Déjà Vu All Over

AgainThe Cambridge Capital Controversies and

Skill-Biased Technical Change

Introduction

The precipitous rise in US personal income inequality since

the late 1970s

The dominance of the skill-biased technical change

hypothesis

The ubiquity of one-commodity aggregate production

function models

The neglect of the Cambridge capital theory controversies

and their implications for the use of such models

Skill-Biased Technical Change

The stylized facts:

The increase in the relative supply of “skilled” workers (e.g., the

ratio of college to high school educated workers within the

employed labor force)

The increase in the relative price of “skilled” workers (e.g., the

ratio of the average rates of pay of college to high school

educated workers within the employed labor force)

According to basic supply and demand analysis, this implies a

simultaneous increase in the relative demand for “skilled”

workers that more than offset the increase in their relative

supply, thereby bidding up the “skill premium”.

A Graphical Representation

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Theory-Driven “Facts”

Unfortunately for advocates of the SBTC hypothesis, such a

technologically-induced relative demand shift is completely

unobservable and can only be “imputed” on the basis of the

observable data from within an orthodox supply and demand

framework.

However, the latter was seriously undermined by the

Cambridge capital theory debates of the mid-1950s through

the mid-1970s.

The Cambridge Controversies

A series of debates on the nature and role of “capital” in the neoclassical model of growth and distribution.

Demonstrated the fact that the latter was incapable of being extended to a world of multiple produced inputs and outputs, thereby undermining the generality of one-commodity aggregate production function models (in particular, as regards the derivation of “well-behaved” factor demand curves).

While initially stimulating a movement away from such models over the course of the 1970s, since that time the aggregate production function has reemerged as the standard analytical tool in the analysis of distributional issues.

The Assumptions 1) A simple capitalist economy in which there are only two sectors of production—one

producing a homogeneous investment good (e.g., “machines”) and another producing a homogeneous consumption good (e.g., “food”).

2) Each output is produced by means of homogeneous labor utilizing machines in fixed proportions and subject to constant returns to scale over a uniform period of production.

3) Machines once produced last forever (i.e., zero depreciation) and the economy is in a stationary state (i.e., zero net investment).

4) There exists a single price and best-practice technique within each sector as well as a uniform wage rate and rate of interest across sectors as a result of competition—with wages paid per worker hour at the end of the period and interest received on the value of machines (i.e., “capital”) advanced at the beginning of the period.

5) There exists a wide array of such fixed proportions/constant returns to scale techniques among which cost-minimizing producers can select in response to changes in the relative rental rates of labor and machines.

The Simple Analytics of

Reswitching and Reversing

The Simple Analytics of

Reswitching and Reversing (Cont’d.)

The Simple Analytics of

Reswitching and Reversing (Cont’d.)

The Simple Analytics of

Reswitching and Reversing (Cont’d.)

The Simple Analytics of

Reswitching and Reversing (Cont’d.)

An Extension to the Case of

Heterogeneous Labor

An Extension to the Case of

Heterogeneous Labor (Cont’d.)

Implications and Conclusions

The main conclusion towards which the preceding analysis points is that there need be no systematic relationship between the relative demand for “skilled” workers and their relative price in the context a multi-commodity world.

The latter undermines the basic substitution mechanism at the core of the skill-biased technical change hypothesis.

Given the fundamental role of the underlying supply and demand framework in the empirical “imputation” of a technologically-induced relative demand shift in favor of “skilled” workers, such theoretical difficulties are especially important.

Taken together, the preceding arguments highlight the need to critically reconceptualize the the theory of income distribution, specifically as it applies to the question of contemporary income inequality.