By Thomas Ferguson, the Institute for New Economic Thinking’s Director of Research Projects, a Professor of Political Science at the University of Massachusetts, Boston and a Senior Fellow at the Roosevelt Institute. Originally published at the Institute for New Economic Thinking website

The famous scene in Gabriel García Márquez’s One Hundred Years of Solitude epitomizes Magical Realism: army troops machine gun striking banana workers and their families in the town square and toss the bodies into railway cars for disposal. But José Arcadio Segundo is only lightly wounded and jumps from the train when he comes to. When he finally picks his way back to his hometown of Macondo, a surprise awaits: everyone flatly denies any massacre took place. At night the authorities hunt for rebels from house to house; by day, they deny everything. Eventually, an extraordinary proclamation is made to the nation, repeated until finally accepted: “there were no dead [and] the satisfied workers had gone back to their families.”

Contemporary Economics has more than one Magical Realist moment like this – just look at how the basic building block of the Keynesian Revolution – the decisive role of the principle of effective demand – all but vanished from sight after the late nineteen seventies. But there is another, almost equally fateful: the Cambridge Capital Controversy, which came to consummate expression in a memorable issue of the Quarterly Journal of Economics in 1966.

Probably no summary of the issues at stake in this giant dust up has much hope of gaining assent from all the stakeholders. The issues are so complex and the background so ideological that one can easily understand how one commentator on an early contribution by Robert Solow exclaimed that “perhaps the whole problem is too complicated for adequate reflection in a formal model.” [1]

But with the caution that on this treacherous terrain readers are well advised to protect themselves from bias by sampling the classic contributions for themselves, one might venture to describe the Capital Controversy as the Waterloo of the idea that you could explain the distribution of income in terms of the balance of supply and demand for comparable factors of production reflecting purely physical (or “technical”) production relations. [2]

The most durably influential of these schemes appealed to an “aggregate production function” to partial out the separate effects of capital and labor on overall output. [3] The approach led easily to a theory of distribution according to which capital and labor are each rewarded in proportion to their relative scarcity. In equilibrium, capital should receive its marginal product, while workers should receive a real wage equal to the marginal product of labor.

If this sounds familiar, it is because it is. Just like the non-stop propaganda in Macondo, the refrain is incessantly repeated in contemporary economics – it is almost the Rosary of modern microeconomics. Virtually all textbooks still reflect this approach: divergent cases, such as monopoly, or obvious political distortions (“rent seeking”), are sometimes recognized but taught as deviations from this norm. When you listen to some private equity trader carrying on in the major media about how he (they are mostly he’s) really deserves all the money he is swilling down, because that reflects his contribution to the economy, it is this theory that you are hearing and journalists are witlessly repeating.

But the Cambridge Capital Controversy demonstrated that this approach to production and distribution led to impossible inconsistencies. Some economists, notably Knut Wicksell, who might be accounted the father of the whole “production function” line of thinking, were at least sometimes wary of its logic. Even some protagonists on the MIT side of the controversy occasionally voiced reservations, but they stuck with it. As late as 1964, the sixth edition of Paul Samuelson’s famous textbook proclaimed that the turn of the twentieth century version of the theory advanced by John Bates Clark, “although simplified, is logically complete and a true picture of idealized competition.” [4]

In the nineteen fifties, Joan Robinson, who had been reading Wicksell, started asking loudly how heterogeneous capital goods could be valued in monetary terms without first knowing the rate of interest to discount them by. Piero Sraffa, who himself resembled a character in a Márquez novel, eventually zeroed in on what such approaches assumed about changes in techniques of production at varying levels of wages and profits and showed that prices won’t predictably change when distribution changes. Gradually, battle lines formed between Cambridge, England on one side, which considered the production function approach hopelessly misleading, and Cambridge, USA, led by Paul Samuelson and Robert Solow, which, with increasingly dense qualifications, defended it.

In 1965, Luigi Pasinetti, whom INET is delighted to interview here, produced a decisive counterexample demonstrating that such production functions could not work in a world of more than one good (or technique of production). Concluding that “there is no connection that can be expected in general between the direction of change of the rate of profit and direction of change of the ‘quantity of capital’ per man,” Pasinetti argued that the Neoclassical approach to analyzing production needed to be abandoned in favor of something much closer in spirit to Classical Economics. [5] A number of notable economists confirmed his analytical critique, though they often interpreted its implications differently.

