Economics for Heretics:
denuding the myths of orthodox economics

-by Dante A. Urbina-

translated by D. Ohmans
© copyright 2018

Text imprint Lima Peru, ©2015

Economics for Heretics TOC
PREFACE - Economy in crisis and economic theory in crisis: The necessity of an alternative Chap.1 - THE MYTH OF THE RATIONALITY OF THE CONSUMER o The orthodox theory of the rationality of the consumer o A useless function: the utility function o Inconsistent consistency: "rational fools" o Economic individualism: a universal phenomenon? o Are we egotists by nature: a critique of the anthropological assumptions of economic orthodoxy o Egoistic altruism? Ockam's razor and mother Teresa against economic orthodoxy o Reasons of the heart: the ethical factor in economic decisions o An avalanche of anomalies: homo economicus visits the psychologist o Now homo economicus goes to the laboratory: experimental economics o Do not forget the right hemisphere! Performing an encephalogram on the consumer o We are not omniscient! The problem of limited rationality o We are not cold calculators! The problem of uncertainty o Conclusion Chap.2 - THE MYTH OF THE PRODUCTION FUNCTION o The orthodox theory of the production function o The "Holy War" of capital: the controversy of the two Cambridges o Things become viscous: "molasses" and the aggregation of capital o Murdered with its own sword: mathematics against the economic orthodoxy o The production function castrated: the sterility of the orthodox theory to explain the technological process o With what shall we produce? Critique from the ecological perspective of the production function o A supposition it is necessary to substitute: the assumption of substitutability o The final blow: the sophistry of empirical validation of the production function o Conclusion Chap.3 - THE MYTH OF THE THEORY OF DISTRIBUTION o The orthodox theory of distribution o An unproductive concept: the sophistry of "marginal productivity" o A theoretical anomaly quite normal in practice: the Leontief function and marginal productivity o A theory that through sloth does not change: leisure and the work offer o Is the notion of free and competitive labor markets pertinent? The institutionalist critique o To each according to her contribution? The multi-product case o Is the labor factor merely a cost? A critique from Keynesian and neo-Keynesian economics o The final blow: Sraffa's devastating critique of the orthodox theory of distribution o Conclusion Chap.4 - THE MYTH OF PROFIT MAXIMIZATION o The orthodox theory of profit maximization o No to the "mechanical optimizer"! The Schumpeterian conception of the entrepreneur o "Animal spirits": the problem of uncertainty o Maximize profits or minimize losses? The problem of risk o The behavioral economy returns to the fore: the problem of perspective o The broken plates of a divorce: the problem of agency o Consequences of technological change: the power of the technostructure o A true inconvenience: the possibility of seeking other goals o IMg = CMg: and where is the evidence? o Conclusion Chap.5 - THE MYTH OF COMPETITIVE MARKETS o The orthodox theory of competitive markets o The fallacy of free and competitive markets: the planning system o Everyone against everyone? The law of duality o Market and power: the social structures of the economy o Disappearance of the invisible hand: the birth of strategic thinking o Some scissors that should be cut: the supply and demand curves o Extreme unrealism and contradictions: analysis of the assumptions of the perfect competition model o A terribly imperfect theory: logical inconsistencies of the perfect competition model o Failed recursion: the "false Messiah" of successive approximations o Conclusion Chap.6 - THE MYTH OF MARKET EFFICIENCY o The orthodox theory of market efficiency o The markets are not omnipotent! The problem of market failures o Efficiency for what? The uncomfortable question of content and goals o A not at all optimal criterion: Pareto optimality o Efficiency for whom? Market and exclusion o Fair injustice? The fallacy of "prior votes" and the "meritocratic scale" o Destroying a dogma: the fallacy of consumer sovereignty o Competition leads to efficiency? John Nash vs. Adam Smith o An uninformed argument: the market as socializer of information o Endogenous explanation of the crisis: Minsky's hypothesis of financial instability o Conclusion Chap.7 - THE MYTH OF GENERAL EQUILIBRIUM o The orthodox theory of the general equilibrium o A castle in the clouds: the exaggerated abstractionism of the theory of general equilibrium o Impertinent commentaries: analyzing the pertinence of the assumptions of general equilibrium theory o The mirage of relative prices: the non-existence of general equilibrium o An unprofitable theoretical transaction: the surplus costs of uniqueness o Destabilizing stability: the Sonnenschein-Mantel-Debreu theorem o Stability and sterility: the absolute uselessness of general equilibrium o Is the DSGE model salvation? Confessions of an orthodox economist o Conclusion Chap.8 - THE MYTH OF NON-INTERVENTION OF THE STATE o The orthodox theory of non-intervention of the State o Good for nothing? The fallacy of the intrinsic inefficiency of the State o Saved by the State: the industrialization of Germany, Russia, Japan, and China o What is corrupt in the corruption argument: critique of Friedman and the public choice school o More assistance to those who cooperate? The role of the State in the promotion of economic efficiency o Seeking "the optimum" is not always optimal: the Lipsey-Lancaster theorem o In defense of political economy: critique of monetarism and the theory of rational expectations o Against the sword and the wall: totalitarianism of the State or totalitarianism of the market o Liberal hypocrisy: liberalism, dictatorship and other demons o Conclusion Chap.9 - THE MYTH OF FREE TRADE o The orthodox theory of free trade o Welfare for all? The critique of Singer and Prebisch of the theory of comparative advantages o Porter's critique: competitive advantages and comparative advantages o Why do factor prices not equalize? Critique of the Heckscher-Ohlin model o Liberal hypocrisy once again: the kick down the stairs o The development of underdevelopment: the problem of circular causality with cumulative effects o The law of the jungle and globalization: international Darwinism o The great fraud: United States and the Free Trade Treaties o Refuting Henry Martyn: fallacies of the analogy of free trade and technological progress o Conclusion Chap.10 - THE MYTH OF DEVELOPMENT o The orthodox theory of development o What can be measured and what cannot be measured: the fetishism of the PIB o The obsession with development: the error of the absence of choice o I'm rich! Yet why am I not more happy? The "paradox of happiness" o Persons or merchandise? The personalist critique of the orthodox theory of development o Is the road to heaven paved with bad intentions? Concerning the good, the beautiful, the dirty, and the useful o Development for all? The fallacy of universal prosperity o Only a question of time? "Schumpeterian underdevelopment" and dependency theory o Predestined enemies: orthodox theory and underdeveloped nations o Conclusion EPILOGUE - "What is to be done? Towards a new economic theory"


     Crisis in the economy, crisis in economic theory: that is the context in which we 
live. Nobody knows for certain if we can emerge gracefully from the present world 
economic crisis or exactly how or when we shall do so. It is even possible that the 
crisis originated by the private financial bubble is being "solved" generating a new 
bubble of indebtedness of the States by the massive introduction of fictitious money in 
the bank rescues. Be that as it may, one of the things which the crisis has made clear is 
that we cannot as we are with the same scheme of economic theory.
     But what is this scheme? It so happens that in economics there is a focus that is 
clearly dominant: the Neo-classical theory. This focus, which supposedly "renews" the 
classical economists, practically monopolizes the teaching of what strictly has been 
called "economic theory" in almost all the economics faculties of the world. One can speak
of other focuses, it is clear, in courses "without importance" such as those of the 
"History of Economic Thought, Economic History" or "Economic Sociology"; yet the "pure and
hard" courses in economic theory (Macroeconomics and Microeconomics) have to be centered 
and based almost exclusively upon the conventional scheme.
     It is not that the other focuses have not developed analyses and consistent theories 
upon the same field as macroeconomics and microeconomics, yet what happens is they all 
tend to be minimized or ignored as "peripheral" (curiously, the same attitude that the 
"developed" nations have with respect to the underdeveloped) or, in any case, if it is 
incorporated into the teaching, it has to be fitting the corset of the dominant 
epistemological scheme. What better example of this than the case of the considerably 
broad and complex Keynesian theory that is taught almost exclusively in terms of 
formulation of the Neo-classical Keynesian synthesis, that is to say, only after 
having passed through the filter of that which is consistent with the dominant theory. 
Thus, most of the time, the student will be acquiring her comprehension of the economy on 
the basis of such ideas as the competitive market, the rational consumer, the supply and 
demand model, the production function, general equilibrium, market efficiency, free trade,
rational expectations, economic growth as the primordial objective, etc.
     Perhaps with this one could think that the material treated here has only a 
"theoretical" interest without greater relevance in the "practical" world. Nothing more 
false. The economy is a field where the "good" and "bad" theories can have very great 
effects in reality, which range from the most marvelous to the most devastating. If a 
doctor has a bad theory and applies it, she can end up killling one person; if an 
economist has a bad theory and applies it, they can end by killing thousands of 
persons. Curiously, whereas the doctor goes to jail for negligence, the economist who best
know how to apply savage policies can obtain a good post at the IMF, the World Bank, the 
committee of economic consultants of a "developed" nation or some powerful multinational.
What is important is that the savagery be applied in a very calculated and intelligent 
fashion and in consonance with the interests of those who hold the economic power; or 
that is, thus something like an "economic hitman." Examples in this regard can be clearly 
seen in the application of the neo-liberal policies of the so-called Washington Consensus 
in the poor countries of Africa and Latin America.
     Yet something bad is not necessarily required to cause these negative effects. 
Precisely there resides the great venom of a bad theory: that it can cause good men to do 
ill or lose the opportunity of doing good. Thus then, those students who receive 
unilateral formation in economic theory go into the real world and become impresarios, 
ministers, consultants, and even presidents. And they can be applying even with good 
intentions, erroneous economic policies that generate negative effects on society, upon 
culture, institutionality and/ or the environment. Yet to the conventional economist it 
will be difficult to perceive all that in its true dimensions for she has been repeatedly 
taught in the university that all these are important variable but, in the final analysis,
are "exogenous" variables for the economist, which is to say they fall outside of her 
realm of study. To be occupied with those problems, therefore, is principally the labor of
politicians, psychologists, sociologists, and ecologists. Even this same economist can 
complain of all these problems upon reading the newspaper in her house on Sundays, yet in 
the daily calendar of Monday to Friday will not have them as a central preoccupation since
"they are concerned with exogenous aspects.
     And not only that. A deficient economic theory can leave the economist very badly 
situated when the phenomena of reality occur. This is something now almost classical in 
the history of contemporary capitalism; after epochs of optimism concerning the prosperity
of the economy and the "solidity" of the economic theory, the great crises arrive and 
leave the economists perplexed. That was seen en the Great Depression of 1929, the 
petroleum crisis of 1973 and our current "Great Recession" beginning with the financial 
crisis of 2008. In this regard, an economist as recognized as Paul Krugman (Nobel prize 
2008) wrote, in September of 2009, in his column in the New York Times titled "How 
did economists get it so wrong?" proposing that a large part of the epistemological 
failure of the economists before the crisis is that they preferred "beauty to truth," 
that is, they were too complacent with the "mathematical consistency" of their theories 
and they forgot the hard and complex reality. And in large part this is how the 
theoretical scheme of Neo-classical economics functions: constructing mathematically 
adorned myths that function as bridges between the undeniable contrary evidence and the 
faith which they wish to preserve. The problem is that those theoretical myths create 
real monsters.
     What is it that is required, then? Heresy. We need to strongly question that 
"orthodoxy" of economic thought, that which John Kenneth Galbraith would call "the 
conventional wisdom." A heretic is one who does not believe in the orthodoxy. So 
then, this is an heretical book, heretical with respect to that economic theory 
which includes amny lies and fallacies wrapped in apparently scientific language. This 
orthodox theory, the Neo-classical, has been proclaimed "the king" of the paradigms of the
economy and circulates very happily through the university halls. But someone has to tell 
the "king" that he is naked, somebody has to denude the myths of orthodox
economic theory.
     Now, when someone wants to say that "the king is naked," they will not say it to the 
consultants or courtesans of the king, going there first being foolish. Much better one 
is going to say it to the public. The prestige and even the life of the courtesans depend 
upon their obedience to and reverence for the king: if this is denuded, they will follow 
him saying he is wearing a handsome outfit. Thus, they are the persons least disposed to 
objectively analyze embarassing questions about the king. The people, on the other hand, 
are more open to listen and, what is more important, it is what they need to hear. 
In consequence, this book is not primarily directed to orthodox ultra-specialized 
academics but instead to all those educated and socially committed who might be interested
in the relevant question. Likewise, the book also can be of much interest and utility to 
all those professionals or students of Economics and the like who have "doubts of faith" 
or who are disposed to rationally question the "faith" they profess and/ or that has been 
inculcated in them.
     The foregoing, evidently, has implications for the form of printing this book. One 
seeks to realize a serious critique yet, at the same time, that it not be academicist nor 
ultra-specialized. And indeed this book seeks to be fruitful while with academicism and
ultra-specialization there is, in reality, much sterility given that, with an esoteric 
language that the man in the street will never understand, one begins to submerge herself 
in a type of study where one begins to know ever more and more about ever less and less, 
until one ends knowing almost everything about almost nothing. This book instead tries to 
have a general character concerning the critique of economic orthodoxy and about the 
topics of heterodoxy. Obviously the orthodox economists will take advantage of that the 
criticize diverse parts of the work saying that it has insufficient academic depth (read 
"extension") and that such and such a theory has not been analyzed with such and such 
sophistication that was published in such and such a "paper." It is a price worth paying 
so that the book can reach more persons to whom the questions it treats are very relevant.
To create an academic treatise, apart from that it should have more than two thousand 
pages to represent a minimally "satisfactory" approach in accord with the standards of 
"scientific papers," would result in the book being read, optimistically with luck, by 
little more than a dozen persons.
     Nevertheless, not being "ultra-specialized" does not imply that the book has 
insufficient academic rigor. Even though the language can be considerably sarcastic and 
even amusing, we have sought to realize an approach of pertinent epistemological level and
an abundance of academic literature in books and specialized articles are cited. 
Accordingly, whoever wants to further deepen some topic can refer to the indicated 
reference in that regard and read those sources.
     On another side, is is also possible that the book be criticized for being "too 
radical." With regard to that, three replies might be given. In the first place, to 
welcome the compliment: radical means, in rigorous terms, "that it goes to the 
root" and precisely here we wish to arrive at the bottom of the equivocations of economic
orthodoxy. In the second place, if one wants to use the word in the sense of "extremist" 
one must say that in a certain way it also becomes necessary that there be such a type of 
ideas for in the current context a change is required and the "lukewarm" ideas do not tend
consistently to that but instead, in general, are simply "absorbed" and easily neutralized
by the dominant scheme. Finally, one must say that if it is radical it is not only one's 
fault but instead the orthodox economic theory has its "little share of blame." And 
indeed, this being the established theory, everything that questions it will seem a bit 
presumptuous and even aggressive. Equally, a man who shelters in an old doorway under bad 
conditions and it falls on him could obtain fame as a victim for that. Notwithstanding, 
the poor condition of the door also contributes its part of the blame.
     Yet beyond the foregoing, there will still be those indignant that such a 
"dignified" and "ancient" portal has fallen. They will say, who are you to refute two 
hundred years of economic theory? Well, to tell the truth, two hundred years is not long. 
Economics deals with a "science" still "in diapers" and in an evolutionary process. In 
fact, there have been in physics ideas of greater antiquity and prestige that also have 
been put seriously into question. The emotional attitude of wanting to conserve the 
"intellectual capital" in which we were raised, questioning, when faced with consistent 
criticism, the person who make it (falacia ad homnem) and not the critique itself,
leaves few possibilities for a genuine (and necessary) advance in knowledge.
     In any case, we are dealing with a struggle. And there a "heretic" needs a great 
heart sustained by the confidence that reason is on her side and that she will obtain 
recompense in the "other life." And the recompense in the "other life" of this book will 
be that there can be an economic theory authentically more open to other paradigms, which 
interacts more with other social disciplines and which has a more solid philosophical 
basis. That day, economic theory will be able to do greater and better things for the 
world. And, if there is a struggle that in the final analysis matters, it is the struggle 
for a better world. Let us begin, then, our intellectual contribution to this fight.

