camp’s barbed wire. So impressed was he with his discipline’s account of life in the POW camp that, at war’s end, he published a delightful article narrating the spontaneous birth and development of a complex POW exchange economy, complete with goods markets, money markets, credit markets and even futures’ markets.³⁰

Box 6.7 Natural unemployment

In the 1970s, free-marketers returned to prominence after the shock of 1929 had consigned them to the margins. The old Marginalist dogma on unemployment (see the sixth dogma in Box 6.6) was given a makeover. Any level of unemployment prevailing while price inflation remains constant was labelled natural unemployment. Even if 30 per cent of the population are without work, as long as inflation is not increasing, most economists would refer to that unemployment rate as natural. As with all things ‘natural’, the gods are angered when humans try to interfere with them. The ancient Greeks called it hubris. And so mainstream economists tend to think that if our 'natural’ rate of unemployment is too high, the only remedy is lower wages or greater labour effort for the existing wage levels.

Radford begins his story with what happened after the initial shock of being captured bv the enemy subsided and once the first Red Cross parcels started arriving at the camp. Economic activity, he tells us, began in earnest. Initially, each section (British, French, Soviet, Canadian, etc.) bartered items among themselves, for example, coffee for chocolate Soon after, money emerged, in the familiar form of cigarettes, so that exchanges could be made even in the absence of the rather rare double coincidence of wants. Almost at the same time, some entrepreneurial men recognised the scope for improving their material circumstances (i.e. profiting, in the economists’ language) through arbitrage. The first obvious opportunity for arbitrage arose as a result of the perennial cultural difference between the French and the British: the price of tea (expressed in cigarettes) was, quite naturally, higher in the British than in the French section, where coffee was more highly prized (reflecting different relative marginal utilities). But once arbitrage began, and the British prisoners started ‘exporting’ coffee to the French section in return for tea, both prices (of tea and coffee) eventually equalised between the two sections.

With quite a few prisoners acting as middlemen and with the development of Exchange and Mart notice boards (on which buyers and sellers would post their offers and orders; e.g, ‘I am selling 2 bags of tea for 5 cigarettes. Talk to Jim, English section, 5th row, top bunk¹), prices converged and no significant profit could be made from spot trading: competition had^; pushed prices to the lowest possible level and swaps served the purpose of a more efficient allocation of given goods. It is not at all far-fetched to suggest that these equilibrium prices reflected the relative valuations of the marginal units (or, equivalently, the ratio of marginal utilities). Thus, life in the POW camp confirmed the first two dogmas in Box 6.6. In fact, as Radford’s article demonstrates, many of these dogmas proved approximately correct in the POW camp setting.

Market enthusiasts despair at the moralistic criticism of middlemen and of the idea of profiting from mere buying and selling. While most people find it hard to accept the notion of thousands of young people making oodles of money by sitting in front of a computer screen all day buying and selling unseen commodities in a virtual global market, free marketers take a different stance. Their moral defence of arbitrage is simple: arbitrage eliminates price fluctuations and engenders a kind of radical egalitarianism, as everyone ends up paying similar prices for similar goods. The removal of price and output variability allows for better planning, more investment and a stable environment that is conducive to growth. They also add, for good measure, that unfettered trade leads Jill to the greatest utility possible, given Jack’s utility level. By focusing on the utilities at the time of the exchange, Marginalist thinking eliminates the possibility of subjecting the politics and ethics of arbitrage to serious rational scrutiny. It is for this reason that banks’ trading practices prior to 2008, and even afterwards, were typically defended, deploying Marginalist language, as ‘a nasty job that someone must do’on behalf of all of us.

In Radford’s POW camp, while the arbitrageurs (especially the non-smokers) were also intensely disliked by many, it was unarguable, at least at one level, that most prisoners benefit-ted from the spontaneously created exchange economy that the traders kept going. For their aggressive arbitrage ensured that the person who craved tea the most would have to give up the fewest (and least valuable) of his other items to get it. In this sense, only a dogmatic market-hater would object. Nonetheless, as Radford makes clear, the moral concerns were not absent. Setting aside the larger ethical and political questions involved,³¹ the prisoners’ commanding officers were often worried by ‘market failures’. For instance, there were the many cases ol malnourished heavy smokers;³² or situations that threatened the men’s morale when the spontaneously generated credit and futures’ market collapsed. Crises, it seems, were a common occurrence even in this type of exchange economy were no one could be unemployed, supplies

I jj_0X 6.8 The futures’ trader: A morality tale

1

| One trader in food and cigarettes, operating in a period of dearth, enjoyed a high f reputation. His capital, carefully saved, was originally about 50 cigarettes, with which I j_ie bought rations on issue days and held them until the price rose just before the next I issue. He also picked up a little by arbitrage; several times a day he visited every i Exchange and Mart notice board and took advantage of every discrepancy between prices of goods offered and wanted. His knowledge of prices, markets and names of those who had received cigarette parcels was phenomenal. By these means he kept himself smoking steadily - his profits - while his capital remained intact. Sugar was ; issued on Saturday. About Tuesday two of us used to visit Sam and make a deal; as \ old customers he would advance as much of the price as he could spare us, and [ entered the transaction in a book. On Saturday morning he left cocoa tins on our beds I for the ration, and picked them up on Saturday afternoon. We were hoping for a cal-j endar at Christmas, but Sam failed too. He was left holding a big black treacle issue i when the price fell, and in this weakened state was unable to withstand an unexpected .! arrival of parcels and the consequent price fluctuations. He paid in full, but from his j capital. The next Tuesday, when I paid my usual visit he was out of business, j Credit entered into many, perhaps into most, transactions, in one form or another.

{ Sam paid in advance as a rule for his purchases of future deliveries of sugar, but ] many buyers asked for credit, whether the commodity was sold spot or future. Naturally prices varied according to the terms of sale. A treacle ration might be advertised for four cigarettes now or five next week. And in the future market ‘bread now’ was a vastly different thing from ‘bread Thursday.’ Bread was issued on Thursday and Monday, four and three days’ rations respectively, and by Wednesday and Sunday night it had risen at least one cigarette per ration, from seven to eight, by 1 supper time. One man always saved a ration to sell then at the peak price: his offer j of‘bread now’ stood out on the board among a number of‘bread Monday’s¹ fetching j one or two less, or not selling at all - and he always smoked on Sunday night.

|    Radford (l945)

were unaffected by forecasts and demand was given. In response, the senior officers repeatedly intervened in order both to ameliorate the market’s failures and to prevent future ones.

