On Marx’s and the Marginal School’s transformation problems (Part II)

 

Karl Marx (1818-1883)

 

 

 

https://www.marxists.org/archive/marx/works/1867-c1/p1.htm

 

 

 

What was Marx’s transformation problem? In Volume I of Das Kapital, Marx starts his dissection of capitalism with the concept of value and builds on it his theory of surplus value. Marx declared that capitalism’s secret is the commodification of labor power. Labor power is the only commodity that creates surplus value, the value in excess of labor power’s exchange value–that is, the workers’ wage rate. In that same volume of his magnum opus, Marx explained the profits of capital as resulting from surplus value. He left open the problem of explaining how capitalists with differing ratios of labor to machinery can have similar profits, a contradiction to be resolved in further works. Marx, in Capital Vol III, takes up the matter again, but according to Eugen von Böhm-Bawerk’s essay, does not resolve the issue logically.

 

 

Marx’s transformation problem exists simply because of another problem he noted with capitalism–the so-called realization problem. Workers might create surplus value in the realm of production but unless goods are sold (in the realm of commerce), profits cannot be realized by the capitalists and surplus value remains just potential profit. In the realm of commerce where prices are important, the price level of commodities are important to the extent that they define the size of the profit rate that will be enjoyed by particular capitalists which will in turn serve as a signal to other capitalists if a particular industry is an attractive investment site. Capitalist competition brings profit rates down, However, Marxist political economy also points out that an increasing capital/labor ratio or what Marx called organic composition of capital (the ratio between living and dead labor) will lower profit rates since only living labor can create surplus value. Dead labor simply transfers its exchange value to the total price of the commodities. Dead labor (like capital goods and raw materials) cannot create surplus value.

 

If Marx had to transform value into prices, the marginals had to transform their ‘utils’–a measure of utility to explain why consumers demanded or liked to consume commodities–to exchange values or market prices. Second generation marginalists like Alfred Marshall worked on theories of marginal physical productivity as the explanation for product costs/prices while third generation marginalists like Francis Ysidro Edgeworth and Eugen Slutsky, while believing that utility represents some quantity, developed the concept of indifference curves which did away with the need to quantify utility.

 

Alfred Marshall (1842-1924)

 

In a work published in 1907, the Russian economist and statistician Ladislaus Bortkiewicz identified the transformation problem in Marx’s work. He proved that the data used by Marx was sufficient to calculate the general profit rate and relative prices. Though Marx’s transformation procedure was not correct—because it did not calculate prices and profit rate simultaneously, but sequentially—Bortkiewicz has shown that it is possible to get the correct results using the Marxian framework, i.e. by using the marxian variables constant capital and variable capital, it is possible to obtain the profit rate and the relative prices in a three-sector model. His “correction of the Marxian system” has been the great contribution of Bortkiewicz to classical and Marxian economics but it was completely unnoticed until Paul Sweezy’s 1942 book “Theory of Capitalist Development”. Piero Sraffa’s Production of Commodities by Means of Commodities (1960) has provided the complete generalization of the simultaneous method for classical and Marxian analysis.

 

Ladislaus Bortciewicz (1868-1931)

 

What was the transformation problem of the first generation theoreticians of the Marginal school of economics? The marginalists (marginal analysts) sought to resolve a conundrum that flummoxed Adam Smith: the so-called diamond-water paradox. How come diamonds, which humans do not need to live, are most costly than water, without which humans will die? Menger figured this out at about the same time as Jevons and Walras. He said that the first pail of water satisfied the strongest want (thirst), while succeeding pails satisfied lesser wants, such as cleaning. In a small village next to a large river, all of the people’s uses of water would be filled, making the value of one additional pail of water zero. This is the essence of marginal analysis: look at the value or cost of the last additional unit, the unit “at the margin”.

 

Francis Ysidro Edgeworth (1845-1926)

This theoretical innovation moved economic theory away from Adam Smith’s supply-side “cost-of-production” theory of commodity prices. The marginalists argued that commodities are valuable more because of their ability to satisfy consumers’ demand (to make them happy, in other words) rather than the costs incurred in producing them. And why and how do commodities satisfy consumers or make them happy? They satisfy because they are useful. For this reason, first generation marginals valorized utility to explain commodity prices–marginal utility however rather than total utility.

 

 

 

 

Eugen (Evgeny) Slutsky (1880-1948)

Utility, while difficult to measure, was conceived by the first marginalists as a quantity. Happiness or usefulness, of course, cannot be quantified. But there are methods and assumptions in microeconomics for calculating a reasonable approximation of this elusive concept. In microeconomics, happiness is measured by a concept called utility. The standard unit of measurement that microeconomics uses to measure utility is called the util. The util has no concrete numerical value like an inch or a centimeter. Instead, it’s an arbitrary and subjective – yet convenient – way to assign value to consumer choices and to measure the consumer utility of one choice against another. A number of the first generation marginals were quite bothered by the inability to measure utility. Subsequent marginal analysts innovated theoretically to move from using (marginal) utility to explain commodity price determination. This was the marginal school’s transformation problem.