                        Chapter 1

                                        "Human action is always rational."
                                            Ludwig von Mises, Austrian economist
The orthodox theory of the rationality of the consumer

     The postulate of rationality is the fundamental postulate of orthodox 
economics. In essence it tells us that economic agents act rationally, which is, 
that they always administer their resources (time, effort or money) in such a way as to 
maximize their level of welfare or utility incurring the least costs possible.
     "The economic model for the conduct of the consumer is very simple: it affirms that 
people try to choose the best patterns of consumption that they can afford ," professor 
Varian tells us concisely in his famous manual of microeconomics. Thus, then, modeling of
the consumer behavior becomes rather simple for the orthodox economist. First she 
constructs a utility function of the general form U = f(x, y) which
captures the level of well-being (measured by U) that an individual experiences as 
a consequence of the consumption of determinate quantities of the goods x and 
y. Following this she finds the function of budget restriction of the 
consumer in question, or to say, the combinations (baskets) of the goods x and 
y that can be bought with the given level of income which is available. This budget
restriction has the form I = Pxx + Pyy, where I 
represents the level of the individual's disposable income and Pxx and 
Pyy are the respective prices of the goods x and y. 
Finally, she applies optimization determining the respective quantities that the 
individual should consume of the goods x and y to maximize her utility. That
is achieved by means of the intensive application of the differential calculus to consumer
conduct modeled by means of the two functions mentioned (utility and budgetary 
     Yet do not think that the majority of orthodox economists consider this model of 
rational choice only as a mere speculative representation of the conduct of 
individuals when they consume. Completely to the contrary. With reason some have spoken of
an "imperialism of the economists" in the sense that they seek to explain whatever 
dimension of human behavior by means of the Neo-classical theoretical apparatus of 
rational choice. Thereby, it becomes valid to consider that the soldiers, the kamikaze 
pilots, the heroin addicts, and even the suicides are mere maximizers of utility. A good 
example of that is the economist Gary Becker, Nobel prize in 1992, who has become famous 
by extending the Neo-classical method of analysis to fields that previously were immune to
economic thought such as marriage, robbery, drugs, and prostitution. He himself writes: 
"The economic focus is not restricted to goods and material needs nor to markets 
with monetary transactions, and conceptually does not distinguish between greater 
or lesser decisions nor between 'emotional' decisions and those of another type. 
Strictly...the economic focus provides an applicable measure to all human behavior: to 
all classes of decisions and to persons in all conditions.
     Thus, then, we see that in the writings of the current orthodox economists they make 
manifest a very particular vision of human nature: that of homo economicus. It 
imagines the individual essentially as a "rational calculator" who seeks to maximize her 
utility in a constant balancing process of costs and benefits.
     However, this vision regarding human nature is not new. Already in the 19th century 
the classical economist John Stuart Mill maintained that economics studied man "only as a 
being who desires to possess wealth, and who is capable of comparing the efficacy of the 
means towards obtaining that end...and as a being who, inevitably, does that with which 
she can obtain the greatest quantity of necessary things, commodities and luxuries, with 
the least amount of work and physical abnegation." Elsewhere, in his famous work of 1776, 
The Wealth of Nations, Adam Smith, the so-called "father of Economics," describes 
man as an essentially egotistical being from whom "it is not from the benevolence of the 
butcher, the brewer, or the baker that we expect our dinner, but from their regard to 
their own interest.
     It is understood that it is important to also indicate, for its operationalization, 
that the Neo-classical model of rational choice requires that certain assumptions be 
fulfilled, which are basically three:
1) Completeness: Before any gamut of options whatsoever, the individual always is 
capable of determining which she prefers.
2) Transitivity: If one prefers A to B and B to C, then she necessarily prefers A 
to C.
3) Monotonicity: The consumer is essentially acquisitive, always preferring having 
more to having less.
     Finally, it is necessary to specify that the concept of rationality which orthodox 
economics postulates is not teleological nor intrinsic, but instead more 
instrumental. In other words, it has to do more with the efficient administration 
of the means than with the rationality and/ or pertinence of the ends or the
constitution of the preferences themselves (for the orthodox economist these are 
"exogenous" and so remain outside the model of analysis). The Austrian economist
Ludwig von Mises agrees with the orthodox focus in this respect: "Praxiology (the science 
of human action) and economics...are concerned neither with the motives that lead 
one to act, nor with the ultimate ends of the action, but instead with the 
means which man must employ to reach the proposed objectives. However fathomless
may be the abyss from which the instincts and the impulses emerge, the means one invokes 
in order to satisfy them are the fruit of rational considerations which consider the 
cost, on one hand, and the result reached, on the other."

A useless function: the utility function

     As we have just seen, the totality of Neo-classical analysis rests upon the notion 
of a utility function, that is to say, that which captures the level of well-being 
that an individual obtains through the consumption of determinate goods. The objective 
will be to maximize that function given the restriction of income. This being so, the 
orthodox economists see it as very useful since by virtue of that, it is possible for them 
to construct sophisticated mathematical models about the conduct of the consumer. However,
we maintain that it deals with a useless and even pernicious notion inasmuch
as it does not permit approaching in a coherent way the dynamic of consumer choice.
     We begin by analyzing the problem of measurement. Utility, in being 
constituted as a mathematical function, must necessarily relate quantities. Yet in 
terms of what quantities can we measure happiness? We have units of measurement for 
weight, altitude, velocity...yet we do not have units in terms of which to measure 
happiness! To tell the truth, considered on its face, such a notion itself seems absurd 
for giving a coherent explanation of the consumer. One does not go around thinking: "I 
shall buy a blue pen instead of a red one because the first gives me 8 units of happiness 
and the second only 3." No, we do not make that type of cardinal evaluation in 
terms of exact quantities but instead we more perform an ordinal comparison in 
terms of which good is qualitatively more suitable to satisfy a concrete need ("I 
buy the blue pen because it is the color I normally use to sign documents").
     Surely the orthodox theorists will reply here, together with Samuelson, that 
"Generally the economists of today reject the concept of cardinal (or measurable) 
utility... Or what counts for the modern theory of demand is ordinal utility. With this 
focus, the consumers need only to determine their order of preferences among the baskets 
of goods." A very lovely reply. The problem is that it is not consistent with an 
essential principle for the orthodox theory of the consumer: the equi-
marginal principle! In accordance with this principle--which Samuelson curiously
expounds on the same page (!) as his previous sentence--the consumer should "adjust her
consumption such that the last dollar spent on each good provides the same marginal 
utility." The mathematical expression corresponding to this, considering the case of 
consumption of n goods is the following:

     UMg1/P1 = UMgn/Pn

Very well, to reach this expression it is necessary, in the first place, to apply 
derivatives to the utility function in order to obtain the marginal utility 
(UMg) with respect to each good and, in the second place, to
divide such results between the corresponding prices. Yet both processes 
necessarily imply a utility function in quantitative terms! Thereby the same Neo-
classical economists have placed the noose around their neck. If they want they can 
perform conceptual juggling arguing that "the utility function only uses numbers to 
summarize ordinal ranges." However one would have to respond, paraphrasing the Austrian
economist Murray Rothbard, that "the scales of valuation for each individual are purely 
ordinal and qualitative, and there is no coherent way to measure the distance between such
a type of ranges; in consequence, any concept involving such a distance is nothing more 
than a fallacy."
     We shall now analyze one of the constitutive notions of the utility curve: the
basket of goods. As we have seen at the beginning of the chapter, the analysis of 
the orthodox economists do not start with a function of the type U = f(x) but 
instead one of the form U = f(x, y) in which quantities of the goods x and
y are considered. Now, we all have the experience of entering a store to buy 
certain goods: we basically think about what we want to buy and decide how many units to 
take of each good. At times we go for a single good (a pastry that we craved, let us say) 
and other times we go for various (10 of bread and two cans of milk, for example). The 
decision process is clearly given in terms of how many units of each good 
we consider buying, and that is natural. Nonetheless Neo-classical economics rejects this
evident fact and depicts us as choosing not between different goods but instead between 
different baskets of goods. That is to say, for the Neo-classical economists we do 
not ask how much bread and how many cans of milk we want to take but instead that we 
perform a joint analysis comparing "baskets" of combinations or bread and cans of 
milk (eight of bread and two cans of milk vs. five of bread and three cans of milk, for 
example). But, why adopt a complication so counter-intuitive and absurd?
For a very simple reason: because the baskets can be topologically equivalent and thus 
assure artificially by force that the representative utility function will be 
mathematically well-defined. As is seen, the orthodox economists have no embarassment 
whatever in sacrificing clarity and realism to the functioning of their mathematical 
     Finally, we have the question of continuity. The orthodox economists assume 
that utility functions are continuous, namely, that they can consider utility values even 
for decimal or fractional quantities of the goods in question. That condition is 
absolutely necessary to the Neo-classical analysis because if it is not fulfilled 
it is not possible to apply the differential calculus and, in consequence, the 
optimization of the consumer cannot be operationalized. Yet, is this a coherent 
assumption? In no way. A good is defined as an object with the capacity of satisfying some
human need. Now, what concrete need is satisfied with 0.186 computers or 5.17 pens? That 
simply and plainly is not conceivable by the human mind and thus is not relevant to any 
choice in the real world. We human beings do not make decisions on the basis of infinitely
small steps. Ergo, the evidently extensive discretion within good and prices is made 
simply irrelevant to the Neo-classical theory (or how many of us daily confront decisions 
such as how to buy 0.4875 packets of crackers for, let us say, 1.28479 dollars).
     It is evident, then, that the notion of a utility function, in the context in 
which orthodoxy use it, not only generates no utility for economic theory but, on the 
contrary, constitutes an authentic hindrance to the objective comprehension of consumer 
behavior and therefore should be discarded and replaced because, as the saying well says, 
"that which does not help, hinders."

Inconsistent consistency: "rational fools"

     Independently of the above the Neo-classical economists were in any event conscious 
that to sustain their entire theory of the consumer in an unobservable mathematical 
entelechy was exceedingly problematical with respect to the empirical hallmarks. We see 
persons making consumer choices but we do not see the (supposedly) underlying utility
curves. It was necessary, then, to leave the notion of utility without sacrificing all 
the assumptions, axioms and constructs around the postulate of rationality. And it is 
there where Paul Samuelson comes to the rescue with the concept of revealed 
     Following professor Varian, "we would formulate the principle of revealed preference 
saying: 'If one selects the basket (combination of quantities of goods) X instead of Y 
(when it is possible to select that as well) one must prefer X to Y.' In this formulation,
it is evident that the model of conduct permits us to utilize the observed choices to make
some deductions concerning the underlying preferences." In other words, if under the 
theory of rational choice one deduces what a consumer would select starting from 
her preferences (modeled in a utility function), with the focus of revealed 
preferences he deduces the preferences of the consumer starting from her observed 
     Now, this focus on revealed preferences is evidently tied to the assumption of 
consistency. The individual interests are revealed in each act of selection. If it 
observed that some individual chooses a set of goods in place of another, then we say that
that individual has a revealed preference for the first set. Beneath this conception 
individual interests, choice and utility are essentially the same. In consequence, "with 
this body of definitions, the individual cannot help but maximize her own utility, 
except through the effect of inconsistency." Thus, the behavior of an individual is 
considered rational if it can be explained in terms of some preference relation consistent
with the theory of revealed preference.
     The problem with this definition of rationality as consistency is that it can 
lead to many inconsistencies. For instance, if an individual were to act contrary 
to what she really wants yet does so in a consistent fashion an orthodox economist would 
say that is a rational individual. Furthermore, he would say that, given she chose an 
option she did not want in place of one that (supposedly) she did want, she is 
revealing that in reality she preferred the first to the second, which would lead 
us to the logical (?) conclusion that in reality, she wanted what she did not want!
     And do not think that this is an absurd or exagerrated case. As we shall see below, 
behavioral economics and neuro-economics have repeatedly demonstrated that on many 
occasions we choose things which we would not choose if in reality we were to slowly 
consider our decisions. It is thus that Amartya Sen speaks to us of "rational fools," that
is, subjects who are capable of selecting--very "rationally" and "consistently"--things
they really do not want. And so internal consistency is not a sufficient condition for 
guaranteeing a person's rationality. It is still necessary to evaluate whether they 
act in consonance with their own interests or motivations and on the basis of externally
conditioned impulses. However, the impossibility of distinguishing between inconsistencies
and changes in taste puts such a possibility in doubt. Orthodox economics remains trapped 
in a dead end alley.

Economic individualism: a universal phenomenon?

     Anyone who possesses a basic knowledge of anthropology or sociology will have 
already noticed that one of the principal problems of the model of rationality which 
economic orthodoxy proposes is that it postulates as humanly intrinsic and historically
universal something that in reality is very conditioned and particular: 
individualism, a product of the capitalist spirit of modernity and English 
utilitarian philosophy of the 18th century.
     Perhaps many think that this represents an exagerration and say: "Yes, indeed we 
truly are individualists!" Nevertheless, that is due in large part to our societies (above
all in the West) having been modeled on the capitalist-liberal project of modernity and 
that type of behavior and attitutude towards life becoming common. In this manner, one's
tendency to improve one's own chances, which Adam Smith discusses so much, though in our 
day might seem indisputable, in reality depends upon the type of society. If it is of the
communitarian type (like the Andean society), or rests upon an organicist 
conception (like millennial Chinese society) or is hierarchically structured in 
terms of castes or estates (like the Indian society) vertical mobility will be very 
limited and the individual in general will live in conformity with the security that his 
material lot, except for catastrophes or exceptional events, will be the same for all the 
days of his life. If, additionally, the society in question does not believe in 
progress (an idea belonging to the rationalist philosophy of the Enlightenment) 
there will be no collective endeavor to improve economic welfare and, in consequence, the
individual's greatest preoccupation will  be in following and preserving the tradition of 
his forebears (think for example of feudal Europe).
     In fact, it is squarely in this line of reasoning that, pursuing economic 
anthropology, various critiques of the postulate of rationality have been realized. 
Thus, scholars such as Marshall Sahlins, Karl Polanyi and Maurice Godelier have 
independently demonstrated that in traditional societies the selections that people make 
in matters of production and exchange continue to follow the reciprocity which differs so 
much from what the orthodox model postulates that they have rather tended to call those 
systems "gift economies" instead of "market economies." An example of that is the famous
potlatch ceremony of the North american indians in which they gave away (and even
destroyed) all sorts of goods establishing a kind of duel of gifts where the emerging 
winner would be the one who might give the most valuable gifts to the others. As against 
this, the Neo-classical idea of the egotistical individual, perpetually dissatisfied and 
adverse to working became useless, since the happiest one was he who worked the hardest 
during the year in order to be the one who could give the best and greatest gifts to the 
village. And, in fact, they keep giving today, for example in "stewardship" of religious 
festivals that take place commonly among the Andean peoples whose migrants and/
or descendents, being those who have "invaded" and massively populated cities like Lima 
(more than 10 million inhabitants) in Perú, comprise the true economic motor of the 
country above all as emerging and even informal entrepreneurs.
     In line with the foregoing, another demonstration of economics based upon reciprocity
we find in the interesting phenomenon of "Andean rationality." It concerns a model of 
socio-economic interaction that has been developing since before the Christian era among 
the Andean population of South America and which is principally based on the logic or 
cooperation and reciprocity, as well as on communal property and joint work. So 
structured, the model of Andean rationality differs radically from that of the modern 
West: while in this latter one individually seeks to maximize benefits minimizing the 
risk, in the former the peasant seeks to collectively minimize his risk in order to 
rationalize his endowment of resources. Here one is dealing not so much with 
exploiting the soil to extract as much product as one can, but instead more with 
administering it in harmony with nature and the community.
     It would seem, then, that the orthodox economists, seduced by the entelechy (or the 
fetish?) of the market, must have forgotten that the economy is always and necessarily 
given in a specific socio-cultural environment and it cannot be understood outside of 
it. Thus, when they explain their models they begin by enumerating the assumptions 
upon which they are based yet they always forget to make the most important assumption 
explicit: that they operate in a capitalist market economy. It may seem a tremendous 
truism, yet in reality is not. There are many zones of the world where the socio-cultural 
environment does not entirely correspond with capitalism yet which even so function 
perfectly. Then, when an orthodox economist arrives at one of those she does not 
understand yet even so, on the basis of her pre-determined mental schemes, proposes 
politics of "development" that end by being socially destructive (although, it is 
clear, they will never take account of that because the "social" variables are 
"exogenous"). Furthermore, the incoherence of orthodox "developmentalism" goes to extremes
which, on one hand "reward" ecological and organic production via prices while on the 
other introduces massively anti-ecological trans-genetic cultivation creating "green 
     It is absolutely necessary, therefore, that we economists reflect profoundly upon the
following words of Polanyi, Arensberg and Pearson: "The majority of us have been 
accustomed to thinking that the touchstone of the economy is the market... What to do, 
then, when we come across economies that operate upon a totally different basis, without 
any market feature or gain obtained through buying or selling? It is then that we should 
revise our conception of economics."

Are we egotists by nature: a critique of the anthropological assumptions of
economic orthodoxy

     Orthodox economics sees man as an essentially egotistical being who seeks to 
satisfy his own necessities motivated only by personal interests. So important is the 
notion of egotist man for the orthodox theory that it is already taught in the first 
classes to students of economists throughout the world. Perhaps many of them consider 
egoistical motivation as something undesirable yet end by accepting it as the correct 
basis for construction of the economic theory (and reality) for, at the end of the day, 
they see it as an inevitable feature of human nature. Nevertheless, this uncritically
assumed belief should be critically analyzed.
     Perhaps it is due to the myth of egoistical man (above all in Western culture) only 
it was not until the decade of the Seventies that the scientists began to seriously 
examine their assumptions. One of the things that most surprised them was to find that 
qualities previously considered marginal in human behavior like empathy (to be able to 
feel what another feels), altruism (to help someone without expecting recompense) and 
other pro-social behaviors (sharing, helping, consoling, cooperating, et cetera) were much
more frequent than what had previously been believed. How can we explain the reputed 
Argentine philosopher Mario Bunge that "for man to be competitive over cooperative is 
simply false. We are all at once cooperative and competitive, and the majority of us more 
the first than the second. As the contrary we would not be capable of functioning as 
components of social systems, from the family to the transnational enterprise. To 
exaggerate competition at the expense of cooperation in the manner of the dialectical 
philosophers, the social Darwinists and liberal economists makes comprehending the very 
existence of social systems impossible."
     In particular, the most interesting findings have occurred in the study of babies 
(who have not yet reached school age and, hence, are still not continually compelled by 
their parents and professors to compete with their companions and outmatch them). The 
recently born does not distinguish clearly between herself and others, but cries more 
intensely when they hear the bawl of another baby, evidencing by that an innate tendency 
to respond to the needs of others as if one's own. At one year, they display worry when 
somebody is hurt or shows sadness. At a year and a half, the infant can already 
distinguish between "I" and the "other," but continues assuming that the feelings of the 
other are similar to her own. Already at two years of age, she distinguishes between her 
own feelings and those of others, yet even so seeks to console whoever displays signs of 
pain or sadness, and their empathic emotions are more developed. Thus also at three or 
four years of age it is common to observe all sorts of pro-social behaviors.
     The conclusion of these studies is that the tendency to be concerned for others is as
peculiar to human nature as is preoccupation with oneself. This does not mean that the 
human being is not capable of egotistical and even anti-social attitudes. Yet it does 
demonstrate that persons give evidence of an entire gamut of behaviors from the meanest 
to the most altruistic. Consequently, it becomes clear that the anthropological conception 
of orthodox economics sins from being excessively biased and simplistic.

