Sraffa s Production of Commodities by Means of Commodities Critique and reconstruction of economic theory

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1 Sraffa s Production of Commodities by Means of Commodities Critique and reconstruction of economic theory International Conference, Rome, 2 nd 4 th December 2010 Sraffa and the long-period theory of employment Two ways to effective demand: Keynes s monetary way and Sraffa s real way Andreas von Ah, University of Fribourg / Switzerland Making use of the principle of effective demand, Keynes showed in his General Theory, that, in a monetary production economy, there exists no tendency towards a full employment equilibrium in the short run. However, having rejected in this way the classical, monetary version of Say s Law, the Marshallian or neoclassical, real or market version was left unscathed, mainly because Keynes had accepted the all important first (neo-)classical postulate: the wage is equal to the marginal product of labour (Keynes 1973, p. 5). As a consequence, it was relatively easy for the neoclassical orthodoxy to integrate Keynes into their system through the neoclassical synthesis à la Hicks-Samuelson. With full employment restored through monetary and fiscal policies, the forces of supply and demand could work normally to maintain full employment, rendering thus the principle of effective demand irrelevant for the long run. It is the great merit of Sraffa s (1960) book to have unveiled the fundamental deficiencies of orthodox marginalist long-period theory through initiating the capital-theoretic discussion in the mid 1960s. This definitely opened up the way to work out a long-period theory of employment based on Keynes s principle of effective demand. The aim of this paper is to set forth Sraffa s contribution to establish the Keynesian principle of effective demand in the long run. This is paramount to working out a long-term theory of trend of output and employment, which, in turn, is of fundamental importance in view of setting up a coherent alternative to still dominating orthodoxy. Therefore, the focus of this paper will be set more on the implications of Sraffa s work than on the form and content of his scientific achievement itself. The paper consists of three parts. In the first, Keynes s rejection of the classical, monetary version of Say s Law and the concept of the effective demand in the General Theory are 1

2 briefly described. Subsequently, it will be shown that Keynes s way to effective demand is not sufficient to establish a long-term theory of effective demand. A second route to effective demand (Garegnani 1983), grounding on Sraffa s prelude to a critique of economic theory, was necessary to knock out the neoclassical-marshallian real or market version of Say s Law. Finally, the third part points to the significance of Sraffa s analysis for a theory of the long-term trend of output and employment. For an economy, it is indeed of great importance around what trend curve a trend maybe well below the full employment position cyclical fluctuations take place. An approach to work out a long-period theory of output and employment on the level of principles is suggested by classical-keynesian political economy (Bortis 1997, Bortis 2003a) which builds on a synthesis of Keynes s theory of effective demand with the classical-marxian theory of value and distribution as has been revived by Sraffa. I With the General Theory, focusing on the monetary way to effective demand, Keynes disproved, by means of the concept of the multiplier and of a new theory of interest and money, the classical, monetary version of Say s Law. In this version, the law states that money incomes are always entirely spent on consumption or on new capital goods. An expansion of productive capacity brings about additional factor incomes which the recipients spend in part for consumption. The non-consumed part of the income, savings, is always invested and, therefore, transformed into effective demand. Given this, it is irrational to hold money since it can be profitably invested. Money is essential for transaction purposes, but it is otherwise unimportant. Particularly, money is not held as a store of value since it does not yield any return; hence there is no hoarding of money in the neoclassical view. Therefore, saving in money terms always leads to investment. This implies that saving governs investment through variations of money wages, the rate of interest and the marginal productivity of new capital goods. General overproduction is not possible and a tendency towards full employment equilibrium is, in principle, brought about by a smooth interaction between the labour market and the market for new capital goods, or simply through the interaction between aggregate supply and demand, whereas the adjustment occurs through price variations. Say s Law is the crucial theorem of a real or monetary exchange economy in which the supply oriented market mechanism, building on the principle of supply and demand, grounded on the marginal principle, stands at the centre. Without the marginal principle, the whole neoclassical theoretical construct would collapse. 2

