The Suntory and Toyota International Centres for Economics and Related Disciplines

Marginal Productivity and the Principle of Variation

Author(s): J. R. Hicks
Source: Economica, No. 35 (Feb., 1932), pp. 79-88
Published by: Wiley on behalf of The London School of Economics and Political Science and The
Suntory and Toyota International Centres for Economics and Related Disciplines
Stable URL: http://www.jstor.org/stable/2548977 .
Accessed: 03/07/2014 16:45
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .
http://www.jstor.org/page/info/about/policies/terms.jsp
.
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of
content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms
of scholarship. For more information about JSTOR, please contact support@jstor.org.
.
Wiley, The London School of Economics and Political Science, The Suntory and Toyota International Centres
for Economics and Related Disciplines are collaborating with JSTOR to digitize, preserve and extend access to
Economica.
http://www.jstor.org
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions
1932]
Marginal Productivity and the
Principle of Variation
By
J.
R.
HICKS
THE various modern versions of the marginal productivity
theory are mainly the result of a short period of intense interest
in the subject at the close of the last century. During a few
years (I889-96), Clark, Marshall, Wicksteed, Wicksell, Walras,
Barone and Pareto all wrote about it, each of them propounding
original and individually significant views. It might have been
thought that after all this attention, the status of the theory
would at the end have been firmly established. But this was
not the case; serious differences remained unsettled. J. B.
Clark, for instance, believed without question that the marginal
productivity formula gives a completely satisfactory explanation
of the distribution of the Dividend under conditions of static
equilibrium; and in this he was followed by others, such as
Wicksteed and Wicksell, whose conceptions of the methods
of economic analysis differed profoundly from his own. At
the other extreme stood Pareto, convinced that the marginal
productivity formula is an over-simplification of
realitv,
and
desirous of replacing it by another, even more complicated and
unwieldy, into which marginal productivity would fit as a
special case.' Marshall, it is fairly clear, stood between these
extremes, though inclining to the same side as Pareto. While
never convinced that the marginal productivity formula is
satisfactory, he seems to have doubted, at least in later years,
whether the ground of his opposition was sufficielntly important
to deserve much insistence.2
For a long time the division persisted without causing much
trouble; but of recent years there has been a revival of interest.
Partly this has been due to Professor Cassel's Theory of Social
Economy, through which the ideas of Pareto and Walras have
become more accessible to the non-mathematical reader. The
elaborate but rather inconclusive study of Dr. Valk (The Prin-
1
Pareto, Cours, Vol. II, pp. 82 sqq.; Mantel, p. 63I.
2
Marshall, Principles, Bk. VI, ch. i. Cf. ist edition, Bk. VII, ch. i.
79
F
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions
80 ICONOMICA [FEBRTiARY
ciples of Wages) is evidently ilnspired by Cassel; while Dr.
Valk in his turn has awakened the interest of Mr. D. H.
Robertson.3 On the other hand, Mr. Schultz, of Chicago, has
evidelntly felt the direct thrill of Pareto's mathematical magic.
The arguments he advances are Pareto's arguments, adopted
with scarcely any modification.4 None of these discussions
seem to me to be wholly satisfactory; for although I am in
complete agreement with Mr. Robertson in holding that there
is some sense in which the pure marginal productivity theory
is altogether true, I cannot feel altogether convinced that even
he has finally elucidated precisely what that sense is. Andl
until we have done so, we cannot expect to convince the
opposition.
A further inquiry may thus perhaps be excused.
I
The particular point on which the critics of marginal produc-
tivity have always fastened is the assumed generality of the
Principle of Variation-to use the term employed by Mr.
Robertson. How far is it justifiable to assume that a change
in economic conditions will bring about a change in the quan-
tities of the factors of production which are used to make a
unit of any product? The marginal productivity theory assumes
that a change in the relative prices of the factors will always
be followed bv some change in the quantities of the factors
emploved, that is to say, it assumes that technical methods
are freely variable. For if that is not the case, it will be
impossible to reorganise a business effectively with one unit
less of one factor, but with the same quantity of the others.