Egoistic altruism? Ockam's razor and mother Teresa against economic orthodoxy

     As we just saw, a very evident fact exists that puts the myth of egotistical man 
directly in check: the fact that often we are willing to make sacrifices of our own well-
being for the well-being of others. Upon observing that one person is willing to sacrifice
themself for others the most reasonable is to think that he does it for love. However, 
orthodox economics has invented a more "intelligent" explanation: if a person is willing 
to sacrifice themself for another she does it through egoism. For example, 
economics Ph.D. Sean Masaki Flynn of Vassar College tells us: "The economists take as 
given that people make choices in life to maximize their personal happiness. This 
viewpoint invariably provokes objections, because people frequently are disposed to 
support great personal suffering to help others. Nevertheless, the the point of view of an
economist, you may consider this desire to help others as a personal preference. The 
mother who does not eat so as to give the little food she has to her baby may be pursuing 
a goal (helping her child) which maximizes her own happiness. The same can be said of the 
people who make donations to charity institutions. The majority of people consider such 
generosity 'disinterested,' yet it is also possible to suppose that the persons perform 
certain actions in order to make themselves happy. If people make donations because that 
makes them feel good, their disinterested action is motivated by an egotistical 
     This type of explanations of altruistic acts has two problems: one epistemological, 
the other empirical. The epistemological problem is that they violate a basic 
principle of science knows as Ockham's razor by which a simpler theory in 
explanation of a determined phenomenon should be preferred over another that is more 
convoluted. And indeed with the goal of maintaining intact the traditional version of the 
egoistical economic agent the orthodox economists have elaborated an entire series of 
complicated theories (like the already mentioned "egotistical altruism") to explain those 
facts which put it in peril. In consequence, a simple and direct explanation
has been relegated in favor of another complicated and indirect one.
     Obviously intervening there are the prejudices of the various members (in the 
majority English and North Americans) of the "scientific" community who construct (and
have constructed) the economic theory. The popularity of the egoistical interpretation of 
altruistic acts is not due, therefore, to scientific motives, but instead to the fact that
admitting the existence of love does not accord with the standard mental models of the 
human being manipulated and promoted in the West.
     Regarding the empirical problems of the egotistical altruism theory we have, 
in the first place, that a large part of the "evidence" in its favor already begin from 
the assumption that we are egoists (fallacy of petitio principii) or do not refer 
to authentically altruistic acts. Thus, the "evidence" that we have about various persons 
(including ourselves) who give alms solely to "feel good with their conscience" (which is 
evidently egoist) is not so because in reality there is no form of altruism or sacrifice 
for in reality the concept of "alms," at least in the subjectivity of this type of donors,
logically implies that it involves no sort of real sacrifice: our extra money is donated.
     On the other side, there exists strong and important evidence against the hypothesis 
of egotistical altruism. We take as reference one of the most representative cases: that 
of mother Teresa of Calcutta. According to economic orthodoxy mother Teresa performed all
her acts of sacrifice for the poor solely out of egoism. But note, they will tell us, not 
a mean egotism but instead more of an "inclusive egotism" by which mother Teresa would 
maximize her welfare maximizing the welfare of others. In this mode, its utility function 
will be of the form:

               UMT = f(dUP) such that:
               dUMT / dUP > 0
Where UMT measures mother Teresa's level of well-being, 
UP measures the level of well-being of the others (especially the poor 
of Calcutta) and the condition dUMT / dUP > 0 expresses that 
the higher the level of welfare of the others, the higher will be mother Teresa's welfare 
level (in other words, her utility function is a direct function of the utility of the 
     Now then, according to the Indian economist Amartya Sen, Nobel prize in 1998 and also 
known as "the mother Teresa of economics," our preoccupation for others can be based upon 
two types of attitudes: solidarity (I concern myself with others because it affects
my well-being) or commitment (I concern myself with others independently of how it 
affects my well-being). Following this classification most correct would be to say that 
mother Teresa's attitude toward the poor basically was commitment.
     For those who really know their history this becomes evident. And indeed during 
mother Teresa's beatification process various unknown aspects of her inner life kept 
coming to light which demonstrate her authentic commitment to God and to the poor beyond 
her individual "utility function." The most surprising of them is the experience of the 
"dark night of the soul" that characterized 50 years of her existence. She, who had given 
everything for love of God and the poor and being a great symbol of happiness and hope, 
had the constant experience of being abandoned, of not being loved. Her personal 
experience cannot be explained by the paradigm of home economicus nor by the thesis
of "egotistical altruism." Mother Teresa, evidently, does not pertain to economic 

Reasons of the heart: the ethical factor in economic decisions

     An essential postulate of the epistemology that drives orthodox economics is to 
separate aspects of the human reality into spheres or domains which even if 
"somehow" related do not deserve to be studied conjointly. Thus, constitutive aspects of 
social reality such as politics, history, culture, law, and ethics are designated as 
simply "exogenous" and, consequently, are not taken into account at the time of 
constructing the economic theory. As Shackle put it well: "It has been assumed that the 
field of economic events is enclosed within itself and is self-sufficient, separated from 
the rest of the matters of humanity by a wall of rationality."
     Going specifically to the theme of the rationality of the consumer and taking into 
account the aspect of ethics (the same is valid for the other realms: politics, law, et 
cetera) we find that if orthodox economics does not actually approach the consumer as 
immoral it posits them as essentially amoral: "For a homo economicus,
all that counts are the consequences of his behavior for his interests and desires in a 
concrete case. He is flexible and adaptable, and accomodates to each new situation with 
its specific restrictions... He does not voluntarily subordinate his personal 
interests to the interests of others or to the norms of morality and the law."
     However, as Sen has astutely observed, it is evident that just a motivation as simple
as egotism makes it impossible to untangle the economy from ethics. For rationality is not
something merely empty or instrumental as the orthodox theory purports, but instead it 
always has a content. The conceptions of rationality can be seen to be influenced 
by the motivations and values which are held. The economy does not originate in a self-
sufficient laboratory different from that of ethics. Values guide the behavior of 
individuals and they are institutionally conditioned, through example and education, by 
     In this manner, the individuals' selections can have ethical motivations and not 
thereby be irrational. Ethics has a very clear practical connotation in the inter-
relations between individuals and the prosecution of social welfare. It follows that the 
North American economist Kenneth Joseph Arrow, Nobel prize in 1972, in proposing his 
famous impossibility theorem warns that one should keep values in mind and not only
preferences as variable in the social welfare function and also that in order to achieve 
agreement between individual choice and social choice it is necessary for empathy and 
sacrifice to exist in the subjectivity of the individuals.
     If these considerations have not been incorporated into the orthodox economic 
analysis it is principally because the multi-dimensional complexity of the motivations of 
the individuals disrupts the ruling stability of the traditional economic models. Put 
otherwise, keeping in mind ethical considerations within the economic theory would imply
violating the characteristics of egoistical behavior and introduce new concepts relating 
to motivation (sympathy, compromise, norm of conduct, et cetera) which evidently would 
become very uncomfortable for the economic orthodoxy. Nonetheless, as Pascal said it well,
"the heart has its reasons, of which reason knows nothing."

An avalanche of anomalies: homo economicus visits the psychologist

     In the year 2002 a very curious event happened: the Nobel prize in economics was 
awarded to a non-economist, the Israeli psychologist Daniel Kahneman who, according to his
own declarations, never had taken an economics course. The approach of this psychologist 
was to put to test various of the assumptions of Neo-classical economics with respect to 
the rationality of the consumer by means of "heuristic methods" starting from which he 
determined that on various occasions a large portion of us do not behave in a "rational" 
manner. All this made space for a new focus in economics: behavioral economics. The
themes which behavioral economics has studied are various. One of the most interesting is 
that referred to as cognitive bias. In accord with this we are not self-centered 
subjects who objectively contemplate the available options but instead we allow ourselves 
to be influenced by the mere form in which they are presented (it has been found, for 
example, that people tend to choose a certain medical treatment is they are told it give 
them a 20 percent chance of survival yet tend to reject the same treatment when 
they are told they have an 80 percent chance of dying) and on occasion we are not even 
capable of identifying them correctly.
     Likewise it was found that we are much more likely to be controlled by habits 
than by calculated deliberations. In this mode, if we have a good experience with 
an initial product we tend to continually select it even when there are better 
options. So strong is the evidence in favor of this that starting from it Al Ries and 
Jack Trout have formulated their first immutable law of marketing: "it is better to
be the first than to be the best." They write: "Many believe that the fundamental question
in marketing is to convince the consumers that you have the best product or service. It 
is not so... The fundamental question in marketing is to create a category in which one 
can be first. It is the law of leadership: it is preferable to be the first than to be 
the best. It is much easier to enter the mind first than to convince someone that you have
a better product than the one which arrived first." Obviously they could not say this were
we rational consumers who always select, much in accord with the already mentioned theory 
of rational choice, the best option independently of how the options are presented.
     Following this Ries and Trout provide a very suggestive series of examples to prove 
their thesis: "One reason that the first brand tends to maintain its leadership is that 
the name often becomes generic. Xerox the first photocopier, became the name for 
photocopies. The people stand before a Ricoh, Sharp or Kodak photocopier, and say: 'Where 
is a Xerox?' They will request Kleenex when the box clearly says Scott; they will offer 
you a coke when all that they have is Pepsi-Cola. How many ask for self-sticking tape 
instead of Scotch tape? Not many. The majority use names of brands when they become 
generic. Gillette, Fiberglass, Formica, Gore-Tex, Jello, Krazy Glue, Q-Tips, Saran Wrap, 
Valcro; to name a few.
     In turn, the behavioral economists have studied the problem of the consistency
of preferences associated with the assumption of transitivity, and have found various 
incompatibilities. In effect, individuals often prefer A to B, B to C but not necessarily 
A to C. That can seem a  bit counter-intuitive at the logical level for we view it like a 
uniform comparison of numbers with a greater or lesser value, yet if we carefully analyze 
the empirical world we shall observe that such shifts effectively exist. Or perhaps if we 
prefer an apple to a banana and a banana to an orange we will always and 
necessarily prefer an apple to an orange? No, it is not that simple. In any event, if 
one is not convinced, they can reflect more carefully about the strange decisions we make 
on the amorous plane. That suffices to give justification to behavioral economics.

Now homo economicus goes to the laboratory: experimental economics

     In the year 2002 the Nobel prize in economics was obtained not only by the 
psychologist Daniel Kahneman but also by an economist: Vernon Smith. Why? Basically, "for 
having established laboratory experiements as a tool in empirical economic analysis." 
With that there emerges, then, the paradigm of experimental economics.
     One of the most interesting topics in experimental economics is that referring to 
testing for possible rational conduct of agents in specific contexts of incentives, 
institutions, strategic interactions, and/ or artificially modeled market mechanisms. 
Thus, for example, they have found that in games of complementary strategy a small group 
of individuals with "pro-social" tendencies can significantly change the behavior of 
egoistical individuals. In this fashion, it turns out that egotism is not an 
unequivocally "given" condition in the interaction of agents but instead that their
survival, decline or development depend upon the praxeological context in which they are 
     Similarly, experiments relative to the "ultimatum game" have demonstrated repeatedly
that people are in general more disposed to sacrifice monetary recompense if it is small, 
which openly contradicts not only the notion of the individual as a marginal 
calculator but also the monotonic assumption according to which we are 
acquisitive beings who always prefer having more to having less.
     On another front, experimental economics has developed a very relevant innovation in 
pedagogy: the experiments with students. Basically it concerns economics professors who 
organize controlled dynamics with their university alumni in order to test certain 
postulates of economic theory. This type of experiment has become so important that 
prestigious scientific journals such as the Journal of Economic Literature include 
sections dedicated exclusively to experiments of this sort.
     A particularly interesting experiment in this respect was that organized by the 
German economist Reinhard Sippel at the end of the Nineties to test the hypothesis of 
consumer rationality. He presented a series of prices to his students which they could use
to "buy" diverse goods, with options established to test how rational the students were 
with regard to the benchmark of Neo-classical economics. The great majority of his 
students turned out to be "irrational" according to this standard because they violated 
some or all of the axioms covering preferences. They preferred A to B and later B to A, or
given a choice between A and B, chose A, later between B and C chose C, and between A and 
C, chose C.
     Yet do not think that experimental economics is charged with demonstrating that 
people are irrational without further discussion. As Camerer has said "the objective is 
not simply to create a list of anomalies, but the anomalies are used to inspire and 
structure formal alternatives to the theory of rational choice." What happens, then, is 
that the standards of "rationality" of the orthodox economists are so unrealistic and 
restrictive that the experiments have no option but to evidence their 
irrationality. For instance, in Sippel's experiment one sees clearly that the 
problem with the Neo-classical standard is that it does not take into account in a 
coherent manner the problem of temporality so that, as Veblen keenly observes, "the
marginal utility theory is of a totally static character. It offers no explanation 
whatsoever of any types of change because it is only concerned with adjusting values in a 
given situation." However, when one deals with real individuals (the pupils in 
the experiment in this case) one learns that the making of decisions is not an atemporal 
act but instead it is more that the human beings constantly confront the passage of
time and the conditionings intrinsic to it. In this way, life more resembles a continuous 
movie with many changing elements than a mere set of photos and, in consequence, the 
method of comparative statics of orthodox economics results in sterility.
     Thus, then, perhaps the orthodox economists should imitate the intellectual honesty 
of professor Sippel who, even when he had organized the experiment precisely with the goal
of demonstrating to his students that the orthodox theory indeed worked, felt obliged to 
admit that "the evidence in favor of maximization of utility is, in the best of cases, 
confused... Therefore, we should pay more attention to the limits of this theory as a 
description of how persons actually behave, that is to say, as a positive theory of 
consumer behavior.

Do not forget the right hemisphere! Performing an encephalogram on the consumer

     The advance of neuroscience or sciences of the brain has not been foreign to the 
economy. In fact it is thanks to them that they have been able to inquire into the 
physical bases of various of the discoveries of behavioral ecoomics, in this way giving 
birth to another new branch in economic studies: neuro-economics.
     As with behavioral and experimental economics, various studies have been performed 
with this new focus and very interesting results and conclusions. The goal is basically to
open the "black box of cerebral activity." We have there, for example, the famous study by
Sanfrey and others, who applied the "ultimatum game" to 30 persons connected to equipment 
to register neurological activity, with the objective of verifying the existence of 
significant differences in individuals before the different stimuli generated by distinct
offers. It suffices to say that the selected subjects participated in various rounds of 
the game, having human beings as opponents in 50 percent of the cases and a computer in 
the other 50 percent.
     The results were extremely interesting. They showed that certain regions of the brain
activated in a disproportionate manner when the subjects received "unfair" offers from 
human beings in comparison with what happened with "fair" offers from humans and with all
offers--fair and unfair--stemming from the computer. That evidently demonstrates that a 
physical basis exists in economic decisions and that these are not exempt from elements of
an emotional nature.
     A very important sub-branch of neuro-economics which is highly related to the theme 
of consumer rationality is that of neuro-marketing. This can be defined as an 
advanced discipline that researches and studies the cerebral processes which influence the
conduct and the decision-making of persons in the fields of action of traditional 
marketing: design of products and services, prices, positioning, publicity, channels, and 
     The contributions of neuro-marketing were crucial. As Néstor Braidot explains in his 
interesting book Neuromarketing: why your clients go elsewhere though they say they 
like you? this new discipline "allowed combining a set of affirmations from 
traditional marketing, like the efficacy of emotional publicity in brand loyalty or the
fallacy of attributing rational behavior to the consumer." Similarly it was discovered
that "the so-called buy button seems to be located in the middle pre-frontal 
cortex. If this area is activated, the client is not deliberating, she has decided to 
acquire or possess the product." Evidently this is very different from the consumer 
orthodox economics assumes, who very rationally deliberates over which will be the best 
option given her restrictions and preferences.
     And not only that. As Braidot well reports, neuro-economics, "on analyzing the 
topic of price, discovered that the maximization of utility based upon rational thought 
is not the principal motivation which weighs in decision-making given that, in most
instances, the triggering factors for the purchases were emotions, values and everything 
that activates the brain's system of rewards."
     Yet perhaps the most interesting part of neuro-economics might be the study of the 
particularities of each of the brain's hemispheres and how they influence our economic 
decisions, principally those of purchasing.
     As is known the human brain consists of two hemispheres: the left and the right. The 
left hemisphere is above all logical and analytic, being what we use when we 
verbalize a speech that we have prepared or resolve mathematical exercises or process the 
information in a sequential fashion, and is related to linear thinking. The right 
hemisphere, on the other hand, is above all creative and synthetic, being what we utilize 
when we accomplish a work of art or fall in love, or process information in a holistic 
form, and is related to creative thinking.
     Very well, it is evident that the left side of our brain corresponds much more to the
calculating and analytic activity belonging to homo economicus. Nevertheless the 
role that said hemisphere plays in our economic decisions is ever less for publicity and 
other forms of influence designed, developed and perfected for marketing are directed 
above all towards the right part of our brain causing our buying and consumption decisions
to be ever more emotional and impulsive. In this manner, directly "attacking" the right 
hemisphere manages to avoid that the rational and critical attitude of the left exceeds 
the first level, and thus a set of habits and preferences for irrational consumption are 
generated in the individual.