3 However, Keynes attacked Say s Law regarding the direction of the causal link connecting production and expenditure. Expenditure and demand are not generated by production but just the other way round: it is the expenditure decisions that generate demand, and production then adjusts to demand. The Keynesian multiplier relation and the consumption function imply that consumption and saving depend no longer on the rate of interest associated to future consumption plans, but on current income, and saving is governed by investment which is determined by expectations about the future. It is investment that generates the necessary saving: through the multiplier mechanism additional investment leads to an increase in incomes such that the amount of saving generated by additional income is equal to the increase in investment. The rate of interest is no longer considered as a real variable that in equilibrium equates savings and investments. It is now determined on the money market, partly through liquidity preference, and brings into equilibrium the exogenously given amount of money with the demand for money for transaction and speculative purposes. An equilibrium level of employment is reached through quantity variations with prices adapting passively. Given that the level of output and employment depends on investment and on the marginal efficiency of capital, that is, on unpredictable and unstable psychological factors, the Keynesian principle of effective demand exhibits in a persuasive way the instability of the capitalistic system, in which absolute overproduction and involuntary unemployment are possible. Keynes s analysis focuses on the behaviour of individuals as is coordinated by the system through the principle of effective demand. Uncertainty about the future and expectations play an important role, specifically in governing the amount of investment; on account of the uncertainty about the future saving depends on current income and not on the rate of interest associated to consumption plans stretching into the future. Finally, putting to use the principle of effective demand embodied in the multiplier relation Keynes was able to show that there is no tendency towards full employment equilibrium, rejecting thus the monetary version of Say s Law, stating that saving is always invested. As a result, the second postulate of (neo- )classical economics does not hold which implies that involuntary unemployment may exist; moreover, paradoxes may occur, most importantly the paradox of thrift. II Because of uncertainty about the future, Keynes s monetary way to effective demand is essentially a short-term theory, and does, as such, not provide an appropriate basis for long- 3

4 period theory. At the time when writing the General Theory Keynes s focus was, above all, to explain the massive unemployment during the great depression of the 1930s. Given this, he built his fragmentary monetary theory of production largely upon Marshall s neoclassical monetary theory of exchange (Bortis 2003b). He attacked only those parts of the Marshallian system that were necessary to establish his theory of effective demand. With saving no longer governed by the rate of interest, the position of all demand curves in the various Marshallian markets now depended on incomes. On the basis of this fact, an aggregate demand curve, including consumption and investment demand, could be derived (the D-curve in the General Theory). The aggregate supply curve (Z in the General Theory) resulted from the aggregation of the supply curves of the individual firms. Output and employment are determined by the intersection of both curves. As a rule, employment governed by effective demand does not equal full employment. This is paramount to erecting a barrier on the labour market such that the full employment equilibrium cannot be reached. The first neoclassical postulate (the wage is equal to the marginal product of labour) continues to hold, the second postulate cannot be realised, that is, the supply curve of labour cannot be reached, precisely because of a lack of effective demand. Because of these neoclassical remnants left in the General Theory, it is not surprising that during the 1950s and 60s the orthodox theorists managed to integrate Keynes into their system quite easily through the IS-LM model. This represented the neoclassical synthesis combining Marshall and Keynes, set forth in Samuelson s celebrated textbook. In their view, the laws of the market ultimately always dominate. If markets function satisfactorily and are not too heavily disturbed by monetary factors, then it is reasonable to presume that a tendency towards full employment equilibrium exists in the long run. Marshall s natura non facit saltum is still there. If effective demand constrains the labour market, then this constraint may be removed by appropriate Keynesian policies. The IS-LM diagram, the fundamental device of the neoclassical synthesis, shows how monetary policy and/or fiscal policy, via changes in the amount of money or stimulation of the economy, can bring the labour market into a full employment equilibrium. Uncertainty is negligible in the long run if political institutions, technology and tastes change gradually and if there is sufficient competition. Uncertainty may be important only for partial and short-run events, such as individual investment projects because of unforeseen fluctuations in demand or unexpectedly changing credit conditions. In the long run, the rationality of the market system ultimately coincides with the aggregate rationality of individuals. 4