On Karl Marx’s and the Marginal School’s transformation problems (Part I)

 

Carl Menger (1840-1921)

 

I.

The Austrian School of economics, founded by Carl Menger and popularized by Ludwig von Mises and Friedrich A. Hayek, is the champion of libertarianism, apostle of free markets and the laissez faire state, and of course, the bane of Marx and Marxist political economy.  Together with the Englishman William Stanley Jevons, Menger and the French economist Leon Walras were considered the first generation of the so-called marginalists (or marginal analysts) in the history of economic thought.  Another Austrian, Eugen von Böhm-Bawerk, published in 1898 the English translation of his Zum Abschluss des Marxschen Systems (1896)–Karl Marx and the Close of His System–a critique of Marx’s political economy.  The third volume of Marx‘ Das Kapital was published posthmously in 1894 by his closest associate, Friedrich Engels, in 1894.  Earlier, the English disciple of Jevons, Philip Wicksteed wrote two short essays criticizing Marx’s labor theory of value.  Wicksteed is credited to have steered George Bernard Shaw and the other Fabians from Marxism.

 

Eugen von Bohm-Bawerk (1851-1914)

 

However, the Austrian School started first as a theoretical counterpoint to the German Historical School, which dominated economic thinking in German-speaking countries in the second half of the 19th century.  Menger is the acknowledged founder of the Austrian School with the publication in 1871 of his Grundsätze der Volkswirtschaftslehre (Principles of Economics).  Menger dedicated his 1871 book to his German colleague Wilhelm Roscher, the leading figure in the German Historical School.

 

Wilhelm Roscher (1817-1894)

 

Ushering what is now known as the Marginal Revolution in the history of economic thought, Menger argued that economic analysis is universally applicable and that the appropriate unit of analysis is the individual human being and his choices. These choices, he wrote, are determined by individual subjective preferences and the margin on which decisions are made. The logic of choice, he added, is the essential building block to the development of a universally valid economic theory.  The key argument of marginal analysis is to insist that the market price of a commodity depends more on the demand (which is based on the good’s usefulness or utility) for the same rather than the total cost of producing it.  In fact, the market price (or exchange value) of a commodity depends upon the marginal utility of the last unit of a given commodity purchased and consumed by buyers in a market.

F. A. Hayek (1899-1992)

Ludwig von Mises (1881-1973)

 

Marginal analysis explained this conundrum: why are necessities like water cheap, while luxuries like diamonds are expensive? It seems backward in terms of necessity and utility.   Menger figured this out at about the same time as Jevons and Walras. He said that the first pail of water satisfied the strongest want (thirst), while succeeding pails satisfied lesser wants, such as cleaning.  In a small village next to a large river, all of the people’s uses of water would be filled, making the value of one additional pail of water zero. This is the essence of marginal analysis: look at the value or cost of the last additional unit, the unit “at the margin” (https://www.forbes.com/sites/billconerly/2017/11/22/business-planning-with-austrian-economics-marginal-analysis/#75e1c5315d24).

 

William Stanley Jevons (1835-1882)

 

In essence, the marginalists sought to explain the exchange value (or market price) of a commodity by emphasizing consumer demand rather than the cost of production (or supply-side) theory adhered to earlier by Adam Smith in his Wealth of Nations (1776).  Smith had to confront the ‘diamond-water paradox’ which was why he moved away from any theory that explained exchange values or market prices based on the utility of commodities.  The diamond-water paradox pointedly amplified the truth that while water was more useful to humans than diamonds (given that humans cannot exist without water but can live on without diamonds), water commanded a very much lower market price than diamonds.

 

Leon Walras (1834-1910)

 

The German Historical School, in contrast, argued that economics is incapable of generating universal principles and that scientific research should instead be focused on detailed historical examination. The historical school thought the English classical political economists were mistaken in believing in economic laws that transcended time and national boundaries.  Menger’s Principles of Economics restated the classical political economy view of universal laws and did so using marginal analysis.  Roscher’s students, especially Gustav von Schmoller, took great exception to Menger’s defense of “theory” and gave the work of Menger and his followers the derogatory name “Austrian school” because of their faculty positions at the University of Vienna. The term stuck (https://www.econlib.org/library/Enc/AustrianSchoolofEconomics.html).

 

Gustav von Schmoller (1838-1917)

Random thoughts on taxes, TRAIN, and governments

 

The controversial TRAIN (Tax Reform for Acceleration and Inclusion) proposal is now law of the land  since this year’s beginning.  At least, TRAIN 1, that is.  From what I have heard and read, there’s a TRAIN 2, 3, 4, and 5.

The supposed focus of TRAIN 2 is a further reduction in corporate income taxes.  But what is this I also hear that not one senator is willing to sponsor said measure?  Until known Duterte ally and newly minted Senate President Vicente “TitoSen” Sotto III agreed recently to be the proposal’s champion.