We are not omniscient! The problem of limited rationality

     One of the essential assumptions so that the orthodox postulate of consumer 
rationality can function is the assumption of complete information: consumers--and 
in general all economic agents--always consider all relevant information in order to make 
the best decisions.
     However, this assumption has been strongly questioned through the concept of 
limited rationality proposed by the United States economist Herbert Simon. In 
essence what Simon tells us is that we are not omniscient at the moment of making economic
decisions. In the real world we all have limited resources and information and, in 
the end, find ourselves necessarily obliged to make decisions based upon 
incomplete information and/ or analyses. The search for maximum utility 
involves too much time and effort; therefore, we settle for "reasonably good" decisions 
over "optimal" decisions.
     Evidently with this the sacrosanct mechanism of optimization so much used by 
orthodox economics in their mathematical models falls to the ground. Now it is not 
necessary nor even reasonable to think that individuals optimize. It is sufficient to know
that, in given contexts, they follow as best they can the norms established by the 
different sub-groups of society. Expectations do not have to be of the rational Neo-
classical type. People not always (or better put, almost never) have in mind all the 
variable, nor even the relevant ones. Often they try out decisions. Conventions dominate. 
It is necessary to rely on the behavior of the group, because of strength in numbers 
(think, for example, of the decisions referring to clothing, food or movies).
     We have, then, that limited rationality is compatible with sociological 
organicism because, as a consequence of these real-life deficiencies in the logistics 
of choice, individuals should follow procedures and rules based on experience and social 
practice. The Neo-classical theory, however, continues to cling to the deficient focus of 
sociological individualism.
     And this brings us clearly to the point of difference in the operationalization of 
these two visions concerning the economic agent. While for the Neo-classical paradigm the 
decision of the consumer is basically a mechanical and individual process, 
for focus on limited rationality we deal with an interactive and sequential 
process. And in effect: in real life the majority of times we do not make our buying 
decisions in an isolated fashion and only upon the basis of already given parameters such 
as the price but instead we already have in mind the actions and reactions of the other 
agents and we orient ourselves in relation to them. Thus, for example, we very much take 
into account the reactions and experiences of other consumers around us when we attempt to 
obtain technological innovations (software, cellular programs), recreational goods (trips, 
vacations) or fashion products (clothing, footwear).
     Meanwhile, limited rationality leads us to delimit our range of deliberation. 
We are simply not capable of thinking about all the possible options nor do we have a 
structure of preferences configured for all of them. Or how many of us have, for instance,
established preferences for a Boeing 747 or specific computer microparts? Yet it concerns
not only this type of examples. A decision as simple as choosing among different 
merchandise can already imply an immeasurable complexity in combinatorial terms. How many 
shopping carts could be filled with different combinations from among ten products? 
Several thousand! Thus, if the Neo-classical model of rationality were true, upon entering
a supermarket one would have to confront a decision comparable to having to select a 
shopping cart from among thousands hypothetically available in the parking lot each one 
full of different combinations of goods. But evidently it does not happen in this way. 
More likely what people reasonably do is to ignore all those possible combinations 
utilizing groupings of goods ("buy fruit" instead of "buy apples or oranges or pears or 
bananas, et cetera), habits ("I should always get canned soup"), charges ("my mother told 
me I should buy a box of cereal"), or other forms of practical simplification. It is in 
this way that in reality we act in our purchases. Ergo, the model of limited 
rationality is much more plausible than than of Neo-classical rational choice.

We are not cold calculators! The problem of uncertainty

     In his well-known (and critical) characterization of homo economicus the 
economist Thorstein Veblen, father of the North American institutionalist school, tells us
that "the hedonistic conception of mankind is that of an instantaneous calculator of 
pleasures and pains, which oscillates like a homogeneous globule of desire for happiness 
under the influence of stimuli that move him around the area, yet leave him intact." In 
other words, what Veblen is telling us is that for the orthodox  conception the consumer 
is above all a "cold calculator" guided only by that which causes her pleasure.
     Yet is this truly so? We definitely believe it is not. Human beings are exceedingly 
complex entities. We do not reduce to mere "instantaneous calculators" of pleasures and 
pains. We are, preferably, curious, active and erratic. We seek new ways of doing things, 
we probe, we equivocate, learn, do things out of habit, etc. We are, in summary, a 
substantial and diverse framework of social, cultural, historical, political, and 
psychological complexities; not mere optimizers.
     And all this complexity brings us to the problem of uncertainty. This derives 
from the previous paragraph: given that the agents never deal with complete 
information, they always confront the possibility that their actions do not furnish 
the desired result. The agent can make mistakes. Therefore, because of her
uncertainty, she always makes decisions under risk.
     Yet do not think that this is a condition merely external to the deciding agent. 
It is incorporated in her very subjectivity. Yet the Neo-classical theory has not 
wanted to comprehend this and at most arrives at formulating one model or another of 
"decision under risk" in which the uncertainty is treated by means of 
deterministic probability functions! This is an evidently inadequate treatment for 
it implies completely leaving aside the psychological process constitutive of all 
decision-making. And indeed, the orthodox Neo-classicals like it or not, here psychology 
is eminently endogenous, not exogenous.
     So then, the orthodox economists should be more humble and recognize the 
structural limits of their theory attending to the contributions of economic 
anthropology, behavioral economics, experimental economics, neuro-economics, the focus of 
limited rationality, and institutionalism and also learn from the scientific attitude of 
Carl Menger, founder of the Austrian school, who "with his attention fixed on reality, 
could not abstract, and did not abstract from, the difficulties which the subjects 
confronted" being always conscious that man "far from being an 'instantaneous calculator,'
is a creature who runs in circles, who makes mistakes, is poorly informed, tormented by 
uncertainty, perennially floating between attractive hopes and obsessive fears, and 
congenitally incapable of making decisions fixedly calibrated on the search for 
satisfactions." This seems a more exact description of the actual post-modern consumer,
whether the orthodox economists like it or not.


     The goal of this chapter has been to critically examine the orthodox theory of the 
rationality of the consumer. Basically we have seen that:
     1) The so-called utility function is not only useless but even pernicious to 
economic analysis insofar as it necessarily depends upon implausible and incoherent 
conditions like those of cardinality and continuity and unnecessarily complicates the 
analysis with the concept of "basket."
     2) To attempt to correct the foregoing adding on the theory of revealed 
preferences does not truly resolve the problem since the formal condition of 
consistency implied under this focus can lead to inconsistencies of content and generating
"rational fools."
     3) Strong evidence exists beginning with studies of agricultural economists that 
individualism is not a univeral phenomenon but instead is socially and culturally 
     4) On the basis of psychological studies it has been determined that the pro-
social tendencies (empathy, altruism, solidarity, cooperation, et cetera) are much 
more present in human behavior than had been thought and, therefore, the egotistical 
motivation model errs as unilateral and simplistic.
     5) The thesis of egoistical altruism is a mere ad hoc hypothesis of the Neo-
classicals that not only violates the epistemological principle of Ockham's razor but also
supplies important empirical evidence en contra (principle of the primacy of reality).
     6) Ethical motivations can influence (and in fact do influence) economic decisions 
above all in a sense which contravenes that postulated by orthodox economics yet without 
becoming "irrational" behavior inasmuch as ethics has a very practical connotation for 
social life.
     7) Behavioral economics has demonstrated that the greater number of us do not 
behave in the "rational" manner predicted by the Neo-classical theory given that our 
behavior and decisional process are found to be systematically affected by an entire 
series of psychological factors related principally to cognitive bias and inconsistencies.
     8) Experimental economics has validated the above finding furthermore that 
"pro-social" agents can have an effect on the behavior of the egotists in certain 
environments, that we do not necessarily take the marginal benefits into account and that 
on repeated occasions the assumptions upon which orthodox economics is built are not 
     9) Neuro-economics, by having demonstrated the great importance of the right 
hemisphere of the brain in decision-making for buying casts to the ground the idea of the 
centered and rational consumer who chooses automatically.
     10) The focus on limited rationality establishes that, given our limitations 
in acquiring, understanding and processing information, what is most reasonable is to make
decisions with bounded schemes and with simple rules and not acting "rationally" by means 
of calculation and detailed analysis of all the possibilities.
     11) The problem of uncertainty is not a mere external restriction that we can 
evade by means of probability calculations but instead endogenously affects our decision 
process, such that we are not "cold calculators."
     All this constitutes a powerful cumulative case en contra to the Neo-classical
postulate of consumer rationality. Therefore, the orthodox theory of consumer rationality 
is nothing more than a myth. May it rest in peace.

                        Chapter 2

                               "The laws and the conditions of production have
                                    the character of material truths. They contain
                                    nothing arbitrary."
                                            John Stuart Mill, classical economist
The orthodox theory of the rationality of the production function

     The production function may be the most important relation for technical 
analysis--as much microeconomic as macroeconomic--of orthodox economics. It may be the 
importance of this notion and the faith placed in it which caused professor Paul 
Samuelson himself, 1970 Nobel prize, to come to say: "As long as they do not revoke the 
laws of thermodynamics I shall continue relating inputs and outputs: that is, 
believing in production functions. While factors obtain their remunerations through
the offers made in quasi-competitive markets, we shall adhere to the Neo-classical
approximations in which the offers relative to the factors are important in the 
explanation of their market remunerations."
     Yet what is a production function? According to professor Nicholson's explanation in 
his popular microeconomics text, "the production function depicts what the enterprise 
knows with regard to how to mix different factors in order to produce a product" in terms 
of a "mathematical relationship between factors and products" that, if we want to 
see them as unique factors of capital and work, can be represented through the formula:

               Q = f(K, L)

...where Q represents to quantity of production of a concrete good over a period, 
K represents the machinery (that is to say, the capital) used during a said period 
and L represents the hours of work inverted.
     Then we learn that the great importance of the production function in orthodox 
economic analysis lies in that it might permit the impresario to know the quantities of 
capital and workforce he will need to use to reach a certain level of production. In this 
approach, the problem of the enterprise will be above all a technical problem. On 
this point it is very important to indicate as essential assumption for the 
construction of the production function: the assumption that one operates with a 
given technology. In other words, technology remains constant. This 
assumption is absolutely necessary for orthodox theoretization because were it not 
followed one would always be changing the functional relation between capital and the 
workforce and, ultimately, that would be simply impossible to express in determinate 
mathematical terms.
     Later, given the previous assumption, the orthodox economists advance to modeling 
production functions by means of the famous isoquants. But what is an isoquant? 
Well, nothing more and nothing less than a curve that shows the different combinations of 
capital and labor which would generate the same quantity of production. Graphically an 
isoquant would be as follows:
     A very important characteristic of isoquant curves is the degree of 
substitutability they present, or to say, "the facility with which we can substitute 
capital for labor or, in more general terms, how we can substitute one factor by another."
Why is this property so important? Because it permits the businessperson to fire workers 
replacing them with more capital or save on capital by contracting more workers 
maintaining the same production level as in the initial situation.
     And that takes us directly to the subject of the so-called typical production 
functions. In particular, the economists' favorite typical function is the famous 
Cobb-Douglas production function. The enchantment of this function resides in that,
given that the mathematical conditions of continuity and convexity are 
fulfilled, it permits "continuous substitution of factors" and, in the end, the intensive 
application of differential calculus to derive economic theorems. Its general form is:
Q = AKaLb.
     Another typical type of function is the Leontief production function, 
developed by the Russian economist and Nobel prize of 1973 Wassily Leontief and according 
to which the factors of production must be utilized in already determined fixed 
proportions to manufacture the product, such that there is no possibility whatsoever of 
substitution. The general form of this function is: Q = min (aK, bL).

The "Holy War" of capital: the controversy of the two Cambridges

     In the middle of the past century there occurred one of the most titanic intellectual
wars ever witnessed in the history of economics: the famous controversy of the two 
Cambridges around the definition of "capital" in the current orthodoxy. This "war" 
involved an effective army whose barracks commander was found in Cambridge, Massachusetts,
more specifically at the prestigious M.I.T. (Massachusetts Institute of Technology) and a 
fearsome army whose home general was to be found at Cambridge University in England. The 
ranks of the first army were comprised of the most prestigious economists of the era such 
as Paul Samuelson, Robert Solow and Franco Modigliani, among others. With regard to the 
ranks of the second army, these were composed of heretical economists (principally post-
Keynesians and neo-Ricardians) as fearsome as Joan Robinson, Luigi Pasinetti, Pierangelo 
Garegnani, and Nicholas Kaldor, among others.
     The first shot of this war came from Robinson in 1953 when she published a very 
heretical article entitled "The Production Function and the Theory of Capital." Her 
questioning was prophetic. She attacked the heart of orthodox economics placing under 
judgment the notion itself of a production function. She writes: "The production
function has been a powerful instrument of bad education. The student of economic 
theory is taught to write O = f(L, C) where L is an amount of work, C a quantity of 
capital and O a production level of goods. It asks you to assume that all workers are 
equal, and that L is measured in man-hours of labor; mentions to you something about the 
problem of index numbers involved in the selection of a unit of the product, and then 
quickly passes to the next question, in the hope that it does not occur to one to ask 
in what units is C measured. Before she stops to ask, she will already have become 
a professor, and thus the clumsy thought habits are transmitted from one generation to the
     Robinson goes on to ask: "Should capital be valued according to its irrevocable 
past costs or its unknown future profits?" That put the orthodox economists into grave 
straits. If they answered the second they fell inevitably into a fallacy of circular 
reasoning since in order to know the future earning potential of capital it is 
necessary to actualize its yields, that requires knowing the interest rate level, which in
turn is determined as a price in the capital market where, as much for supply as with 
demand for capital, it is necessary to already know measured and valued 
capital itself! Thus, what one sought to explain entered into the explanation and turned 
out to be a dead end (somewhat as if we were to ask someone "What is your telephone 
number?" and they were to respond "Call me and I'll give it to you").
     Yet the second option is also problematic. If the orthodox Neo-classical economists 
responded that capital should be valued as a function of its past costs they fell into the
serious, undesirable and dangerous extreme of endorsing the Marxist theory of 
capitalist exploitation. In effect, to price capital in terms of its past costs they 
would have had to do so in terms of the social labor quantity necessary to produce it and,
consequently, the production function Q = f (K, L) would have become the function
Q = f(L) where the only actually productive factor would be the labor and that 
would make it highly difficult to justify capitalist profit understood as reward to mere 
capital (think of the profits of the stockholders who possess yet do not work) for the 
entirety of the value would be produced by the labor, yet this would not receive 
all of the reward. In this manner, if they advocated for the second solution, the Neo-
classical economists culminated giving a great gift to the Marxists since they thus 
corroborate what Marx said, that  "capital is not solely the possibility of utilizing 
labor, as Adam Smith says. It is, in essence, the possibility of utilizing unpaid 
     Thus, more than 20 years of controversies elapsed. Hundreds of academic articles 
published about this debate. Many brilliant minds working on the problem. Much rivalry 
between the two sides... Yet nobody could consistently resolve Robinson's critique.
The orthodox side in Cambridge Massachusetts was defeated. Eloquent in this respect is the
testimony of Ferguson, the great martyr of orthodox economics: "The problem we confront is
not that of knowing whether the Cambridge critique has theoretical validity. It 
has. It is more of dealing with an empirical or econometric problem: does the system 
possess sufficient substitutability to establish Neo-classical results... Until the 
econometricians give us a solution, to confide in the validity of Neo-classical 
economic theory is a question of faith." What a man of faith! The heretics, on the 
other hand, we doubt...
     Another eloquent testimony is that of the orthodox economist Robert Solow who even 
came to admit that he had taught his theory of economic growth--intensively based on the 
aggregate production function--to the students at M.I.T. "for more years than one 
would like to remember." He also admitted that what he constructed was nothing more than 
an entirely simplified scheme, a "parabola" as Samuelson called it: "My dictionary defines
'parabola' as a 'fictitious narration or allegory through which moral or spiritual 
relationships are typically expounded.' If moral or spiritual relations, why not economic?
A parabola does not ask to be true to the letter, but instead to be well-
formed. Even a well-formed parabola has a limited applicability. There are always 
tacit or explicit assumptions serving as the basis for a simplified story. It may 
not matter for the point being discussed to explain the parabola; that is what parabolas 
make possible. When it does matter, the parabola can be deceptive. In a simplified 
model, there are always aspects of economic life that remain external. Consequently, 
there will be some problems upon which it sheds no light; but even so, there may 
be problems upon which it seems to shed light, but which in fact are propagating an 
error. Sometimes it becomes difficult to distinguish between both types of situation. The 
only thing that can be done is to honorably try to circumscribe the use of the parabola 
to the domain where in fact it is not deceptive, and that cannot always be known in 
     Yet it so happens that simply and plainly there is no domain where the "parabola" of 
the production function would not be deceptive. In effect, if the capital cannot be 
measured, it becomes absurd to construct a mathematical function (that is, with 
quantitative terms) on the basis of itself. Therefore, the "parabola" is empty of 
content. A logically inconsistent theory cannot ever be called scientifically 
valid concerning empirical reality, as Hahn had well recognized when he confessed 
that "when the aggregate version of the Neo-classical theory is used, simplicity is 
obtained at the cost of logical coherence and, in general, these theories deliver 
erroneous answers... The opinion that, despite everything, 'it can work in practice' 
sounds a little fraudulent, and in any event the responsibility to provide proofs falls 
upon those who hold this." Furthermore, when Solow says that "there will be some problems 
upon which it sheds no light; there will be some problems upon which it sheds no 
light; yet even so, there may be problems upon which it seems to shed light, but which 
in fact are propagating an error but even so, there may be problems upon which it seems 
to shed light, but which in fact are propagating an error" it clearly brings to mind that 
drunken man who sought the keys to his house far from where they had actually fallen, 
adducing that in the site where he was looking there was more light. Sincerely laughable 
(if not to make us cry).
     With all this, the Neo-classical production function continues to be taught. In 
economics departments around the world the professors keep training (and besotting)
their "university children" with humorous stories of "Neo-classical parabolas," thus 
transmitting, from generation to generation, those "clumsy thought habits" of which 
Robinson spoke (yes, though you may not believe it all this continues being taught in 
economic theory courses...and the uncritical pupils keep becoming 
     The orthodox position in this respect has already been thoroughly refuted, yet none 
of this has been incorporated in a clear fashion into standard economic theory. The 
strategy of silence rules. Practically no professor or academic talks about these 
problems. Or if they speak, they ignore or "neutralize" them. And the same occurs with 
"over-curious" students. If anyone dares to mention the Cambridge critique in class, she 
will be told it is off the subject or that that will be explained afterwards but 
first they must strive to understand the Neo-classical theory (with this achievement the 
student forgets the question in the short term, subjects her mind to the corset of Neo-
classical theory in the medium term and now will never ask uncomfortable questions in the 
long term).
     To conclude, a very significant datum. Paul Samuelson received the Nobel prize in 
1970 for his "contributions to the betterment of analysis in economic science," Franco 
Modigliani received it in 1985 for his "pioneering analysis of savings and the financial 
market growth," and Robert Solow in 1987 for his theory of growth, entirely based upon the
production function. No participant from Cambridge in England--not even Robinson (?!)
received this distinction.