5 Hence the neoclassical synthesis combines Marshall and Keynes: deficiencies of effective demand in the short run resulting in unemployment will be eliminated by Keynesian full employment policy measures. Once unemployment is eliminated the market mechanism comes in to explain prices and functional income distribution (Bortis 2003b). The law of supply and demand based upon well-behaved relationships between prices and quantities is fundamental and will finally bring about a tendency towards full employment long-period equilibrium. Keynes could not offer any alternative to the orthodox long-period theory of output and employment, because the presence of uncertainty confined him to the short run; the long run simply did not matter. However, he did not realise that well-behaved supply and demand curves on goods and factor market could eliminate uncertainty. Indeed, through changes in the relative prices the law of supply and demand would in the long run dominate and create a strong tendency towards equilibrium. In fact, Keynes was less interested in criticising the orthodox theory than in constructing a short-period alternative to it, considering the long run as irrelevant because of uncertainty. Moreover, Keynes still was fundamentally a Marshallian and, as such, influenced by the neoclassical parables. Given this, Keynes accepted the first (neo-)classical postulate: the wage is equal to the marginal product of labour (Keynes 1973, p. 5). This and his putting to use of the marginal efficiency of capital (Keynes 1973, chapters 11 and 17) suggests that Keynes had not dismissed the existence of factor markets. Moreover, he did not challenge the notion of substitution between labour and capital which, in the orthodox view, contributes to bringing about a tendency towards full employment. In a way, Keynes did not deny the premises of orthodox theory and implicitly accepted the forces of supply and demand leading to long-period full employment of the factors of production (although in the long run we may all be dead). Keynes failure in getting established the principle of effective demand in the long run and the success of the neoclassical synthesis reinforce the affirmation that there must be an alternative theory showing that the principle of effective demand can also be applied to the long run. Keynes s short-term theory cannot simply be transferred to the long run, since, to show that there are no forces pushing the economy towards full employment in the short run is a very different thing from showing that the economy does not gravitate around a full employment trend in the long run (Garegnani 1983, p. 76). The orthodox neoclassical theorists and the adherents to the neoclassical synthesis consciously or unconsciously all postulate that Say s Law is valid in the long run. Moreover, 5

6 neoclassical theory, in its being based on the demand and supply or the market mechanism, essentially deals with real values. Given this, a convincing attack on neoclassical theory has to focus on the market mechanism. That is, the neoclassical, real version of Say s Law allowing the transformation of saving into investment in the long run has to be disproved. Or, to put it another way, it must be shown that if there are ideal conditions, i.e. if there is perfect competition and there are no disturbing factors such as uncertainty and money, one or more markets do not function properly so that, even in the long run, no tendency towards full employment exists. This problem has to be tackled not on the level of possible market failures, but on the sphere of principles (Bortis 1997, p. 81). This immensely sophisticated task has been performed on the basis of Sraffa s (1960) work. This book has provided the theoretical basis for the Cambridge-Cambridge capital-theoretic debate (Harcourt 1972) which culminated in the mid 1960s and considerably shattered the neoclassical long-period parables. Given this, Sraffa s Production of Commodities by Means of Commodities complemented Keynes and opened up the way to long-period effective demand. Sraffa s main work has two dimensions: First, in a critical vein it represents a critique of the neoclassical market or supply and demand theory on a fundamental level. As such, Sraffa saw his work as a Prelude to a critique of [marginal] economic theory [of value and distribution] which subsequently led to a revival of the capital-theoretic discussion. As for the second dimension, it must be seen [the] connection of this work with the theories of the old classical economists [,that is their theories of production, value and distribution, among which] ( ) is found the original picture of the system of production and consumption as a circular process, and it stands in striking contrast to the view presented by modern theory (Sraffa 1960, p. 93). Sraffa discusses here principles in a positive, constructive way and shows that the classical production based approach is superior to the neoclassical exchange theory. This is crucial for the further development of Keynes s theory of employment and the associated classical theories of value and distribution. In the following, the critical aspect of Sraffa s contribution including the basic characteristics of the neoclassical theory of markets is outlined in more detail, and then some brief remarks on the positive dimension of Sraffa s work will be made. Finally, some comments will be made on the significance of Sraffa s work for the long-term theory of effective demand. Sraffa s (1960) work, to get back to the critical dimension, implies a fundamental critique of the neoclassical-marshallian system. This system builds upon the market mechanism of supply and demand on goods and factor markets. The market system is seen as a selfregulating mechanism based on exchange, a balance of supply and demand is brought about 6