The quantity theory of money, Dogma 4 in Box 6.6, was also confirmed, as the general price level fluctuated with the quantity of cigarettes that came into the camp. However, the fluctuations were neither proportional nor predictable. News from the front had uneven effects and caused large waves of optimism to alternate with mass pessimism. Prices oscillated erratically and, at times, the market mechanism broke down, which meant that many prisoners ended up with stocks of items they did not want while lacking that which they needed. To limit these occurrences, the senior officers came up with an interesting plan: they attempted to introduce a new currency which would be less volatile than cigarettes and which would also help prevent the malnourishment of the heavy smokers.

Around D-day, food and cigarettes were plentiful, business was brisk and the camp in an optimistic mood. Consequently the Entertainments Committee felt the moment opportune to launch a restaurant, where food and hot drinks were sold while a band and variety turns performed.... Goods were sold at market prices to provide the meals and the small profits were devoted to a reserve fluid and used to bribe Germans to provide grease-paints and other necessities for the camp theatre... To increase and facilitate trade, and stimulate supplies and customers therefore, and secondarily to avoid the worst effects of deflation when it should come, a paper currency was organised by the Restaurant and the Shop. The Shop bought food on behalf of the Restaurant with paper notes and the paper accepted equally with the cigarettes in the Restaurant or Shop, and passed back to the Shop for the purchase of more food. The Shop acted as a bank of issue. The paper money was backed 100 per cent; and hence its name, Bully Mark. The Bully Mk was backed 100 per cent by food; there could be no over-issues, as is permissible with a normal bank of issues, since the eventual dispersal of the camp and consequent redemption of all BMks was anticipated in the near future.

Radford, R.A (1945)

At first, the camp’s ‘central bank’, that is, the Shop-Restaurant authorities (akin to the Federal Reserve-Treasury nexus in the USA or the equivalent Brussels-Frankfurt duet of the European Union) set the exchange rate: one BMk was to be worth one cigarette. Ax first, the new currency system worked well. The currency was pegged (or tied) to food, not cigarettes. As long as the Red Cross food parcels kept coming, the Restaurant was well supplied by prisoners, in exchange for Shop items, and prices were stable. But during a ‘recession’ caused by a reduction in incoming food parcels, confidence in the BMk was shaken and the currency began its steady devaluation to oblivion. In the end, it could only be used to buy dried fruit from the almost deserted Restaurant. The monetary dynasty of the cigarette had re-established itself once again.

The new but ill-fated currency was a ‘political’ instrument that the senior officers devised to intervene without however charging headlong against the torrent of market forces. But the ‘authorities’, especially the Medical Officer, did not think it was enough to stop prisoners from over-trading. It was their considered opinion that monetary intervention should be supplemented with standard regulatory measures for limiting the market’s vagaries. The authorities, thus, came up with price bands above or below which no trade was allowed. Technically, this meant that the Exchange and Mart notice boards came under the aegis of the Shop whose staff saw to it that advertised prices diverging from the ‘recommended prices’ by more than 5 per cent were removed forthwith.

While the Shop-Restaurant institution was at the height of its power, the regulatory regime worked well, using its oligopoly power to keep prices stable. But when the crisis which destroyed the Restaurant and devalued the BMk hit, prices ‘wanted’ to move much more quickly than the officers were willing or able to allow. An increasing number of notices were being removed from the official notice boards and, predictably, a black, unregulated, market emerged. The imported ‘recession’, therefore, led not only to the collapse of the currency system but also to the demise of price controls.

By the summer of 1945, the parcels stopped coming and the market crashed. Radford concludes his eloquent account in an almost utopian fashion:

On 12th April [1945], with the arrival of elements of the 30th US Infantry Division, the ushering in of an age of plenty demonstrated the hypothesis that with infinite means economic organisation and activity would be redundant, as every want could be satisfied without effort.

Marx would not have put it differently.³³

6 8 Beyond Manna from Heaven: Marginalism on wages and profit rates

In R-A. Radford’s POW camp, the items bought and sold were ‘exogenously’ provided; a kind of Manna from Heaven (or from the Red Cross, more accurately).³⁴ The exchanges between prisoners were, to a large extent, an inessential pastime. Even so, as Radford reported? energetic trading caused enough consternation and grief to create a widespread demand for some central intervention to avert crises, restrict over-trading and deal with the ethical dilemmas caused by the new market ethos in the camp.

Once we move from the communities of prisoners or stamp collectors to fully fledged capitalist economies (in which people not only swap pre-produced ‘items¹ but also work beside machines, enter into joint production, save for the future, borrow to invest and even go on strike for better wages), Marginalism finds itself totally out of its depth. When it tries ¡ts hand at analysing capitalism-proper, its otherwise perfectly sensible analytical statements about pure exchanges turn into absurd and dangerous dogmas (see Box 6.6); doctrines which both contributed to the crises of 1929 and of 2008, not to mention our inability to understand the causes of such calamities.

When arbitrage involves trading between actual producers and speculators, or the trading of financial ‘products’ that have a potential to siphon off the credit on which material production depends, the stakes rise far beyond anything we saw in the previous section. Box 6.8 contains a fictitious, but also chillingly accurate, tale of how a middleman’s activities can harm struggling producers. Yet, as we shall see immediately afterwards, the ethical dimensions introduced by projecting Marginalism onto a world of human labour are eclipsed by theoretical troubles which make Marx’s duel with the Inherent Error look like a benign sideshow.

Chapters 4 and 5 made a big deal of the centrality of free labour in human economies. The POW camp featured next to none of it.³⁵ This is precisely why its ‘economy’ was almost adequately captured by the dogmas emanating from a straightforward application of the equi-marginal principle (Box 6.6). But when material production enters the scene, the radical inadequacy of these dogmas emerges in full ®Technicolor, Before we argue this controversial point, let us revisit Marginalism’s price theoiy and, in particular, its pronouncements on the price of labour (i.e. the wage) and the reward to capital (i.e. the profit rate). With the Marginalist claim to a universal theory of price in mind (see Box 6.9), we begin with the equi-marginal principle and its derivative all-encompassing price theory in equation (6.1).