Things become viscous: "molasses" and the aggregation of capital

     Following the above line, we now analyze the aggregation problem, which is to 
say, that referring to how the different elements can be grouped that enter into 
production of variables K, L and Q to be able to coherently construct the 
     With respect to the aggregation of the product (Q) there is no great problem. 
While the good is homogeneous it will always maintain commensurability: apples plus apples
will give us apples and chairs plus chairs will give us chairs. With regard to the 
aggregation of labor (L) the thing is a little more complicated because in a 
business there are different types of work and workers and not all are homogeneous (an 
hour of work by the engineer is not the same as an hour of work by the accountant or the 
laborer). Nevertheless, even though "we take a wide view" and consider the labor factor as
if it were a more or less homogeneous element summing it in terms of man-hours. However, 
in the case of the aggregation of capital (K) the thing becomes practically 
impossible. Capital is neither homogeneous nor divisible. There is in it an 
irreducible element of incommensurability and, in consequence, it cannot be 
simply aggregated. Therefore, once again the question arises regarding the very 
existence of the production function such as it is approached.
     However, the first Neo-classical authors were already conscious of this problem and 
to solve it postulated the existence of a sort of magical substance that provided capital 
with incredible plastic and malleability capacity: "molasses." Thanks to this "substance" 
capital not only became a multi-purpose and homogeneous good, but also it could be treated
as a flow and, at the same time, as a stock. In this manner, the blessed "molasses" 
functioned like a "philosphers' stone" for orthodox economics: it converted into gold its 
unusable and used up theories and promised to give eternal life to the production 
function. However, Joan Robinson arrived to ruin the party. After her lapidary article 
nobody could allege lack of knowledge of the difficulties that encumbered this type of 
magical resource used to "simplify" reality.
     Yet let us return to the aggregation problem. We had seen that if indeed the labor 
factor could be apparently homogenized into "man-hours" the same could not be done 
with capital given that a basic term of commensurability for it did not even exist. Let us
illustrate by way of example. Suppose that we are in a bakery in which there is a 
computer and an oven. In this case the computer as much as the oven forms part of the 
capital of the enterprise yet they are not the same thing nor have the same price. 
Thereupon, if we assume (as the orthodox economists do) that there is a generic price "r" 
for the computer and the oven by the fact that they form part of the "capital" we are 
tacitly asserting that this capital is some type of homogeneous substance which can be 
added, subtracted and divided, when the fact is that, given their heterogeneity, 
this is not so: an oven divided into two is not an oven, nor even a capital good; half an 
oven plus half a computer is not a new machine.
     But there remains another option: to price in money each one of the elements that 
comprise the capital and later sum the quantities of money. "Eureka, we have found a 
method to homogenize and, therefore, to aggregate capital!" the orthodox economists will 
say. Yes, congratulations. The bad news is that this method of aggregating capital does 
not work being incorporated into a production function! In a production function one must 
include physical units or K and L, not sums of money. Furthermore,
this method of aggregation of capital can result in leading to many absurdities and 
contradictions. Let us imagine, for example, two identical enterprises with the same 
physical endowments of capital and labor, yet which are differentiated by the fact that 
one of them has paid a higher price than the other for the same machinery 
(capital). The stock of capital measured in money is greater in one than in the other: is 
it therefore more productive? Does that allow increasing the quantity of the product 
fabricated per hour? No. Ergo, monetary valorization alone does not allow solving the 
aggregation problem.
     Nevertheless, current microeconomic and macroeconomic texts keep speaking about 
capital as if treating a homogeneous and malleable substance; to capital can be added more
capital, a part can be removed and another added, and it keeps being capital. That deals 
with a lie. A lie upon which basis have been constructed very beautiful and sophisticated 
macroeconomic models (Solow's model, Ramsey's model, Diamond's model, Romer's model, et 
cetera). Yet a lie in the final account.

Murdered with its own sword: mathematics against the economic orthodoxy

     One of the things that the orthodox economists most treasure is the logical rigor of 
their theories, which they achieve, according to them, by means of the mathematization of 
all the economic analysis. "One must always use mathematics to be rigorous, one 
need never fall into discourse," they say.
     However, it is precisely in this respect that it becomes quite ironic the the Neo-
classical economist, who so insist on the use of mathematics to avoid logical fallacies, 
systematically evade the critiques which are made of the very logico-mathematical 
fundamentals of their theories. In order to see that, we return to the traditional 
Cambridge critique concerning the Neo-classical theory of capital. As we have seen, this 
critique was not limited to indicating that the Neo-classical assumptions were forcing 
reality but also--or better, above all--demonstrated that the orthodox theory of 
capital had internal inconsistencies. Nonetheless, the years have passed and, 
despite the vainglorious orthodoxy of "theoretic rigor," the question persists without 
     Next, given that in the Cambridge controversies we have an example of how mathematics
can be used to make logical fallacies evident, we shall present a simple demonstration of 
how the Neo-classical conception of capital is incoherent. In other words, we will kill 
the orthodox school with their own sword.
     With y the output per worker, k the capital per worker; r the 
interest rate for rental of capital; w the wages; and y = f(k) the per 
capita labor production function, we have:

               y = rk + w

Very well, taking the derivative, we have:

               dy = + k.dr + dw

And given that, in theory, "r" is equal to the marginal productivity of capital:

               r = dy / dk

From which, simplifying, we will have capital being defined as:

               k = - dw / dr.............................(1)

However, additionally, we know that:

               r.k = y - w

Therefore, simplifying, we have another definition of capital:

               k = (y - w) / r...........................(2)

     Thus we have two definitions of "k" given by (1) and (2) and they will only be 
coherent if they coincide. Lamentably for orthodox economics, that only happens--as 
Samuelson demonstrated--in the case where all the compositions of capital in all the 
sectors of the economy are equal, which evidently never happens under capitalism (would
anyone be disposed to postulate that the composition of capital in agriculture is exactly 
the same as in mining or industry?) The orthodox theory only works for an absurd 
and non-existent case. Yet let us not be ill-mannered, and so excuse ourselves as 
Robinson excused herself: "I am sorry if I give the impression that it does not bother me 
that two exactly equal pieces of equipment can represent different quantities of 
accumulation of capital."

The production function castrated: the sterility of the orthodox theory to explain the 
technological process

     We had seen that one of the essential assumptions for the construction of the 
production function was that the relation between capital and labor remained constant. The
consequence of that? That the orthodox theory remains irremediably "castrated" during the 
moment of explaining the most important and crucial element of production: 
technology. Let us see why.
     By technology orthodox economics understands the given sets of information and
knowledge that can be applied to the production of goods and services, i.e. the 
knowledge held by the enterprise about the different production possibilities, 
which in turn are determined by the engineers.
     By now one can posit various critiques of this vision of technology. In the first 
place it is inconvenient because it treats (even if it be only "methodologically") as 
static and exogenous something that is essentially dynamic and endogenous. In 
effect: technology is more a process than a result. Even further: it deals with a 
continuous process that develops at each moment within the same enterprise, 
as the evolutionist school of technological change maintains as well as a Neo-
Schumpeterian focus on innovation according to which, as an inevitable 
consequence of the evolution of capitalism, innovation comes to be a systematic 
activity of the large enterprises with the capacity to invest in R+D (research and 
     Yet do not think that the endogeneity of the technological factor is only 
something pertaining to the large enterprises (if indeed a more conscious, systematic and 
organized mode is found in them). It is valid for all types of businesses. That becomes 
evident, for example, if we begin to see the workers as "human capital" with freedom and 
capabilities instead of seeing them simply as "factors of production" almost comparable 
with raw materials. The workers form a continuous, inevitable and 
constitutive part of the enterprise's technological progress to the extent that 
they keep learning special abilities for executing their work and, therefore, for them 
technology cannot be considered as given (and still less in our times of 
professional ultra-specialization).
     Now, returning to the critique of the orthodox conception of technology we find that,
by defining it as a given stock of information which does not need to be explained,
this paradigm is limited only to describing its impact upon the production function and 
the equilibrium conditions leaving aside that which would be more important to 
know: the origin and the causes of technological change. Thus it is that
Pepall, Richards and Norman tell us that: "The Neo-classical focus does not lack 
weaknesses. Although it indicates the way in which the enterprise's production plan 
changes in response to changes in inputs and the price of production, in reality it 
tells us little about the way this plan is designed. In other words, it reveals 
little about what happens inside the business, and more specifically the way in which 
the different competitive interests of the administration, the workers and the 
stockholders are reconciled in the design and execution of a production plan."
     Clearly shown in the above is the fact that despite practically all orthodox 
economists recognizing that changes in technology progressively and 
radically alter production they are not interested in developing a consistent 
theory which explains their dynamic and center more upon explaining by means of the 
blessed production function how the utilization of factors is optimized with a 
given technology. An example of that is the already variously cited professor 
Samuelson when in the part referring to the production function in his famous economics 
manual begins by explaining to us that the level of production that can be obtained from a
determinate set of factors "depends on the state of technology" whereby it follows, 
returning to the minutia explicable in class, to say: "yet at any moment there will be a 
quantity of product obtainable starting from given quantities of the introduced 
factors." We see, then, the essence of the strategy (fraud) of orthodox economics: 
to recognize the importance of the important so as later to commence theorizing over 
things without importance.
     Meanwhile, with regard to the orthodox conception of technology it also must be said 
that it becomes inconvenient because it distorts and hides the true nature of business 
technology selection and also abstracts from the intrinsically uncertain, random and 
probabilistic nature of technological change. In effect, the enterprise has no 
certainty regarding its choice, as the Neo-classical theory pretends with its dynamic 
of optimization, yet instead randomly scrutinizes the technology, even within itself, 
developing R&D projects on the basis of its own knowledge and technological learning 
in order to later decide on a basis of satisficing over and above that of 
optimizing. Given this context, even the "advanced" Neo-classical models for 
explaining the dynamic of technological change, like Romer's model, become irrelevant. 
And, it is clear, this drama of sterility is even more evident in Solow's famous model, 
taught as the basis of macroeconomic growth theory in practically all the economics 
departments of the world, now that the conclusion for this model is, paradoxically, that 
the model does not work, so should be the dynamic for the unexplained 
variable A (that includes technology) which will explain growth (do the orthodox 
economists have to commit so much mathematical juggling to arrive at the obvious, that 
technological progress is the funamental factor for growth?)
     Now then, the assertions of the evolutionary school of technological change 
seem more relevant in this regard than the most sophisticated Neo-classical models. And 
indeed, even though one must always take care with unjustified extrapolated notions from 
the natural sciences to the social sciences, the basic schema of the "theory of evolution"
through random mutation and natural selection, constitutes a schema with great heuristic 
capacity to analyze the way that enterprises perform their "technological search" in a 
changing, uncertain and competitive environment where they must survive and progress.
In this context, as we have already said, the enterprise acts more on the basis of 
"satisficing" than of "optimizing." In fact, as the evolutionary economist Sidney Winter 
has shown, the Neo-classical theories of endogenous technological progress on the basis of
impresarios who optimize the stock of information for production are logically 
inconsistent because they end by implying an ad infinitum regression: "It can be 
said that a determined maximizer of profits will adopt the form of organization which 
requires observation of those things it is beneficial to observe at the moments when it 
is beneficial to observe them: the simple reply is that that choice of an informative 
structure which maximizes profits requires information and it is not evident how the 
aspiring maximizer of profits is to acquire such information. Or which guarantees that she
does not pay an excessive price for this information"; so, at the end of the day one must 
seek "satisficing" and not necessarily "optimizing" conduct since there "should be limits 
for the spectrum of analyzed possibilities, and such limits should be arbitrary in the 
sense that whoever makes the decisions cannot know that they are optimal." It would not 
seem, then, that technological change occurs in the manner suggested by even the most 
sophisticated orthodox models of "endogenous growth."
     Also, from the Marxist viewpoint, with its wider and more pertinent concept of 
"development of the productive forces," the reductionism of the Neo-classical scheme has 
been criticized by simply discussing this as something purely technical without taking 
into account the intrinsically implied historico-social aspect. Arrizabalo writes: "One 
thing is the formulation of a productive workforce, strictly associated with their 
technical production capacity, in an asocial mode and, thus, exclusively related to 
productivity. Another thing, very different, is the economic and thus social category of 
productive forces, a category that goes far beyond a purely technical consideration. 
Certainly the productive forces are based upon the productive capacity, which depends in 
turn on the combinations that can be established between living work and the available 
means of production. Yet in no case are these combinations divorced from the social 
'rules of the game' (the relations of production) that determine which of those 
combinations is actually carried out." It is clear, therefore, that the Neo-classical 
conception of technology is absolutely impoverished and sterile.