7 by the equilibrium price, which is an absolute price. Since the same good is supplied and demanded on some market in terms of money, Marshall s theory of value implies a monetary theory of exchange: M C... MP... C' M ', with money M and commodities C. The factor markets ( M C ) and the markets for final goods ( M ' C' ) are linked by a mysterious process ( MP ), Sraffa s one-way avenue that leads from Factors of production to Consumption [or final] goods (Sraffa 1960, p. 93). The process of production in which primary and intermediate products are transformed into final products is not explained in neoclassical economics. To set out the process of production is, in fact, not required since the neoclassical economists see production as a market problem, or a problem of exchange, respectively. The mysterious process can therefore be considered as a method or technique that allows the invisible transformation of inputs into outputs and has not to be elucidated further. Money can be considered as a veil and its role is therefore not essential, but nevertheless not negligible: a certain quantity of money ( M ), required for the circulation of commodities in the various markets, is given exogenously; hence M equals markets, the real sphere to the monetary sphere (Bortis 2003b, p. 88). M '. The Cambridge equation links the The markets for final goods determine the quantities and prices of goods. And the problems of distribution, production and employment are solved on factor markets. Therefore, a full employment equilibrium position is reached through a smooth interaction of the market for new capital goods and of the labour market: starting from an unemployment situation real wages will decline which induces a rise of employment for two reasons: as profits and investment increase, additional jobs will be created, and as labour is now cheaper relative to capital, which, in turn, becomes relatively more expensive and is, therefore, substituted by labour. Hence changes in relative prices bring about equilibrium with quantities passively adjusting (Bortis 2003b, p. 88). Now, Sraffa uncovers the fundamental deficiencies of the mechanism of supply and demand on goods and factor markets. More precisely, he attacks the concepts underlying this mechanism, that is, the marginal principle appearing in the form of marginal productivity. On the basis of Sraffa (1960) it has been argued in the course of the capital theory debate that capital cannot be conceived of as a scarce factor of production that can be measured physically: the rate of interest cannot be the price of capital goods, an unknown to be determined on a capital market. Since the notion capital stands for all the single commodities taken together and these capital goods are physically heterogeneous and produced by means of commodities (that is labour, land and various circulating capital 7

8 goods ), capital is not a natural factor of production that can be aggregated or measured, in principle, in physical terms like labour and land. Because with Sraffa production is conceived of as a social and circular process, and hence is not a linear and individualistic process but highly complex and interdependent, it is impossible to measure capital independently of income distribution since relative prices depend upon the conditions of production and upon the profit rate. Hence, in a Sraffian perspective, capital can only be measured in terms of some numéraire-good once the rate of profits is known. The neoclassical economists would argue, however, that the rate of profits is an unknown to be determined on the market for capital. The complexity of the social and circular process of production brings about that the associations between profit rates on one hand, and capital and output per worker and the capital-output ratio on the other hand, are totally irregular. There exist no regular, wellbehaved associations between rates of interest and quantities of capital : lower interest rates need not be associated with larger quantities of capital. Variations in income distribution, real wages and profit rates, bring about a change in the relative prices of the different commodities because the proportions between wage costs (money wage rate multiplied by the quantity of labour) and the value of the means of production in money terms are different in the various industries. Therefore, all the relative prices vary when distribution, that is, the rate of profits, changes (there are complicated patterns of price-movement with several ups and downs (Sraffa 1960, p. 37).). In fact, the distribution curve linking the profit rate and the real wage rate, is no longer linear with its slope exhibiting the value of capital measured in terms of some numéraire. With the same technique of production the value of capital changes with changes in income distribution. Moreover, the same technique of production maybe applied at different profit rates. Thus, variations in prices and wages, and hence profit rates, may bring about re-switches in the methods of production and capital reversals (the value of capital increases as the rate of profits increases). All these findings not only question Walras s model of general equilibrium (lower profit rates are not necessarily associated to larger quantities of capital), but they also seriously damage the neoclassical-marshallian system as they suggest that, in principle, well-behaved longperiod relationships between factor prices and factor quantities cannot exist; there are no factor markets in the long run (Bortis 1997, p. 283). Or, as Sraffa points out: the marginal product of a factor ( ) would not merely be hard to find-it just would not be there to be found (Sraffa 1960, p. v), because, in a monetary production economy, output is always 8