Suppose that Jill agrees to wash Jack’s shirt in exchange for 2 bags of tea. To have agreed to this deal, equation (6.1) reports that the following must hold:

Box 6.9 Of famine and arbitrage

In a small settlement somewhere in Africa, ten families grow wheat, which they take to the nearby market every year. The minimum income they need to stave off starvation is, say, $ 100 per family per annum. Output depends on the weather and the weather can be good, normal or bad. If it is good, a bumper crop of 150 tonnes is harvested. If the weather is normal, the harvest comes to 100 tonnes. But if the weather is bad. the harvest shrinks to only 50 tonnes. During normal years, their 100 tonnes fetch $ 10 per tonne at the local market. In the good years, however, they have 150 tonnes to sell and, therefore, must reduce their price to $8 to find buyers. In years with bad weather, they only bring to the market 50 tonnes and so price rises to $19. Summing up, in normal years, the settlement’s income is $1000 (or $100 per family), in good years it goes up to $1200 ($120 per family) whereas in bad years it falls to $950 ($95 per family). So. over a cycle of three years (one good, one normal and one bad), average family income is $105; that is, just above starvation levels.

Suppose that during a good year, a middleman arrives and offers them the following deal: ‘you take the 100 tonnes to the market and sell it for $ 10 per tonne, like you would in a normal year. As for the remaining 50 tonnes, you sell them to me for $8.50 per tonne. If you turn this offer down, and take all 150 tonnes to market, you will make much less money since the price would drop to $8.’ Naturally, the villagers agree. But then the bad year comes, and their crop is only 50 tonnes, the middleman sells the 50 tonnes he had stocked up during the good year and, therefore, ensures that aggregate supply is that of a normal year (100 tonnes) . The market then sets a normal price of $ 10, The middleman’s gain is: 50 tonnes x $10 minus 50 tonnes x $8.50 = $75. How do we interpret his role:

Interpretation I: Like all middlemen, his contribution to society is price stability. By buying during the bumper season and selling off when the harvest is lean, he irons out price and output fluctuations over a period of variable weather conditions. Bakeries and the wider public, who need a constant supply and predictable prices, benefit from his trading. As for his moral rectitude, the farmers did not have to accept his offer at the end of the good year. It was a free trade, one to which they consented.

Interpretation 2: He is a scoundrel who capitalises on the fact that he has money with which to trade. Without producing anything, he pockets a net profit of $75 when the harvest is bad while, in the process, condemning the poor fanners he trades with to starvation, as their average income now dips below the $100 per family starvation level.¹ Looked at intertemporally, the middleman’s profit was bought at the cost of the farmers’ suffering.

Note well that both interpretations are soundly founded on the facts. Economic analysis has no analytical means by which to privilege one of the two interpretations above on the grounds of its scientific superiority. This is another example why economics is, and can only be, political economics.

Note

1 In the good year, the middleman has helped the villagers boost their income from $1000 to $1422 (by buying 50 tonnes from them for $8.50). But during the bad year, he sells these 50 tonnes at the marketplace and the villagers (who only bring to market 50 tonnes too) now see their income crash from $950 (which is the income they would have drawn from their 50 tonnes if the middleman did not sell his 50 tonnes, thus preventing price from rise from $10 to $19) to a measly $500. During these two years (one good and one bad), the village’s average total income falls, because of the middleman, from $2150 (or $1075 per annum or 107.5 per family per annum) to only $ 1922 or $96.1 per family per annum - well below the starvation level.

f fi_0X 6.10 A thoughtful Marginalist on how labour may differ from all other

I commodities

I

|

j Alfred Marshall was one of the more thoughtful Marginalists. He tried to moderate | some of Marginalism’s more extravagant claims and to temper the Marginalists’ pro-f pensity for mathematising that is, by nature, not quantifiable: Most economic phenom-! _ena. wrote Marshall do not lend themselves easily to mathematical expression’. We must therefore guard against ‘assigning wrong proportions to economic forces; those elements being most emphasised which lend themselves most easily to analytical methods’ (Marshall, 1890 [1920], Mathematical Appendix, p.850). Nevertheless, it is instructive that even he thought that labour was, analytically speaking, no different from electricity generators, com or androids. Was there a difference between selling ‘things’ and selling one’s labour? Yes, Marshall thought, but not in the deeper ontological sense that we espoused in Chapters 4 and 5. He wrote:

When a workman is in fear of hunger, his need of money (its marginal utility to him) is very great; and, if at starting, be gets the worst of the bargaining, and is employed at low wages, it remains great, and he may go on selling his labour at a low rate. That is all the more probable because, while the advantage in bargaining is likely to be pretty well distributed between the two sides of a market for commodities, it is more often on the side of the buyers than on that of the sellers in a market for labour. Another difference between a labour market and a market for commodities arises from the fact that each seller of labour has only one unit of labour to dispose of. These are two among many facts, in which we shall find, as we go on, the explanation of much of that instinctive objection which the working classes have felt to the habit of some economists, particularly those of the employer class, of treating labour simply as a commodity and regarding the labour market as like every other market; whereas in fact the differences between the two cases, though not fundamental from the point of view of theory, are yet clearly marked, and in practice often very important.¹

Note that the emphasis in the last sentence is ours. It highlights the point that Marshall, even though sensitive to the workers’ special bargaining disadvantages, did not think (as we did in the previous two chapters) that labour was profoundly different to other commodities. In that regard, Marshall’s take on labour was like that of the other Marginalists.²

Notes

1    Marshall (1890 [1920]), v. ii § 3, pp. 279-80.

2    in his Principles (Book vi, Chapter iv) Marshall offers a number of reasons why labour is different from other commodities including the role of upbringing and education and the fact that ‘when a person sells his services, he has to present himself where they are delivered. It matters nothing to the seller of bricks whether they are to be used in building a palace or a sewer: but it matters a great deal to the seller of labour, who undertakes to perform a task of given difficulty, whether or not the place in which it is to be done is a wholesome and a pleasant one, and whether or not his associates will be such as he cares to have.’ (1890 [1920] vi, iv§5, p. 471). This led to the theory of ‘compensating wage differentials.’ in fact, since the worst jobs are highly correlated with low pay the theory suggests that inequality of wages should have been even greater if ‘psychic’ wages were not taken into account.

It is only a matter of some manipulation to show that equation (6.2) translates into a sinip|_e statement (see Box 6.11):

Wages reflect the ratio of the marginal utilities of both employer and worker.

Moving from barter (1 clean shirt for 2 teabags) to a monetised economy (like that in the POW camp once the BMk was established), the above Marginalist theory of the wage becomes even simpler. As long as workers are competing against one another:

The utility of the money wage per unit of labour equals the employer’s utility from marginal unit of labour.

