The debate concerned the nature and role of capital goods and a critique of the neoclassical vision of aggregate production and distribution.
[6] Roy Harrod, in his seminal paper,[7] developed a model, subsequently refined by Russian-born Evsey Domar,[8] that aims to explain an economy's growth rate in terms of the level of saving and of the productivity of capital.
[14][note 7] Post-Keynesian economists, such as Nicholas Kaldor, Luigi Pasinetti, Richard Kahn, and Joan Robinson, proposed a different model of growth.
"[6] The neoclassical and Neo-Keynesian sides were represented by Paul Samuelson, Robert Solow, and Franco Modigliani, who taught at the MIT, in Cambridge, Massachusetts, US, while the Keynesian and Post-Keynesian sides were represented by Nicholas Kaldor, Joan Robinson, Luigi Pasinetti, Piero Sraffa, and Richard Kahn, who mostly taught at the University of Cambridge in England.
The American Cambridge side focused on adjustments to the capital/output ratio through capital-labour substitution if capital and labour were growing at different rates.
[6] Much of the emotion behind the debate arose because the technical criticisms of marginal productivity theory were connected to wider arguments with ideological implications.
Responding to the "indictment that hangs over society" that it involves "exploiting labor," Clark wrote: It is the purpose of this work [his 1899 'Distribution of Wealth'] to show that the distribution of the income of society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates.
However wages may be adjusted by bargains freely made between individual men [i.e., without labor unions and other "market imperfections"], the rates of pay that result from such transactions tend, it is here claimed, to equal that part of the product of industry which is traceable to the labor itself; and however interest [i.e., profit] may be adjusted by similarly free bargaining, it naturally tends to equal the fractional product that is separately traceable to capital.
(Later, John Maynard Keynes and his school argued that saving does not automatically lead to investment in tangible capital goods.)
Strictly speaking, however, modern neoclassical theory does not say that capital's or labor's income is "deserved" in some moral or normative sense.
[16] In neoclassical economics, a production function is often assumed, for example, where Q is output, A is factor representing technology, K is the sum of the value of capital goods, and L is the labor input.
In some more complicated general equilibrium models developed by the neoclassical school, labor and capital are assumed to be heterogeneous and measured in physical units.
The law of diminishing marginal returns implies that greater use of this input will imply a lower marginal product, all else equal: since a firm is getting less from adding a unit of capital goods than is received from the previous one, the rate of profit must increase to encourage the employment of that extra unit, assuming profit maximization.
Piero Sraffa and Joan Robinson, whose work set off the Cambridge controversy, pointed out that there was an inherent measurement problem in applying this model of income distribution to capital.
Note that it does not vary in proportion as with a general inflation or deflation that changes both prices by the same percentage: the exact result depends on the relative "capital intensity" of the two sectors.
This does not work, however, because the variation of the rate of profit is theorized as happening at a specific point in time in purely mathematical terms rather than as part of an historical process.
Sraffa suggested an aggregation technique (stemming in part from Marxian economics) by which a measure of the amount of capital could be produced: by reducing all machines to a sum of dated labor from different years.
assume that both individual firms (or sectors) and the entire economy fit the Cobb–Douglas production function with constant returns to scale.
In a 1966 article, the famous neoclassical economist Paul A. Samuelson summarizes the reswitching debate: Samuelson gives an example involving both the Sraffian concept of new products made with labor employing capital goods represented by dead or "dated labor" (rather than machines having an independent role) and Böhm-Bawerk's concept of "roundaboutness" — supposedly a physical measure of capital intensity.
There is no simple (monotonic) relationship between the interest rate and the "capital intensity" or roundaboutness of production, either at the macro- or the microeconomic level of aggregation.
It has been pointed out, however, that when neoclassical general equilibrium models are extended to long-run equilibria, stability proofs require the exclusion of capital reversing (Schefold 1997).
[22] The neoclassical economist Christopher Bliss comments: "...what one might call the existential aspect of capital theory has not attracted much interest in the past 25 years.
[30] Huerta De Soto[31] argues that reswitching actually benefits Austrian capital theory, but warns: We must not forget that although neo-Ricardians may have been circumstantial allies to the Austrians in their criticism of the neoclassical trend, the neo-Ricardians’ stated objective is precisely to neutralize the influence (which is not yet strong enough, in our opinion) exerted on economics since 1871 by the subjectivist revolution Menger started.
Peter Lewin and Nicolas Cachanosky [33] argue against Fratini, and more developed versions of the cycle not based on "Neo-Austrian" capital theory [34][35] are unaffected by reswitching.
The original neoclassical models of aggregate growth presented by Robert Solow and Trevor Swan were straightforward, with simple results and uncomplicated conclusions which implied predictions about the real, empirical, world.
To choose an example that did not get much attention in the debate (because it was shared by both sides), the Solow–Swan model assumes a continuously-attained equilibrium with 'full employment' of all resources.
Some theorists, such as Bliss, Edwin Burmeister, and Frank Hahn, argued that rigorous neoclassical theory is most appropriately set forth in terms of microeconomics and intertemporal general equilibrium models.
Indeed, the vast majority of economics graduate schools in the United States do not teach their students about it: It is important, for the record, to recognize that key participants in the debate openly admitted their mistakes.
Levhari and Samuelson published a paper which began, 'We wish to make it clear for the record that the nonreswitching theorem associated with us is definitely false.
Leland Yeager and I jointly published a note acknowledging his earlier error and attempting to resolve the conflict between our theoretical perspectives.