9 governed by effective demand, and can, therefore, not be changed at will as marginalist theory requires. The capital theory debate thus heavily damages the neoclassical theory of value and distribution. In fact, this theory would only be valid in a one good world or when the conditions of production are the same in all industries. And very importantly, the neoclassical law of supply and demand cannot produce a full employment situation since there exist no tendency towards a long-period equilibrium. If there is disequilibrium on interrelated markets a tendency towards equilibrium in one market may deepen the disequilibrium on the other market. For instance, an increase in investment may not reduce profit and interest rates but, on the contrary, raises, in a Kaleckian vein, the rate of profits due to the income effect of investments (Bortis 1997, p ). Or, if there is unemployment and money wages fall, this may reduce the demand for consumption goods and subsequently the rate of profits in the consumer goods sector. This will very probably affect the volume of investment in a negative way and hence result in an increase in involuntary unemployment (Bortis 2003b, p. 88). Hence the free functioning of markets does not produce any tendency towards equilibrium, but may, on the contrary, bring about cumulative tendencies for disequilibria to deepen; for example, growing inequalities in income distribution may result in higher involuntary unemployment, and vice versa. In the real world, markets are not perfect and independent but complex and strongly interrelated. As such, they do not only react to price signals but also to quantity changes, frequently in ways inconsistent with neoclassical theory. For example, the macroeconomic aggregate production function, if it existed, may work differently from the production function on the industry or the firm level. Given this, one cannot generalise conclusions obtained for particular instances. Another instance would be the marginal principle, originally applied by Ricardo to the largely individualistic production in agriculture in the nineteenth century. This principle simply cannot be put to use in complex monetary production economies where production is a social and circular process and the scale of activity is governed by effective demand (Bortis 1997, p. 285). The results of Sraffa s critique of neoclassical theory stretching from 1926 to 1960 and the subsequent capital-theory debate, in fact, seriously question the long-period validity of the neoclassical version of Say s Law. The validity of the critique of the marginal principle is widely accepted. But there remain questions in regard to the extent of this criticism, which the neoclassical economists put forward in defence of their theory (Roncaglia 1978, pp ). However, the far reaching significance of Sraffa s critique and its following discussion must 9

10 be put in a wider context. In fact, the outcome of the discussion is linked up with the fundamental question of the functioning of the socioeconomic system and with the essence of society itself (Bortis 1997, p. 284). The capital-theory debate questions the proper functioning of the market system on the level of principles and heavily damages neoclassical theory, greatly reducing its role as the dominating paradigm in economic theory (Bortis 1997, pp , Bortis 2011). Sraffa s main 1960 work comprises, besides the important, largely implicit critical dimension also a constructive dimension, which explicitly emerges. In dealing with the functioning of the socioeconomic system Sraffa sets out a long-period theory of value and distribution. In fact, the main determinants of the prices of production and of distributional outcomes are constant or slowly changing institutional and technological factors. Building on Ricardo s surplus principle and taking into account Quesnay s view of the social process of production, he suggests that it is the social and circular process of production P ( M C... P... C' M '), not the market, which stands at the centre of a monetary theory of production. While Keynes works on a short-period level and examines the coordination of behavioural outcomes by the system in a monetary production economy, Sraffa is concerned with the realm of the production system in the long-term and offers an alternative to the corresponding neoclassical view. With Sraffa, production takes place in the social sphere where individuals and society are interrelated in a highly sophisticated way. Because of this, the important economic problems of (long-term) distribution, price formation and employment determination are social processes as well (Bortis 1997, p. 287). And of crucial importance, Sraffa demonstrates that the determination of relative prices is possible without any reference to marginal changes, i.e. with levels of activity and proportions of factor of production both being given (Roncaglia 1978). Prices of production depend on the conditions of production and the institutions that regulate the distribution and are thus determined before goods appear on the market. (And because the rate of interest is governed within the framework of the surplus principle, the money market is no longer required to determine the interest rate. Endogenous money is now possible.) Beside his main 1960 work, Sraffa s (1926) article must here explicitly be mentioned too: Even though Keynes never really took account of drafts for Sraffa s 1960 book, he must have known about the 1926 article, since he suggested its publication in the Economic Journal. Now, this article lays the microeconomic foundations for Keynes s theory of effective demand, but it would seem that, in 1926, Keynes did not see this implication. Indeed, Sraffa examines here the supply curve and postulates that, in the short run, output of each single firm 10