Note how the above analysis is indifferent to Jill’s actual labouring, Whether Jack is paying

2 teabags in exchange for a clean shirt or for Jill’s labour input is one and the same thing" Labour inputs are, therefore, treated as no different from ‘things’. In Chapter 4 we argued that this amounts to a flight from human economies where labour is impossible to objectify even if the worker wants nothing more. But let’s set this aside, for the time being, to illustrate Marginalism’s internal inconsistencies. For, even if we were prepared to accept (which we definitely are not!) that labour input is a ‘thing’ for sale, like all other ‘things’, the Marginalist theory of the wage (and of profit) leaks like a sieve.

Marginalism’s main point is that, when workers compete against each other in the labour market, wages reflect two things:

(a)    the marginal labour unit’s output, and

(b)    the employer’s extra revenue from that output.

Box 6.11 The Marginalist calculus of wages

Suppose that for every util Jack forfeits when paying Jill (in tea, cigarettes or dollars) j he gets 3 utils when she washes his shirt for him. Then, by equation (6.1), Jill must receive one of her utils from her ‘wage’ for every 3 utils she forfeits when washing Jack’s shirt. Let the dis-utilities be thought of as the ‘price’ paid by Jack and Jill. Jack pays the ‘price’ of forfeiting two teabags (p_K) and Jill pays the ‘price’ of labouring to wash his shirt (p_L). They do this in exchange of the following utilities:

•    Jack’s utility for not having to wash his marginal shirt = MU_K

•    Jill’s utility from the two teabags = MU_L

Re-writing equation (6.2), using the new notation, we derive:

MU_k _ MU_L MU,

El

Pl

(6.3)

Pk Pl MU'

And since the ratio Pk!Pl can be thought of, simply, as a measure of the wage (relative to the worker’s disutility), it turns out that the equi-marginal principle is telling a simple story identical to that it tells regarding all prices ~ recall equation (6.1).

Indeed, the employer’s marginal utility from labour (which determines the wage, according ■) the equi-marginalprinciple) is no more than the product of (a) and (b). Marginalists refer p (a) as the marginal productivity of labour (denoted by MP_f) and to (b) as the employer’s marginal revenue (MR). The product of (a) and (b) is known as labour’s marginal revenue product (MRPl )■ Summing up, the theory concludes that (as long as workers compete against \nc another) the wage stabilises at a level equal to labour’s marginal revenue product.

The money wage equals the product of labour’s marginal productivity and the employer’s marginal revenue, known as labour’s margined revenue product, MRP_L OR

_w = M.P_l x MR = MRP_{l    4)}

An identical logic is deployed in explaining capital’s price, or rate of return, or profit rate or whatever we may wish to call it. Capital, just like labour, is seen as a ‘thing’ for sale and equations (6.3) and (6.4) are repeated, only this time in terms of the capitalist’s marginal dis-utility from providing capital (which is due to deferring consumption into the future), the marginal productivity of capital (MP_k), etc. The gist of the matter is that:

The price of capital, which is the same as the profit rate n, equals the product of capital’s marginal productivity and the firm’s marginal revenue; that is, capital’s marginal revenue product (MRP_k)

OR

p = MP_k x MR = MRP_{k    (6 5)}

All of the above is a complicated way of telling a terribly simple story: both capital and labour are rewarded by a payment reflecting the capacity of the last unit of capital or of labour to add to the firm’s net revenues. As for the quantity of capital and labour the firm will engage, the answer (again courtesy of the equi-marginal principle) could not be simpler: capitalists will recruit more labour units until the wage rate exactly equals the capacity of the last unit of labour to add to the firm’s revenues. Similarly, they will keep 'hiring’, or enlisting, more units of capital until the cost of each unit of machinery equals the capacity of the last unit of machinery to add to the firm’s revenues.

6.9 Marginalism and the Inherent Error, part 1: The trouble with capital

A theory that cannot see the profound, ontological, difference between labour input and some material quantifiable input like electricity is unsuitable for the purposes of illuminating capitalism’s ways. At least this was our argument in the preceding two chapters. Interestingly, even if we were prepared to recant and enthusiastically accept Marginalism’s basic premise (that labour is ontologically no different from electricity), it turns out that the resulting (Marginalist) analysis of capitalism is incoherent on its own termsl Indeed this section explains how the Marginalists’ ambition to elucidate all prices in terms of the equi-Mtrginalprinciple proved an open-ended invitation for economics’ Inherent Error to return. And when it returned it did so with unprecedented vengeance. It inflicted so formidable a retribution, wrecking Marginalism’s scientific claims with abandon, that under normal circumstances we should not be discussing Marginalism at all, except perhaps in a book on heroic intellectual failures. But, regrettably, our circumstances are far from normal.

We live in a world in which Marginalist economic thinking is the secular religion. It pro, vides the rhetorical framework in which all the important debates are couched. Central bank-ers and hedge fund managers, presidents and prime ministers, ambitious opposition politicians and even many trade unionists, influential journalists and well meaning environmentalists-they all formulate their thinking and policy proposals within the straitjacket of Marginalist thinking. With their imagination severely circumscribed by the Marginalist framework, thev acquiesce to a narrative conducive to catastrophic practices. And none of these are more catastrophic than those concerning the markets for labour and capital. This is why the present section puts under the microscope Marginalism’s claims regarding wages and profit rates and explains how the Inherent Error returned to destroy the logical coherence of its claims,

Marginalists, as we have seen, delegate all social explanation to subjective appraisals or utility. But if production is to be defined as the costly generation of utility, professional comedians are producers. Fair enough. But what of the friend who makes us laugh aiound the dinner table? Is he/she a producer too, even though he/she may be having just as much fun as we are? And if so, what is his/her capital? Could it be his/her stock of jokes? Perhaps. But then what is the difference between his/her utility from making us laugh (his/her notional wage) and his/her profit? These simplistic questions echo Marginalism’s difficulty to distinguish between production and consumption, capital and labour, wages and profit. They mav sound frivolous but they pack important insights into why the dominant economic thinking of our day finds it so hard to recognise that which most sensible people already know and worse, remains blind to the less visible causal relations surrounding us (see Box 6.12 for an example).

in the last section we became acquainted with Marginalism’s main theory of distribution which, in fact, could be framed in quasi-ethical or political slogans:

each according to the market value of her marginal product! All powers to marginal productivity and to the price the final product can fetch at the marketplace! Labour and capital earn their keep in proportion to the revenue generated for the firm by their last unit!