The removal of a unit of one factor will not only mean that
the other factors are used less advantageously-that is granted
in any case-but that a portion of the supply of the other
factors becomes completely useless. If the price of a machine
falls, while the price of the labour used to operate the machine
remains the same, it will clearly be to the interest of the
entrepreneur who employs both to use more machines and
relatively less labour. It will be to his interest, but it does
not follow that he can do it. For if the machines are made
in such a way that they require one workman, and only one,
to run them, no change
in relative prices can lead to a change
3
See his essay " Wage-Grumbles " (published in Economic Fragments)
particularly pp. 46-52.
4
G. F. Schultz, " Marginal Productivity and the Pricing Process "
(Journal of Political Economy, December I928).
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions
19323 MARGINAL PRODUCTIVITY 8i
in the proportions of labour anld machinery that are used; for
the proportions are fixed by technique.
If we have to use the margilnal productivity theory in such
a way that this objection is important, then its consequences
are most serious. If the proportions are fixed, then an extra
unit of one factor, unaccompanied by an increase in the other,
will yield precisely no addition to the total product. On the
other hald, the withdrawal of one unit will lead to a far areater
diminutioll in the product than can fairly be attributed to
that unit alone, since its removal would put corresponding
units of the other factors out of action. If all the factors were
paid according to their marginal products calculated in this
second manner, their total pay would undoubtedly be far in
excess of the value of the goods they produced. Which is
absurd.
In fact, where the proportions are fixed, the zero difference
got by adding one unit, and the large difference got by sub-
tracting one ullit of the factor, give us upper and lower limits
within which the return to the factor must lie. In the extreme
case, where the quantities of all the factors required to give a
unit of the product-the " coefficients of production
"
as Walras
called them-are given by technical facts, marginal productivity
breaks down completely. For the lower limit to the wages
which can be paid is zero; and the upper limit is the total
incomings of the enterprise. And to know that the total wage-
bill must lie between these limits we do not need to have
recourse to elaborate analysis !
But even in this extreme case, even when no variation is
possible and all the coefficients of production are constant, it
is still not true that the returns to the factors are indeterminate,
and that the mechanism of adjustment breaks down. For many
of the factors, particularly capital, can be used in many different
businesses and different industries, and if its earnings in olle
are lower than they are in others, it will move. Even if we
are sceptical about the general validity of the Principle
of
Variation, we can still fall back on the " net productivity
"
analysis of Marshall or on the corresponding
formula of Walras.
The wages of labour, according to Marshall, must tend to
equal the
"
net product of a man's labour
"-
"
the value of
the produce which he takes part in producing
after
deducting
all the other expenses of producing it."' If wages rise above
this level, costs of production
will exceed selling prices, or,
in
5
Principles of Economics, ist edition, p. 548.
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions
8 UECONOMICA L[EBRUARY
other words, the return to capital in that industry will become
less than is offered for it in other industries, so that it will
tend to move elsewhere. Siince the proportion of capital to
labour in each industry is
fixed,
the withdrawal of capital
must mean unemployment.
Mr. Robertson, while recognising that this holds true of a
particular industry, seems to find some difficulty in seeing that
the same process will suffice to maintain equilibrium throughout
industry as a whole. His difficulty emuerges most clearliy in his
discussion of Walras, but it is fundamentally responsible for
his criticisms of Marshall as well. Commenting on the Walras-
Cassel argument, he says, " The method consists in building
up a series of equations in which the total supply of each factor,
and the technical combinations of factors required to make each
product, are taken as given. The demand function for each pro-
duct being also given, it is shown that the price of each factor, and
of each product, is unequivocally determined. But how can the
first two things both be taken as given? If each of ten industries
requires the use of ten units of labour to every unit of capital,
and if there exist ioo ullits of labour and ioo units of capital,
what is to happen?
"
Now, of course, it must be admitted
that in this special case the theory breaks down-or rather,
since capital is present in such complete superfluity, it must
become a free good, and its price fall to zero. But in practice,
it is surely most unreasonable to assume that the proportions
of capital to labour are the same in all industries. It is absurdly
contrary to fact, so that it was perfectly reasonable of Walras
and his followers to take the case of different proportions to
be typical.
Once we abandon the
assumption
of identical
proportions,
it becomes possible to fit into the system any amounts of the
factors we please to take. If the supply of one factor increases,
that will mean a proportionately greater development of those
industries which use relatively large quantities
of that factor,
and perhaps a contraction of the industries which use relatively
less.