11 is primarily governed by the downward sloping demand curve and not by the costs of production. Since the position of all demand curves mainly depends on the income of consumers, Keynes s macroeconomic demand curve arises directly from the aggregate of Sraffa s (1926) microeconomic outcomes. This represents an additional argument against neoclassical theory: output levels cannot be varied at will once output is governed by demand; changes in input would make no sense and consequently marginal products are not possible, even if the associated demand and supply curves existed. Hence since output is fixed by the social or macro-phenomenon of effective demand, it is not possible to obtain marginal products if effective demand determines the behaviour of firms. This and the fact that markets are not independent but strongly linked to non-economic institutions strengthen the presumption that, in a monetary production economy, the long-period level of economic activity is, on historical and theoretical grounds, not governed by the law of supply and demand but by effective demand (Bortis 1997, pp ). This overview points to the crucial significance of Sraffa s work for establishing the principle of effective demand. In a way, Keynes s approach to effective demand was necessary to eliminate the classical, monetary, and short-period version of Say s Law, but not sufficient to knock out the neoclassical, real market version of this law. Keynes s disproving of the classical, monetary version, according to which supply creates its own demand, was of course an extremely difficult undertaking, but his theory of interest and money has been reinterpreted by the neoclassical orthodoxy to the effect that Say s Law maintains its validity in the long-period version. Keynes could not have succeeded in establishing the principle of effective demand in the long run because of his accepting the first neoclassical postulate and of his putting to use of a quasi-neoclassical theory of investment and interest. This in fact opened up the way for the neoclassical synthesis which combines Keynesian employment policies with the market regulation of value and distribution on goods and factor markets. However, it was Sraffa s (1960) work that created the possibility to bring about the capitaltheoretic discussion. The results of this debate gravely damaged the long-period validity of Say s Law: if production is conceived of as a social and circular process then long-period factor markets cannot exist. Given this, it can be argued that the Sraffian real way to effective demand is much more fundamental than Keynes s monetary way to effective demand (Bortis 2011). Hence, Keynes s theory of interest and money and the results of the capital-theoretic debate are, taken together, necessary and sufficient to disprove Say s Law and to establish definitely the Keynesian principle of effective demand, also in the long run. 11

12 However, if Keynes and Sraffa are considered in isolation they can be integrated in the neoclassical equilibrium theory. The interpretation of Keynesian theory by the neoclassical synthesis has clearly shown this: Keynes is included into a monetary theory of exchange (Marshall) and his disequilibrium theory becomes an equilibrium theory on the basis of the IS-LM model. However, Sraffa s 1960 theory of value and distribution, too, runs the danger of being absorbed by neoclassical equilibrium theory (Mandler 2008). In fact, Sraffa (1960) determines relative prices only (absolute prices would only be fixed once the money wage is given). Although the undertaking is highly fanciful, Sraffa s theory may be interpreted as a special type of a general equilibrium model and thus becomes a simple exchange model à la Walras ( C M C' ) in which money M only facilitates the exchange of commodities (Mandler 2008). Hence Sraffa and Keynes, left isolated, cannot bring about a complete alternative to the neoclassical orthodoxy. Only a synthesis of both of them, Keynes s theory of employment, interest and money and Sraffa s classical theory of production, value and distribution, taken together, can bring about a powerful alternative to prevailing orthodoxy. However, the synthesis must be prepared: Sraffa s inter-industry model has to be converted into a labour model and Keynes s short-period model of output and employment has to be adapted to the long run (Bortis 2003a and 2011). We take both conversions for granted and now turn to the long-period theory of output and employment as is part of the classical- Keynesian synthesis. III An alternative, coherent and consistent theory of the long-term level of output and employment is crucially important. Now, the persistent economic forces cannot work undisturbed, that is, there is no stationary state or a steadily growing one (Robinson) as is required for an eventual equilibrium position to be reached. Furthermore, there are the results of the capital-theoretic debate and finally, in the long run we are all dead : in a monetary economy with the quantity of money given, a long and painful deflationary process would be required to reach some equilibrium situation lying in the future. All this suggests that the long-period equilibrium must not be sought in the future but in the present (Bortis 2003a, pp ). Indeed, a given level of output at a given point in time can be governed by a cyclical movement fluctuating around some trend. Most importantly, the trend line need not be at a natural full employment position, but can be located on a long-period level implying some percentage of permanent involuntary unemployment, for example 5, 10 or 20 per cent; 12

