Distribution
Wicksell’s recipe for synthesis has been aptly described by Uhr (1951: 842) as:
using the marginal-utility-marginal-productivity theories of Jevons and Menger, adding to these the derived Bohm-Bawerkian analysis of capital, and fusing the product within a Walrasian framework of general equilibrium to reveal the multiple causal interrelations of the theoretical edifice.
In this process he became the founder of the marginal productivity theory of functional distribution.That theory has actually many fathers, notably John Bates Clark and Philip Wicksteed. Wicksell has nevertheless helped to make the theory more precise, and he has taken it to its limits.
The core of the theory can be expressed in terms of two propositions. The first is that, in competitive equilibrium, the prices of the factors of production (wage, interest and rent) correspond to the marginal productivity of the factors. In classical political economy, only rent is determined by the scarcity of the corresponding factor of production - “land” or, more generally, “the external natural forces at the service of man” (Wicksell 1901 [1934]: 107). The neoclassical theory of value, on the other hand, is based on scarcity as the general principle of the explanation of the prices of goods and factors of production. This use of the notion of scarcity implies that demand and supply are independently determined by given tastes and technology. It also implies that the prices that match supply and demand in the markets lead to an efficient allocation of resources, so that production cannot systematically exceed or fall short of the demand that follows from the incomes it generates.
The second proposition of the neoclassical theory of distribution is thus the exhaustion theorem: if all factors of production are paid according to their marginal productivity, aggregate output (the “social product”) will correspond exactly to aggregate income, and aggregate demand will thus suffice to absorb aggregate supply.
While Clark only asserted this in 1889, Wicksell demonstrated it in 1893 (1893: 146-53), even though his proof was less elegant than that accomplished by Wicksteed a year later. When Walras claimed to have been the first to prove the exhaustion theorem, Wicksell (1900, 1902) countered by declaring Wicksteed to be the main pioneer of marginal productivity theory, completely ignoring his own contribution of 1893. He also showed that, contrary to Walras’s claims, the exhaustion theorem is valid only in the special case of an aggregate production function that is linear and homogenous of degree one (Wicksell 1900 [1958]: 97-100). Moreover, Wicksell pointed out that Wicksteed’s analysis was limited in scope because of the underlying assumption of constant returns to scale. According to Wicksell, this condition was not as innocent and plausible as Wicksteed had claimed. Yet Wicksell also demonstrated that the condition of constant returns holds in perfect competition, as the firms achieve their profit maximum in this setting at the point of minimal average costs, where they pass from increasing to diminishing returns (1902 [1958]: 123-30). In an extended version of this argument Wicksell had proved a year earlier, in his Lectures of 1901 ([1934] 125-31), that a remuneration of labour and land according to their marginal productivity would lead to excessive claims on the social product in the case of increasing returns to scale, and to insufficient claims in the case of decreasing returns. For the reference case of exact exhaustion he used a linear and homogenous production function where the scale elasticity is equal to one. This special form was later promoted to the standard formula for the neoclassical theory of production and distribution - by Charles Cobb and Paul Douglas.In all his enthusiasm for marginal analysis Wicksell did not forget to point out that factor pricing at marginal productivity may lead to suboptimal results at the individual and the social level.
Taking issue with Ricardo’s analysis of the income effects of laboursaving technical progress, Wicksell (1901 [1934]: 133-44) drew attention to cases in which technical change lowers the marginal productivity of labour even while total output is growing. If free competition prevails in the labour market, this could easily happen, as the displacement of labour will tend to reduce wages. Competing with the firms that have introduced the new labour-saving methods, other firms may find it profitable to re-employ the displaced workers at the lower wage level, in plants that use less productive older methods. Given the pressure on wages, Wicksell concluded that technical progress may result in a decline of both marginal productivity and the wage level.In view of the miseries of overpopulation, his old nemesis, Wicksell drove the argument further:
Nor is the result any different if we assume that wages are already at the subsistence level (and cannot, according to the usual view, fall lower). In reality, wages can not only be forced below it for a little, but can remain below it indefinitely, if the labourers and their families can make up the difference by poor relief, as happened in England to a great extent at the end of the eighteenth and the beginning of the nineteenth centuries. (1901 [1934]: 141)
This insight led Wicksell to advocate wage subsidies that preserve full employment. In logical consequence he rejected minimum wages and reductions of working hours, arguing that such measures would lead to persistent unemployment and impoverishment. This view, which he had actually propagated since the early 1890s, cost him a lot of sympathy from his old friends in the workers’ association and the trade unions. Yet it provided neoclassical foundations for the theoretical justification of employment policies in welfare states. Wicksell pointed out that wage subsidies could be financed out of the increase in the social product generated by labour-saving technical progress. He thus argued in favour of a redistribution of incomes by way of taxes, suggesting that such corrections of the primary “functional” income distribution support growth by way of reducing the costs of unemployment.