With what  shall we produce? Critique from the ecological perspective of
the production function

     Let us imagine for a moment that the production function that orthodox economics 
presents is valid. And then, let us imagine that, in fact, we have to carry out a 
real production process upon its basis. Let us think, for example, of the 
production of a cake. What do we need for it? In accordance with the Neo-classical 
production function--of the general form Q = f(K, L)--we would need the elements 
capital and labor. We gather, then, all the elements of capital (defined as 
the set of instruments utilized for production): pitchers, bowls, vats, pallets, 
oven, molds, knives, etc. Now we gather the elements of the labor factor: basically it 
would be our own workforce (or that of a pastry chef contracted for the term) with all 
the abilities incorporated for making cakes. Then, given a technological configuration, 
that is to say, a relation established between the productive factors (Q = f(.)) 
re-uniting the elements of capital (K) and labor (L) that we have 
enumerated, we should be able to obtain the product, or that is a cake. But we do not 
obtain anything! It is not possible... There must be an explanation...
     We try an intensive incrementing of productive factors: we obtain much bigger vats 
and contract with various pastry chefs whom we instruct to mix more rapidly...yet not even 
thus do we obtain a single cake! "Why?" we ask disconcerted.
     The answer is very simple: nothing is produced because there are no raw materials 
with which to produce! It does not matter how many vats we get nor how many cooks we 
hire nor how rapidly they stir-if there is no batter to mix! And in effect: basing 
ourselves upon the Neo-classical production function, we have gathered together all the 
elements of capital and labor yet have not taken raw materials into account at all.
We have enumerated various things, surely. Yet at no time have we mentioned flour, sugar, 
eggs, etc. Thus, basing ourselves upon the Neo-classical production function, we have 
attempted to be God: we have wanted to create something from nothingness! However, it 
becomes evidently absurd in this context and in any relating to a real productive 
process: one cannot make a cake without cake batter. One cannot produce without raw 
     So then, it is precisely on this basis that the great economist Nicholas Georgescu-
Roegen, father of an ecological focus, presents his critique of the production function 
and of orthodox economics (which he rightly calls "pencil and paper economics"). He starts
by analyzing the physical bases of the productive process and from there jumps to 
viewing the implications of the First Law of Thermodynamics (whereby "Matter is neither 
created nor destroyed, only transformed"): one cannot produce without a material 
basis. Consequently, the Neo-classical production function becomes inconsistent
and absurd for not taking the factor nature into account.
     And it was expected. In the 19th century, the era when the Neo-classical school was 
born, they still believed in the so-called "theory of indefinite progress" and the 
modernists asserted that the resources of nature were endless such that there never
could be a limit to human prosperity. The orthodox theorists assumed this belief and on
its basis constructed the economic theory. Thus, the most essential and 
limiting factor of the economic process was left totally aside: the ecological
factor. Nevertheless, as Max Neef put it well: "There is no economy that would be 
possible exclusive of the services offered by the ecosystem. This is so absolutely 
evident and obvious that is is truly an epistemological scandal that in no 
economics textbook, if one goes to the final word index, can they find the words 
'ecosystem,' 'nature' or 'thermodynamic.' They do not exist! They simply do not 
exist. Why? Because the economics which is taught is conceived as a system closed upon 
itself having no relation with any other system...when obviously it is inserted in a 
larger system that is called the biosphere and around which come all the services 
offered by the elements of that biosphere. Where will the economist be is photosynthesis 
ceases? There would be no economists! What would happen to the economy if suddenly all the
world's bees were to die? There would be no pollenization... Yet no economist presumes 
that he must know this... That entire part is presented as a gigantic sea of ignorance on 
the part of the economy." In other words, there cannot be economics without ecology
and orthodox economists have not even acknowledged this.
     "But the problem is easy to solve!" the orthodox economists will say. "We add the 
factor R (natural resources) to the production function, and it's ready!" What 
ignorance! An ignorance only comparable with that also shown by such economists when they 
pretend to have comprehended the process of technological change only because they have 
incorporated a variable A in the production function.
     Let us see. It will be a "Solow-Stiglitz" variant of the production function (what 
they call the artifice with which they have pretended to solve the problem) in a Cobb-
Douglas format which is:

               Q = Ka Lb Rc

               such that: a + b + c = 1

     How a Cobb-Douglas function is treated implies complete substitutability of 
factors, which is to say that one can replace one of the factors with another (or 
others) maintaining the same level of production. But it is precisely there where 
the inconsistency resides.
     Mathematically, if R (natural resources) tends to zero, such a 
diminution can be compensated with increases in K or L maintaining the
same production level. The multiplicative structure of the function permits that. 
However, this becomes inconsistent on the factual plane because if R tends 
toward zero, K and L must necessarily do so sometime. In the first 
place, because they depend on R: the capital goods are products of a previous 
process that already presupposes the natural factor and, in turn, the workforce requires 
natural resources to sustain itself (can anyone imagine what would happen to our 
productivity if we only imbibed the equivalent of one glass of water per day?)
In the second place, because the amount of the product that capital and labor can generate
always and necessarily depends upon the flow of inputs to be transformed (it
does not matter how rapidly the pastry chef stirs or how big the available vat is, for 
without having ingredients for the dough she will be unable to make a single cake).
     So then, the Georgescu-Roegen critique of the production function shows us clearly 
that the economy has ecological limits. And that brings us to a central concept for
analysis: entropy (growing and irreversible decay or disorder) which implies that 
in a closed system (dimensionally bounded) and assuming matter as a packet of condensed 
energy (read ordered or organized, as it is in practice) and every time it is transformed 
(for example, burning wood to ashes and smoke but obtaining light and heat) what we are 
doing at root is disordering it and that is irreversible. And also, and with this the 
explanation is complete, if the scientists of the future succeed in obtaining wood 
starting from smoke and ashes, that which is certain is that the quantity of energy they 
would have to use for that would be greater than that generated by burning it (they, 
knowing that by the law of entropy there is no perfect reversibility, would 
not undertake such an absurd project). Ergo, the benefit from the qualities of natural 
resources has an objective limit and capital and labor cannot forever exploit nature 
because it too is subject to the law of diminishing returns.
     And that is not to mention the problem of the residues and ecological contamination 
that all productive processes imply. In effect, given that--due to the law of 
entropy--it is impossible to arrive at 100 percent efficiency, to produce something 
always and necessarily generates a residue or waste which must be treated. It is to say, 
after making a cake it is needful to clean the kitchen and wash the utensils. And the 
same applies for the planet earth as a whole which, imprudently, we are not doing.
     Nevertheless, orthodox economics has systematically left all this to one side. For 
them the ecological factor is purely exogenous. Now then, etymologically 
economics means "administration of the household." And our house in the last 
analysis is the planet earth. Yet orthodox economics has proved itself--evidently--as a 
poor administrator of it because, by leaving the ecological factor out of the analysis, it
necessarily carries a large part of the blame for the current problem of global warming
which advances uncontrollably operating against our very survival.

A supposition it is necessary to substitute: the assumption of substitutability

     As we have seen, one of the essential concepts of orthodox production theory is that 
of substitution, which is that referring to the possibility of substituting one 
factor for another without changing the level of production. Thus, under this assumption, 
the economic problem was reduced to finding that combination of factors (capital and 
labor) that enables reaching the highest isoquant curve (that is, the greatest production 
possible) given the isocost restriction (that is, the budget utilized by the enterprise 
to contract for the distinct factors of production). In turn, in reference to the theme of
"degree of substitutability," we recall that there were two typical forms of the 
production function: the Cobb-Douglas and that of Leontief. And it is upon those that we 
shall center our analysis.
     Let us see. Between these two types of typical functions orthodox economic theory 
strictly prefers Cobb-Douglas to that of Leontief. Why? Because the former--once 
complying with the mathematical conditions of continuity and convexity--
allows for "continuous substitution of factors" and the intensive application of 
differential calculus, while the second display a zero degree of substitutability and, to 
top the evils, is not derivable - remember that its general form is Q = min(aK, bL)
In other words, the Cobb-Douglas function is a "well-behaved" function--according to the 
same Neo-classical economists--whereas Leontief's function of fixed coefficients would be
a "spoiled" function.
     Yet beyond how the orthodox economists feel with regard to the Leontief function, we 
have to ask ourselves in the interest of scientific realism which is the type of 
production function more consistent with reality. So then, for anyone who has some 
real experience with the phenomenon of production and who has not remained simply 
and fully with what the microeconomics manuals say, it will be evident that reality has a 
"strict preference" for the Leontief production functions. Why? Because, as common 
sense well advises us, the most reasonable is to think that the relationship between 
labor and capital is, in practically the totality of production methods, one of 
complementarity over that of substitutability. A form of production is 
almost never found where one can simply replace capital with labor (or vice versa) 
maintaining the same level of production (we leave it as an exercise for the reader to try
to think of one). Every machine will be in general complemented by a fixed quantity of 
workers that cannot be varied or which can be varied very little. Thus, for example, once 
we have decided how "modern" or technified our bakery should be, the engineers will tell 
us that to use the installations over a period of time t it will be necessary to 
apply an average workforce flow in order to remain within that parameter. In this manner, 
if we attend to the real world, the most probable is that we will not obtain "well-
behaved" isoquants so needed by the orthodox economist to display her preparation in the 
calculus of derivatives.
     Some might object to this point saying that indeed there are some microeconomics 
manuals, such as that of professor Nicholson, which speak of the great importance and 
realism of the Leontief production function. Nonetheless, whoever holds that must also 
concede that in those same manuals, even though they accept the existence of various types
of production functions besides the Cobb-Douglas, they conclude developing practically 
all argumentation on its basis. One repeats, then, in this instance the ingenious 
sophistical gimmick that orthodox economics applies to technological change: to recognize 
the importance of the important so as, nevertheless, to later advocate unimportant 
     It is evident, then, that the orthodox manuals sacrifice the realism of the theory 
in favor of mathematical elegance. And indeed, as Martin Shubik well stated in his very 
heretical article "A Curmudgeon's Guide to Microeconomics": "probably one of the most 
important technical considerations that led economists to adopt the concept of continuous 
substitutability among input factors would be that continuous isoquants (like those of the
Cobb-Douglas type) are easier to form than the discontinuous (like those of the Leontief 
type) since "if one wants to present the theory utilizing calculus it is convenient to 
have curves like a pair of derivatives defined at every point."

The final blow: the sophistry of empirical validation of the production function

     At this point the reader should have lost all faith in the theoretic validity of the 
so-called production function. Nevertheless, it must be said still that various orthodox 
economists hide under the viewpoint according to which the validity of the Neo-classical
theory is an empirical and not a logical question. In particular, what they argue is that 
the cited Cambridge critique is correct in a formal sense but that it has no consequence 
in the real world. "It is true, the theory is inconsistent... Yet it continues being valid
because it still functions," they maintain.
     The empirical proof that normally is used to back up this position is comprised of 
the numerous regressions performed with different Neo-classical production functions in 
which the awaited coefficients have been produced.
     Sato's declaration is eloquent in this respect: "While we live in this world, we 
need not abandon the Neo-classical postulate. In order to reject it, it is necessary to 
demonstrate that this world is imaginary. This demonstration has not been attempted by the
literature... My argument is that the state of the question at this moment tends to 
establish the world in which the Neo-classical postulate dominates... Furthermore, the 
same Neo-classical postulate is the empirically proveable principle in the form of 
estimation of the "CES" production function and other varieties. This can cause us to go 
beyond the purely theoretical speculations upon this theme."
     In fact, the confidence which the orthodox economists place in the empirical validity
of the production function is such that it even has infected Mario Bunge himself, who 
maintaining that economics is not a science, even refers, contradictorily, to the Cobb-
Douglas function as "an empirical law."
     Very well, it is precisely here that we wish to exploit to inflict the final blow 
upon the orthodox theory of production. We shall begin with the sacrosanct Cobb-Douglas 
     Let it be a dynamic Cobb-Douglas function (which is, that takes time into account) 
and with constant returns to scale (which means, assuming a form such that if the factor
endowment is multiplied by "n" the production too will be multiplied by "n"):

               q1 = eut KaL1-a.... (1)

Where: Q is the production level, eut is the updating factor 
(t and u are the indices of time and technical progress respectively), 
K the capital, and L the labor. Now, if we assume that, as the Neo-classical
theory postulates, the participation levels of capital and labor in the product are equal 
to their marginal physical products, the coefficient a will be equal to its share 
of the profits and the coefficient (1-a) will be equal to labor's share in the 
national product.
     "But this is precisely what is seen in the great majority of national estimations of 
national production by means of the Cobb-Douglas! The calculated coefficient a is 
equal to the share of profits in the aggregate accounts! The orthodox theory has triumphed
once more and has defeated the Cambridge critique on the grounds of empirical reality!" 
the orthodox economists exclaim. Not so fast... As the distinguished Marxist economist 
Anwar Shaikh has shown in 1974 this result does not need to worry us at all. Let us see 
     If we re-write the Cobb-Douglas production function as output per unit of work, we 

               y1 = eut Ka.................... (2)
Where y and k are the output per capita and the capital per capita. If we 
take the logarithmic derivative of (2) we obtain the standard formula with which dynamic 
Cobb-Douglas production functions are estimated empirically, with △y and 
△k being the rates of growth of the output per capita and the capital
per capita:

               dy = du + (3)

     Curiously a very similar result can be obtained by means of the identities of 
aggregate accounting. If w is real wages and r the profit rate, national 
income is:

               Y = wL + rK..................................................... (4)

Then the output per capita is:

               y = w + rK...................................................... (5)

     Later, if we take the derivative of equation (5) with respect to the returns over 

               dy / dt = w.(dw / dt) / w + kr. (dr / dt) / r + rk. (dk / dt) / k

Now we divide this whole expression by y. If we remember that (dy/dt)y is 
the production growth rate per capita, and the symbol "d" the indicator of the growth 
rate of a variable, we arrive at the following equation:

               dy = (w / y) dw + (rk / y) / dr + (rk / y) / dk................. (6)

This can be rewritten as:

               dy = T + B / dk................................................. (7)

Setting the real share of profits equal to:

               B = rk / y

Such that:

                T = (1 - B) / w + B. dr

     In this manner, the equations (3) and (7) are similar, with both parameters a 
and B representing the percentage of profits. However, the first equation is 
derived from the typical Cobb-Douglas production function and its restrictive assumptions,
while the second is nothing more than a dynamic expansion of the national accounts. 
Consequently, it is no surprise that, when shares in the income are approximately
constant over time and among sectors, the Cobb-Douglas represents a good approach, because
it can be derived from the identities in the national accounts!
     And do not think that this is something exclusive to the Cobb-Douglas. As Simon has 
well demonstrated, the same observations are valid for the much beloved by orthodox 
economists CES (constant elasticity of substitution) production function.
     In consequence, we can conclude that estimations by the Cobb-Douglas and other 
production functions have in no way proved the empirical validity of the orthodox 
postulate. On the contrary, it has been limited to only verifying countable identities 
that are fulfilled in a necessary mode independently of the Neo-classical theory. 
It remains then in the dust, the attempted empirical defense of the production function.


     The objective of this chapter has been to critically examine the orthodox theory of 
the production function. Basically we have seen that:
     1) Starting from the controversy of the two Cambridges the very existence of 
the production function has remained seriously in question since no coherent form of 
measuring capital has been found and thus, it becomes unviable to include it as a 
quantitative variable in the former.
     2) To attempt to resolve the above clinging, as the first Classical economists did, 
to a magical substance called "molasses" which would make capital malleable and 
homogeneous is simply improper because, as we have already demonstrated, there always are 
elements of irreducible heterogeneity that prevent us from aggregating different 
capital goods as if they were commensurable and divisible.
     3) The Neo-classical approaches can lead to inconsistent mathematical 
formulations regarding capital that only match in the absurd and non-existent case 
where the compositions of capital in all sectors of the economy are equal.
     4) By assuming technology as "given," the Neo-classical orthodox focus becomes 
absolutely sterile for explaining technological change, which is perhaps the most 
important element in production.
     5) By not considering the ecological limits and the non-existence of perfect 
reversability that the law of entropy implies, the production function becomes 
unviable for our own survival. In turn, the pretended Solow-Stiglitz solution simply is 
not workable because its mathematical properties are openly counter-factual.
     6) The Cobb-Douglas production function, on which the orthodox analysis is 
intensively based, is in open contradiction with the greater part of reality where the 
relationship of productive factors is not so much of substitutability but instead of 
complementarity as seen in the Leontief production function which, however, becomes
very problematic with regard to the properties desired by orthodox economics, since it 
offers a zero degree of substitution and does not permit applying differential calculus.
     7) A large part of the attempted empirical proofs of Neo-classical production 
functions like the Cobb-Douglas or the CES are in reality spurious because their 
correspondence with the observed data are provided simply by a casual coincidence
of the identities in the national accounts when those are involved and the factor shares 
are relatively constant over time, which is common.
     All this constitutes a powerful cumulative case against the Neo-classically 
postulated production function. Thus, the orthodox theory of production is nothing more 
than a myth. May it rest in peace.