Why the new reluctance compared to the earlier alacrity among legislators to be associated with TRAIN 1?  I believe the principal reason is, rightly or wrongly, TRAIN 1 is blamed for the unprecedented inflation that gripped the economy since the beginning of 2018.

 

Politicians, being politicians, know how to behave specially if elections are near.  Sotto is quite bold since he is not up for re-election in May 2019.  Senators up for re-election next year like Senator Sonny Angara, who sponsored TRAIN  1, was candid enough to admit that he will not touch TRAIN 2 with the traditional ten-foot pool given the 2019 elections.

Nobody loves taxes and the tax collectors. The latter were often killed and robbed in the ancient days.

Woe to the politician who campaigns for or is associated with a tax increase.

 

Senator Ralph Recto aka Mr. Vilma Santos

 

 

 

Exhibit A: Senator Ralph Recto, who was not re-elected at some point as he was strongly associated with the increased VAT.

 

 

In the final analysis, a tax is an extortion since nobody will pay taxes voluntarily. People have to be coerced to pay taxes and reduce their disposable income. For that reason, Charles Tilly and other scholars of European state building cynically observed that there is not much difference between a neighborhood toughie–who threatens to break a window if the shop-owner does not hand over some cash for ‘protection’–and the state who imposes and collects taxes.

 

TRAIN Tax Law: Guidelines and Sample Tax Computations

 

 

Both the toughie and the state are ‘selling’ the same (public) good–security of life and property–in exchange for money. Both ‘sales’ are involuntary and force (or the threat to use force) underpin them.

In that sense, taxation is an exchange transaction. In exchange for the payment of taxes, citizens get to enjoy public goods.

The capability to free ride is one reason why individuals will not pay taxes if payments were decreed to be paid on a voluntary basis.

While it is indeed an exchange transaction, it is not a straightforward (kaliwaan) one unlike sales involving private goods.

To enjoy a burger, a consumer must first pay before he can have the first bite of the juicy sandwich. That is not the case with taxes.

 

Charles Tilly

 

There’s an obvious time lag between the payment of taxes and the ‘consumption’ of a public good. This time lag is another reason why people want to avoid paying taxes.

In addition, taxation may not be a pari passu (equal footing) arrangement. The taxpaying public may not enjoy or obtain the full value of their money since government officials retain the ability to determine the quantity and quality of public goods they will supply.

For example, a concrete road may be built but it may be lacking in the promised length, or built with sub-standard materials, or built over an extremely long period.

Another reason behind the citizens’ reluctance is the impact of taxes on consumer good prices. The payment of taxes already reduces their disposable income. If taxes were increased on key inputs such as fuel, electricity, water,sugar, food packaging, interest income, and the like, these increases will raise consumer goods’ prices and will thus further reduce disposable incomes.

For all these reasons, taxation should be understood as primarily a political act.

The collection of taxes are socially necessary for they fund socially necessary public goods. Without public goods, a human community cannot exist. Thus, the payment of taxes finance human community building.

Government officials, policy makers, and tax collectors must be fully aware of the collective action problems (CAPs) associated with taxes, specially in societies with pronounced poverty and wide income/asset disparities like the Philippines.

The time gap between the collection of taxes and the provision of public goods must be as short as possible.

The quality of public goods must be high and its quantity must be adequate for a growing population.

The collection of taxes must be equitable because none grates the ire of citizens more than the knowledge that some evade or do not pay the rightful amount of taxes.

Last but not least, we must all help develop a healthy tax culture in our country: that we must pay our taxes promptly and properly; that government must provide adequate and high quality public goods; and that both the tax burden and the supply of public goods must be equitable and judicious.

We must also be chastened by the truth that the ability to provide public goods is not the monopoly of governments. Non-state actors can and do provide ‘public’ goods in exchange for ‘payments’ that are akin to taxes.

 

NPA fighters in parade formation

 

 

 

The ‘revolutionary taxes’ collected by the New People’s Army (NPA) comes to mind in this regard.  The ‘kotong’ collected by erring police officers is of the same genre.  The Catholic Church and other charities are enabled by donations to provide public goods.  Governments must therefore make sure that the tax-public good exchange transactions with their citizens must be as equal and equitable as possible. 

 

 

post-politics truths

Political Photo-Poems

HELSINKI, FINLAND – JULY 16: U.S. President Donald Trump (L) and Russian President Vladimir Putin arrive to waiting media during a joint press conference after their summit on July 16, 2018 in Helsinki, Finland. The two leaders met one-on-one and discussed a range of issues including the 2016 U.S Election collusion. (Photo by Chris McGrath/Getty Images)

Post-politics truths

I dare say

are frozen incredulities!

Fake news

are news 

just the same!

Suspend disbelief

factor them in for they’re

the new game changers!

The fake news queen of the Philippines, PCOO Asst. Secretary Mocha Uson

©bongmallongamendoza 30 jul 2018

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