Note that, in tliis context, only one determinant of wages and profit rates lies outside the firm: the price of the final commodity, which determines the market value of the marginal product of both capital and labour. As long as capitalism is competitive, nothing else that goes on in the economy at large (and which is independent of the final product’s price) matters in the determination of wage and profit rates.

Ignoring any external critiques (such as those in Box 6.13 below), how coherent, or internally consistent, is this view? Not much, we shall be arguing. Starting at the level of the individual firm, suppose that Jack and Jill are employees working in the bread industry. Jack works for the Sliced Bread Co. and Jill for the Wholesome Bread Co. Suppose, however, that the Sliced Bread Co. is antiquated and uses old electric ovens whereas the Wholesome Bread Co. uses modem low-energy industrial microwave ovens. There is only one way the Sliced Bread Co. can survive: by having Jack work harder than Jill in order to compensate for its slower, more expensive, ovens. At the end of the day, one of our two workers works harder than the other and yet both the products of their labour sell at the same price and both col lect the same wage. Because of the difference in the machines used, Jack’s payment per unit of labour supplied is lower than Jill’s. But because the political economics built upon the | gox6.12 The discovery of domestic labour

) Are women who give up their jobs to raise their children producers? If they enjoy I doing it, they can be said to gain utility directly from the activities involved, in which I _case they may be thought of as consumers. In contrast, if they loathe changing nappies j ¡3_Ut do it for the future rewards of parenthood, they are investors. Producers even! But I does this mean that only disgruntled stay-at-home mothers are producers, while the I perfectly blissful ones are not? Surely this is absurd. For centuries housework was

i considered a woman’s duty, if not her calling, pleasure, purpose in life. No one thought of them as producers. Marginalism, alas, did not help in this regard, since it could not tell the difference given its recourse to the definition of production as a form of utility generation. Feminists, on the other hand, protested that women were called housewives so as to hide the fact that they were unpaid producers of housekeeping services (some cheerful, others desperate). This later view seems to resonate better with our times. What has changed? Marginalism cannot say. However, deploying the perspective of the last two chapters (which makes room for the dialectical overcoming of binary contradictions), a useful answer emerges. According to one such argument,¹ the emer-i gence of a new economic sector that provides many housekeeping services for a price I reflecting the cost of waged labour (e.g. domestic cleaners, professional nannies and contractors undertaking various housekeeping chores) has brought into light women’s unwaged work. Marginalism, by focusing exclusively on the utilities of the contracting parties, has no way of seeing, let alone recognising, this type of social dynamic.

Note

j 1 See Himmelweit (1995).

equi-marginalprinciple [e.g. equation (6.5)] leaves no room for the difference in qualities or vintages of capital goods, nor for the differences in labour inputs extracted by the firm from a given number of hours worked, it cannot explain why Jill’s effort is paid (per unit) more generously than Jack’s. In short, this difference cannot be attributed to the marginal productivity of the labour that the two firms hired from Jack and Jill.

Marginalists respond to this criticism in two ways. The first one is to argue that, in the long run, the Sliced Bread Co. will have to upgrade its ovens or close down. When this happens, Jack and Jill will be working as hard as each other in order to bake bread of similar market value. Be that as it may, a theory that works only as long as firms are assumed to utilise machines of identical quality, vintage, capacity, etc. is profoundly unconvincing. Marginalists, naturally, understood this point and felt compelled to reconfigure their theory m order to allow for heterogeneous machinery. What follows is their second response to what is, unsurprisingly, a very old riddle:³⁶

For equation (6.5) to work, the stock of capital (K) must be conceivable as a homogeneous variable; something like an army of capital units must be lined up and the output of the marginal (or last) unit noted. Leading Marginalists confessed that this is not possible. Machines are, by nature, heterogeneous and their physical quantities indivisible and therefore impossible to line up so neatly. Thus, no amount of technical ingenuity can reduce a firm’s capital stock to a single variable. In contrast to land holdings and labour hours worked which

Box 6.13 On the impossibility of a sensible microeconomics    j

\

Microeconomics is Marginalism’s pampered firstborn. On the basis of the equi- | marginal principle, a whole new political economics was founded that sought to deter- i mine the price of everything at the level of individual agents. Indeed, if prices reflect I buyers’ marginal utilities, then a general price theory is possible that focuses not on the f economy as a whole (which is what the classical political economists did) but on the I individual. That this is at best a tendentious claim can be gleaned from our example | with Jack and Jill baking bread for different employers. If Jack’s employer could, how- I ever temporarily, make him work harder for the same pay, and during the same period, f as Jill, then it must be true that how much labour effort, or labour inputs, will enter j production depends on how successful management is in making Jack and Jill labour j harder for the same pay and hours. Management experts dedicate their lives to this task. Beyond the techniques that they develop (often employing psychology), there is also another important factor that all self-respecting managers understand well: the fear of dismissal and its connection with the prevailing rate of unemployment: the more widespread unemployment is the lower the wage per actual labour unit provided (as Jack and Jill increase their work’s tempo fearful that if they do not the likelihood of joining the dole queues increases). And it is not just the overall level of unemployment that matters but also its spatial distribution. So, if the Sliced Bread Co. is in an area of deeper and graver unemployment than that the Wholemeal Bread Co. is located at, the result may be that Jack’s wage per labour unit is even lower than Jill’s, even if everything else (e.g. the technology of the two companies, the marginal productivity of the two workers) were identical. But then if the determination of a price (like the wage) depends on macro-variables (like unemployment) and their spatial variations, then no micro-economic analysis of the wage is secure. By extension, profit rates may be irreducible to microeconomic phenomena which renders a satisfying microeconomics chimerical.

can be added up reasonably easily, how does one add up a truck with an industrial robot to come up with the firm’s (or, worse, the sector’s) aggregate quantity of capital? How can the different machines littering the factory floor be lined up, one unit after the next, before working out capital’s marginal productivity?

It was Knut Wicksell (1901) who came up with a possible solution:³⁷ He argued that a firm’s capital stock, while hopelessly heterogeneous and indivisible, can still be turned into a smooth variable by calculating the price of each machine and then constructing a measure of capital stock based on these market prices. For example, if a firm uses a truck worth S50 thousand, a computer system worth $25 thousand and a drilling device worth $15 thousand, then its capital stock is, simply, $90 thousand. Instead of lining up units of machinery (before we work out the contribution of each of these units to production), the idea here is to line up each dollar of capital stock equivalent and find out what was its contribution to total output.