                        Chapter 3

                            "The main problem for Political Economy is to 
                                   determine the laws that regulate distribution."
                                                David Ricardo, Classical economist
The orthodox theory of distribution

     As we have seen in the previous chapter, in accordance with the concept of the 
production function, to generate a certain quantity of product two factors 
intervene: capital and labor. This product generates, in turn, in the market, an income 
for the enterprise. And it is there where the fundamental problem of distribution 
emerges, to wit: how do we perform sharing of that income among the factors that generate
     For orthodox economics the reply to this (in truth complicated) question is very 
simple: each factor will be compensated according to the value of its contributions to 
production. And how do we measure such contributions? Easy: by means of their 
marginal productivity. We shall explain this.
     In the first place, we should define the concept of productivity. By 
"productivity of a factor" is understood the quantity of product that a unit of it can 
generate. Thus, we can speak of the productivity per worker, per machine, per hour of 
work, etc.
     What, then, is marginal productivity? It is the quantity of additional product
that is obtained by incorporating one more unit of a certain factor, keeping all 
the other factors constant. Mathematically it is obtained in the following manner: first, 
we start with a production function Q = f(K, L) where Q is the level of 
production, K the capital, and L the labor. Later, in order to obtain the 
marginal productivity of a factor, we take the partial derivative of the production 
function with respect to the factor whose marginal productivity we wish to obtain, 
maintaining the other constant. That should be thus because, conceptually, a partial
derivative is that which shows an infinitesimal change in value of a function given an
infinitesimal change in one of the variable which comprise it, maintaining the others 
constant. With this form, in the case of the labor factor we would have that:

               PMgL = ∂Q(K, L) / ∂L
Where: PMgL is the marginal productivity of labor, dQ(K, L) represents the 
increment of production with capital K constant and dL represents the 
increment from the labor factor.
     With that, we already have all the necessary elements for modeling the orthodox 
theory of distribution, that is, for studying how the levels of profits (reward to 
the capital factor) and wages (reward to the labor factor) are determined. Given 
that in the previous chapter we have already spoken sufficiently about the capital factor,
in this we shall center upon the labor factor.
     Without more preambles, let us move to the analysis. How is it, then, that wages are 
determined in orthodox economics? Simple: they are determined like any other price, that 
is to say, in a market equilibrium. In this fashion, there exists for orthodox economics 
something called the labor market wherein the workers are the offerers and the 
impresarios are the demanders, and in which wages (price) and the level of employment 
(quantity) are negotiated.
     Thus, moving to a more thorough analysis, we have on the side of the offer, 
that the workers offer their labor power in a mode consistent with utility theory, 
performing a leisure-income choice of the type:

               Max U(x, l)     s.a : p . x = w . l............................. (1)

Where U(x, l) is a utility function that depends positively on the 
quantity of good x (that is, the greater the worker's consumption level, the 
greater will be her welfare) and negatively upon the quantity of hours l 
dedicated to work (which is to say, the greater the quantity of hours worked, the less 
will be one's welfare). The budget restriction tells us that the expenditure made (p . 
x) will be equal to the labor income obtained (w . l) In this way, the worker 
will offer their labor power following the logic of maximizing their utility subject to 
the budget restriction. Thus then, optimizing, the solution to (1) will be given as:

               UMgL / UMgx = w / p............................................. (2)

     On the demand side, we see that businesses confront a profit maximization 
problem of the type:

               Max Π = p . Q(K, L) - w.L - r.K............................ (3)

Where: Π is the enterprise's profit level, p is the price of the good 
that is produced and sold, Q(K, L) is their production level with a given level of
capital, w is the reward to the workforce L, and r is the reward to 
capital K which remains constant. Then, optimizing, the solution of (3) will be 
given by:

               PMgL = w / p.................................................... (4)

     Finally, in equilibrium, given that the supply and demand for labor must be equated, 
we shall obtain:

               w / p = UMgl / UMgx = PMgL

     The implications of this result are much more interesting than one might imagine at 
first sight. In the first place, it implies that the real equilibrium wage level
(w / p) is consistent with the needs for consumption and leisure of the workers 
(UMgl / UMgx). And in the second place, it implies that the capitalist pure free 
market system is the fairest system possible from a meritocratic perspective for it
rewards the workers (w / p) in an amount exactly corresponding to their 
contribution to production (PMgL). There was no reason, then, for the good Karl
Marx (along with all the Marxists) to rail against the capitalist system for exploiting 
the workers. Laissez faire capitalism is simply and totally perfect. Yet...can so 
much beauty be assured?

An unproductive concept: the sophistry of "marginal productivity"

     As we had seen at the beginning, the key concept of the orthodox theory of 
distribution is that of marginal productivity since it is starting from that that 
one can evaluate the input of each factor to the production process and, thereby determine
the part of the income generated corresponding to it.
     But, in truth does this treat of a consistent and valid concept? We think not. In 
the first place, because it necessarily depends upon the concept of production
function (the marginal productivity of a certain factor is obtained, mathematically, 
finding the partial derivative of the production function with regard to said 
factor) which, as we have already shown in the previous chapter, is plagued with logical 
and empirical inconsistencies.
     And not only that. Even if we accept the possibility of constructing production 
functions in a consistent fashion, the orthodox concept of marginal productivity would not
be redeemed by that given that in order to obtain the marginal productivity of a factor
--generally labor--it is necessary to assume that the other--usually capital--remains 
constant, which, in general, is factually impossible. Why? Because in actual
production it is almost never possible to isolate the constribution of one factor with 
respect to the other. The utilization of the factors is interdependent.
     For instance, if we were to want to know how only the increases in the labor 
factor influence the growth of production, that is, if we wished to calculate only the 
marginal productivity of labor (PMgL) it is obvious that we must assume capital 
remains constant. Yet can we really ensure that the capital remains constant as against an
increment of employment? Assuming that work is a homogeneous factor (as is assumed in
orthodox economics) an increase in employment would mean increasing the number of workers
per unit of time, which implies that the available capital would be utilized with more 
intensity than what had been habitual before the increment in the employment level.
But then, it would not be remaining constant!
     The orthodox economist could respond this is not so because it is nowhere necessary 
to vary the quantity of capital. But that only shows us that she is not 
understanding the true nature of the problem. In production the amounts of potentially
available capital and labor are not primarily important, but instead rather the 
quantities of capital and labor actually used. If we have a great stock of capital 
and a large number of workers yet do not use them, we simply cannot generate any 
production! Therefore, the relevant concept here is that of utilization more than 
that of availability.
     Having that in mind we can pose the previous argument in a much clearer form: with 
an increase in employment perhaps the fixed capital remains constant, yet not 
its degree of utilization! Consequently, how can we ponder the increment in production
with an increment in the labor factor if it also is changed the utilization of capital? It
truly is a difficult--not to say impossible--task given the continuous interdependence 
between capital and labor that we always observe in reality.
     The distinguished English professor Eric Roll had reason then, in his famous work 
History of Economic Doctrines, to write that: "The notion of a specific 
productivity independently from a factor is an abstraction, and can have no relation to a 
problem as realistic as the justification of a certain level of remuneration. The 
product is the joint result of factors employed in combination, and the 
asseveration that wages are equal to the net marginal product of labor has to be 
considered as only one of the elements of a theory of wages."

A theoretical anomaly quite normal in practice: the Leontief function
and marginal productivity

     As we had explained in the previous chapter, the Leontief production 
functions, which relate the quantities of capital and workforce in fixed proportions, 
if indeed are considered mere "theoretical anomalies" by the orthodox economists, are 
nevertheless the most common in practice. In effect: in the real world it is observed 
that the relationship between the productive factors is more one of complementarity
than of substitution. Capital and labor are strictly interdependent in the 
productive process. Orthodox theory can do little or nothing before the patent realism of 
this assertion.
     Now, as we also had seen the the previous chapter, the Leontief functions do not 
behave at all well in the orthodox production theory. Will they behave better in that of 
distribution? Lamentably no. These functions, just like in reality, are quite maladjusted 
to the entelechies of orthodox economics. Principally because they do not permit obtaining
marginal productivities. What?! Yes, what you heard. If we start from a world where 
production is given in the typical Leontief form Q = min(aK, bL) which is a world 
very similar to the actual, marginal productivity will not exist either for the 
capital factor nor for the labor factor. In effect, mathematically:


     Let us illustrate with an example: if a man (L) is digging a well with a 
single shovel (K), to incorporate a second person maintaining constant the quantity
of shovels, the depth that can be dug per unit of time (PMgL = 0) will not 
increase at all. Why? Because of the constitutive restriction on the production
process to which we are referring: one man, one shovel.
     Thus we see with clarity that, given the constant complementarity between the 
worker and the capital, such a thing as the productivity of labor does not exist 
independently of capital nor the productivity of capital independently of labor. In other 
words, at least in the great majority of instances, marginal productivity as 
conceptualized by Neo-classical economics does not exist.
     We now have, then, analyzed the fundamental concept upon which the orthodox theory of
distribution rests. Now we shall move to analyzing the specific case of the "labor 
market." We shall commence on the side of supply.

A theory that through sloth does not change: leisure and the work offer

     In accordance with the orthodox theory, to decide under what conditions to offer 
their labor power, people confront the sort of decisions known as leisure-income 
decisions where what determines the number of hours they will be disposed to work is 
such which maximizes their welfare equilibrating the hours of leisure with the hours of 
work necessary to get the income with which to finance their consumption.
     Starting from that, as a result of the individuals' leisure-income choices, 
the orthodox theory advances to construct the individual labor offer curve, which 
relates the hours of work that the individuals will offer with the different wage levels. 
Later, adding all the individual labor offer curves, the aggregate labor offer 
curve is obtained, this being that which in its intersection with aggregate labor demand 
determines the employment level and equilibrium wage.
     All this sounds very orderly and pretty, yet there is a small problem... As the 
orthodox theory itself well accepts, starting from a certain point (in general, when too 
many labor hours are being offered) individuals begin to have a much stronger preference 
for leisure than for income and, consequently, are now indisposed to work more hours even 
before important salary increases. Even more: to the degree that the workers' wage levels 
increase fewer work hours begin to be offered. Why? Because the individuals need the 
leisure time to spend and enjoy the income that they obtain from their work. Thus, if 
indeed at the beginning they have a great incentive to exert themselves for better 
remuneration, the moment shall arrive when they commence to value their leisure hours more
than the increments in their wages and, in consequence, will offer fewer hours of labor. 
To understand this logic in more simple terms: one works to live, not lives in order to 
     Now then, if it occurs that individuals behave such as we have just described them 
(and as the orthodox theory fully accepts for analyzing leisure-income decisions) we shall
have to accept that individual labor offer functions do not only proceed in a growing 
direction, which means, as positive functions of the type: "the more the wages, the more 
the hours of work offered," but instead that at a certain point they will cure backwards, 
ending with a shape similar to that of an inverted "C." This is shown in the following 
graphic where w  represents the wage levels and L represents the labor hours


     Yet what is the problem with it? A large problem to tell the truth. Given that the 
market aggregate labor offer curve is obtained by adding the individual work offers it 
will follow that, if these are sloping backwards, the former will present many 
irregularities, now sloping backwards or forwards, generating many points of intersection 
with the aggregate demand curve and, therefore, breaking with the assumed existence of a 
unique and stable equilibrium in the employment and wage levels of the labor market.
     But not only that. Even were we to accept that the labor offer theory of orthodox 
economics is well constructed, one would have to say that it merely deals with a fiction 
proper to the Neo-classical world of the "Alice in Wonderland" type for it is more than 
evident that in the labor markets of real capitalist societies the number of labor 
hours depends practically not at all upon individual "leisure-income choices" but instead 
more on institutional restrictions (think of the 8-hour regime) or upon business 

Is the notion of free and competitive labor markets pertinent? The
institutionalist critique

     As we have seen, the orthodox theory of distribution is based upon the notion of 
"labor markets," that is to say, spaces (not necessarily physical) in which 
businesspersons (demanders) and workers (offerers) mingle to transact employment and wage 
levels in a free and competitive context.
     Yet does this constitute a pertinent notion? Our opinion is no, and we are very 
solidly and decidedly supported by the institutionalist school. Let us see their 
     In the first place, we have the phenomenon of collective bargaining and the 
unions. With regard to this it is interesting to indicate the context in which the 
institutionalist labor focus originated. The institutionalist theory of labor 
markets emerged during the decade of the 1940's in the United States, at a moment when
the syndicates were growing rapidly in that nation and centralized collective bargaining 
was being promulgated. That caused certain economists to consider that the orthodox 
theory of wages had ceased being realistic and relevant. Why? Because collective 
determination of wages in the presence of unions was very far from competitive, this being
above all a qualitative and not merely a quantitative difference. And indeed
the unions are fundamentally political and not so much economic institutions, that act in 
a context of "pressure plays" among the government, the businesspersons and the workers 
themselves following a logic of negotiation over one of optimization.
     As a consequence of the foregoing, the wage comes to be more an administered 
wage than a market wage. And in effect, given this context of collective 
bargaining, the wages become a fruit of conscious human decisions and now not from 
impersonal market forces. Or in any event, as the institutionalists say, instead 
of it being the salary that adjusts to the supply and demand for labor, it is the supply 
and demand for labor which adjusts the wage.
     The second critique by the institutionalist economists of the orthodox theory of 
distribution is based upon the famous theory of the dual labor market. In accord 
with this theory--originally proposed by Doeringer and Piore--there exist two well-
differentiated types of labor markets: primary and secondary.
     The primary labor markets are, by definition, where the "good" work positions 
are found. Their characteristics are: 1) stability and security, 2) high and growing 
wages, 3) constant labor training and education, 4) opportunities for advancement on the 
scale of positions, 5) utilization of advanced and capital-intensive technologies, and 6) 
the existence of effective and efficient unions.
     On the contrary, the secondary labor markets are those where the "bad" 
workforce posts are found. Their characteristics are: 1) instability (because of high 
worker turnover), 2) low and relatively stagnant wages, 3) lack of labor training and 
education, 4) non-existent scales of positions or having few possibilities for 
advancement, 5) use of superceded labor-intensive technologies, and 6) the non-
existence or precariousness of unions.
     Why does this comprise something problematic for orthodox economics? Simple: because
it contradicts that postulate whereby the justice of capitalist distribution is 
"demonstrated," namely, that each worker is paid according to her productivity. And
if indeed duality exists in the labor markets (or, at least, in a large part of 
them) we shall find that wages are now not only and primarily determined by 
individual productivity of the workers but rather instead by the type of labor 
market to which they belong (primary or secondary).
     Perhaps an orthodox economist can object at this point that even accepting the 
existence of duality in the labor markets one need not negate the mobility of the workers 
since it may very well be the case that a worker belonging to a secondary labor market 
increases her productivity and moves to the primary. Obviously this case can occur, and on
occasion does occur. But it is the exception, not the rule. And even more so when 
the characteristics of the secondary labor markets are inter-related and have mutual 
feedback. In effect: as a consequence of the low level of wages paid in this type of 
market, the businessmen have no great incentives to introduce labor-saving technologies 
and, consequently, the productivity of the workers stalls together with their wages (not 
to mention the case where this type of technology is introduced but the wages do not go up
in order to thus obtain greater "profits"). And not only that. The presence of a stagnant 
technology from then on diminishes the opportunities and incentives for workers to improve
their qualifications. Thus, it is not so simple for a worker under these conditions to 
"ascend" to a primary labor market.
     Finally, the third line of critique by the institutionalists has to do with the 
existence of the so-called internal labor markets. An internal labor market can be 
defined as an administrative system of the enterprise that is guided by a set of intra-
institutional rules and procedures to establish prices and allocations of the labor 
     Thus, in accordance with this focus, even were we to accept the orthodox theory of 
the setting of wages via offer and demand we would have to say that its validity ends at 
the enterprise's door, that is, exactly where this theory ought to apply. Why? 
Because from the door onwards the most "universal" and "apodictic" laws of supply and 
demand are immediately replaced, as we have already said, by an entire series of internal 
rules and procedures to determine the positions and salaries of the employees.
     Any economist who may have had the opportunity to know real businesses will 
notice that the existence of those so-called internal labor markets is not a mere 
"bureaucratic anomaly" but instead deals with a widely extended phenomenon in business 
organization and administration. The main reason for that is the need that enterprises 
(especially medium and large ones) have to reduce labor turnover. In the first place, 
because the replacement costs for personnel usually are quite high (not thinking only of 
monetary ones) and, in the second place, because on investing in the specific 
qualifications of their workers the impresarios are conscious that they should stablize 
the employment in order to obtain a better and sustained return for these investments in 
human capital.
     So, taking as a fundamental referent "free" and "competitive" labor markets in the 
sense that orthodox economics does is nothing more than believing in a theoretical fiction
having nothing to do with reality and that in the final account obscures and complicates
its correct comprehension. And that is well-known by the university professors of 
economics who, on one side, in the shelter of classes, speak of the sacrosanct "free" and 
"competitive" labor markets and, on the other, when leaving the hall, do not confront the 
daily perspective of being displaced from their work by another equally capable person 
willing to work for a lower salary. Thus, in practice, though it may be in an unconscious 
manner, not even they themselves take as a central referent what orthodox theory says...