And the possibility
of
precisely
the same
adjustment is
sufficient to maintain an industrial system
in determinate
equilibrium. Suppose wages rise-say
all
wages bv the same
proportion-then the returns to the other factors will be
diminished. But since some industries use more labour than
others, the returns to the other factors will not fall in the
same proportion in different industries. There will thus be
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions
1932] MARGINAL PRODUCTIVITY 83
an incentive for these other factors to move, capital, for
instance, moving out of the less capitalistic into the more
capitalistic industries. In the less capitalistic industries there
will be unemployment; in the more capitalistic industries
there will be an expansion of the demand for labour. But
since in the more capitalistic industries the amount of labour
needed to use a given quantity of capital is less than it is in
the rest, the transferred capital in its new position absorbs
into employment less labour than had been thrown out by its
withdrawal. There is net unemployment.
Similarlv, a fall in wages will lead to a transference of the
other factors in the opposite direction, and a rise in the demand
for labour.
Thus it is not necessary to assume, as Mr. Robertson seems
to imagine, that a declilne in the reward of capital will lead
to a diminution of its supply, irL order for the " net produc-
tivity " analysis to be perfectly valid. A rise in wages above
the equilibrium level will lead to unemployment, through the
transference of other resources betweell industries, even if no
other route is open.
The
" net productivity
"
analysis remains valid, on the other
hand, even if we do admit the principle of Variation. It is
still true that a system will not be in
equilibrium,
if any
advantage is to be gained by transferring resources between
industries; so that wages must equal the net product of labour.
But in this case they must also equal the marginal product;
the net product and the marginal product must be equal in
a state of equilibrium.
II
Having, we may hope, established that the method by which
Pareto and Marshall sought to " eke out "
marginal produc-
tivity is a perfectly valid one, it now remains for us to examine
directly their criticisms of the Clarkian form of that doctrine.
In the case of Marshall, we are dealing with one of the vaguer
and more slippery parts of his work, so that it is not easy to
be quite certain what his difficulties were. But Pareto was
never vague; we have to face up to Pareto.
The mathematical method, of which Pareto was so great
a
master, is an almost perfect safeguard against mistaken
inference; if a conclusion is wrong,
the fault is likely
to lie in
the premises. And the thing which, I wish to
suggest,
Pareto
had overlooked, does lie deep in his premises; it is a funda-
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions
84 tCONOMICA [FEBRUARY
mental weakness of that great analytical tool which he wielded
so skilfully. With the arrogance which (now that he is safely
dead) is one of his more pleasing characteristics, Pareto
believed that he had found in his equations the one perfect
method of ecolnomic analysis, besides whose results all the
doctrines of " literary economists " were mere fragments of
knowledge. It was a great claim; and on many counts it is
justified. But to hope that from any single line of approach,
all the facets of economic life would be equally illumined, was
probably to indulge a vain illusion.
It is one of the great advalntages of the Lausanne analysis,
that in it the " individualistic 9 method, which has been
described bv Dr. Hayek as olle of the greatest assets of neo-
classical economics,6 is carried to its most complete fulfilment.
It is the object of Walras' and Pareto's equations, to determine
that svstem of prices which can exist in an economic system
(with given population, given tastes, given abilities, given
knowledge and given stocks of capital and land), without any
single inidividual, as consumer or labourer or capitalist or entre-
preneur, havilng any incentive whatever to do anything else
than go on doillg what he has done in the past. And the way
by which these conditions are reduced to a system of equations,
is by taking each individual, one by one, and findilng what he
will prefer to do at any given set of prices. Alnd if a system
of prices can be found at which the preferences of all the
individuals in the community are contsistent, the communitv
is in equilibrium at those prices. If anyone had an incentive
to change his conduct, that change would chalnge prices and
so upset the whole equilibrium. But at the equilibrium system
of prices, no one has any incentive to chalnge, and so the
equilibrium can go on. It is proved that such aln equilibrium
can be found.
The particular conditions which interest us at present
are
those which concern the entrepreneurs. Each entrepreneur
has a choice of different methods by which to make his produLct,
each method using different quantities of the factors of produc-
tion. In order to be in equilibrium, he must choose that method
which makes his unit cost of production
a minimum. For if
he does not do so, he can move to a
preferred position by
changing his methods, and so increasing
his
proi'ts.