13 obviously it is of the greatest importance around which trend a cyclical movement takes place (Garegnani 1983, pp. 76-7). To explain why an economy fluctuates around a certain trend line, and why a persistent natural position of full employment may not be reached, a theory of the long-term trend which focuses on objective, constant and slowly evolving factors and puts the subjective, short-term forces of the market in the background, is essential. In the long run, the functioning of the system determines employment and investment volumes and, therefore, sets restrictions to the behaviour of individuals and collectives. To isolate conceptually long-period outcomes we must abstract from accidental, behavioural aspects and concentrate on essential elements of the real world made up of the technological and institutional structure in order to get hold conceptually of a system equilibrium. Institutions and technology are the determinants of long-period output and employment. In contrast to a market equilibrium, in which the market stands in the centre surrounded by a social, political and legal framework, in a system equilibrium it is the entire socio-economic system that governs prices and quantities; the material basis and the institutional superstructure form a structured entity (Bortis 1997; Bortis 2003a, p. 420). Sraffa largely paved the way to establish the preconditions for a long-term alternative to the neoclassical approach; he in fact set the basis to elaborate a long-term theory along Keynesian lines. Based on his classical theory of production, value and distribution building on the classical surplus principle, it is possible to set up a fully-fledged and stable long-term system equilibrium. Indeed, if this theory is linked, on a Pasinettian basis of vertical integration (Bortis 2003a), with Keynes s theory of effective demand, with normal output and employment being governed by the entire institutional system we obtain a synthesis of classical and Keynesian elements of analysis (Bortis 1997, pp ). This synthesis of Sraffa s theory of production, value and distribution, adapted to the long run through vertical integration, and Keynes s theory of employment, interest and money, also appropriately adapted to the long run through institutions, emerges in Bortis (1997) and (2003a) as a system of classical-keynesian political economy. This undertaking of bringing together Sraffa and Keynes, has been rendered possible by the capital-theoretic debate and by Pasinetti s vertically integrated approach to production (Bortis 2003a and 2011). This has opened the way to synthesise Keynes and Sraffa who, if taken individually, were separated by a large theoretical gap. Both indeed worked on different problems and at different levels of analysis, and, given this, did not mutually understand each other s work (Bortis 2003a, p. 471). But it is precisely a synthesis of their work on a Pasinettian vertical integration basis set out in (Bortis 13

14 2003a and 2011), which represents a coherent and consistent alternative to the neoclassical- Walrasian model and its further developments. And, very importantly, classical-keynesian political economy represents a monetary production economy; there is a system equilibrium, but disequilibria may be taken into account through considering business cycles for example (Bortis 1997, pp ). Finally, classical-keynesian political economy elaborates, complements and synthesises the various post-keynesian strands (Keynesian Fundamentalists, Robinsonian/Kaleckians, and neo-ricardians). The classical-keynesian long-period theory of trend or normal output is summarized by the supermultiplier-relation (Bortis 1997, chapter 4). This relation holds in every, short-, mediumand long-term, situation and pictures how output and employment are governed, in principle, by the various demand variables and parameters depending on the institutional and technological set-up. The supermultiplier relation is definitely established as soon as income distribution is regulated by some institutional device. In this relation the long-period investment volume emerges as derived demand, governed by the institutional system, and is, as such independent of uncertainty which, however, is attached to each individual investment project. (This stands in contradistinction to the short-period investment volume which is autonomous and associated to uncertainty about the future). Hence the supermultiplier represents the pure long-period Keynesian employment theory in which long-period output and employment are determined by institutionally governed effective demand. Keynes s and Sraffa s contribution to economic theory represents a theoretical twin revolution. Keynes developed a fragmentary monetary theory of production and with his theory of employment, interest and money he refutes the classical, monetary version of Say s Law. Hence Keynes paved the monetary way to effective demand. In the course of Shackle s Years of High Theory [-1960], Sraffa revolutionised the thinking on production, value and distribution, initiating thus a revival of classical political economy. Sraffa s work renders possible a systematic criticism of neoclassical theory, specifically the marginal principle on which the neoclassical theory of capital and distribution is set up. Given this, he heavily damages the neoclassical, real version of Say s Law and thus paves the real way to effective demand. Sraffa s contribution to economic theory is of immense importance, because Keynes s shortterm, monetary, way to effective demand can easily be absorbed by neoclassical theory in the form of the (IS-LM) neoclassical synthesis. Sraffa s work now leads to the elimination of the strongly established neoclassical remnants in Keynes s theory. This seriously puts into question neoclassical theory as the dominating and fundamental paradigm in economic 14