To each according to their contribution? The multi-product case

     On reading the above critique surely the woke reader will have taken note of an
important detail: if in the internal labor markets the workers are not paid in accordance 
with labor supply-demand but instead more based upon rules and administrative procedures, 
there is no reason to suppose they are paid in correspondence with their marginal 
productivity and, it follows, nor must one assume that capitalist distributions 
are necessarily just.
     In what follows, we shall demonstrate this point mathematically using the 
scheme of orthodox economics itself. For that we shall start from a joint or multi-
product production function, that is, one whose basis is formed not from a single 
product but instead various. Perhaps the reader accustomed to the mono-product 
production functions presented in microeconomics and macroeconomics texts will suspect 
this point of departure. Yet there is no reason. In the first place, because the joint or 
multi-product production functions are perfectly possible in the orthodox theoretical 
scheme. And, in the second place (and this one interest us the most) because they are the 
preferences of reality. In effect, anybody who has not remained solely in the 
textbooks and has been able to study real businesses will have seen in 
practice that what is most common is not that a single homogeneous good is 
produced but rather instead that a whole series of differentiated goods and/ or services 
are, each with its proper price.
     Thus, we have Qi = f(L, K) different goods and/ or services 
produced by the enterprise, each one with its respective price pi. On the work 
factor side, we denote this with Lj, with j being the business' department, 
occupations or categories. Now wj wage units are paid according to departments or 
occupations and zj rates per worker. On the capital factor side, to simplify, we 
measure it directly as a function of its cost as Mk.
     With this data we shall have the following function for profits:


Where the incomes I are given by the quantities of each good sold multiplied by 
its price and the costs C for the labor costs (wages and benefits) in each 
department together with the costs of capital.
     Now, assuming that we are in the short term, with the capital factor constant and the
labor factor variable, we derive that the businessperson can only maximize profits 
varying the quantity of labor (the price of the product cannot vary because it is "given" 
by the market). Mathematically that will imply equating to zero the derivative of the 
profit function with respect to total labor (the initial L of the joint production 
function). Operating with this equation we obtain that the result of the maximization 
with respect to total labor is given by:


which is actually the formula for payment of wages in the modality of "joint 
production" with social benefits.
     Now, to correctly analyze the marginal productivity we have to consider the labor 
L from two points of view: one, which we have already explained, as a function of 
the m departments, occupations or categories (j) of the enterprise; and 
another, as a function of the quantity of work incorporated into any of the n goods 
and/ or services that the enterprise produces. Thus, it will follow that:


Then, replacing the corresponding terms of (2) into (1), we derive that the equation for 
the marginal productivity under the modality of joint production will be:


Where the first term is the value of the marginal productivity of labor considered for a 
specific product and the second, the remuneration (wages and benefits) for labor applied 
by specific department and product.
     The implications of this last expression are truly demolishing for the Neo-classical 
distribution theory. And indeed, in accordance with this, it is no longer necessary 
for the businessperson to pay his workers in a specific department or area in accord with 
their marginal productivity. Why? Because for condition (3) to be realized, deduced 
from maximizing profitable conduct, it suffices that the businessperson equate the joint
sum of value for the marginal productivities according to the labor incorporated  into
each one of the commercialized goods and services (dLi / dL).
     In this form, what matters is the equating of the sum of values of the marginal 
productivities to the sum of the wage (and benefit) units considered,  not 
necessarily that each be paid "according to their contribution" (although it might be the 
case that this results, but that would only be by chance or through an ex-
ante administrative policy having nothing to do with the orthodox dynamics of the 
labor market). Or it may occur, to illustrate with an extreme case, that the group of 
workers who effectively contribute 80 percent of the production are only paid ten percent 
of the wage total and that the group who only contribute 20 percent are paid the remaining
90 percent without thereby violating the logic of business optimization which the orthodox
theory proposes. It is enough simply that the sum of salaries be equated with the sum of 
the productivities evaluated, independently of how such wages are distributed among the
people who participated in the productive process.
     How will they determine, then, the wages for each of the business' departments? Most 
probable is that it will be done according to the institutionalist dynamics of 
collective  bargaining, dual labor market and above all internal rules and 
procedures, in which hierarchical power relations and pressure tactics
weight more than the criteria and principles of social and distributive justice.
     In conclusion, the "marvelous" meritocratic distribution system of orthodox economics
fails precisely in that case most common in reality, to wit, the case of joint production 
and by departments, for then it cannot be assured that each worker shall be paid 
according to their marginal productivity. Productivity is disassociated from wages and,
in consequence, all the discussions fall to the ground concerning just distribution under

Is the labor factor merely a cost? A critique from Keynesian and neo-Keynesian 

     Within the schema of profit-maximization of orthodox economics the labor factor, just
like the capital factor, is considered above all as a cost for the businessperson. 
Clearly shown thereby is that, in the so-called "factor choice to minimize costs" that 
orthodox economics postulates, the impresario makes the best decision when she locates 
the lowest level of costs that a certain volume of production is allowed to 
generate, with her function for minimizing costs:

               CT = w.L + r.K

The matter seems sufficiently obvious: given that the labor factor must be compensated 
with a wage, this should be considered primordially as a cost. Yes, will it be only a 
cost? Of course the orthodox economist will respond, no and adduce that the labor factor 
is not only a cost but also a productive factor which, in union with the capital, 
generates the product. However, there are many economists who consider the matter to go 
far beyond that.
     In the first place we have the Keynesian economists. They start from the 
notion of the fundamental psychological law enunciated by Keynes and according to 
which "when real income increases, consumption also increases, although not as much as 
income." In this mode, if they increase one's salary, if in fact he will not spend 
everything, his consumption level will increase. The consequence? That an increase in the 
level of real wages of the workers will imply not only an increase in business costs but 
also will have a synergistic macroeconomic effect since, upon causing the increase 
in consumption among the great mass of workers, it will stimulate aggregate demand for 
goods and services and, therefore, also production. And who will benefit from this 
increase in production? Why (in addition to the economy in general) the impresarios 
     Another group of economists who question the orthodox scheme of minimization of costs
with respect to the labor factor are the neo-Keynesian economists. Their basis is 
the notion of efficiency wages. What are efficiency wages? They are a wage level 
such that it stimulates persons to improve their levels of efficiency and productivity in 
their work. In this instance it follows an inverse logic from that of the Neo-classical 
orthodoxy: it is not that workers are paid little because they are less productive but 
instead that they are less productive because they are paid little.
     According to Romer, the existence of this type of wages is due, basically, to three 
     In the first place, to that a high wage can contribute to increasing the effort of 
the workers when the enterprise cannot control its throughput due to a lack of adequate 
mechanisms for supervision of the productivity.
     In the second place, a high wage also can contribute to improving the capacities of 
the workers at an enterprise by affecting specific aspects that cannot be controlled 
because they occur in a context of imperfect and asymmetric information. That can be the 
case, for example, in the processes of personnel selection. Thus, if we assume that the 
reserve wage of the qualified workers is greater and the business decides to pay wages in 
excess of the market equilibrium, it will attract the more capable workers and, therefore,
increase average labor productivity.
     Finally, a high wage can stimulate a feeling of loyalty in the workers and induce a 
greater effort. Or the contrary, if the workers have the perception that their 
remuneration is inferior to that due they could quit the enterprise, reduce their level of
effort, and resentment can even result in acts of sabotage or negligent behaviors.
     Evidently such a logic has its limitations for it cannot deny that in every way 
productivity is one of the factors that influence the determination of wages (not 
to mention the fact that by doubling the pay of a person this will not necessarily result 
in a doubling of productivity for were this so, it would be sufficient to pay one 
infinitely in order for them to be infinitely productive) but in any case it puts an 
extremely important consideration on the table, to wit: that a person works better when 
they feel well and find themselves in good conditions. But given that the wage level has 
to do with that, it is evident that these are not a mere "cost" but also can be considered
in a certain sense as an investment in human capital.

The final blow: Sraffa's devastating critique of the orthodox theory of distribution

     In the year 1960 the Italian economist Piero Sraffa, founder of the Neo-Ricardian 
school, publishes one of the most feared books in the history of orthodox economics. Yes, 
in effect we are referring to his work Production of Commodities by Means of 
Commodities : prelude to a critique of economic theory.
     Sraffa's principal contribution is this work is to demonstrate that the 
distribution of the economic surplus into profits and wages is above all a social 
phenomenon that is not necessarily dependent upon production. More specifically, what 
Sraffa demonstrates is that the distributive variables (profits and wages) do not in 
themselves depend on the methods of production, nor are resolved with a derivative of the 
production function, nor necessarily correspond with the marginal productivities of the 
factors. In this manner, the problem of the distribution of the economic surplus 
between workers and owners, if not already outside of the field of economics itself, at 
least is so regarding production.
     Yet how is it that Sraffa comes to this surprising conclusion? Consistent with his 
project of actualizing the approaches and focuses of the classical theory in order 
to criticize the Neo-classical theory, he begins by analyzing the problem of 
distribution centering upon the concept of the surplus, that is to say, the income 
generated in the process of capitalist production and re-production that the
owners of capital obtain and which should be divided into salaries and profits.
     Starting from there they construct a linear model of production by which it is
possible to determine the structure of relative prices and of one of the two distributive 
variables (level of profit or wages) with the other variable and technology given 
exogenously, this latter being represented by the physical quantities of the individual 
goods necessary to produce the diverse merchandise.
     As a result of this approximation Sraffa revives Ricardo and Marx's iron law of 
wages. In effect, resolving the system of relative prices in his model confirms that 
the relationship between wages and profits is effectively inverse according to the

               r = R . (1 - w)................................................. (1)

Where r is the level of profits, w the wage level and R the surplus 
(income) to distribute.
     It is obvious why in this expression we say that the relation between wages (w)
and profits (r) is inverse. Given a level of surplus R to distribute, the 
greater are the wages the less will be the profits, and while the profits are greater, 
the wages will be less. The only difference from David Ricardo and Karl Marx is that here 
the wage is paid with part of the surplus, something like in the case of Marx where 
surplus value is defined dividing only the constant capital (c) and not with the 
sum of the constant capital and the variable capital (c + v).
     Now, as Foncerrada aptly observes, "it is important to notice that in Sraffa's scheme
it is not defined which of the distributive variables should be fixed. This means that 
the system remains open to accept an independent theory of wages, such as all the 
classical authors had, furthermore providing an opening--insofar as w is 
paid with part of the surplus--for admitting modern theories about the payment of 
certain compensations to the workers and employees, the non-salaried in general, with
part of the surplus product. A surplus which originally, in the theory, was solely 
utilized for paying the owners of the means of production. Or, in the same fashion, 
one is open to add an exogenous theory of the type of profit to the system. This 
also offers the possiblity, in the modern economy, where there is great mobility of 
capital, of allowing a theory of profits that can be integrated into the system. In other 
words, Sraffa's distributive parameters, not being predetermined, offer a system open 
to theoretical constructions concerning their determination.
     Thus then, as can be gleaned from the foregoing, Sraffa's scheme provides us with a 
more open and realistic model than the Neo-classical for analyzing the distribution 
problem as it really is: a primordially social phenomenon.
     Yet Sraffa's scheme not only offers us constructive possibilities but also 
some very interesting destructive implications (for orthodox economics, that is). 
For if this focus is correct, then now there is nothing sacrosanct about the 
distribution of income for it, instead of reflecting technical relations of 
productivity, will reflect social relations of production determined by the 
relative power of the different groups in society (though, and it is important to 
note, that too is in some measure restricted by the technical limits of production). In 
this way, given a technological framework, the distribution of the net product or social 
surplus will be open in its determination to multiple social forces and, 
 consequently, now will no longer be treated solely as a "technical" matter.
     Yet even if we remain only with the mere technical aspect the orthodox theory 
continues to be highly questionable for there still persists the famous problem of 
"technics reversing" signaled by Sraffa. The reswitching of techniques or 
double-switching of techniques denotes the possibility that a certain technics can 
be more profitable than all possible other technics for two or more values separated by 
profit rate even though other technics may have been more profitable at intermediate 
levels. From that one deduces the also famous capital reversing, which is the 
possibility of a positive relation between the value of the capital and the profit level.
     Why does all this become so inconvenient for the Neo-classical economic theory? 
Simple:  because that assumes that a reduction in the type of interest would lead to the 
use of more intensive capital techniques, and Sraffa, by proving capital reversing 
and reswitching of techniques as theoretical possibilities, casts such a 
supposition to the ground. Specifically, Sraffa demonstrated that that elementary relation
of orthodox economics did not have to be so: starting from an initial equilibrium 
(r0, K0, L0) a reduction in the price of capital
(from r0 to r1) makes its employment more profitable 
at the expense of the labor factor (r1 < r0, K1 > 
K0, L1 < L0) but successive reductions can reverse 
this situation, making a more labor-intensive technology profitable (r2 < 
r1, K2 < K1, L2 > L1).
     The conclusion is immediate and serious: orthodox economics cannot ensure the 
existence of an inverse and monotonic relation between the demand for a factor and its 
price. Thus, the grand implication of the reversion of technics for the marginalist focus 
is that, inasmuch as there ceases being a general relation between the profit rate and the
quantitCy of capital that is utilized, the possibility ends of using the profit rate 
as an indicator of the capital intensity, that is, it no longer functions as an index 
to the scarcity of the capital amount, and it remains in doubt as an instrument for 
allocating resources. From this, Sraffa concludes that: "Investments in the direction 
of the movement of relative prices, confronted with unvarying production methods, cannot 
be reconciled with any notion of capital as a measurable quantity independent of 
distribution and of prices."
     This critique was so convincing that Paul Samuelson himself, a distinguished member 
of the orthodox team in the famous "Holy War" regarding capital to which we have referred 
in the previous chapter, had to recognize that: "The phenomenon of the reversion to a very
low interest rate on a set of technics that had only seemed viable at a very high 
interest rate suggests more than an esoteric technicality. It indicates that the
simple stories of Jevons, Böhm Bawerk, Wicksell, and other Neo-classical authors 
cannot be universally valid. So, as Maurice Dobb said, the reversion of technics 
"gives the 'coup de grace' to any notion of a production function and hence to the 
identical idea of marginal productivity as a determinant of the gain."


     The object of this chapter has been to critically examine the orthodox theory of 
distribution. Basically we have seen that:
     1) The notion of marginal productivity itself can be questioned showing that 
it is almost impossible to calculate it in empirical terms because it proves unviable to 
isolate the contribution of one factor with respect to another in the real productive 
     2) Simply and clearly marginal productivity does not exist when dealing with the 
production modality most common in practice: the Leontief function.
     3) The backward curvature of individual labor offers beginning at some wage level 
places into question the uniqueness of the equilibrium in the labor market and, 
furthermore, the leisure-income model has almost no relevance before the institutional
restrictions of the contracting regimes of the real world.
     4) The notion of "free" and "competitive" labor markets becomes light and even 
insubstantial if we contract it with the approaches of the institutionalist school with 
respect to collective bargaining and dual and internal labor markets.
     5) When the relevant multi-product case is examined, that is to say when more 
than one good is produced, it is found that it is no longer necessary for each 
worker to be paid in accordance with her individual marginal productivity, which 
then opens the door to injust and arbitary forms of distribution as the requisites that 
the orthodox theory imposes are fulfilled.
      6) To consider wages as mere business costs is excessively reductionist if we 
compare it to the Keynesian (synergistic macroeconomic effects of stimuli to 
effective demand) and neo-Keynesian (efficiency wages) visions.
       7) By means of the Sraffa critique it was demonstrated that the 
determination of profits and wages ended by dissociating from production as a purely 
technical phenomenon and, thus, remained open to the influence of multiple social forces 
and the implied power relations.
     All this constitutes a powerful cumulative case against the Neo-classical 
vision concerning capitalist distribution. Accordingly, the orthodox distribution theory 
is nothing more than a myth. May it rest in peace.

                        Chapter 4
                        THE MYTH OF PROFIT MAXIMIZATION

                            "Businesses behave as if rationally seeking to maximize 
                                   their expected profits and possessing complete knowledge
                                   of the necessary information to achieve such a goal."
                                                Milton Friedman, Nobel Prize 1976
The orthodox theory of profit maximization

     In the first chapter of the present book we analyzed the theme of consumer 
rationality. Now, we shall approach the subject of the rationality of the enterprise.
     The enterprise, in the capitalist system, is defined above all as the basic 
unit of production. In other words, it concerns "an organization which transforms 
factors into products." With regard to how it does that we have already spoken in 
the two previous chapters. Here we shall be occupited with why. That will carry us 
to the question of the business' objective.
     What is, then, the objective of businesses? A complicated question. Yet again 
orthodox economics has a simple answer: the goal of enterprises is to maximize 
     Such a response seems quite logical. The owners seek to obtain the maximum possible 
profits from their enterprises and these, given that they exist solely and 
exclusively to serve their interests, will seek such a goal. At this point professor 
Nicholson explains that "this focus assumes that the decisions of the business are taken 
by a sole, dictatorial administrator who, in rational fashion, pursues an aim which, 
generally, consists in maximizing the economic profits (or gains) of the business."
     But, what do enterprises do to maximize profits in the Neo-classical scheme? Well, as
always: by means of marginalist analysis, which means, applying differential calculus. We 
shall see how.
     We start from the profit function. These are constituted as the difference between 
the total income and total costs that the enterprise has in selling and producing a 
specific good, respectively. Thus, the profit function is given by:

               B = I(p, q) - C(q).............................................. (1)

Where B is the profits, I the total income (being a function of price 
p and quantity sold q) and C the total cost (being a function of the 
quantity produced q, which also is equal to the quantity sold).
     Now in order to maximize function (1) we apply the First-order condition, that is, we
equate the derivative of the profits function with respect to quantity, to zero (we take 
the quantity as the variable because the price, at least if we assume perfect 
competition, if given exogenously by the equilibrium of supply and demand in the 
market for the good in question).

               dB / dq = dI(q) / dq - dC(q) / dq = 0........................... (2)

     But since in this case we are analyzing the variation in total income (I) and 
the total costs (C) as a consequence of a variation in the production level 
(q) we derive that dI(q) / dq will be the enterprise's marginal 
income (IMg) and dC(q) / dq, the marginal cost (CMg). Therefore:

               dB / dq = IMg - CMg = 0......................................... (3)

     From which, finally, we obtain the golden rule for the maximization of 

               IMg = CMg....................................................... (4)

Which tells us that the production level by which the enterprises will maximize profits 
will be that equating the marginal cost with the marginal revenue.