Now if the Principle of Variation is accepted,
this condition
of minimum cost of production results in
margilnal productivity.
6
Prices and
Production, p.
.4.
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions
1932] MARGINAL PRODUCtIVITY
85
For if the price of any factor exceeds the value of its marginal
product, unit costs of production can be decreased by using less
of it; in the reverse
case,
unit costs of production can be
decreased by using more. But we are now in a position to see
why Pareto had difficulty in accepting the Principle of Varia-
tion. In hardly any modern industry does an entrepreneur
buy only the factors of production, land, labour and capital;
in nearly every industry a considerable portion of his expendi-
ture
goes
on "intermediate
products,"
raw materials
and
plant, the products of other industries. Now so long as we
fix our eyes on one entrepreneur only-and that is all, that,
according to the strictness of the Lausanne method, we are
allowed to do-the only
possible
change which that entrepreneur
can make, is to buy more or less of the particular kinds of
plant, machines and raw materials, which are for sale on the
market. He is definitely limited to these kinds of goods, those
which are already being
produced,
and these goods,
under
modern conditions, are likely to consist, to a large extent, of
specialised articles made for a specialised use, which require
a given amount of other factors to be used with them. If the
amounts of co-operating factors can be changed at all, it is
only within narrow limits. An entrepreneur, working
under
Pareto's limitations, is faced to a considerable extent with
fixed proportions, and therefore he cannot alter his methods
to such a point as would achieve that ideal of minimum cost,
where the prices of the factors equal their marginal products.
But these limitations are set, not by the circumstances
of
reality, nor by the fundamental economic advantages of Pareto's
system, but by mere assumption that the only goods with which
the market need be concerned are those goods which are actually
being produced,
and which have definite known prices.
This
assumption is introduced for mathematical convenience,
and
on it, indeed, the whole mathematical edifice rests, but it has
absolutely no economic significance. Once it is dropped,
Pareto's
objection
to marginal productivity falls
flat.
It is perfectly possible
to conceive of a community in
which
all Pareto's equations are satisfied, but which is not in
equilibrium.
For so long as the n commodities which are being
produced
are arbitrarily chosen commodities, each individual
may have reached his preferred position within that charmed
circle,
but he may still have an inicentive to move outside it.
And in the case we have just been considering, where
each
entrepreneur
has reached his position of minimum cost within
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions
86 ECONOMICA [FEBRUARY
the limits set by an arbitrarily restricted list of possible com-
modities, but where the prices of the factors of production are
not given by their marginal products, there would be an
incentive to change. It would be possible for the machine-
makers (say), or generally the entrepreneurs in earlier
(" higher ") stages of production, to modify slightly the
character of the goods they produce, so as to meet the needs
of their customers more exactly. By so doing, it would be
possible for them to sell their new goods at a price which would
yield them a greater profit than they had earned before; while
on the other hand their customers would be better satisfied,
for they in their turn would also earn larger profits.
To look at the matter another way. Pareto's arguments do
not suggest7 that he would have denied that the pure marginal
productivity
doctrine holds good in one particular case-when
all the industries are perfectly
"
integrated," so that there are
no intermediate products, but each entrepreneur hires only the
services of the true factors of production, land, labour and
money capital. In this case the only technical limitations on
the change of methods would arise from sheer ignorance of
different methods to pursue; and in these days, at least, we
surely need not have so low an opinion of man's devising
ability as to deny that, sooner or later, he would find means
of reducing his costs to the lowest possible level. And that
is all! that the equilibrium doctrine assumes.
If the marginal productivity doctrine would work with
integrated industries, is there any reason, other than the formal
convenience of a particular method of analysis, to deny that it
would work where the industries are differentiated into stages ?
Surely
not.
III
I believe the foregoing to be an answer to Pareto's objections
against marginal productivity, but it has evidently little to do
with Marshall's difficulties. The indications seem to be that
Marshall was chiefly troubled by the durability of material
equipment, and its consequence, that the variation in methods
brought about by a change in factor-prices, may be a very long-
run affair. In the first edition of the Principles, the only
7
Apart from an odd passage in the Cours (p. 85) when he suggests that a
silk factory requires a fixed amount of land, and would get no advantage
from an increased supply, unaccompanied by an increase in the other
factors. This is merely
silly.