15 theory. Given this, Keynes s General Theory of Employment, Interest and Money, and Sraffa s Production of Commodities by Means of Commodities combined in an appropriate way, as in Bortis (2003a), may be considered the most important contributions to economic theory of the 20th century. Both works have given rise to further developments of economic theory in the direction of a long-period theory of distribution, value and employment represented by the system of classical-keynesian political economy sketched in Bortis (1997 and 2003a). To conclude we may point to the importance of putting the significance and the implications of Sraffa s work in a wide and fundamental context. We should indeed see Sraffa s work as a discussion about fundamentals. How does the classical theory of production, value and distribution, in principle, look like. Or are there, in principle, well-behaved associations between factor prices and factor quantities. It is of greatest importance to tackle complex socioeconomic phenomena on the level of principles as Sraffa indeed does. It is in this way only that the analysis may be kept manageable. The final step would be to consider and to compare differing sets of principles, classical- Keynesian and neoclassical-walrasian, for example. The more plausible approach has to be selected. It has been attempted to suggest in this paper that Piero Sraffa has greatly contributed to rendering Keynes s employment theory, and the classical theory of value and distribution much more plausible than their neoclassical-walrasian counterparts. References: Bortis, H. (1997): Institutions, Behaviour and Economic Theory A Contribution to Classical-Keynesian Political Economy, Cambridge: Cambridge University Press; paperback edition Bortis, H. (2003a): Keynes and the Classics - Notes on the Monetary Theory of Production, in: Rochon, L.-Ph. and Rossi, S. (eds.): Modern Theories of Money The Nature and Role of Money in Capitalist Economies, Cheltenham (UK) and Northampton (MA, USA): Edward Elgar, pp Bortis, H. (2003b): Marshall, the Keynesian Revolution and Sraffa s Significance, in: Journal of Economic Studies, Vol. 30, No. 1 (2003), pp

16 Bortis, H. (2011): Toward a Synthesis in Post-Keynesian Economics in Luigi Pasinetti s Contribution, in: Arena, R. and Porta, P.L. (eds.): Structural Dynamics and Economic Growth, Cambridge: Cambridge University Press. Garegnani, P. (1983): Two Routes to Effective Demand, in: Kregel, J.A. (ed.): Distribution, Effective Demand and International Economic Relations, London: Macmillan, pp Harcourt, G.C. (1972): Some Cambridge Controversies in the Theory of Capital, Cambridge: Cambridge University Press. Keynes, J.M. (1973): The General Theory of Employment, Interest and Money, The Collected Writings of John Maynard Keynes, The Royal Economic Society (ed.), Vol. VII, London, Basingstoke: Macmillan. Mandler, M. (2008): Sraffian economics (new developments), The New Palgrave Dictionary of Economics, Palgrave Macmillan. Roncaglia, A. (1978): Sraffa and the Theory of Prices, Chichester: Wiley. Sraffa, P. (1926): The Laws of Returns under Competitive Conditions, Economic Journal, Vol. 26, pp Sraffa, P. (1960): Production of Commodities by Means of Commodities, Cambridge: Cambridge University Press. 16