Nicholas Kaldor and Cumulative Causation: Public Policy Implications

By Pressman, Steven; Holt, Richard P. F. | Journal of Economic Issues, June 2008 | Go to article overview

Nicholas Kaldor and Cumulative Causation: Public Policy Implications


Pressman, Steven, Holt, Richard P. F., Journal of Economic Issues


Kaldor and his Theory of Cumulative Causation

Kaldor was born in Budapest, Hungary in 1908. In 1925, he went to the Humboldt University of Berlin to study political economy because of a fascination with the hyperinflation plaguing Germany at that time. In 1927, he left for Great Britain to study at the London School of Economics (LSE) where he earned a degree two years later. It is not surprising that Kaldor (1972; 1985) would have serious concerns about equilibrium analysis given the discussions that were going on at the London School of Economics and Cambridge University during his undergraduate years. He was particularly influenced by the work of Allyn Young who was teaching at LSE. His first published article (Kaldor 1934) contained an account of the cobweb theorem, clearly showing dissatisfaction with equilibrium theorizing, and argued that equilibrium is undetermined in many real world instances. In some of his earliest papers, Kaldor ([1939] 1960; [1940] 1960) used the idea of cumulative causation to show how economies could go through a series of business cycles, while at the same time the economy moves along on either an upward or downward trajectory. Later, Kaldor (1985, 24) would emphasize that quantity changes are more important than price changes, and that this caused cyclical behavior in commodity markets and at the macroeconomic level.

As Thirlwall (1987, 319) points out, Kaldor had three main objections to equilibrium theory. The first objection was methodological--the theory was tautological and could not be tested or proven wrong. The second objection was that it relied too much on substitution effects and the allocative function of markets. Because of its assumption of full employment and efficient resource allocation, any change must have opportunity costs. Allowing for the possibility of underutilized resources, or replacing substitution effects with income effects, means that there can no longer be a neat equilibrium solution. In the real world, especially in a real world where increasing returns operates, capital and labor become complementary, the manufacturing and the service sectors expand together, as the expansion of one sector generates demand for the goods of other sectors. Forces for change are endogenous in the system, and there is a cumulative process of change (Thirlwall 1987, 322). Finally, in the presence of increasing returns there can be no movement toward equilibrium and the idea of optimal allocation of resources is meaningless since the position of a production possibility curve depends on the allocation of resources. Simply put, as more resources are devoted to capital goods, production possibilities expand. Increasing returns also means that wages and employment will be positively related and mutually reinforcing. Increased wages lead to increased demand, increased employment, and higher wages.

For Kaldor (1985), cumulative causation, rather than equilibrium analysis, means that economies follow a growth process with no mechanism to establish full employment and no equilibrium growth rate that would tend to establish full employment. Jettisoning equilibrium, economic analysis must understand how actual economies work and what causes them to change over time.

Three Key Policy Applications

Kaldor is probably best known for three policy' proposals that he argued would mitigate real world economic problems. These policies follow from an economic analysis focusing on economies moving through time and employing the principle of cumulative causation--an industrial policy in England, an expenditure tax, and an incomes policy (rather than monetarism) as a means of controlling inflation.

For Kaldor cumulative causation was an integral part of the growth process. Those nations that developed their manufacturing sector embark on a virtuous cycle of productivity and income growth; in contrast, those nations specializing in agriculture or services will experience stagnating productivity and incomes, and a vicious cycle of decline. …

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