Wicksell’s next suggestion was that machines ought to be seen as the crystallisation of human labour and land; a line similar to Marx, except that Marx did not see land as a contributor to capital formation. Capital is then acquired by a conscious decision by the capitalist to postpone his consumption. He could have spent his $90 thousand on a new car but chose to invest it instead in capital goods. Also, he could have chosen to spend less (more) on machines and more (less) on labour or land. Thus, in Wicksell’s thinking, the capitalist

j g_ox & 14 Knut Wicksell on capital

1 We have already pointed out that capital itself is almost always a product, a fruit of I the cooperation of the two original factors: labour and land. All capital goods, however different they may appear, can always be ultimately resolved into labour and land: and the only thing which distinguishes these quantities of labour and land from those which we have previously considered is that they belong to earlier years, whilst we have previously been concerned only with current labour and land directly I employed in the production of consumption-goods. But this difference is sufficient to ! justify the establishment of a special category of means of production, side by side I with labour and land, under the name capital; for, in the interval of time thus I afforded, the accumulated labour and land have been able to assume forms denied to ! them in their crude state, by which they attain a much greater efficiency for a number of productive purposes... .

[Wicksell (1901 [1934], pp. 149-50). First emphasis original, second emphasis ours.]

performs a crucial, two-fold task: he strikes a fine balance between consumption and savings and also between the different bundles of land, labour and capital that can produce output. Captains of industry, in this reading, preside over the economy’s parsimony and over the various sectors’ choice of production techniques (e.g. how much labour-saving technology to utilise). Their profits are their reward for these important tasks. But above all else, it is a just reward for postponing consumption; for saving.

It follows that, since the capital stock is now measured in dollars, and capital accumulation (or investment) is a form of savings by the capitalist, his/her (and capital’s) rate of return cannot be (sustainably) different to the rate of interest r. In terms of equation (6.5), the rate of profit is the rate of interest (i.e. n^r). As this rate fluctuates, capitalists adjust their utilisation of capital relatively to that of labour and land. When r falls, capital utilisation rises and machines play a greater role in the production of each unit of output; and vice versa. These fluctuations will continue until, at the given interest rate, the supply of capital (or savings) becomes equal to the demand for capital (or investment).³⁸

Problem solved? Hardly: WickselFs method requires a strict separation of the quantity of capital (measured in dollars) from the price of capital (also measured in dollars), which corresponds to the market value of the output due to the last or marginal unit of capital. It is not difficult to see that this separation is very hard to achieve, except in very special cases. The conundrum here is plain to see: if the physical capital’s magnitude depends on its price, how can its price be explained by its magnitude? This is the analytical equivalent of a cat chasing after its own tail ad infinitum. There are only two cases in which WickselFs solution makes sense and avoids this infinite loop (or regress):

Case 1: A single good economy (e.g. Ricardo’s corn economy, where corn featured both as the consumption and the capital good) in which, however, the capitalist can select from an infinite number of capital intensities, each with its own mix of capital and labour employed (a menu of intensities that the capitalist will choose from depending, as already shown, on the rate of interest).

Case 2: A multi-good economy with infinite potential capital intensities but where the sam_e product must be produced with exactly the same capital intensity by each and every firm. This condition is sine qua non because, without it, we lose the inverse relationship between (a) the interest or profit rate and (b) the quantity of capital.³⁹ And if this relationship vanishes, Marginalism’s theory of capital formation disappears.

It is now abundantly clear that we are back to square one: to the Inherent Errorl The very same error that struck Marx when he discovered that his basic value theory (on which he based his whole political agenda) required a uniform organic composition of capital, i.e identical capital intensities in every sector. Both Cases 1 and 2 above inflict the same calamity upon Marginalism’s price theory; namely, the verdict that a theory of prices erected on the equi-marginalprinciple cannot extend to a genuine multi-product economy!

The blow to Marginalism’s political agenda was no smaller than that in the case of Marx. Marginalists invested heavily in linking capital intensity, profit rates and the rate of interest in a manner consistent with the view that, in competitive capitalism, labour and capital receive their just desserts which reflect their marginal productivities and relative scarcity, But we have just discovered that in realistic settings (with different capital intensities across different firms, sectors, product lines, etc.) neither the profit nor the interest rate can express the relative scarcity of capital or its marginal productivity (see Box 6.15 for more on this).

Put simply, Marginalism has no convincing stoiy to tell about the determinants of profits. The corollary is that it has no persuasive explanation either regarding wages. In the Marginalist conception of capitalism there are markets, prices, utilities but no profits. The price that the economics profession paid by espousing Marginalism is that it could no longer tell the difference between capital’s physical quantity and its returns to the capitalists. A theory of capitalism without a theory of capital was a unique achievement of political economics.

6.10 Marginalism and the Inherent Error, part 2: The trouble with time, scale and composition

Marginalism’s ideological aim was to defend the capitalist realm from critics like Marx, whose own ideological aspiration was to portray capitalism as a conflict-ridden, crisis-prone, irrational system that curbs human freedom and turns us into ghosts possessed by their own inventions. To do this, Marginalism set out first to prove that Marx’s own theoretical scheme was wrong (recall Bohm-Bawerk’s (1896 [1898]) work) and, at once, to prove as a mathematical theorem that Adam Smith was right; that, as long as markets are competitive and unhindered by non-entrepreneurs (state institutions, trade unions, even conservative social mores), the common good is best served by the institutions of a market society.

Marginalism’s first step in constructing its Grand Proof was mathematically to derive the prices and quantities a ‘free’ market would generate. Its second step was mathematically to define the common good as a function whose maximisation would coincide with societal bliss. Finally, the third step that would complete the Grand Proof is the demonstration that the prices and quantities discovered in the first step in fact do maximise the function specified in the second step, subject to society’s available resources. Unfortunately, Marginalism’s great expectations were dashed as insurmountable theoretical problems beset the first and second steps above.

Beginning with the first step, a defensible theory of competitive pricing and quantity proved impossible. Antoine Augustin Cournot (see Box 6.5) had realised this problem as far back as 1838. In his impressively far-sighted book Researches into the Mathematical

I Box 6 15 The loss of measurable capital

I

I [_n Chapter 4 we objected strongly to the idea that human labour inputs are measurable ( on a single, quantifiable scale. Our point there was that if labour could be thus measured, J the world we live in would tend to some dystopia, like that in The Matrix, Marginalists I had no such qualms. Eager to use calculus in order to work out the price of everything ! (on the basis of marginal utilities), they assumed that labour input is no different from electricity: that it can be quantified and therefore bought and sold as readily as AC/DC power. Alas, economic theory proved its vindictiveness by forcing Marginalists to pay the ultimate price for their hubris: the loss of a meaningful measure of capital.