Paul Samuelson, at least, took the point. He repudiated a “non-switching theorem” associated with work by him and his students and handsomely acknowledged that Cambridge, UK, was correct. “Pathology illuminates healthy physiology. Pasinetti, Morishima, Bruno-Burmeister-Sheshinski, Garegnani merit our gratitude for demonstrating that reswitching is logical possibility in any technology…If this causes headaches for those nostalgic for the old parables of neoclassical writing, we must remind ourselves that scholars are not born to live an easy existence. We must respect, and appraise, the facts of life.” [6]

But Samuelson’s generous response was not typical of the economics profession as a whole, which to this day collectively continues to brush aside and deny the relevance of this controversy and, in fact, suppresses virtually all reference to it. Even before Pasinetti’s result became known, however, some Neoclassical economists had explored whether their general approach to “factor rewards” and “marginal productivity” could be pursued by jettisoning production functions and appealing to notions of general equilibrium. [7]

There are good reasons for doubting this program can really go much beyond sketches for analyzing any real economy. Subsequent research on general equilibrium has emphasized how precarious any such momentary equilibria are. [8] In addition, as emphasized by Joseph Halevi in some recent lectures, the Cambridge dispute has destructive implications for the stability of Neoclassical versions of growth theory.[9] Not surprisingly, some economists who attend carefully to the Cambridge results think they require a wholesale rethinking of economic theory and especially of the theory of distribution, since the technical conditions of production cannot determine a unique solution for the distributive variables..

But for mainstream economics, we remain in the Magical Realist world of Macondo. Contemporary students of economics rarely hear of the controversy or Samuelson’s straightforward concession to the Cambridge, U.K. critics. Pasinetti’s subsequent work on growth, income distribution, finance, and structural dynamics, as well as the other work of Sraffa, Kaldor, and Joan Robinson are only rarely discussed. Instead, growth models that feature cheerfully guilt free old style production functions proliferate, with most of their consumers and producers seemingly unaware of their fragility. Central bankers and many affluently supported monetary theorists also talk airily about “natural rates” of interest, without realizing that the Cambridge results shake that notion, too. [10]

Now, however, developments in the world economy, especially soaring inequality within countries and anxieties about the mainsprings of economic growth, are once again bringing to the fore the issues of growth and “factor rewards” that fueled the Cambridge Capital Controversy. Not one, but several reviews of Thomas Piketty’s invaluable Capital in the Twenty-First Century, for example, have emphasized the importance of the Cambridge discussions.[11]

Believable “general equilibrium” approaches to this brave new world are few and far between. At best one finds highly contrived Dynamic Stochastic General Equilibrium Models that have nothing to say about soaring corporate compensation, the real political economy of tax cuts and starvation public budgets, or rising mark ups in major big business sectors.

Sometimes the fastest route to new economic thinking begins with a careful study of existing strands of economic theory, especially when its protagonists have so clearly been right about so many subsequent policy questions and won the basic theoretical debate. [12] In the summer of 2014 the Institute for New Economic Thinking interviewed Professor Luigi Pasinetti for several hours over the course of a week. Dr. Nadia Garbellini was the interviewer. I also interviewed Professor Pasinetti and Dr. Marcello de Cecco together for one special session.

Professor Pasinetti relates some of the high points of his distinguished career in the videos: Born near Bergamo in the north of Italy, he compiled a brilliant academic record that eventually won him fellowships to Cambridge University, Oxford, and Harvard. He describes how his thinking evolved at Cambridge, where he was first supervised by Richard Goodwin, then by Richard Kahn, and actively engaged with Nicholas Kaldor, Joan Robinson, and Piero Sraffa.

One of the high points of the whole series is his discussion of the conference panel at which he first presented his famous paper on the Capital Controversy. But many viewers and readers may find Pasinetti’s discussions of growth and income distribution, multi-sectoral economic models, and international trade a very helpful way into his later work. There are some other good sources also, including Pasinetti’s website at the Catholic University of Milan.[13]

In Márquez’s novel, when the government declared that up was down, it poured rain in Macondo for almost five years, leading to floods that washed away most of the town. But economists ought to be capable of coming in out of the rain. Our hope is that these interviews with one of the great figures of contemporary economics will lead to some serious rethinking of fundamental tenets of mainstream thinking.