There is nothing corresponding to it in the
Mcanuel,
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions
I932] MARGINAL PRODUCTIVITY 87
paragraph in which he discusses true marginal productivity
poses the case of an employer who is " in doubt whether he
has enough labour to turn his stock, machinery and other trade
appliances to good account "; and although in later editions,
the extraordinary confusion between net productivity and
marginal productivity (quite clearly distinguished in the first
edition) makes it extremely difficult to see what is meant by
words which are evidently the fruits of separate and un-
co-ordinated layers of Marshall's development, the probability
seems to be that he had not profoundly modified his attitude
to the problem. If we do not allow the entrepreneur time to
replace his equipment, the old difficulty of fixed proportions
is absolutely unescapable. Marginal productivity does leave
a considerable range of indeterminateness, and is therefore
wholly unsatisfactory as the main part of a theory of distribu-
tion.
Marshall's refusal to look ahead to the replacement of material
equipment, sprang no doubt partly from his well-known dislike
of the rigours of static analysis, but partly, one cannot doubt,
because he was trying to impose upon the theory more weight
than it will carry. For Marshall, it is true, marginal produc-
tivity (and net productivity, for that matter) is a case of normal
value; but in the case of a price which is notoriously sticky,
the difference between market and normal value did not appear
significant. It is hard to resist the conclusion that Marshall
was seeking a formula which would, generally at any rate,
express the level of the wages which are really paid to particular
men at particular times; and his obscurity arises from the
fact that no amount of juggling with marginal productivity and
net productivity would give him such a formula. But is not
the reason for this that he was going too fast.? To have
dallied a little longer in the realm of abstractions might
have
meant greater sureness and greater concreteness in the end.
If we accept the view, which it has been the business of these
pages to justify, that the marginal productivity proposition is
a necessary condition of static equilibrium, then that in itself
only gets us a little way towards a theory of wages. But it
is a necessary prolegomenon to such a theory. It does sum-
marise in a silngle convenient expression
the complex
causes
which slowly mould the level of wages, and the prices of other
factors of production. It is not true that a man's wage must
always equal his marginal product, but if it does not, there
is a danger of certain things happening.
If his wage
is below
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions
88 ECONOMICA [FEBRUARY
his marginal product, other employers will have an incentive
to attract him away by offering him higher pay. They may
desire to take him on so as to put him in the place of another
man who was costing more; or because they are reorganising
their businesses, and can thus put him in the place of some
other more expensive factor; or because they are expanding
their businesses. The statement that his wage is less thanl
his marginal product means simply that these things can be
done profitably. Similarly, if his wage is more than his
marginal product, his own employer has an incentive to dismiss
him. This may take place because it is cheaper to use some
other method of production, which dispenses with his services;
or because the whole business in which he works ceases to pay.8
But dismissal may not be feasible at once; it may have to wait
until machinery comes to be replaced; yet an incentive to
dismissal exists, and again that is what is meant by the
marginal productivity proposition. Stated in these terms, the
theory seems both simple and impossible to controvert. It is
an absolutely necessary foundation for sound economic reason-
ing about wages.
8 The contraction of the demiiand for labour because of substitution and the
contraction which arises from the contraction of businesses are most
properly distinguished bv Mr.
Robertson;
but one must question the neces-
sity of the extraordiniary terminology which he uses. " An artificial raising
of the rate of wages " produces
"
two analytically separable reactions. The
first is a movement along the existing curve-a reduction in the numbers
employed up to a point at which the product of the marginal man equals the
artificial wage. The second is a cunmulative lowering of the curve, caused
by the decline in profits and the consequent check to the supply of capital
and enterprise " (Op. Cit., p. 49). It must certainly be granted that the
second tendency will take time to work out its full effect (although surelv
so will the first). But why describe a price-movement as shifting the curve,
which is surelv a simple expression of the relation between the price and
the amount bought? After all, just the same thing takes place with com-
nmodity demand. I buy less foreign vegetables if a tariff is imposed, partly
because the English variety is now relatively more advantageous, and partlv
because I cannot afford the higher price demanded. If we are to say that
the raising of a price shifts the demand curve, we had better abandon all
hope of teaching elementary economics. What do they mean by curves
at Cambridge ?
This content downloaded from 148.205.84.30 on Thu, 3 Jul 2014 16:45:55 PM
All use subject to JSTOR Terms and Conditions