This is how it happened:¹ Marginalism aimed at eliminating the classical political economists’ separation of value (or price) from distribution; to argue that the distribution of national income between landowners, workers and capitalists is not a political matter but reflects their respective factors’ contribution to society’s utility from physical output.² Just like apples have a price that reflects their marginal utility to the buyer, so do machines have a price that reflects their marginal utility to the firm (or \ their marginal productivity). The problems began when that view had to be spelt out analytically: for when production uses both capital goods (K) and labour (L), even speaking of capital’s marginal productivity requires that we imagine the existence of a well-defined production function telling us which combinations of quantities of capital and labour' (K and L) yield every possible level of output Y. Something like Y=F(K,L),

By the end of the nineteenth-century, neoclassical economists like Wicksteed, Wicksell and Walras have understood the grave significance of this.³ To argue that the I Iasi: or marginal unit of capital contributes to output a quantity whose value reflects the price of (or return to) capital (i.e. the profit rate), it must be the case that some units of output (T) must be due to capital and the rest to labour; that there is no residual (i.e. units of Y that are due neither to K nor to L nor to both at once). For this to make sense, the production function F(K, L) must have a special property which, in mathematics, is called homogeneity of the first degree. In plain language, this means that, if the quantity of both factors is doubled, output must double too. And if only one of the two factors (capital or labour) is augmented, then the output will rise but the rate of that increase will diminish. It is these diminishing and strictly separable marginal productivities of capital and labour that allow Marginalists to think of the demand for capital as a decreasing function of its price and of the demand for labour as a decreasing function of the wage. Then and only then can it be said that the marginal revenue product of capital (MRP_A) is the price of capital (which is the same as the rate of profit n, which, in turn, must be equal to the rate of interest r) and that the marginal revenue product of labour (MRP/j is the wage rate.

In this manner, through the marginal productivities of the factors of production, Marginalist political economics drove a wedge between the quantity and the price of capital and unified price theory with a theory of income distribution. To see this, it suffices to note that the prices of the factors (i.e. the profit and wage rates) represent also the shares of the firms’ income accruing to capital and to labour. The theory of income distribution, therefore, loses all the political dimensions that it had under classical political economics and becomes a branch, or a by-product, of Marginalist price theory.

In this unified theory of prices and income distribution, the rate of interest r plays two roles at once: (a) it determines the capital intensity in each firm (since the higher r is the more firms will substitute labour for machines); and (b) it equilibrates savings and investment (since a drop in r will reduce savings and increase investment until the two balance out).

To see the importance of this theoretical resolution (beyond its political utility of claiming that profit is a fair reward for capital’s contribution to production, just as much as the wage is for labour), suppose that (for some reason) business confidence drops and, consequently, investment falls. This should push the interest rate down (as some savings will not be invested), a development that has two simultaneous effects: first, it cheapens machinery and, therefore, encourages firms to replace labour with capital units; second, it reduces savings. The first adjustment boosts the demand for machines (thus creating new investment and employment in the capital goods sector) while the second adjustment increases consumption (and thus demand). If all goes well, the economy should bounce back and confidence will be restored. Crises? What crises?

Alas, note how the harmonious operation of the benign markets described above is predicated upon the assumption concerning the homogeneity of the production function F(K, L). This assumption (that all production functions must be homogeneous of the first degree) is equivalent to assuming either a single commodity economy or one in which eveiy product is produced by the same capital utilisation intensity. The question then becomes: what light can Marginalist political economics throw on an economy where each product is produced by firms which employ different mixes of capital and labour? Not much!, is the honest answer. Once capital’s marginal contribution to output cannot be measured separately from labour’s contribution (since hardly any relation between a firm’s inputs and output is homogenous), its price cannot be determined by the marginal revenue product of capital (MRP^). But then, if capital cannot be priced, there is no measure of the quantity of capital either. No quantity of capital, no theory of investment, savings or interest rates. One after the other, Marginalism’s chips fall, leaving behind very little that can pass as a theory of capitalism.

Notes

1    The main point made below originates in the works of Cambridge economists Piero Sraffa, Joan Robinson and Luigi Pasinetti. Their argument occasioned a bitter debate with American economists like Robert Solow and Paul Samuelson, whose location in Cambridge Massachusetts meant that this debate became known as the Cambridge Controversies. For a fascinating account, see G.C. Harcourt (1972). For a more recent review of the debate see Avi J. Cohen and G.C. Harcourt (2003). Note that recourse to General Equilibrium models, where no aggregate notion of capital is required, does not save the day, since this reformulation does not preserve the relationship between the price of capital and its scarcity.

2    Of course, the marginal productivity theory is political in a much more important sense. It argues that despite vast inequalities in income between the owners of factors of production, the distribution of incomes in a perfectly competitive economy is just. As John Bates Clark put it ‘what a social class gets is, under natural law, what it contributes to the general output of industry’ (1891, p. 312). See also his ‘Distribution, Ethics of ’ [Clark, 1894], Moreover, the marginal productivity theory also has a corollary that the ensuing allocation of resources is efficient, since if marginal products were not equated across jobs, a more efficient allocation could prevail by moving the worker from the job with the less- marginal product to a job with a higher one (see Dorfman, 1987). Thus we have the best of all possible worlds: an economy which is efficient and just. QED.

i 1 Wicksteed has pointed this out in his The Coordination of the Laws of Distribution, in 1894. I ' pj_e produced the necessary conditions for the production function for the law to hold. As Alfred W. Flux pointed out in 1894, the production function must be homogeneous of the first decree so that Euler’s theorem must apply. To see it clearly, if the product is ‘exhausted’ into the rewards of factors of production, and each factor of production receives the value of its marginal product, we must have for a production function Q = F(K, L) that Q = rK + \vL, where O is output, K and L the units of capital and labour and r and w their i    ~    40    dO

I rewards We assume that price p = 1. Then if r = —and w = — , we must have 1    dK    dL

j n - K + L • But this is not a general function; it must obey the law of constant { ~ dK dL

f returns to scale. Walras wanted to steal Wicksteed’s contribution and complained that it was \ all there in the second edition of his Elements and hence he included an appendix in the third f edition with an unjustified and virulent attack on Wicksteed, which because of its vehemence f was removed from the 4th edition. (« Note sur la réfutation de la théorie anglaise du fermage î de M, Wicksteed » Appendix to the 3rd (1896) edition of the Elements [Appears in Walras I ¡1954)]) Wicksell in his Lectures (1901 [1934]) took another path. He suggested that when ! competition is worked out, firms produce at the minimum average cost where the necessary

