Pasinetti on Income Distribution and Growth

Pasinetti’s economics has a constant focus on economic dynamics, or rather (more precisely) on growth and income distribution. His works in the field have generated an extensive literature in scholarly journals, plus numerous books and a ‘must’ reference in a large number of textbooks on economic analysis and growth (see Baranzini and Mirante 2013; Baranzini 1991). His 1962 seminal paper, which set the tone, provided a constructive critique of Kaldor’s growth model, published in 1956, where there exist two different and positive saving rates, one for the workers and one for the capitalists or entrepreneurs. Pasinetti (1962) shows that the equilibrium rate of profits is totally independent of the saving behaviour of the working class; it is determined only by the saving rate of the pure capitalists (s_c) and by the rate of growth of the system (n). His work thus established the so-called Cambridge equation, spelling out the conditions whereby the rate of growth is coincident with the profit rate. In Pasinetti’s model, the rate of profits is independent of the production function and of the capital-output ratio. This was a smart, elegant, impressive result: ‘[I]magine now the general surprise’, Pasinetti (2012: 1,438-1,439) recalled, ‘when in preparing his PhD [Cambridge] dissertation, the present author discovered that the “Cambridge equation"., remains valid.. .in general! ... This result had a devastating effect [and it] created much discomfort ... Paul Samuelson and Franco Modigliani [at MIT] took up the challenge and reacted’: they produced a ‘dual’ theorem, ‘which they called the Anti-Pasinetti theorem’ ... ‘Its sole function was that of protecting mainstream economics from a debacle, by giving the impression that it could provide an alternative to the Cambridge equation’.

In this way, on the basis of the Pasinetti Theorem (i.e. the Cambridge equation), the Cambridge (or Post-Keynesian) School was in a position to:

1. Provide a solution to the famous Harrod-Domar dilemma by specifying an aggregate saving ratio determined by the exogenously given rate of growth of population, capital-output ratio, and the entrepreneurs’ propensity to save;
2. Determine the long-period equilibrium value of the rate of profits, the distribution of income between profits and wages, and the distribution of disposable income between classes;
3. Allow for the existence of an income residual (very much in line with classical and neo-Ricardian models), namely the wages consistent with the assumption of a relationship between the savings of that class of individuals (the capitalists or entrepreneurs) who determine the process of production and the patterns of capital accumulation;
4. Provide new insights into the process of accumulation of capital by specifying the equilibrium shares of capital for the two or more socio-economic classes.

On Kaldor’s and Pasinetti’s original contributions via their Cambridge equation, Pasinetti (ibid.: 1,440) wrote:

The importance of this outcome goes well beyond Kaldor’s attempt at applying it to the working of a capitalist economy. The principle of income distribution that emerges from this theory really becomes much more important than Kaldor himself thought, because it belongs to that level of investigation that I have called ‘natural’ (i.e. normative). At such a basic level of investigation, the Cambridge Equation is independent of the institutional set-up of the society that is considered.

The above range of results was obtained by Pasinetti (1962, 1974: Chapter 6) with the use of a fairly simple framework and on the basis of relatively few assumptions, much less ‘hybrid, opposite and extreme’ (Pasinetti 1974: 125) than those of the neoclassical model. In fact, the Kaldor-Pasinetti model gave rise to whole stream of literature including a flood of subsequent contributions branching out in various directions and covering many aspects of the wider research programme relevant for the general topic of income distribution, profit determination, and capital accumulation, both from a theoretical and applied point of view. Among the research lines grafted onto the model, we may distinguish at least the following six:

1. The introduction of a differentiated rate of return on savings for the two or more classes. This hypothesis has generated a huge literature since the late 1960s with contributions by Neil Fullerton Laing, Richard Kahn, and Geoffrey Harcourt. In general, it has confirmed the validity of the Cambridge equation. (On this point, see Baranzini and Mirante 2013: 292—295.)
2. The introduction of the monetary sector and of portfolio choice. The introduction of the monetary sector and of portfolio choice (where groups of individuals or classes may choose among different assets with different rates of return and different variances) has the merit of bringing together the ‘objec- tivist’ and ‘subjectivist’ Keynesian research programme. Additionally, stochastic models including portfolio choice, under fairly general conditions, confirm the polarization of different socio-economic classes, with a very different rate of wealth accumulation (see, for instance, ibid.: 295-298).
3. Stability analysis and the long-term properties of the model. The Kaldor- Pasinetti model in general displays good local and global stability. Numerous scholars have considered this issue (for a review see, for instance, Baranzini 1991: 60). As was to be anticipated, the adjustment time required to arrive at the steady-state solution (or to return in the case of external shocks or disturbances) is, in general, quite long. However, we should not forget that the scope of comparative static analysis is not primarily to consider the conditions under which the system may converge towards, or may be deviated from, its long-term steady-state growth path, but instead to inquire into the mechanisms that, under general conditions, are bound to influence and determine the distribution of income and wealth (on this see ibid.: 61).
4. The introduction of a public sector. It may be shown that the equilibrium rate of profits is determined by the natural rate of growth divided by the capitalists’ propensities to save (as from the ‘Cambridge equation’), here ‘modified’ by the effects of taxation of profits and of government deficit (or surplus) spending.
5. The introduction of micro-foundations into the model. The propensities to save of the various socio-economic classes are not simply exogenously given but are a function of economic, demographic, and institutional parameters of the system. In this way, the historical aspects of savings and capital accumulation are brought to the forefront.
6. The distribution of wealth and the income shares of the economic classes. Various studies have tried to determine the share of income and wealth (both intergenerational and life cycle) accruing to each class of the system. This aspect is important since the seminal works focused on the distribution accruing to the factors of production on the basis of the value of the equilibrium rate of profits. At least ten scholars (for a list see ibid.: 65) have formulated models where the savings of the classes are determined by the kind of income earned and not by the class status. This of course tends to weaken the assumption of two constant propensities to save related to the existence of homogeneous socio-economic classes and introduces the possibility of a more flexible approach to the treatment of savings. The extreme step in this direction is represented by the case in which the saving ratio becomes endogenously given and is conditioned by the value of a number of parameters and variables. Then the analytical solutions obtained will depend on the framework of analysis chosen, that is, on the assumption or rejection of a neoclassical production function and on the constancy or flexibility of the capital-output ratio. (On the relative weights of the life cycle and intergenerational capital stock of the socio-economic classes see, for instance, ibid.: Chapters 5, 6, 7, and 8.)