I conditions for the exhaustion of the product apply. Hicks in his Theory of Wages (1932) pro-j vided the mathematical proof of this. The exhaustion of the product is still with us and it is ; responsible for the ubiquity of the Cobb-Douglas production function, which in its canonical j form Q -    is homogeneous of the first degree. In fact when Wicksteed first pro-

! posed the theory - which he thought that ‘would hold equally in Robinson Crusoe’s island, in an American religious commune, in an Indian village ruled by custom, and in the competitive centres of the typical modern industries’ (1894, p. 42), he met the sarcasm of Edgeworth (1904 [1925], p. 31) who wrote: ‘There is a magnificence in this generalisation which recalls the youth of philosophy. Justice is a perfect cube, said the ancient sage; and rational conduct is a homogeneous function, adds the modern savant. A theory that points to conclusions so paradoxical ought surely to be enunciated with caution’.

Principles of the Theory of Wealth^ he analysed the mathematics of competition between two or more firms. His first discovery was that no mathematical analysis can ever explain prices and quantities when firms are allowed (as they are in real life) to choose both their output level and the price they charge. Put simply, it was like trying to solve a system of two equations in four unknowns.

Cournot, therefore, chose to study what would happen when competing firms chose their output and left the price to the market to determine (i.e. as if firms brought their produce to some market where an auctioneer auctions off the good’s total supply). Even then, there was a problem. When firm A tries to decide how much to produce, it cannot predict the price it will be selling at without knowing the output of firm B. So, firm A cannot know which output would maximise its own profit. But this applies also to firm B. Clearly, competitive output selection is like a game where what one does depends on what one thinks others will do. Before long, too much over-thinking takes over and leads to hopeless indeterminacy: firm A’s output will depend on what it thinks B will think that A will expect B to think that A win predict ad infinitum. Cournot’s masterstroke was to work out (i) A’s profit maximising output given its prediction of B’s output; and (ii) B’s profit maximising output given its prediction of A’s output. These two equations formed a nice system in two unknowns: an eminently solvable problem yielding one output level for A, one for B and a price that corresponds to the total of these two outputs (assuming we know how much consumers are prepared to pay for a given total supply).

There was a snag; however, and Cournot was, in our estimation, painfully aware of it- ¡_t was difficult to explain how the market would converge to this price and output. Cournot hypothesised that each firm sets some output level on the basis of its prediction of its competitors’ output. That estimate would only prove accurate (for every firm) by some freak accident. When, as is more likely, a firm observes a discrepancy between its estimate of the competition’s output and their actual output choice, it adjusts accordingly both its estimate and its own output. For example if A had overestimated B’s output, it will have also underestimated the market price. With this new information under its belt, A now adjusts its price estimate upwards and, correspondingly, boosts its output. But then, B will also adjust its output once it observes A’s adjustment. The question then is: how do we model mathematically this adjustment process? First blush it sounds like a technical question that can be answered by some clever technical fix. But it is not.

The problem is that when A is about to adjust its estimate of B’s output, and alter its own output level, it must know that this adjustment will cause B to readjust. So, unless A knows in advance B’s own reaction to A’s reaction, A does not know how to react ad infinitum: In short, the problem has been elevated onto a higher order without being solved. Initially there was uncertainty regarding what the competition would do. Now the uncertainty moves to the level of worrying about how one’s output adjustment, caused by one’s shifting estimates of the competition’s output, will alter the competition’s estimates. In essence, the mathematical problem is getting more and more complicated, rather than edging towards a solution.

Cournot understood this and decided to deal with the developing Gordian knot in Alexandrian fashion. He drove his analytical sword through it by assuming that firms do not over-think things. That, mechanically, whenever B’s output proves higher than A had expected, A boosts its estimate of B’s output by a certain arbitrary factor falsely assuming that B will keep output steady. If B does the same, it can be shown that the two firms will edge towards an equilibrium at which the market will rest. Of course, the theoretical price to pay here is that the firms’ behaviour can be modelled only if their managers are lobotomised; prices and outputs can be partly explained⁴¹ only if firms are assumed to hold false beliefs about the repercussions of their decisions.

More than a century later, through the work of celebrated game theorist John Nash Jr wc discovered how deeply ingrained this problem is. Nash’s analysis, circa 1950, revealed that Cournot’s problem could be solved even if the firms’ rationality was fully restored. But then, something else would have to be sacrificed: time! In Cournot’s own scheme, as described above, firms chose and kept adjusting their output in real time on the basis of their irrational, or myopic, estimates of the competition’s output. In Nash’s framework, firms were allowed to be fully rational (at least as rational as Nash) but the solution could only be worked out mathematically in a time-vacuum; that is, in the absence of any opportunity to adjust their output since the radical lack of time forces them to select their output once and for all.

Thus, caught in between Cournot and Nash, the Marginalist theorist faces two successive dilemmas: to determine prices he/she must ditch quantities, or vice versa. Then, he/she must either abandon the idea that firms act rationally in their pursuit of profit or discard time itself. The task of producing Marginalist models of markets featuring firms that are rationally operating in real time is equivalent to the task of squaring the circle.⁴²

The second step of the Grand Proof was meant to depict the common good by means of a function that increases in proportion to society’s welfare. Marginalists, having already identified the private good with some individual utility function, thought that a social utility _or welfare function (reflecting the common good) could be put together by somehow aggregating these separate private utility functions. Yet again, their ambition was thwarted as the transition from private interest (the individual utility functions) to the common good (the overarching social welfare function) proved impossible to achieve in a politically neutral (or ‘scientific’) manner. It was not just hard to synthesise private utilities into an overarching "'"function whose maximisation would coincide with the best interests of society: it was, in fact, impossible!⁴³

With the demise of its first two steps, the planned Grand Proof could never reach its third and final step; at least not without some serious sleight of hand. So, a sleight of hand was used! Marginalists (with some exceptions), frustrated by their inability to deliver the Grand proof chose to behave as if it had been delivered; to assume that which they had hitherto been trying to prove on the basis of whatever axioms it took to prop up their claims. Thus, neoclassical political economics was born; probably the most significant fraud in humanity’s intellectual history.